‘The world economy: the way forward’

Press release

EBRD President’s statement to the China Development Forum

That we should be gathering here in Beijing to talk about the world economy and its future strikes me as entirely appropriate.

In a way that would have been almost unimaginable only a few decades ago, the influence of China and its people on the global economy today is enormous. And it can only grow greater still. 

With that in mind, I have no hesitation in confiding to you what I believe to be one of the most significant developments so far this year for the bank I have the privilege of serving as President, the European Bank for Reconstruction and Development. The “EBRD” as we like to be known.

The event was China officially becoming the EBRD’s latest shareholder back in January. This was a historic moment, for so many reasons.

It is a genuine ‘win - win - win’: for the EBRD, for the countries where we invest and for China itself.

Not least among the reasons for that is the fact that, if you look at the countries where we invest on the map, you see how closely they overlap with those covered by something as important to China as the Belt and Road Initiative.

I will touch on this common geographical scope we share later when I look ahead to the future.

The last 25 years

It so happens that we at the EBRD are in a rather historical frame of mind at the moment. And the reason for that is that we are about to celebrate our 25^th birthday.

We pride ourselves on being an institution with a long-term perspective. And hitting the age of 25 does seem to be a good occasion to take stock of how we got to where we are today – and where we are heading.

We were set up to help build a new post-Cold War era in Central and Eastern Europe and beyond.

Or to put it another way – and to quote from our founding documents - our purpose is ‘to foster the transition towards open market-oriented economies and to promote private and entrepreneurial initiative in…countries committed to and applying the principles of multiparty democracy, pluralism and market economics’.

As such, our primary focus was - and remains - working with the private sector. But our geographical reach has expanded so that it now stretches from Morocco to Mongolia, from Egypt to Estonia – and thus has a lot in common with the Belt and Road Initiative.   

Some of the countries where we invest have joined the European Union. Others are what we call Early Transition Countries.  All are ‘emerging’, some faster than others.

One thing they all have in common is us, the EBRD – and our accumulated expertise in investing in projects to change lives for over a quarter of a century.

So we know our countries very well as far as investment opportunities in a whole host of sectors are concerned. And we also have an insider’s grasp of the policy challenges they face - and a great track record in helping our countries overcome them.

The rise of emerging markets

So what does the world and its emerging markets look like now, compared to the way we found them at the birth of EBRD 25 years ago?

Well, they account for an ever larger share of the world economy. A quarter of a century ago emerging markets and development economies were responsible for only 20 per cent of global GDP.

Today they account for over 40 per cent - and contribute an even higher share of overall global growth.

And a number of countries that back then were very much in the emerging markets camp are now more often than not described as advanced economies.

These include the Republic of Korea, Singapore and some of the Gulf states. 

The levels of prosperity in emerging markets as a whole relative to those within the G7 have been transformed.  

In Emerging Europe and Central Asia income per capita measured at purchasing power parity was around a quarter of that of the G7 economies in the early ‘90s. Today that figure is in the region of 45 per cent.

Several large emerging markets, in particular those in Asia, have seen their per capita incomes start to converge with those of the G7. This process has been swift, dramatically so.

For example, China’s income per capita has risen from less than 10 per cent of that of G7 economies a few decades ago to over 30 per cent today.

The world over, this new prosperity has come about in parallel with far reaching structural reforms.

Indeed, the reforms many of them very much in the spirit of what we do at the EBRD, have helped create the conditions for that prosperity.  

We have seen the role of the private sector enhanced, entrepreneurship encouraged, market competition boosted and emerging market economies better integrated into global supply chains.

So, as we at the EBRD look back at our first quarter of a century, we see our regions, emerging markets as a whole and indeed a world transformed. 

There have been accelerations and slowdowns in tempo along the way. But the speed with which all this has happened has been little short of incredible.

Emerging markets under pressure

Sustaining such a rate of change was always going to be a challenge.  And so it has proved, especially in the EBRD’s countries of operation.

The growth model I have just sketched is now under pressure from many different directions.

Incomes in general have risen. But so has inequality. If you look at the latest Forbes magazine list of global billionaires, China, Russia and India all come in the top five countries for the number of billionaires, alongside the United States and Germany.

Together, emerging markets account for around one third of the wealth of the world’s richest people.  

Perhaps reflecting this increase in inequality, life satisfaction, what you might even call the pursuit and attainment of happiness, has in many cases failed to keep pace with the rise in incomes.

Every few years we and the World Bank carry out a survey of households and values in the countries where we invest. This is called the Life in Transition Survey.

The most recent survey revealed that only around 40 per cent of respondents were reasonably satisfied with their lives, compared with a figure of more than 70 per cent in advanced European economies (where the survey was also conducted).

As a result, support for reforms has been weakening. We documented this malaise - a marked deceleration in structural reforms - in our 2013 Transition Report, titled “Stuck in Transition”.

