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GlobalEconomic
Prospects
Managing the Next
Wave of Globalization2007©2007 The International Bank for Reconstruction and Development / The World Bank
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ISBN-10: 0-8213-6727-7
ISBN-13: 978-0-8213-6727-8
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DOI: 10.1596/978-0-8213-6727-8
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Cover photo: Pallava Bagla/Corbis
The cutoff date for data used in this report was November 22, 2006. Dollars are current
U.S. dollars unless otherwise indicated.

Contents

Forewordvii

Acknowledgments
Overview

ix

xi

Abbreviations

xxvii

Chapter 1 Prospects for the Global Economy
1
Summary of the medium-term outlook
1
Global growth surged to 3.9 percent in 2006
Regional outlooks
6
Financial markets
12World trade18
Commodity markets
20
Downside risks predominate
23
Notes
26
References
27

2

Chapter 2 The Coming Globalization
29
The evidence of globalization
30
The world in 2030—the big picture
36
The four channels of globalization
46
What will happen if growth is slower—or faster—in the next 25 years?
Challenges of the coming globalization
58
Notes
61
References
63
Chapter 3 Income Distribution, Inequality, and Those Left Behind
The global distribution of income
70
Within-country inequality and poverty reduction
80
Policy implications
89
Notes
94
References
97

52

67

iii

C O N T E N T S

Chapter 4 New Pressures in Labor Markets: Integrating Large Emerging
Economies and the Global Sourcing of Services
101
The impact of globalization: the story so far
102
New challenge I—absorbing large emerging economies into theglobal market
109
New challenge II—global sourcing of services
120
Policies to confront the labor market challenges of globalization
Notes
133
References
136
Chapter 5 Managing the Environmental Risks to Growth
The immediate risk of epidemics
143
The medium-term risks to marine fisheries
146
The long-term risk of climate change
149
Conclusions and policy recommendations
160
Notes
163
References
164
Appendix: Regional Economic Prospects

125

141

167

Figures
1.1
Industrial production may be slowing2
1.2
Regional growth trends
4
1.3
Inflation has increased moderately
13
1.4
Inflation is rising in high-income countries
13
1.5
Signs of overheating in some developing countries
13
1.6
Despite turbulence, financing conditions remain favorable
14
1.7
Private capital flows to developing countries remain strong15
1.8
Ample liquidity keeps long-term interest rates low
15
1.9
Global demand shifts from the United States to Europe
and developing countries
16
1.10
A start to orderly adjustment?
16
1.11
Interest rate spreads support the dollar
17
1.12
Turbulence resulted in sharp depreciations for some developing countries
17
1.13
Rotation in global trade18
1.14
China’s exports exceed those of the United States
19
1.15
Diverging trends in commodity prices20
1.16
Oil prices continue to rise21
1.17
Higher prices slow oil demand22
1.18
A disappointing supply response
22
1.19
Spare production capacity remains low
22
1.20
After rising rapidly, housing price growth slows sharply
24
2.1
World trade has expanded dramatically . . .
31
2.2. . . and become more diversified . . .
31
2.3. . . than increase in migrants—in particular toward high-income countries . . .
2.4. . . and a sharp rise in capital flows
32
2.5
Diffusion of traditional technologies has been slow, except inhigh-growth regions . . .
33
2.6. . . but the uptake of new technologies has been faster
33

iv

32

C O N T E N T S

2.7
2.8
2.9
2.10
2.11
2.12
2.13
2.14a
2.14b
2.14c
2.15
2.16
3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.8
3.9
3.10
3.11
4.1
4.2
4.3
4.4
4.5
4.6
5.1
5.2
5.3
5.4
5.5
5.6
5.7

World population growth will be concentrated in developing countries in coming
decades38
Developing countries will account for a larger portion of world output in coming
decades39
In some developing regions, per capita incomes will begin to converge with those inhigh-income countries
41
Labor force growth is slowing
43
Due to the demographic dividend, fewer resources will be needed for a
declining youth population
44
More resources will be needed to take care of a growing elderly
population
45
Future-flow securitizations in developing countries, 1990–2004
50
Past global growth . . .
52. . . has been around 2 percent per capita for high-income regions . . .
53. . . and much more volatile in developing countries
53
More acceleration in growth is possible
57
Wages outpace profit income
59
Middle-class expansion is sensitive to growth assumptions
75
World tourism is expected to double between 2004 and 2020
77
The world’s poor may be concentrated in Africa
78
By 2030, East and South Asia are likely to move up the global
income distribution ladder, while other regions will lag
79
Migration out of agriculture reduces poverty more when education
is more equally distributed
82
Changes in inequality are mainly due to economic shifts
84
Inequality hampers the potential of growth to reduce poverty
84
Restricting intersectoral mobility can lead to large increases in inequality
86
Ending aid would hurt the poor
90
Global trade reform can be pro-poor
91
The inequality effects of trade liberalization are not large and dependon the structure of initial protection
93
Developed countries’ imports of manufactures increasingly comefrom developing countries
103
In many developed countries the gap between high- and low-income earners has
widened106
Average wages in China have increased more than in other countries
113
China’s imports from developing countries have surged overthe last two decades
114
Developing-country exports of business services are growing rapidly
121
Low-income countries depend heavily on import duties for tax revenues
132
The SARS epidemic was contained in a matter of months
144
Total marine fish catch has leveled off
147
Temperatures have increased rapidly since the Industrial Revolution
149
Temperatures and greenhouse gas emissions have risen
150Greenhouse gas emissions have long-term effects
152
Carbon emissions from developing countries are set to rise
157
Global trading in carbon emissions has mushroomed
159v

C O N T E N T S

Tables
1.1
2.1
2.2
2.3
3.1
3.2

4.2
5.1
5.2

The global outlook in summary
3
Services exports rise in line with goods exports
34
Country rankings—1980–2005
40
Regional breakdown of poverty in developing countries
60
The global middle class is growing, its composition changing
73
Where the return to education is high, its poverty-reducing impact
is also high88
Some factors affect the probability of being in the lowest income decile
more than others—and the differences are changing over time88
Employment in developing countries has shifted out of agriculture
into manufactures and services
104
In 2030 most workers will be in developing countries and unskilled
110
Progress in providing many global public goods is limited
143
Uncertainty and incentives affect international institutions
161

A.1
A.2
A.3
A.4
A.5
A.6
A.7
A.8
A.9
A.10
A.11
A.12

East Asia and the Pacific forecast summary
167
East Asia and the Pacific country forecasts
168
Europe and Central Asia forecast summary
169
Europe and Central Asia country forecasts
169
Latin America and the Caribbean forecast summary
171
Latin America and the Caribbean country forecasts
172
Middle East and North Africa forecast summary
174
Middle East and North Africa country forecasts
175
South Asia forecast summary
176
South Asia country forecasts
176
Sub-Saharan Africa forecast summary
177
Sub-Saharan Africa country forecasts
178

