This note, prepared by the UNCTAD Secretariat for the fourth session of the Multi-year Expert Meeting on Promoting Economic Integration and Cooperation (14-15 April 2016), reviews the prospects for improving all forms of international cooperation and partnership for trade and development with a view to accomplishing the Sustainable Development Goals and the post-2015 development agenda.

It first takes stock of the challenging global economic climate and how developing countries and countries with economies in transition face serious threats to their economic stability, resilience and prospects for inclusive growth. The note then explores how macroeconomic policies can help build resilience and enhance development in both the short and long terms, better enabling countries to weather economic crises, ensure macroeconomic stability and use industrialization to enhance long-term resilience in ways that generate inclusive development.

A central focus of the discussion is on how collaboration, particularly among countries of the South, can enhance these capacities and directly contribute to achieving the Sustainable Development Goals, particularly Goals 8, 9 and 17.

Introduction

Given the increasingly volatile economic conditions that have characterized the global economy and the continuing failure of developed countries to fully emerge from the great recession, developing countries face serious threats to their economic stability and resilience. These threats could compromise long-term growth prospects as well, and seriously challenge the viability of the Sustainable Development Goals and the post-2015 development agenda.

The fourth session of the Multi-Year Expert Meeting on Promoting Economic Integration and Cooperation will be invited to consider these threats and challenges from the perspective of South-South cooperation and how collaboration and the identification of best practices can help build capacity to weather economic crises, ensure macroeconomic stability and enhance long-term resilience in ways that also generate inclusive growth and end poverty.

Macroeconomic policies can help build resilience in both the short and long terms. In the short term, countercyclical monetary and fiscal policies, as well as financial policies designed to blunt the destabilizing effects of capital flows, are essential tools for countering external shocks. In the long term, industrialization and diversification can serve to increase both macroeconomic stability and resilience, but require industrial policy and the building up of institutional capacities to fulfil the development promises of structural transformation. In this context, there are a wealth of lessons to be drawn from past experiences in developing countries, both successful and not. There are also many opportunities to collaborate in ways that substantially raise the likelihood of success.

While traditional North-South and multilateral cooperation have been fundamental for many developing countries since the end of World War II, South-South and triangular cooperation have been increasing in importance and potential. Experiences and opportunities exist with regard to both finance and trade, as well as the coordination of domestic policies for investment and the expansion of public infrastructure. All told, despite the challenging global economic circumstances developing countries face in the current era, there is tremendous potential to draw from best practices and build cooperation in order to support and even speed up inclusive and sustainable development.

Such issues are important components of the 2030 Agenda for Sustainable Development. While macroeconomic stability and resilience are an explicit part of target 13 (enhance global macroeconomic stability, including through policy coordination and policy coherence) of Sustainable Development Goal 17 (strengthen the means of implementation and revitalize the global partnership for sustainable development), the questions that may be addressed by the fourth session of the Multi-Year Expert Meeting contribute to the achievement of many of the Goals including, most directly, Goal 8 (promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all), Goal 9 (build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation) and the wider scope of Goal 17 by identifying promising opportunities for international collaboration.

The external economic environment

Many of the targets of the Sustainable Development Goals are affected by the state of the external economic environment. Robust growth of external demand and trade, as well as productive channelling of global financial flows, are essential tools for generating economic growth, decent work and pathways towards industrialization and innovation. Moreover, the level and volatility of global prices and financial flows are key to successfully implementing the global partnership for sustainable development.

Trade continues to falter

In the recent past, trade has been cited as an engine of global growth, growing at double the pace of gross domestic product (GDP) in the past decade. External demand from advanced countries has been central to growth and export earnings for many developing countries, while the relatively high prices of commodities have also generated significant export revenues for a large number of countries. However, the relative strength of external demand from advanced countries was to a large extent based on credit creation and asset appreciation, a shaky foundation that ultimately fell apart with the financial crisis.

In the post-great recession world, many advanced economies have experienced sluggish job recovery and little wage growth, and the external demand that raised growth in many developing countries has been severely weakened. In addition, spending by Government is generally still below pre-crisis trends, as austerity-type approaches to economic recovery remain the dominant policy choice. After the initial recovery period, the combination of lower private and public demand in advanced countries has been associated with declining or stagnant trade volumes across regions. In the past three years, world trade growth has slowed significantly, and is now at par with global GDP growth. Although imports seem to have gained some traction in advanced countries over the past 18 months, they have barely reached pre-crisis levels.

Declining external demand and stiff international competition are further apparent when the export unit values of different regions and product groups are considered. Export unit values for all developing countries remain well below pre-crisis peaks. Asia’s relatively better performance stems from its large share of low-cost manufactures exports; the exports of other developing regions are heavily skewed towards raw materials and commodities. The most affected regions remain Africa and the Middle East, where export unit values fell to levels reached during the worst of the great recession. This highlights the continued vulnerability of many poor countries, especially the least developed countries, and threatens progress accomplished to date under the Millennium Development Goals, let alone achievement of the Sustainable Development Goals.

During the years leading up to the financial crisis and directly after, a large number of developing countries, particularly in Africa and Latin America, relied extensively on the continuing expectation of high or even increasing commodity prices. Many directed resources to their primary sectors, expecting to increase productive capacity and export revenues. However, the reversal of the rising trend in commodity prices beginning in 2011 – widely considered to mark the end of the upward phase of the latest commodity super cycle – threatens both short-term macroeconomic stability and the viability of commodity-dependent development strategies. In addition, the significant role of financial speculation in the determination of commodity prices portends continuing volatility, regardless of the state of commodity market fundamentals. In both the short and long terms, macroeconomic stability and resilience significantly depend on an economy’s productive structure. Narrow productive structures, such as those based on extractive sectors or primary commodities, increase the depth and length of a recession and expose countries to large swings in exchange rates and other key macroeconomic indicators.