In part, this trend reflected something quite simple and even understandable: reform fatigue.  

In part, it was the result of something else:  the “low-hanging” fruit of productivity-boosting reforms had already been harvested.

Deeper structural problems were harder to tackle and had still to be resolved. There had been, for example, significant progress in liberalising trade through slashing tariffs on manufacturing goods.

Now, removing non-tariff barriers and liberalising agriculture and services to secure new comprehensive trade deals are looking increasingly difficult.

In some instances, protectionism is staging a comeback in the guise of non-tariff barriers.  And, more broadly, “economic nationalism” is on the march around the globe.

This coincides with a marked slowdown in the pace of convergence over the last five years.

The average growth of emerging markets has almost halved: from 7.5 per cent in 2010 to an estimated 4 per cent in 2015.

In the EBRD regions the slowdown has been even more stark: from 4.6 per cent in 2010 and 2011 to just 0.4 per cent last year.

On top of this, ever since the global financial crisis of 2008 and 2009, investment activity has been sluggish. And the drop in investment has been far sharper than the weakness in economic activity could explain all on its own.

The EBRD’s regions, in particular, face a large investment gap, which we conservatively estimate to be of the order of some US$ 75 billion a year.

The sharp drop in commodity prices has further exacerbated the emerging markets’ malaise.

Less than five per cent of advanced economies’ GDP is accounted for by major commodity exporters. But that compares with a figure of around a quarter for emerging markets.

In the EBRD regions, major commodity exporters account for as much as 40 per cent of overall GDP.

Large commodity-exporting economies such as Russia or the Gulf states are also major trading partners and sources of remittances for their poorer neighbours. As a result, they are now implicitly exporting something else: economic pain.

And as the world economy as a whole is slowing down, emerging markets are no longer seen as a magnet for capital flows.

The Institute for International Finance estimates that net inflows of capital into emerging markets were around seven times weaker in 2015 than in recent years.

Some of these challenges may be temporary. But others are likely to be long term.

The technological revolutions of the 1990s and 2000s - notably email and the internet - enabled a dramatic multiplication of supply chains which resulted in the very rapid growth of global trade.

Emerging markets were major beneficiaries of this dynamic. But now global trade is slowing down.

And, as the economies of emerging markets mature, they undergo a shift from a growth model based on manufacturing and exports to one in which services play a much bigger role.

Managing this transformation and its effects on income distribution will be tricky, not least because cities are much better placed to adapt to this trend than rural areas.

Taking an even longer term perspective, it is absolutely clear that, in the future, growth will have to be green.

The threats posed by climate change, and acknowledged in the commitments made by governments at COP21 in Paris last year, demand as much.

In other words, we need to lay the foundations for low-carbon, sustainable growth, not become trapped in a model for the future which is carbon-intensive. 

Responding to the challenges

The stakes are now extremely high. This mix of short-term and long-term challenges raises some uncomfortable questions about the future of emerging markets. 

We know that matching the remarkable achievements of the last two to three decades is going to be difficult.

We know that, taken together, a slowdown in growth, reforms going into reverse and the rise of protectionism could provoke a downward spiral and breakdown in cohesion which seriously undermine economic development.

Managing all this will require boosting productivity growth notwithstanding the difficult external environment - and policies that ensure the enhanced productivity translates into better livelihoods for populations at large.

When we at the EBRD took a close look at firms’ productivity in the regions where we operate, we found some interesting, perhaps surprising, results.

Every country boasted many firms that are as productive as their peers in advanced economies such as the United States or Israel. There were many other firms, though, that were much less so.

The conclusion we drew from that was that emerging market firms can definitely learn from their productive peers and improve their productivity.

And that they can do so quickly as well. But we need to create the right incentives and the right conditions for them to succeed.

To improve productivity, firms need to innovate. They have to upgrade their products and transform their production processes. Innovation in turn requires investment.  

I have already sounded the alarm, both about the recent shortfall of investment in emerging markets and the fact that there is now less capital flowing into them anyway.

Plugging that investment gap in an age of limited liquidity and higher cost of debt will require leveraging much more equity financing - via foreign direct investment, private equity and equity through stock exchanges.

That will necessitate in turn reforms that strengthen shareholder rights and help develop local capital markets.

The willingness and ability of firms to invest does not exclusively depend on the availability of finance. Crucially, they also depend on the cost of investment.

In this respect, I cannot stress enough the importance of strengthening institutions and improving the business climate.

Strong institutions are key enablers of better, more efficient markets and hence of more stable economies, able to attract stronger flows of investment.

We need to focus on core state institutions such as the Presidency and Prime Minister’s office, the Finance and Economy Ministries, the Central Bank and an independent judiciary as key to delivering and implementing reforms.

We need to strike a balance between institutions that intervene and those that regulate. Whether within the state, the judiciary or the corporate sector, we must fight the curse of corruption and confront vested interests head on.