3.3
4.1

Boxes
2.1
2.2
3.1
3.2
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
5.1
5.2
5.3

vi

Inside the box—the components of scenario building
37
Challenge of geopolitical shifts for long-term economic forecasts:
lessons of history
55
Changes in demographic structure, occupational choices, and factor rewards
determine the authors’ hypothetical 2030 world income distribution
68
Aggregate economic performance: distribution matters
71
What causes the gap between skilled and unskilled labor—technology or trade?
105
Workers in the nontraded sector—the role of migration
107
Is the world flat . . . or just smaller?
111
Global production and the iPod
118
Does globalization lead to a race to the bottom on labor standards?
119
The number of services jobs liable to be moved abroad: large or small?
122
Trading goods and services or trading tasks?
126
Key challenges for education systems in the new global economy
129
Overview of the impact of active labor-market programs
131
The vanishing polar ice
151
Can efficiency and renewables be the answer?
152
Stern Review: The Economics of Climate Change
155ForewordG

LOBAL ECONOMIC PROSPECTS reports
have customarily aimed to stand backfrom the Bank’s day-to-day work andexplore existing or emerging debates in theinternational arena that are of critical importance to developing countries. We have endeavored to focus on areas in which the Bank’s
researchers and technical experts may provide
insights based on their cross-country andglobal knowledge. Thus, past reports havehelped to deepen the Bank contribution to policy debates in areas such as international andregional trade, investment, and, last year, migration and remittances.
The strong performance of the global
economy—and of developing countries inparticular—in recent years led us to ask
whether these higher rates of growth could besustained for the long term. And if so, what
would the implications be for the global economy and for the world’s poor? Answering
those questions leads us to explore the natureof the “next globalization.”
Three features are likely to be particularly
prominent in the next wave of globalization.
First is the growing economic weight of developing countries in the international economy, notably the emergence of new trading powerhouses such as China, India, and Brazil. Second
is the potential for increased productivity that isoffered by global production chains, particularly in services, arguably the most dynamic sector of trade today. Third is the accelerated diffusion of technology, made possible throughfalling communications costs and improved

access to telecommunications and the Internet,
as well as through innovative forms of businessorganization, often linked to foreign investment.
The next globalization—deeper integration
with the world economy through trade, flows
of information technology, finance, andmigration—will offer renewed and enhanced
opportunities to increase productivity andraise incomes. Producers participating inbigger international markets will be able toproduce on a larger scale, access the most appropriate technology and knowledge, and participate in increasingly integrated global
production chains. Consumers everywhere will
have access to the latest international products.
However, along with rising average incomesmay come dislocations and environmentalpressures. This Global Economic Prospects
analyzes three possible consequences—
growing inequality, pressures in labor markets,and threats to the global commons. All are evident in the current globalization, but in coming years they are likely to become more acute.
If these forces are left unchecked, they could
slow or even derail globalization and thus
adversely affect growth and development inmany developing countries. The report ispremised on the idea that the threats to continued global growth and poverty reduction fromenvironmental damage, social unrest, or new
increases in protectionist sentiment are potentially serious, and it is worth exploring waysthat these disruptive forces might be addressed
now if we wish to see sustainable global
growth in the future.

vii

F O R E W O R D

To analyze these problems, the report employs a series of projections and simulations
built around a central scenario of the evolution of the global economy. The objective of
the scenario-based approach is to analyze thebenefits and stresses of integration. The purpose is not to predict the future—the actual
numbers for global or country performance
may turn out to be higher or lower—but tothink about dynamics in the global economy
in a coherent analytical framework.
Focusing on the future helps bring into
sharper relief the choices facing policy
makers in managing global integration today.

viii

National policy makers must decide how best
to respond to globalization—because thegrowth and long-term competitiveness of
their countries are at stake. And international policy makers must devise ways fornations to work together to ensure thatgrowth is sustained and widely shared, anddoes not cause irreparable damage to theenvironment.

François Bourguignon
Senior Vice President and Chief Economist
The World Bank

AcknowledgmentsTproduced by staff from the World Bank’s Development Prospects
Group. Richard Newfarmer was the lead author and manager of the report. The principal
author of chapter 1 was Andrew Burns. Chapter 2 was written by Dominique van der
Mensbrugghe, with written contributions from Dilek Aykut and Sanket Mohapatra and withsupport from Sebnem Sahin. Chapter 3 was written by Maurizio Bussolo and Denis Medvedev,
with the benefit of guidance from Francisco Ferreira and with support from Victor Sulla and
Rafael De Hoyos. Chapter 4 was written by Julia Nielson, Paul Brenton, and Mombert Hoppe,with guidance from Gordon Betcherman. Chapter 5 was written by consultants Peter Sturm andWilliam Shaw, with written contributions from Maureen Cropper and Philippe Ambrosi and withanalytic work by Mombert Hoppe. The accompanying online publication, Prospects for the
Global Economy (PGE), was produced by a team led by Andrew Burns and comprising Sarah
Crow, Cristina Savescu, and Shuo Tan, with technical support from Gauresh Rajadhyaksha.
The report was produced under the guidance of Uri Dadush and François Bourguignon.
Several reviewers offered extensive advice and comment throughout the conceptualization andwriting stages. These included Nancy Birdsall, Cornelis de Hann, Shahrokh Fardoust, Alan Gelb,
Lidvard Gronnevet, Bernard Hoekman, Robert Holzmann, Eriko Hoshino, Kieran Kelleher,
Jeffrey Lewis, William Maloney, Branko Milanovic, Moisés Naím, Ian Noble, Stefano Scarpetta,
David Wheeler, and Roberto Zagha.
Several people contributed substantively to the various chapters. In chapter 1, the Global
Trends Team, under the leadership of Hans Timmer, was responsible for the projections, with
contributions from John Baffes, Maurizio Bussolo, Betty Dow, Annette De Kleine, Donald
Mitchell, Denis Medvedev, Mick Riordan, Cristina Savescu, and Shane Streifel. In chapter 2, thepoverty numbers originated with Shaohua Chen and Martin Ravallion from the Development
Research Group.
In addition, Steven Kennedy and Bruce Ross Larsen edited the report. Dorota A. Nowak andNigar Farhad Aliyeva managed the publication process for the Development Prospects Group,and Merrell Tuck managed the dissemination activities. Book production was coordinated by theWorld Bank Office of the Publisher.
HIS REPORT WAS

ix

Overview

T

HE INTENSE PACE of globalization has

improved living standards worldwide
on an unprecedented scale—but notfor everyone. Some countries and some socialgroups have been left behind. Even in countries that have benefited greatly from globalization, tensions in labor markets havesimmered, at times boiling over into civil disturbances. Meanwhile economic growth,
while essential to improving living standards,
is damaging what many call the “global commons,” giving rise to concerns about the sustainability of long-term growth.
These pressures are likely to intensify incoming years. Why? Because as markets integrate, competition among countries—andtheir firms and workers—increases. Developing countries, once at the periphery of the
global economy, are now moving to center
stage and are becoming serious competitors
in the markets of high-income countries andin each other’s markets. Concerns about
competition from China and other low-wage
suppliers now pepper the headlines in richand poor countries alike. The loss of whitecollar jobs from global sourcing of services,
often to India and other developing countries, provides fodder for heated debate ontalk shows and as the theme of several bestselling books.1
Will global integration—of trade, finance,technology, ideas, and people—continue into
the foreseeable future? If so, what will itmean for developing countries and for today’shigh-income countries? How will global integration, interacting with demography, technical change, and other forces, affect the distribution of income and labor markets in richand poor countries? How will it affect the
global environmental and health threats thatcloud long-term growth prospects?
Global Economic Prospects 2007 explores
the next wave of globalization. The organizing vehicle for discussion is a set of growth scenarios covering the years 2006 to 2030. The
objective of the scenario-based approach is toanalyze the opportunities and stresses of integration. The purpose is not to predict the future but to bring into sharper relief the choices
facing the world today. National policy
makers must decide how best to respond to
globalization—because the growth and longterm competitiveness of their countries are atstake. And international policy makers must
devise ways for nations to work together toensure that growth can continue without
becoming destabilizing.

