Spring in DC draws more than just tourists. Last week, government officials, policy makers, civil society representatives and other thought leaders converged to take stock of the global economy during the IMF-World Bank spring meetings. The tone in the hallways was optimistic, but cautious. Growth in advanced economies still remains tepid, weighed down by lingering effects of the global financial crisis, demographic challenges, as well as weakening innovation and productivity growth. At the same time, there are encouraging signs that developing countries are in good shape, thanks to fiscal buffers that helped them to weather the storm.
Nevertheless, we must be mindful of the work ahead: the IMF warned of a ‘3-speed recovery’, where emerging markets are growing rapidly, the United States is recovering faster than most other advanced industrial countries, but Europe continues to struggle. Where does this leave developing countries? At a meeting with the G24 – a group of developing countries – I had the privilege of discussing the prospects for growth, and policies needed to achieve productivity growth essential for eliminating extreme poverty and for creating shared prosperity.
While productivity growth in developing countries did accelerate in the 1990s, and in the 2000s before the crisis, productivity levels still remain far below those in advanced countries. To bridge this gap, it is hard to overstress the role of the government in maintaining macroeconomic stability. Improved macro conditions helped developing countries weather the global financial crisis much more robustly than in previous crises.
Second, productivity in developing countries depends on the ability of an economy to absorb advanced technology creatively. Fostering openness – openness to trade, to FDI, to movement of skilled workers, to communications and the flow of ideas is crucial. Despite much progress over recent decades, barriers to foreign trade and investment persist in many developing countries.
Third, domestic distortions to competitiveness –barriers to entry, or unnecessary regulations in product and factor markets – hamper the effective functioning of markets. Politically well-connected “insiders” gain at the expense of much larger numbers of “outsiders”. In addition to creating monopolies, they also prevent the movement of resources to their most productive uses across and within sectors. Policy makers must prioritize building a level playing field, and maintaining a strong competition agenda.
Market failures such as the inadequate provision of public goods can sap productivity. Fiscal policy is a critical instrument available to government to potentially address these market insufficiencies. The benefits of well-managed spending on critical public goods such as basic infrastructure, education, law and order directly raise the productivity of capital, particularly in the private sector.
However, the composition and quality of taxation and public spending – what and how to tax, what to spend public money on and how to spend it – can have significant implications for the incidence of fiscal policy. The pattern of taxes, subsidies and government spending can affect different social groups very differently, can be progressive or regressive, and can have direct impacts on income distribution, inequality and poverty outcomes.
Developing countries continue to face important challenges in boosting productivity growth in the difficult post-crisis environment, but also many opportunities to eliminate poverty and create shared prosperity. The World Bank is working to develop its diagnostic and analytical capabilities, which will help assess the impact of tax and public spending policies on poverty and inequality across different regions of the world.
Follow the latest from Otaviano Canuto at twitter.com/OCanuto and keep up with the World Bank’s efforts to help countries fight poverty and close gaps in income and opportunity at twitter.com/WBPoverty. For Economic Premise notes, go to worldbank.org/economicpremise.