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Growth realignment to domestic demand

  • Report Highlight
    Growth realignment to domestic demand
Altering this balance calls for productivity growth in emerging economies and realignment of demand away from external sources

Even with a moderation of growth in developing countries, successful realization of the baseline scenario presented in GDH 2011 is dependent on several important changes to the character of growth in emerging economies. In particular, strong future growth performance of emerging markets depends critically on these economies’ ability to sustain improvements in technological dynamism—often referred to as total factor productivity (TFP)—and to successfully transition toward internal sources of demand.

Historically, economic progress in emerging economies has followed one of two paths. The first, which characterizes economies such as China, India, and Russia, is one in which TFP grow. This a major contributor to economic growth. The second path, which has recently been common among the economies of Latin America and Southeast Asia, is one in which grow. This led by the rapid mobilization of factors of production. Yet even in the former case, TFP growth has been largely due to the rapid adoption of existing technologies, economy-wide factor reallocation, and improvements in institutional governance, rather than progress in pure innovative capacity. The long-run viability of fast-paced growth in emerging economies will thus depend, in part, on the ability of emerging economies to enhance their indigenous innovation through investments in human capital and through the creation of appropriate institutional mechanisms to stimulate expenditure on research and development (R&D).

Innovation and innovative capacity are already rising in emerging economies. Since 2000, China and India have invested heavily in R&D; expenditures on R&D accounted for 1.4 percent of gross domestic product (GDP) in China and 0.8 percent in India, about an order of magnitude greater than that shown by peer economies in their respective income groups. The siting of major research facilities in China by Microsoft, the invention of the Nano microcar by Indian firm Tata, and the continued string of aeronautical breakthroughs in Russia suggest the emerging-economy giants’ strong potential for fostering growth through technological advancement.

Rapid growth in the major emerging economies will also need to be accompanied by a realignment of growth away from external sources and toward internal demand—a process that is under way in many cases. In China, for example, consumption is projected to rise from the current 41 percent of national income to 55 percent by 2025, much closer to the level of developed countries. Similar increases are also likely to occur in the emerging economies of Eastern Europe. Latin American economies, where the consumption share of income is already 65 percent and is expected to remain at that level, will be the exception to this trend. The sharpest declines in savings rates are likely in East Asian and Eastern European economies, where population aging will be at a more advanced stage. In Eastern Europe, rising levels of consumption are likely to occur concomitantly with relative declines in investment shares, consistent with the declining labor force in several countries. As a result, current account deficits could narrow in those countries. Conversely, account surpluses in several Asian countries could be reduced with the declining savings rates. Together with rising domestic savings in the United States after the financial crisis, the more prominent role of emerging economies coincides with a narrowing of global imbalances, which indeed is part of the baseline scenario.

Sustaining higher consumption shares of output in emerging economies will be key in consolidating the transition from externally driven to internally driven growth and will require an expansion of the middle class, which, in turn, will call for emerging-market policy makers to usher in broad financial sector development and to improve domestic social safety nets. To meet demand for more diverse consumption goods, increasing numbers of small and medium enterprises are required, together with open trade relations.

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