Prospects for 2007 and 2008—bright, with a few dim spots

The medium-term outlook for the world
economy remains fairly bright (chapter 1). While the pace of economic expansion
is slowing, developing economies are projected to grow by 7.0 percent in 2006, morethan twice as fast as high-income countriesxi

O V E R V I E W

Figure 1 Growth, though tapering off, will likely remain solid over the medium term
Percent change in GDP
10
9

2005
2006

8

2007
7

2008

6
5
4
3
2
East Asia andthe Pacific

Europe andCentral Asia

Latin America
and the Caribbean

Middle East andNorth Africa

South Asia

Sub-SaharanAfricaSource: World Bank.

(3.1 percent), with all developing regions
growing by about 5 percent or more (figure 1).
Looking forward, limited inflationary pressures and high savings among oil exporters
and in Europe (as Europeans prepare to meetthe challenges of their aging societies) are expected to keep long-term interest rates low. As
a result, while growth in developing countries
may slow somewhat over the next two years,
it is expected to remain very robust—at morethan 6 percent in 2007 and 2008. Increases insupplies of key commodities, in combination
with demand-side substitution and conservation measures, should allow for some easing ofprices, including those for oil, but continuing
strong global growth is expected to keep commodity prices high by historical standards.
Even though a tapering down of growth to asustainable but robust rate remains most likely,
this positive outlook is subject to significant
risks. Efforts to temper the expansion in someof the fastest-growing developing countries
may not succeed, leading to stronger growth in
the short term but a sharper slowdown later.
A faster-than-expected weakening of housing
markets in high-income countries could brakethe economy much more abruptly than
expected, thus weakening global demand.

xii

Disruptions in oil markets are always possible.
And the unwinding of the U.S. current accountdeficit and its mirror surpluses in oil-exporting
countries and East Asia could also be disruptive
if sudden movements in capital markets, perhaps abetted by collective policy inaction, drive
the rebalancing. Even so, these risks appear
manageable, and the promising environment
for growth makes this an opportune time tofocus on long-term issues.

Globalization’s next 25 years—
incomes up, poverty down, three
big threats to growthDemographic trends will be a major driverof future events. The Earth’s current population of some 6.5 billion is expected to rise to
8.0 billion by 2030, an average increase of
60 million annually. More than 97 percentof this growth will take place in developing
countries. Both the European Union and Japanare likely to experience a decline in population,and most of the increase in other rich countries
will be due to migration. The largest country in
the world, China, will see its population continue to grow, but at a slower pace than the restof the developing world. With more rapid

O V E R V I E W

population growth, India will likely surpass
China as the world’s most populous country
sometime during this period. The global labor
force will increase from just over 3 billion
today to 4.1 billion in 2030, a rate of increase
greater than that of population. Meanwhile
the dependency ratio is likely to fall, providing
a sustained boost to world growth.
If this report’s central scenario materializes,
global economic growth will be somewhat
faster in 2006–30 than in 1980–2005. But
growth in the global economy will be powered
increasingly by developing countries, where
per capita incomes will rise 3.1 percent a year
on average, up from 2.1 percent over the earlier period. That rate of increase will produce
average per capita incomes in the developingworld of $11,000 in 2030, compared with
$4,800 today,2 roughly the level of the Czech
Republic and the Slovak Republic today.
Average income in rich countries will also risedramatically: the average income of the children of today’s baby boomer is likely to benearly twice that of their parents.
The output of the global economy will risefrom $35 trillion in 2005 to $72 trillion (at constant market exchange rates and prices) in 2030,
an average annual increase of about 3 percent—
2.5 percent for high-income countries and
4.2 percent for developing countries. Though
the incomes of developing countries will still beless than one-quarter those in rich countries in
2030, they will continue to converge with thoseof wealthy countries (figure 2). This would
imply that countries as diverse as China,
Mexico, and Turkey would have average living
standards roughly comparable to Spain today.
This is good news for the world’s poor. The
implications of sustained growth for reducing
poverty around the world are nothing short ofastounding. Despite population growth, thenumber of people living in dire poverty—below
the $1-a-day poverty line—is likely to fall to
550 million from 1.1 billion today. Similarly,
the number of people living on less than $2 a
day should fall below 1.9 billion, 800 million
fewer than today. The bottom line? Poverty will
decline, despite continuing population growth.

Figure 2 Average incomes are likely toconverge, if modestly
Per capita incomes as percent ofhigh-income countries
2030

24
2020

22
2010

20
2005

18
16
14
12
10

Low- and middle-income countries
Source: World Bank simulations using the Linkage model.
Note: Ratio of Purchasing Power Parity (PPP)–adjusted
per capita incomes relative to high-income average. PPP
is fixed at base year (2001) level.

Figure 3 Developing-country share of the
global economy will rise in coming years
GDP, 2001 $ trillions
80
70
60
50
40
30
20
10
0

23%

25%

2005

2010

28%
2020

31%

2030

High-income countries
Low- and middle-income countries
Source: World Bank simulations using the Linkage model.
Note: GDP in 2001 $ trillions, using PPP exchange rates.

Developing countries, once considered the
periphery of the global economy, will become
main drivers. Overall, developing countries’
share in global output will increase fromabout one-fifth of the global economy tonearly one-third (figure 3). Their share ofxiiiO V E R V I E W

global purchasing power would surpass
half. Today, six developing countries have
populations greater than 100 million and anannual gross domestic product (GDP) of
more than $100 billion. By 2030, under reasonable assumptions of economic growth, atleast 10 countries will reach the twin 100s
thresholds.3
Global integration is likely to enter a newphase. In virtually every growing economy theimportance of trade—captured by the ratio oftrade to GDP—will rise, continuing the trend of
the past two decades. The growth in the traderatio over the next 25 years will be powered bya new dynamism in services trade. Global tradein goods and services, growing faster than output, is likely to rise more than threefold to$27 trillion in 2030 (figures 4 and 5).
Roughly half that increase will come fromdeveloping countries. This means that a
growing share of global production of goods
and services will be performed in those developing countries able to take advantage of

Figure 4 Countries everywhere increase
exports as world trade outpaces othersources of growth
Export-to-GDP share (%)
40

Projected

35
30
25
20
15
10
5

19
70
19
75
19
80
19
85
19
90
19
95
20
0
20 0
05
20 *
10
20 *
15
20 *
20
20 *
25
20 *
30
*

0

Sources: Development Data Platform (DDP) and staff
calculations. *Indicates World Bank using the Linkage model.
Note: Export-to-GDP ratio for the world. The export shareis calculated in nominal dollar terms. Observations aresmoothed using five-year moving averages.

