BUS614: International Finance

Larger role of faster-growing developing countries in the world economy

Developing countries' share in world GDP was about 24 percent in 2008. Estimating the share of the same countries in 1929 is not easy, but a rough calculation suggests around a 13 percent share at that time. China and India's combined share in world GDP was about 8.5 percent in 2008, versus an estimated 2.8 percent in 1929 (figure 1). GDP share by itself would not necessarily affect the evolution of the present global recession were it not for evidence that developing countries as a group are now also tending to grow substantially more rapidly than developed countries.

Figure 2 clarifies this statement. The chart suggests that economic cycles in developing  countries remain closely correlated with those in developed countries. Developing country growth has fallen sharply in 2009 through a variety of well-known channels, such as declining exports to developed countries, precipitous falls in private capital flows to developing countries, and weakening remittance flows. In other words there has been no decoupling in the cyclical component of developing country growth. However figure 2 also suggests that, while before the early 2000s the trend rate of growth in developing countries was close to that in developed countries, since then trend growth in developing countries has become substantially higher than in the advanced world. In other words, there has arguably been a decoupling in underlying trend rates of growth. Thus, for example, developing country growth averaged only 0.8 percentage points higher than developed countries in the 1990s, but this growth gap widened to 3.5 percentage points in 2000–08.

Figure 1. China and India : Share of World GDP (%)

(Constant 2000 Market Prices and Exchange Rates)

One hypothesis is that the rise in developing country trend growth over the last decade is mainly a payoff for the strenuous efforts by many of these countries to improve their macroeconomic, structural, and other policies over the last 2–3 decades, accompanied over the past decade with a marked improvement in country balance sheets. As such it should persist in the medium term, despite the severe negative shock of the present crisis. Another hypothesis is that the growth improvement of recent years mainly reflected the extraordinary but temporary boom or "bubble" conditions in the world economy, including very low international interest rates and huge but unsustainable credit flows to developing countries. In this case we should expect the recent higher growth of developing countries to quickly disappear, along with the bursting of the bubble and the present global recession.

It is doubtless too early to fully judge which if either of these hypotheses is correct. There are, nevertheless, some significant pieces of evidence in favor of the first hypothesis. All major forecasters expect developing countries to continue growing much faster than developed countries even during the depths of the present crisis. For example, World Bank projections are for developed country real GDP to shrink by 4.2 percent in 2009 while developing country growth is expected to hold up at a positive 1.2 percent, a 5.4 percentage point positive growth gap. If these projections are roughly correct, then the positive growth gap for developing countries and their larger share in world activity together would have helped to reduce the size of the contraction in overall world output in 2009 by a significant amount – by about 1.3 percentage points – from a potential 4.2 percent fall to the smaller 2.9 percent global contraction that is currently projected. Recent data indeed suggest that growth in at least some emerging economies has rebounded with unexpected strength in the second quarter of 2009, averaging around 10 percent at annualized quarter on quarter rates among several emerging East Asian economies, for example.

Figure 2. World Output Growth 1961 - 2011 (% Change)

Source: Milan Brahmbhatt and Luiz Pereira Da Silva, https://openknowledge.worldbank.org/bitstream/handle/10986/11110/516310BRI0Fina1Box342046B001PUBLIC1.pdf?sequence=1&isAllowed=y
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