Adopting a longer term view on growth and investment opportunities

The past two years, you will agree with me, has been a roller coaster ride — a pretty long one and the ride is yet to stop.

It has led to a new global disequilibrium. The developing world has, all of a sudden, become the new driver of the global economy. The picture is already becoming clear. Take a look at this slide: (SLIDE 1)

• As we are “exiting” the crisis, GDP growth is clearly driven by the right hand side of the graph—emerging economies as a whole are taking the lead.

• Asia’s share of the global economy has risen steadily from 7 percent in 1980 to 21 percent in 2008. Asia’s stock markets now account for 32 percent of global market capitalization, ahead of the United States at 30 percent and Europe at 25 percent. In the early 80s, we could not possibly have conceived of this scenario taking place so soon!

• Last year, China overtook Germany to become the world’s lead exporter. It also overtook the United States to become the world’s largest market for automobiles.

• Developing country imports are already 2 percent higher than their pre-crisis peak in April 2008. In contrast, the imports of high-income countries are still 19 percent below pre-crisis levels.

• Even though developing world imports are about half of the imports of high-income countries, they are growing at a much faster rate.  As a result, they accounted for more than half of the increase in world import demand since 2000.

Yet, it is a mistake to focus on just the bigger developing economies–the change is not just about them.

• Turkey, Mexico, Indonesia are cases in point, together with Rwanda, Botswana, Mauritius, Colombia and several others.  They are performing admirably well, or making inroads quicker than we once thought possible.  I was pleasantly taken aback by the disciplined and constructive way Rwanda is thinking about its future development. I am convinced that there is only one thing true about economic forecast—there will always be surprises.

• Sub-Saharan Africa could grow by an average of over 6 percent through 2015. Investment in telecoms alone with private participation virtually tripled from $4 billion in 2001 to close to $12 billion in 2008. And, many of you would have heard about success stories such as M-Pesa in Kenya that are truly testing the horizons of how technology can be effectively used to reach the poor. Africa is making a signal turnaround, their story is only beginning, and they are in a hurry.

The crisis did offer us an opportunity to welcome some major shifts. 

For one thing, it gave birth to new meaning for the modern G20.  Yet it took 2 crises cycles to realize the inevitable.

• As a recent FT article proposed, it has become obvious that the G8 can no longer claim leadership over the international system.

• In my neck of the woods, the Bretton Woods organizations, are reflecting such changes in their own structures. At the recent WBG and IMG Spring meetings, the voting power of member countries of the World Bank increased to over 47 percent – this represent a total shift of voting power to Developing and Transition Countries of about 5 percentage points since 2008.

So, as we emerge from the crisis, everything points to greater certainty now for investment opportunities in the emerging and developing world.

But we should avoid getting too comfortable.

• Following the traumatic events of 2008, market participants’ horizons have shortened.

• Vulnerabilities from capital flows and asset prices in emerging markets are on the rise. The massive influx of funds from developed countries to certain emerging ones may result in asset bubbles that could threaten these economies’ financial stability.

It is important to keep these uncertainties in clear view.  They may continue for several more years. At the end of the day, however, it is also important to keep in plain sight, a few long term global forces or trends that we believe will dictate opportunities as well as pitfalls. I see three of these in particular.  The inevitability of urbanization, the potential for crowding out by what I call the “China squeeze” issue, and structural imbalances in consumption that will force the emerging world to re-orient themselves away from the traditional markets of opportunity.

Let me touch on the first of these: the inevitability of urbanization.  Urbanizationis one of the unstoppable forces driving growth and investment.  Take a look at this next slide and imagine it taking place in several more cities, not only in China but also in Latin America, Africa and other regions.What are its implications on the future of investment flows, and the implications of the enormous stresses this rapid urbanization will bring on demand for services, environmental impact, and so on?  (SLIDE 2)

• Cities account today for some 70% of global GDP. They attract investment and create jobs as firms seek locations with access to markets, good infrastructure and connectivity.

• (SLIDE 3) For the first time in human history, the world’s urban population has surpassed its rural population, while 2 billion new inhabitants are expected in the next 20 years. In twenty to thirty years, the likely urbanization level would be about 70-75% of the global population.  This has massive implications.  Implications for growth and opportunities, for sure, but also implications of where poverty could be concentrated, and implications on the environment.  The pace is remarkable – a developing country today is experiencing within one or two decades what early urbanizing countries experienced over a century – it’s as much as 10 times faster!

• This has huge implications on where growth will reside. With 90% of all urban population growth taking place in developing countries, investment flows are bound to follow.

• The challenge with urban development, however, is that you don’t have two chances to get it right. You need to get it right the first time.  If the US knew what it does now, for example, would the Eisenhower Highway system have been conceived in the same way?  Is China’s national infrastructure energy and transportation grid optimized for the most efficient urban development gain?  Are there actions that a city like Abuja can plan differently to avoid it becoming the LA of 2030–a trend that, unfortunately, appears to be already happening?