xiv

Figure 5 Globalization will intensify incoming years
Exports of developing and developed countries,
2005–30
Share of world exports (%)
80
70

High-income
countries (left axis)

trillion
30

High-income
countries (right axis)

25

60
50

Developing
countries(right axis)

40

20Developing
countries(left axis)

15

30

10

20
5

10

0

0
2005

2010

2020

2030

Source: World Bank simulations using the Linkage model.
Note: Exports in US$2001 trillion.

new opportunities. For example, agriculture
now accounts for about 2 percent of theeconomic value added of most rich countries; that share will shrink to boutiqueniches. A few resource-rich regions andcountries, including Latin America andAustralia, will be the source of 90 percent of
the world’s sugar, 50 percent of its grain,
and 40 percent of its dairy products.
Whether countries exceed projections—orfall short—depends heavily on the policies
they adopt over this long period.
Several factors could alter this relatively
sanguine outcome for better or worse. The
central long-term scenario in this report isrobust enough to resist periodic recessions,
isolated regional conflicts, and even many ofthe destabilizing crises the world has experienced in the past 30 years. These threats arelikely to affect particular regional or national
economies more than the world economy,
and if history is a guide, are likely to be ofrelatively short duration. Between 1980 and2005 the world economy grew at a steadypace despite several major disruptions—
including the Latin American debt crisis,
the demise of the Soviet Union, the East Asia

O V E R V I E W

Figure 6 More acceleration is possible
Income growth per capita, % per year, 2010 – 30
8
7

High

6

Central

5
4
3
2
1
0
High-income
countries

East Asia andthe PacificSouth Asia

Europe andCentral Asia

Middle East andNorth Africa

Sub-SaharanAfricaLatin America
and the Caribbean

Source: World Bank staff simulations using the Linkage model.

crisis, two global downturns, and the tragedy
of September 11, 2001. These events had
only short-term effects on global growth anda marginal impact on the steady advance of
globalization, even though regional ripples
continued for years afterward. This suggeststhat the basic long-term trends discussed
here, if not the assumed growth rates, arefairly impervious to all but the most severe
and sustained shocks.
At the same time, the possibility existsthat the world will be even better than envisioned in the central scenario—thanks
possibly to unanticipated technological improvements, more innovation in businessprocesses that allow for an acceleration of
globalization, and widespread adoptions ofgood policies within countries. Indeed,
greater integration promotes knowledge
about policies that work. It also shortensthe duration of bad policies, as investment
capital and human resources can more readily flee poorly performing nations. That discipline is likely to become more effective as
financial, merchandise, and technologicalmarkets continue to integrate. The upside

scenario in this report (figure 6) is based on
the assumption that countries perform
closer to their full potential over a longer
period of time. Predicated on maintaining
the solid growth rates of the last halfdecade, the high-growth scenario sketchedhere would lead to incomes in 2030 thatare some 45 percent higher than those projected under the central scenario and to
declines in absolute poverty ($1 per day)from about 20 percent of the world’s population today to less than 4 percent in 2030.
Two points emerge from the discussion of
scenarios (chapter 2). First, policy matters.
The right domestic and international policies,
sustained over long periods, have the power toraise incomes around the world, especially incertain countries. Second, whether the underlying growth rates are low or high, the dynamics underpinning any likely scenario will generate stresses that require policy attention
today. The report analyzes in detail three mainstresses in the global economy that could
threaten growth: widening inequality, growing
tensions in labor markets, and new environmental pressures.

xv

O V E R V I E W

Income inequality could widen—among and within countriesT

he benefits of globalization are likely to
be uneven across regions and countries(chapter 3). Africa, because of underlying
growth trends and the presence of many fragile states, is the region most likely to fall farther
behind. But, it also has the most to gain from
integration, because it can take advantage oftechnology and wage gaps to propel higher
sustained growth.
Of equal concern, strong forces in the
global economy may tend to increase inequality in many national economies. Even thougha large segment of the developing world is
likely to enter what can be called the “global
middle class,” some social groups may be left
behind or even marginalized in the growth
process. Unskilled workers, in particular, may
fall farther behind. Technological progress, bygenerating demand for greater skills, tends towiden the gap between the wages of skilled
and unskilled workers. Demographic patterns
that affect social dependency ratios (the ratioof workers to youth and retirees) and educational attainment are also important.
Trade per se has been found generally tohave no systematic effect across countries as adirect channel for wage-gap widening. However, in combination with technological change
and, to a lesser extent, foreign investment,these globalization-related forces may combine
to increase inequality in many countries—atthe same time as they are raising average
incomes.

A global middle class will emerge
By 2030, fully 1.2 billion people in developing countries—15 percent of the world
population—will belong to the global middle
class, up from 400 million in 2005. Families
of four in that class earn between $16,000
and $68,000 in PPP dollars (figure 7). (Because
the definition used here is absolute and basedon a global scale, most of those who consider
themselves middle class in high-income

xvi

Figure 7 The “global middle class” will
expand significantly
Population in low- and middle-income countries
earning $4,000–$17,000 per capita (PPP)
Percent
16
14
12
10
8

Sub-Saharan Africa
South Asia
Middle East and North Africa

1.2 billion

Latin America and the Caribbean
Europe and Central Asia
East Asia and the Pacific

6
400 million
4
2
0
2005

2030

Source: World Bank staff calculations.

countries are classified as rich in a global context, while many people viewed as wealthy
in developing countries are members of the
global middle class.) This large group will
participate actively in the global marketplace,demand world-class products, and aspire tointernational standards of higher education.
That is, they would have the purchasing
power to buy automobiles (perhaps secondhand), purchase many consumer durables,
and travel abroad.
While still a minority in their own countries, the new members of the global middle
class will place new and quite different demands on domestic political structures. Their
livelihoods and standards of consumption arelikely to be connected to the global market,
so, as the studies reviewed in chapter 3 show,
their political predilection may be more likely
to favor access to the international market, if
not greater openness itself. They also are more
likely to demand transparency in political andcorporate governance, certainty of contracts,
and property rights—all hallmarks of an
improving investment climate.

O V E R V I E W

Most who enter the middle class will do so
because they are able to move from agriculture into manufacturing and services or acquire valuable skills faster than their compatriots. For a given rate of growth, policies thatallow mobility across sectors and that provide
broader access to education can accelerate
economic growth by creating the opportunity
and incentives for all citizens to develop theirproductive potential.