In short, we need strong institutions that seek to embed a development-friendly culture.

Another crucial ingredient for higher productivity is better quality human capital – among workers and managers alike.

Governments can help here by doing three things:

• aligning the supply of education with the demand for skills in the economy;
• ensuring equal access to education; and
• designing vocational training programmes with the close involvement of private sector firms.

Productivity is also highly dependent on how different parts of a single economy - and different economies as a whole - are connected.

Here, infrastructure is another huge challenge for emerging and developing countries. We estimate that infrastructure investment needs will more than double over the next decade.

Currently, most infrastructure investment - more than 80 per cent - comes from public budgets. Clearly, given the prevailing fiscal pressures, additional new investment will need to come from the private sector.

Mobilising such levels of private investment is going to be a major test of us all - but not the only one. Infrastructure locks in technologies and models of growth for decades.

Here, we will need to reimagine the way we finance, produce and consume energy, something we at the EBRD are very involved in via our new Green Economy Transition approach.

Whereas, in the past, the need to ‘green’ the economy was seen as a constraint on growth, in the future I believe it will be a powerful engine for growth.   

And at the core of this ambitious reform agenda, emerging market policymakers will need to put much greater emphasis on addressing inequality and building social safety nets. That will also help minimise any backlash against markets and reforms.

An optimistic scenario for 2040

I have already conjured up an image of the downward spiral that would result from a major slowdown in growth, reforms going into reverse and a rise of protectionism, all made worse by the unmanaged risks of climate change.

And yet I am optimistic about the future.

If emerging markets can follow the playbook I have just described and find new sources of growth, their prospects remain bright.

Their potential for convergence is high, with new generations with advanced skills poised to join the global workforce and the world’s ranks of entrepreneurs.

Increasingly, they are better connected not only to advanced markets but to each other as the trend towards greater integration within the EBRD regions continues.

And they are well placed to adapt to a world economy focussed on services and, in many cases, to diversify away from excessive dependence on commodities.

The appetite for reforms in many EBRD countries is high, higher than when we identified the ‘Stuck in Transition’ syndrome only a few years ago.

A new generation of leaders has emerged throughout our regions – in countries as diverse as Jordan, Kazakhstan and Serbia. A leadership generation that focusses on the long-term, not just the next election cycle.

In our most recent Transition Report we discovered that, in a way completely unlike that of previous years, reforms in crucial sectors significantly outnumbered reversals of reform.

Several countries have made important progress in reforming power and energy and infrastructure sectors and strengthening frameworks for markets.

We recently held separate investment forums for the Western Balkans and for Central Asia and the determination to enact many of the policies we have discussed today was palpable at both.

This is partly down to the fall in commodity prices. But it also speaks to a new maturity among political and business leaders.

The example of Central Asia is particularly relevant here. It is one of the first places that come to mind when we think of the Belt and Road Initiative.

I would not be at all surprised if, further down the line, Central Asia becomes the first region where the renminbi establishes itself as a currency for global trading.

In general, emerging markets can and should remain a powerful engine of global growth.

Even as China’s growth has slowed compared to a decade ago, it makes the same contribution to overall global demand by growing at 6.5 per cent as it did when growing at almost 11 per cent prior to the onset of the financial crisis.

And, as we look into the future, one more point I would highlight is the way different emerging economies are likely to negotiate the turbulence we are currently experiencing.

I am thinking again of Central Asia and some of the other countries where we invest which, for better or worse, largely missed out on the cheap money that quantitative easing has been pumping into the world economy over the last decade.

With their financial markets and trading routes relatively unintegrated with those of the rest of the world, QE almost passed them by.

And, as a result, when we come out the other side of our current problems and countries in Central Asia resume their long march towards economic integration and convergence, they will do so with a strong bias towards reforms. 

They, and other countries in our regions, can learn from the missed opportunities in those other emerging markets which, when the going was good, failed to embrace the crucial reforms required.

These EBRD emerging countries can, I hope, now lay the foundations for stronger, more stable growth in the future.

And here I would urge the world’s multilateral development banks, like EBRD, to rise to the challenges of tomorrow and show leadership of their own by gearing themselves up to support these changes.

Conclusion

The world’s transformation over the last 25 years has been breathtaking.

Of course, as the saying goes, hindsight is always 20/20. If we had known what we do now when the EBRD was set up at the beginning of the ‘90s, many mistakes could have been avoided. 

But as I look to the future, to the next 25 years, I am confident that the changes will continue and that the changes will continue to be for the better. The policy reforms we saw in 2015 in the EBRD regions were a down payment on that.

I am also convinced that we have it in our power to influence those changes ourselves – provided we adopt the right policies, strengthen institutions, adopt a long-term view and display strong leadership.

I am convinced too that all of us will celebrate once more the resurgence of emerging markets in the years ahead.