(SLIDE 5)  The second force I’d like you to consider is the China Squeeze Factor.  This force has to do with who occupies the manufacturing space.

• Consider this fact.  The US remained the world’s biggest manufacturing nation by output last year, but is poised to relinquish this spot to China according to many analysts in 2011.

• This is good news for China, but can it be good news for the rest of the world? Let me answer this question with another question.  If China’s manufacturing prowess continues to grow at its current pace will other developing countries be crowded out?

I have not done the full due diligence on this question. But I speculate that the answer is yes—at least in the short run.  In a recent World Bank report on competitiveness, we established that China can now deliver washing machines to the U.S. at the same cost Mexico can. This is because the Mexican road infrastructure is just not competitive enough.

• Other developing countries can respond to China’s juggernaut effectively if they take concerted steps to improve competitiveness, whether indirectly by removing barriers to doing business or directly by reducing per unit costs through enhanced productivity raising measures.   Some of these are necessarily long term interventions. One cannot expect immediate results.

(SLIDE 6) The third global force hinges on correcting the fundamental imbalance between countries in fostering greater domestic demand.  As this slide shows, China’s consumption as a percentage of its GDP has been trending downwards until recently.  The US, simply put, has had a high level of consumption for quite some time now.It cannot continue to fuel global growth as President Obama indicated recently at the G-20 meeting; so can’t Europe. If not the US and Europe, then who?

• The answer is developing economies and they have no choice.  Many economies have to begin looking to their own domestic or regional markets for spurring growth.

• The BRICs are obvious candidates to lead in this arena. They have large enough markets to boost domestic consumption.  The answers are not straightforward though.  One can boost consumption when income is growing.  But even if they are growing, if social safety nets are not sufficiently strong such that citizens feel comfortable enough to boost their spending, it won’t happen.  So, concerted policy effort to positively influence domestic demand in these economies would be a prerequisite.  Albeit, we certainly do not want unbridled spending that depletes public coffers.

• The potential rise of African countries as the next lionesses, if you will, is very high. Africa’s growth goes beyond a resource boom. Many African countries have taken positive steps and enacted internal changes to foster positive changes in labor participation rates, urbanization, and the rise of a middle-class of consumers.  I would be remiss if I don’t state that it has only just begun.  Lot’s more need to be done.

(SLIDE 7)  What does it all mean? The world is still finding its footing after the global financial crisis of 2008. But the longer term global forces are already shaping tomorrow’s poles of growth and investment trends. Are developing economies rising to the challenge?

From what the World Bank and IFC knows, many developing countries are taking positive steps to create more accommodating investment climate regimes.  The World Bank’s Doing Business reform unit that ranks countries on reforms in the business environment has shown that there have been over 280 reforms between 2008 and 2009 that countries have acted on to reduce the cost of doing business.  Rwanda, a country that has only recently emerged from devastating ethnic strife was the Doing Business top reformer in 2010.  Colombia, Kenya, the Philippines, Mexico, and Indonesia, and many more, have challenged themselves to reform their business environments at the state, provincial and city levels.  They are trying and we should applaud them for this.   But, by no means are developing countries as yet providing the optimal climate for investment, either portfolio or direct.

Let me now address a few point on the financial sector and the implications of the new international regulatory framework on the domestic financial markets and I am going to fix my remarks especially on the implications for developing countries—they are, after all, my clients.

First let me say off the bat that there is a requirement for better financial regulation, with stronger capital, liquidity and supervisory standards.  Few would argue against this.

However, beware of the unintended consequences. We should not compound costs by encouraging financial protectionism or unfairly constraining financial services. If regulations choke off the financial sector, or choke off innovation and risk management in the developing countries, they could make it harder to invest across national borders.

Several countries have implemented rules designed to increase domestic lending at the expense of cross-border lending. This is the “lend local” analogue to “buy local.” Just like with trade in goods and services this can stymie investment flows as well.

In addition, financial innovation now has a bad name. This is understandable when one remembers AIG or for that matter many of the financial institutions that became quite innovative leading up to the crisis. But I also remind us that Mexico used energy options to lock in a price for the oil that pays for much of the government’s budget. The World Bank has pioneered livestock insurance for Mongolian herders; a Malawi weather derivative against drought; and the Caribbean catastrophe insurance pool. The latter gave Haiti an immediate $8 million in January when its earthquake struck – faster money than from any other outside source. If you choke innovation, you choke new opportunities, markets and ultimately constrain financialflows.

Additionally, I also worry about the global consultative process of regulatory reforms while impressive, not being fully inclusive.  The developing member countries, in particular the nonmembers of the various global forums, would benefit from greater clarity and dissemination of the scope, application and implications of the proposed reforms for their national jurisdictions.  The World Bank Group aims to represent them in these forums.