Africa and some groups within countries
may lag behind
Sub-Saharan Africa will have to make a strong
effort, with the support of the international
community, if it is to avoid being left behind(figure 8). Today, half of the poorest tenth of
the world population lives in Asia; by 2030
Asia’s share in the lowest tenth will be reduced
to one-fifth under the central scenario. By contrast, Africa, now home to one-third of thepoorest people, is likely to see its share of
the lowest tenth double by 2030. To be sure,
the region has the potential for more rapid
growth, and sustained improvements in policy
and investment climate could bring out that

potential. Most fundamental is a cessation ofcrippling civil conflicts that have stunted development in several regions of Sub-SaharanAfrica. In the high-case scenario explored inchapter 2, Africa’s income could be twice ashigh as projected in the central scenario (seefigure 6).
While developing countries are closing theincome gap with rich countries, as many as
two-thirds—more than 80 percent of the developing world outside China—may experience aworsening of within-country inequality, thus
muting the poverty-reducing effects of growthand fanning social tensions that could derail
growth. Demography plays a role, as aging societies tend to become more unequal. But themain driver is the widening difference in earning potential between skilled and unskilledworkers (figure 9). This is because investments
in capital and technology create a more rapidly
growing demand for skilled workers. The simulations in this report suggest that the combined effects of all these forces—technology,
globalization, demography, and demand forskilled labor—may widen income distributionin as many as two-thirds of all countries,

Figure 8 Africa risks falling behind, as average incomes are unlikely to converge
Per capita incomes as percent of high-income countries
40
35
30
25

2030
2020
2010
2005

20
15
10
5
0
East Asia andthe Pacific

Europe andCentral Asia

Latin America
and the Caribbean

Middle East andNorth Africa

South Asia

Sub-SaharanAfricaSource: World Bank simulations using the Linkage model.
Note: Ratio of PPP-adjusted per capita incomes relative to high-income average. PPP is fixed at base year (2001) level.

xvii

O V E R V I E W

Figure 9 Returns to skilled workers are likely to rise faster than for unskilled workers in the
global economy
Ratio of skilled wages relative to unskilled wages
7
6
5
4

2030
2001

3
2
1
0
East Asia andthe Pacific

Europe andCentral Asia

Latin America
and the Caribbean

Middle East andNorth Africa

South Asia

Sub-SaharanAfricaSource: World Bank staff calculations.

including many of the most populous developing countries.
Since in some countries, girls are deprivedof schooling, women in these countries are
more likely to enter the labor market without
skills. This discrimination in effect foredooms
them to be denied access to the opportunities
afforded by global integration, and means
the widening skill premium is likely to affectthem disproportionately.
Several policies can lead to more egalitarian countries and a more egalitarian world.
Governments can create new opportunities
for the poor through additional investments
in education. Investments in girls’ education
can be an important complement to reducing
gender discrimination in the workplace. Additional resources for education and otherpro-poor investments are likely to become
available from a tax base centered on a growing middle-class. Moreover, increasing development assistance for lagging regions and thepoorest countries—and making that assistance more effective—is critical. Particularly
important are investments to overcome bottlenecks in infrastructure, education, andxviii

health. Finally, increasing the access of poor
countries to global markets (and thus raisingliving standards) by completing the nowsuspended Doha Round of world trade negotiations and lowering barriers unilaterally
could boost incomes in poor countries. Measures to expand trade should be coupled withaid to overcome supply-side constraints thatnow weigh down the trade of poor developing countries. Of these constraints, counterproductive domestic policies are often themost binding.

China, India, and global sourcing
will put pressure on labor markets,
especially for the unskilledRapid technological progress, burgeoning
trade in goods, and growing internationalsourcing of services have come together to put
new pressures in labor markets, pressures thatwill only become more acute in the next
25 years (chapter 4). Globalization offers opportunities for export growth and access to awider range of cheaper imported products that

O V E R V I E W

can fuel productivity growth and raise averageliving standards. But by creating a progressively more integrated global market for labor,
it imposes adjustment costs on certain groups
within countries, exerting downward pressure
on some wages, decreasing job security, andmaking retraining and relocation necessary.
Even though wages of unskilled workers in virtually all countries have risen as productivity
has increased with globalization, the unskilled
have received wage increases that are lower
than those for skilled workers—and they haveexperienced greater difficulty in sustaining
their employment. The projections in this reportoffer little reason to believe that this willchange in the coming decades.
Particularly challenging is the rise of China,
India, and other developing countries as manufacturing powerhouses, and, with growing
tradability of services, as suppliers of services
to the global market. While the qualitative implications of increasing exports of manufactured products from China and India are thesame as for the emergence of the Asian tigers
more than a decade ago, their sheer size raises
the specter of intense export competition. Imports of high-income countries from all developing countries have rise from below 15 percent in the 1970s to nearly 40 today—butmore important, their share is expected to rise
to more than 65 percent in 2030 (figure 10).
This has already exposed workers in richcountries to competition from low-wagecountries, a pressure that will only intensify
over the next 25 years.
Many developing countries fear that exports from these large new players may
swamp their domestic markets, squeeze themout of the global export market, foreclose
avenues of diversification in manufactures as aroad to higher growth, and soak up the poolof foreign direct investment (FDI). Highincome countries worry that if the large
emerging economies can readily acquire andmaster the newest technologies, their exports
may soon take over high-tech markets.
Global sourcing of services exerts similarpressures. The transfer to firms in developing

Figure 10 Imports from developing
countries could rise, spawning
productivity growth…and tensions
Share of high-income countries’ imports ofmanufactures originating in developing countries,
1973–2003
Percent
80
70
60

Other Asia

50
40

China

30
Europe andCentral Asia

20

Latin America

10Middle East
Africa

0
1973

1983

2003

2020

2030

Source: Bank staff projections using the Linkage model.

countries of formerly nontradable service
activities imperils white-collar employment inthese activities in both high-income countries
and advanced developing countries. Services
exports have grown by leaps and bounds inmany developing countries (figure 11), creating opportunities for productivity gains inboth high-income and developing countries—
but have led to more rapid job turnover informerly nontraded white-collar jobs. The
global sourcing of such relatively high-paying
skilled jobs, in contrast to the displacementof low-skilled manufactures, has the potential
to destroy the investments of white-collar
workers in firm-specific knowledge.
The analysis in this report suggests thatthree factors are likely to mitigate these effects
in the medium and even the long term.
• First, the growth of the Chinese, Indian,and other emerging markets offers enormous offsetting opportunities for otherdeveloping and developed countries toincrease exports. As China and India
increase their exports, they will havexixO V E R V I E W

Figure 11 Services markets are integratingeven more rapidly
Cumulative services export growth, 1994–2003 (%)

Figure 12 China’s non-oil imports from alldeveloping countries have surged over thelast two decades
Imports in $ billions

India

140

Estonia

Sub-Saharan Africa
South Asia
Middle East and North Africa

120

Romania
China

100

Latin America and the Caribbean

Israel80

BrazilEurope and Central Asia

Argentina

60

Mauritius

40

East Asia and the Pacific

EU15
20

United States

Canada0
1985

Barbados
Dominicaa

1990

1995

2000

2005

Source: World Bank staff calculations.