Industrial policy for long-term resilience

The central importance of industrialization for sustainable development is reflected in Sustainable Development Goal 9, which calls for promoting inclusive and sustainable industrialization in addition to building resilient infrastructure and fostering innovation. However, externally generated economic shocks and crises not only threaten short-term macroeconomic stability, but may also compromise prospects for long-term industrialization and growth, as development is fundamentally path dependent. The building up of productive capacities and institutions may be seriously compromised or redirected as a result of macroeconomic shocks and ongoing fragility, as when cutting investments in public infrastructure to service external debt lowers the profitability of private investment or when volatile exchange rates driven by volatile capital flows lower export competitiveness and hamper industrialization. Fortunately, this cause and effect works both ways; industrialization and diversification into higher productivity activities can lower an economy’s vulnerability to external shocks, strengthening the developmental case for industrial policy.

A key feature of most successful development paths is diversification out of agriculture and the production of traditional goods. Labour and capital progressively shift into manufacturing, services and modern economic activities, favouring increases in productivity and the expansion of income. Advanced economies also produce a vast spectrum of goods and services and generally do not depend on any specific industry. Diversification is also crucially related to economic resilience, that is, the capacity of an economy to successfully recover from shocks that throw it substantially off its growth path and cause an economic downturn. Economic resilience may exist because an economy can simply bounce back (for example due to favourable shifts in demand for its products) or as a result of an economy undergoing changes in its industry or occupational structure (with productive factors moving towards more productive sectors) or less radical economic changes (for example, existing firms adopt better technologies or organizational forms or produce new products). In a sufficiently diversified economy all of these reactions are more likely to take place effectively, as follows:

1. With a vaster production and export base, it is more likely that negative economic shocks will be compensated for by favourable price variations affecting other industries operating in the country

2. A wider production base would also facilitate the relocation of jobs and capital away from the industries most affected from a shock

3. Diversified economies are generally populated by dynamic firms able to adapt quickly to the changing conditions of the market by adopting new technologies or organizational forms.

Recent empirical research confirms that countries with more diversified production structures tend to be more resilient and to display a lower volatility in output, consumption and investment. Papageorgiou and Spatafora (2012) studied the link between diversification and volatility in the context of large diversification spurts and identified a total of 61 spurts in the last 50 years, including the well-known examples of Chile, Malaysia and Thailand in the 1970s and 1980s. As shown in the study, such spurts were associated with a 17 per cent average reduction in the volatility of output growth in developing countries. Geographic diversification also helps reduce volatility. Countries whose exports are geographically concentrated are more likely to import volatility from their trading partners and be exposed to external shocks. Conversely, if fluctuations in different countries or regions are not highly correlated, geographically diversifying an economy’s external linkages reduces exposure to external shocks.

In the current context, characterized by increasing trade and productive integration across the world, the fundamental policy challenge faced by developing economies is to ensure that participation in global trade and production networks is one of several complementary components of a development strategy that focuses on a rapid pace of capital formation, economic diversification, technological upgrading and high-quality employment generation. Significantly, in the first-tier East Asian newly industrializing economies, this included import substitution industrialization (in conjunction with export orientation) in an effort to move from the assembly of imported components to their domestic production.

Active policy responses are now under consideration in many developing countries as industrial policies are once more on their agendas. While simple imitation is ruled out by country-specific constraints and challenges, a number of broad policy lessons may be drawn from successful industrializers.

First, a broader pro-growth macroeconomic stance is essential. This requires adopting a full range of macroeconomic instruments to both stimulate investment and counteract any damaging effects on social welfare and capital formation from economic shocks and volatility. For example, in China, the second half of the reform era (from the early 1990s onwards) was characterized by high levels of investment in infrastructure and industrial upgrading. This led to a path of “capital-deepening, investment-led industrialization, carried out mainly by State-owned enterprises in a number of basic industries and by transnational corporations in higher technology industries. Combined with a ready supply of low-cost labour, these investments propelled a strong export drive. Around 1998-2002, China’s State leadership adopted a policy shift under the new policy line known as ‘constructing a harmonious society’, which widened the previous narrow focus on market reform and growth to pay more attention to social and environmental outcomes, in particular growing inequality and worsening social polarization”.

Second, given the strong links between investment and diversification, and the importance of financing investment from retained earnings, States need to raise enterprise profits to levels above those that would likely emerge from the workings of the market, and ensure that such profits are used to support an agenda of diversification and productive transformation. The acceleration of growth in East Asia since the start of the 1980s has been underpinned by a Government–business relationship in which Governments have created conditions for higher business profits than would otherwise have been possible under normal market conditions and firms have delivered by investing a large part of their profits instead of distributing them as dividends.

Third, while most fiscal and other instruments may be applied deliberately to specific industries at specific times, investment should be especially promoted in industries with the greatest potential for upgrading skills, reaping economies of scale and raising productivity growth, thereby increasing the rates of return on investment. The selection of the relevant sectors and industries for industrial policy support varies from country to country according to areas of strength and potential for dynamic comparative advantages.

In South America, for example, Brazil – a country with an already large industrial base – prioritizes sectors such as capital goods, electronics and pharmaceuticals; Uruguay – in recognition of the limitations imposed by its small domestic market – promotes biotechnology, information and communications technologies and cultural industries.

Finally, it is important to note that effectively implementing such a diversification strategy depends on the creation of an appropriate structure of public and private institutions and, not least, the development of a strong and competent bureaucracy. Successful economies of the past have practiced what has been called adaptive efficiency, developing institutions that provide a stable economic environment for existing activities to flourish while at the same time allowing room for, and providing support to, new lines of activity and the promotion of technological upgrading.