Australia
Ghana
Japan
0

100 200 300 400 500 600 700 800
Percent

Source: Data are from IMF Balance of Payment Statistics.
Note: Business services are defined as total services minustransportation, travel, and government services.
a. Indicates 1994–2002.

to increase imports of intermediate inputs, energy, technology, and investment
goods. Driven by Chinese demand, Asia
was the principal destination for accelerated export growth for Africa and Latin
America during the late 1990s and theearly years of this decade (figure 12).
• Second, as exports and domestic living
standards rise in these emerging
economies, wages (and exchange rates)
rise as well, creating space for lowincome countries to move into low-skill
activities abandoned by producers in thelarge emerging countries. Wages alreadyhave risen in China faster than in manyother developing countries, a trend
expected to continue (figure 13).
• Third, developing the social institutions
that support a dynamic market economy
in China and India will take time,
providing an opportunity for smaller,xx

more flexible countries to progress
faster in institutional development andfor rich countries to continue to lead inproductivity-enhancing innovation. The
flow of service activities from rich topoor countries, which entails some transfer of know-how, will be slowed to theextent that institutional frameworks failto protect the ownership of such assets
and thus discourage FDI.
Despite this sanguine conclusion, the policy response of countries will determine
whether they will be among those able to takeadvantage of the new opportunities and improve their living standards—or fall behind.
Policies to embrace, rather than resist, global
integration will lay the foundations for future
growth and job creation. Openness to tradeand FDI will become ever more critical if thepoorest countries are to absorb technologies
and know-how from abroad and seize the opportunities created by rising demand from,and production shifts in, China and India. But
openness alone will not be sufficient to foster
integration in the absence of an attractive investment climate, with sound institutions andpolicies that allow resources (labor, capital,

O V E R V I E W

Figure 13 Average wages in China are rising rapidly, creating new opportunities for otherlow-income countries, 1995–2005
Internationally comparable average wage rates
Index 1998 ⫽ 100
230

China

180

Mexico
India

130

80
South Africa
30
1995

1996

1997

1998

1999

2000

Philippines
2001

2002

2003

2004

2005

Sources: China Statistical Yearbook 2005, People’s Bank of China, International Labour Organization (the Philippines, South Africa),
IBGE (Brazil), Banco de Mexico, Ministry of Statistics and Programme Implementation (India); exchange rates from IMF International
Financial Statistics.
Note: Wages are average wages for China, the Philippines, and South Africa, average private sector wages in Brazil, and manufacturing
wages for India and Mexico. Wages for 1998–2000 for the Philippines have been estimated using observed wages from 2001 andprojecting them backward using GDP per capita growth rates.

and knowledge) to flow from low-return
sectors to high-return sectors. Developing
knowledge-intensive activities as future drivers of growth will require investing in theinstitutions and policy frameworks that foster
innovation and providing effective educationand lifelong learning for all workers.
Even in the most propitious economic environments, policies are needed to cushion
the adjustment costs associated with rapidlychanging work force demands and involuntary dislocation. Projections indicate that returns to skilled labor will continue to increase more quickly than those to unskilledlabor, extending today’s natural wage-widening tendencies evident in many, if not most,countries, and underscoring the need for
public policies to support workers at the low
end of the scale. Together, both volatility andrising wage inequality argue for labor-market
policies focused on protecting workers rather
than protecting jobs. These trends also argue
for creating opportunities for low-income
people through educational and infrastructure investments while eschewing subsidies
to inefficient activities.

Environmental threats will
demand much more multilateralcollaborationThe gains from growth and globalization
could be undermined by their environmental side effects. Because increases in production magnify cross-border pollution, while
improvements in technology make it possible
to expand or intensify exploitation of scarce
global resources, decisions at the national levelare having a growing impact on other countries. International institutions will thus be required to play a larger role in a wide spectrumof issues—all involving global public goods4—
where exclusive reliance on the decisions of individual governments or the private market
can lead to adverse outcomes. As developing
countries enlarge their role on the global stage,
their integration as full partners in multilateralsolutions to global problems will be essential.
Mitigating climate change, containing infectious diseases, and preserving marine fisheries are three prominent global public goods
that demonstrate the need for—and benefits
of—international policy cooperation.

xxi

O V E R V I E W

Figure 14 Carbon emissions in developing countries are set to rise sharply
Annual carbon emissions in the GREEN baseline scenario
Million tons of carbon

Million tons of carbon

18,00018,00016,00016,000Major
emitters

14,000World

12,00014,00012,00010,000Annex 1

10,000

8,000

8,000

6,000

6,000

4,000

4,000
Industrial countries

2,000
0
1990

2000

2010

2020

2030

2,000
0
2050

2040

Source: OECD Green model simulations.
Note: Annex 1 includes the industrial countries plus some countries in Eastern Europe and the former Soviet Union. Major emitters
include Annex 1 countries plus large developing countries: China, India, Indonesia, Mexico, and South Africa.

xxii

implications for the welfare of future
generations.
• Technological progress and rising demand have increased efforts to harvest
fish from the open seas, degrading ocean
environments and driving some valuablespecies to near-extinction. Fish catches
already have leveled off (see figure 15).

Figure 15 Worldwide maritime catches
have leveled off
Millions of tons
110
Trendline, 1995–2004
90

Trendline, 1950–95

70
50
30
10

19
5
19 0
5
19 3
5
19 6
5
19 9
6
19 2
6
19 5
6
19 8
7
19 1
7
19 4
7
19 7
8
19 0
8
19 3
8
19 6
8
19 9
9
19 2
9
19 5
9
20 8
0
20 1
04

• Rising industrial output means that,based on current trends with existing
technologies, annual emissions of greenhouse gasses (GHGs) will increase
roughly 50 percent by 2030 and will increase twofold by 2050 (figure 14). This
necessarily would sharply increase theconcentrations of GHGs in the atmosphere, with substantial risks of detrimental effects on future productivity
and—more generally—on human welfare around the globe. The problem is
how best to provide energy necessary
for growth, while at the same time reducing emissions toward levels that will
eventually stabilize atmospheric concentrations. Even in the next decade or two,scientists underscore the possibility—
though still low probability—thatglobal warming could cause natural
disruptions severe enough to push
growth rates perilously below historic
trends. While decades will pass before
the most severe effects of climatechange will begin to be felt, the collective response of today’s global leaders isalmost certain to have far-reaching

Source: Food and Agriculture Organization’s FISHSTAT
database 2004.

O V E R V I E W

Recent scientific calculations projectnear-complete depletion by 2048 in theabsence of collective international efforts to limit fishing to sustainable levels(see Worm and others 2006). Longstanding efforts to limit marine catches
to sustainable levels have met with only
a few successes, as institutional weaknesses, technical difficulties, and inappropriate incentives, such as fishing subsidies, impede sustainable management.
• The growing interaction of national
economies through trade and movementsof people, while broadly beneficial, has
increased the risk of spreading contagious diseases. HIV/AIDS (human immunodeficiency virus/acquired immune
deficiency syndrome) is one example.
The severe acute respiratory syndrome(SARS) is another. The most prominentcurrent threat is posed by the avian influenza virus.
These examples of the side effects ofglobalization—one long-term, one mediumterm, and one immediate—pose risks to theprogressive expansion of the global economy,
and to developing countries in particular.
Some of the more catastrophic climate-change
scenarios, if they materialize, could undermine
the development prospects of whole countries
and even regions through their effects on agriculture, water, and ecosystems. According
to the United Kingdom government’s recent
comprehensive analysis, the Stern Review,
failure to address climate change could—
potentially—lead to huge reductions in welfare (cuts in per capita consumption of 5–20
percent), while the cost of stemming the risein GHG concentrations at a reasonable level
could be about 1 percent of annual GDP by
2050 (U.K. 2006). These estimated costs of inaction are substantially higher than previous
estimates. The report concludes that an international framework should include emissions
trading to encourage energy efficiency, technological cooperation to ensure more rapid

adoption, action to reduce deforestation, andassistance to poor developing countries topromote adaptation to permanent climaticchanges.
Similarly, failure to contain an epidemic
could suddenly brake global commerce, isolate some populations, and impose huge losses
on affected developing countries. Unrestrained
marine fishing, while less potentially calamitous than climate change or a flu pandemic,
could permanently degrade a critical global
food source and destroy irreplaceable deepsea habitats and biodiversity.
Effective multilateral collaboration isneeded to ensure that economic growth andpoverty reduction proceed without causing irreparable harm to future generations. Developing countries are central to the management of these risks. Though these countries
are relatively small contributors to global
warming today, the projections in this report
imply that soon enough they will becomelarge contributors; moreover, if no action istaken, the standard of living that they could
otherwise expect may well be put at risk. Similarly, given the limited supply of medical
facilities and nursing care in the developingworld, a flu pandemic could have horrificconsequences. In many developing countries
people depend on fish for an important shareof their diet, and the poor would suffer if theprice of fish, as well as substitutes, were to
skyrocket as supplies dwindled.
The three cases differ in the degree ofagreement among policy makers—and, to lessdegree, scientists—regarding the risks
involved. There is a large international consensus on the need to protect against the
spread of (selected) contagious diseases, andon the right methods of doing so. The potential for exhausting marine fisheries is well understood, although disagreement remains on
the amount of resources to commit, the limits
on fishing to impose, and how to allocate
access to fisheries. There is an international
consensus that human activity is contributing to climate change, and that industrial

xxiii

O V E R V I E Wemissions are directly related to atmosphericconcentrations of GHGs, although the precise
implications of different levels of GHG concentrations for climate change remain
uncertain. While disagreements over the facts
in each case have hampered efforts at international cooperation, they have not been the
major impediment to progress.
The greatest policy challenge in safeguarding the global commons involves strengthening international agreements and institutions.
The World Health Organization has addressed the threat of global pandemics effectively. The basic legal framework is in place tosafeguard the sustainability of marine fishing,but is often inadequately enforced by weak
institutions. Even more work is required toestablish the global institutions capable of reducing the risks from climate change. Discussions aimed at replacing the Kyoto Protocol,
which expires in 2012, with a more comprehensive and ambitious agreement are underway within the framework of the United
Nations Framework Convention on Climate
Change. Meanwhile, it may be useful to startputting in place other vehicles, such as a
global system for trading emission permits
and better means of monitoring emissions inboth high-income and developing countries,
so as to allow a rapid implementation ofeffective policies, once these are agreed.
Achieving policy consensus is difficult, but it is
now urgent.

The world in 2030

A

ll these developments are pieces of the
new burden lying on the shoulders of national policy makers: to manage globalization
or risk being run over by it. This requires
government policies to ensure that the poor
are incorporated into the growth process
through pro-poor investments in education,
infrastructure, and transfers. Similarly, it
requires policies to support and invest inxxiv

workers—all the while promoting change,
not fighting it.
Deepening economic interdependence also
places a new burden on the collective actions of
the international community. Several positive
responses are clear. First, increasing theamount and effectiveness of development
assistance through both multilateral andbilateral institutions can ease the tendencyof globalization to produce uneven growth.
Second, liberalizing trade in the framework of
the World Trade Organization can create newopportunities for poor countries and poor people. The most immediate task is to reactivate
the Doha Round and conclude an agreementthat lowers trade barriers to the products theworld’s poor produce, especially agriculture
and labor-intensive manufactures. And third,
deepening institutional mechanisms to deal
with threats to the global commons can ensurethat globalization is not undone by its own
success—by providing forums in which disagreements about how to provide global public
goods in which all nations ultimately have aninterest can be resolved. Multilateral cooperation will be even more important in the integrating world of tomorrow than it is today. The
way the international community, acting together, manages the process of integration will
determine whether the world of 2030 will realize its potential.

Notes
1. Several recent and provocative books deal withthese themes or variations, and from quite different
perspectives. See, for example, Dervis (2005),
Friedman (2005), Goldin and Reinert (2006), Mishkin(2006), Stiglitz (2006), and Wolf (2004) as well as
various issues of Foreign Policy.
2. This is measured in constant dollars adjusted
for purchasing power parity.
3. Today the six countries are Brazil, China, India,
Indonesia, the Russian Federation, and, most recently,
Mexico. By 2030, Bangladesh, Nigeria, Pakistan, thePhilippines, and Vietnam will reach both thresholds.
Already today the populations of Bangladesh, Nigeria,
and Pakistan exceed 100 million.

O V E R V I E W

4. Examples of global public goods, in addition
to protecting the environment, include ensuring
global security, keeping the trading system open andnondiscriminatory, and maintaining global financial
stability. A useful overview of many of these can befound in Bhargava 2006.

References
Bhargava, Vinay. 2006. Global Issues for Global
Citizens: An Introduction to Key Development
Challenges. Washington, DC: World Bank.
Dervis, Kemal. 2005. A Better Globalization: Legitimacy, Governance and Reform. Washington, DC:
Center for Global Development.
Friedman, Thomas. 2005. The World Is Flat: A Brief
History of the 21st Century. New York: Farrar,
Straus and Giroux.

Goldin, Ian, and Kenneth Reinert. 2006. Globalization
for Development: Trade, Finance, Aid, Migration,
and Policy. Washington, DC: World Bank.
Mishkin, Frederic S. 2006. The Next Great Globalization. Princeton: Princeton University Press.
Stiglitz, Joseph. 2006. Making Globalization Work.
New York: Norton.
U.K. Government. 2006. Stern Review: Economics of
Climate Change. London: Government of theUnited Kingdom.
Wolf, Martin. 2004. Why Globalization Works. New
Haven: Yale University Press.
Worm, Boris, E. Barbier, N. Beaumont, J. Duffy, C.
Folke, B. Halpern, J. Jackson, H. Lotze, F.
Micheli, S. Palumbi, E. Sala, K. Selkoe, J.
Stachowicz, and R. Watson. 2006. “Impacts ofBiodiversity Loss on Ocean Ecosystem Services.”
Science 314 (5800): 787–90.

xxv

Abbreviations

ALMP
APEC
BOP
CGE
CPIA
DDA
DDP
DPRs
EU
FCC
FDI
GDP
GATT
GATS
GHG
GTAP
IMF
IPPC
ITA
MDG
MNEs
NAFTA
NIEs
ODA
OECD
OPEC
PPP
RTAs
TAA
TFP
UNCTAD
WHO
WTO

Active labor market program
Asia-Pacific Economic Cooperation
Balance of payments
Computable general equilibrium (economic models)Country Policy and Institutional Assessment
Doha Development Agenda
Development data platform
Diversified Payment Rights
European Union
Federal Communications Commission
Foreign direct investment
Gross domestic product
General Agreement on Tariffs and Trade
General Agreement on Trade in Services
Greenhouse gas
Global Trade Analysis ProjectInternational Monetary FundIntergovernmental Panel on Climate Change
Information Technology Agreement
Millennium Development Goal
Multinational enterprises
North American Free Trade Agreement
Newly industrialized economies
Official development assistance
Organisation for Economic Co-operation and Development
Organization of the Petroleum Exporting Countries
Purchasing Power Parity
Regional trade agreements
Trade adjustment assistance
Total factor productivity
United Nations Conference on Trade and Development
World Health Organization
World Trade Organization

xxvii

1
Prospects for the Global Economy

Summary of the medium-term
outlookDespite high commodity prices, risingshort-term interest rates, and a bout of financial market volatility, global growth accelerated in the first half of 2006. While there areindications that the pace of the expansion isalready slowing, developing economies areprojected to expand by 7 percent for the year
as a whole, more than twice as fast as highincome countries (3.1 percent), with all developing regions growing by close to or morethan 5 percent.
The very fast growth of developing countries over the past five years has been fueled
by low interest rates and abundant global liquidity. This has led to rising commodity prices
and overheating in some high-income anddeveloping countries. This, in turn, has provoked a tightening of monetary policy that is
in part responsible for the slowdown that has
already begun. However, in most countries
strong productivity growth, due in part to theabsorption of China and the former Eastern
Bloc countries into the global economy, haschecked inflationary pressures.
Limited inflationary pressures and highsavings among oil exporters and in Europe (asEuropeans prepare to meet the challenges of
their aging society) are expected to keep longterm interest rates low. Moreover, improved
fundamentals have boosted trend growth rates
in many developing countries. Together thesefactors suggest that, while developing-country

growth is projected to slow over the next two
years, it should remain robust at 6.1 percent in2008. Mainly because of the continued expansion of developing economies, global growth
will remain robust and this should keep commodity prices high. Nevertheless, increases insupply, combined with demand-side substitution and conservation measures, should allow
for some easing of commodity prices, including that of oil.
This positive outlook is subject to significant risks. Past episodes of fast growth andfavorable financial conditions have been followed by sharp and largely unanticipated reversals. While stronger fundamentals in mostdeveloping countries reduce the likelihoodthat a hard landing would be as severe as in
the past, countries need to take particularcare to ensure that their fiscal, monetary, andstructural policies are in order so as to minimize the domestic consequences of external
shocks—a point driven home by the financial
market turbulence observed in the spring of
2006, which affected most sharply thosecountries whose fundamentals were most outof balance.
A soft landing remains likely, but the
global economy has reached a turning point
and many factors could result in a more pronounced slowdown. A faster-than-expected
weakening of housing markets in highincome countries could generate a muchsharper downturn and even recession, withpotentially significant effects for developing1

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 7countries. Much slower growth would likely
cause commodity prices to weaken more thanalready projected, potentially placing many
developing countries that have so far avoided
current-account problems in difficulty. In addition, demand is expanding unsustainably
rapidly in many developing countries. Should
efforts to contain growth in these countries
fail, their economies could overheat, yielding
initially stronger growth outcomes and additional inflation, but a much sharper slowdown later on. An oil-sector supply shock
could be similarly disruptive, driving up oil
prices even further, while simultaneously
slowing growth and weakening the prices of
non-oil commodities. Finally, although global
imbalances appear to be stabilizing, they remain large. There is a continuing risk thatthey will be resolved in a more disruptive
manner than is assumed in the baseline scenario outlined here.

Global growth surged to
3.9 percent in 2006

D

espite oil prices that topped $75 a barrel
during the course of the year, world grossdomestic product (GDP) growth is estimatedto have strengthened in 2006, coming in at
3.9 percent, compared with 3.5 percent in2005 (table 1.1). To a significant degree, thisstrong global performance reflects the very
rapid expansion in developing economies,
which grew by 7 percent—more than twice as
fast as high-income countries (3.1 percent).
Overall, 38 percent of the increase in global
output originated in developing countries, far
exceeding their 22 percent share in world GDP.
As discussed in chapter 2, continued faster
growth among developing countries over the
next two decades is expected to lift their shareof world output to about 31 percent in 2030.
Very strong growth (10.4 percent) in China
played a significant role in the recent strength ofdeveloping countries, contributing an expected
0.5 percentage points to global growth. Nevertheless, the pickup was broadly based. Even excluding China and India, developing countries

2

Figure 1.1 Industrial production may
be slowing
3-month annualized growth rate
Percent
12

Percent

Developing countries,
excluding China

30

China (right axis)

25

10

20
8

15

6

10

4

5
0

2

⫺5

0

⫺10

High-income countries

⫺2
Jan.
2004

⫺15
July
2004

Jan.
2005

July
2005

Jan.
2006

July
2006

Source: World Bank.

grew 5.5 percent (5 percent for small oil
exporters), and all regions are expected to havegrown by close to, or more than, 5 percent.
Most of the acceleration in global growth
was concentrated in the first half of the year.
World industrial production grew 6.7 percent
in the first six months of 2006, compared with
4.3 percent in 2005 (figure 1.1). Among developing countries, rates of growth of industrial production eased in the second and third
quarters, although this was partially offset bystronger growth among high-income countries. Order books and business sector confidence are strong in both Europe and Japan,
suggesting that industrial activity should remain robust for the remainder of the year,
while in the United States there are clear signs
that industrial production is slowing.
In the United States, the acceleration in industrial output was mirrored by GDP, whichbegan 2006 expanding by a torrid 5.6 percent.
However, responding to higher short-term
interest rates, residential investment spending
has fallen sharply and a cooling housing market has moderated consumer demand.1 As aresult, the economy slowed in the third quarter to a 1.6 percent annualized growth rate,with most of the slowdown restricted to theP R O S P E C T S

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Table 1.1 The global outlook in summary
Percentage change from previous year, except interest rates and oil price
Estimate

Global conditions
World trade volume
Consumer prices
G-7 countriesa,bUnited States
Commodity prices (US$)
Non-oil commodities
Oil price (US$ per barrel)c
Oil price (percent change)
Manufactures unit export valued
Interest rates$, 6-month (percent)€, 6-month (percent)Real GDP growthe
World
Memo item: World (PPP weights)f
High-incomeOECD countries
Euro Area
Japan
United States
Non-OECD countries
Developing countries
East Asia and the Pacific
China
Indonesia
ThailandEurope and Central Asia
PolandRussian Federation
TurkeyLatin America and the Caribbean
Argentina
BrazilMexicoMiddle East and North Africa
AlgeriaEgypt, Arab Rep. of
Iran, Islamic Rep. ofSouth Asia
Bangladesh
India
Pakistan
Sub-Saharan Africa
Kenya
NigeriaSouth Africa
Memorandum items
Developing countries
excluding transition countries
excluding China and India

Forecast

1960–80

1980–2000

2004

2005

2006

2007

2008

—

5.8

10.4

7.7

9.7

7.5

7.8

1.8
2.7

2.2
3.4

2.5
3.4

2.1
2.5

1.7
2.1

17.5
37.7
30.6
6.9

13.4
53.4
41.5
0.8

20.6
64.0
19.9
2.4

⫺4.5
55.9
⫺12.7
3.8

⫺8.4
52.7
⫺5.7
0.4

1.6
2.1

3.6
2.2

5.4
3.0

5.7
3.6

5.0
4.2

4.1
5.2
3.3
3.2
1.7
2.7
4.2
6.4
7.2
9.0
10.1
5.1
6.2
7.2
5.3
7.2
8.9
6.0
9.0
4.9
4.4
4.8
5.2
4.2
5.1
8.0
6.3
8.5
6.4
5.2
4.9
6.5
4.5

3.5
4.7
2.7
2.6
1.4
2.6
3.2
5.8
6.6
9.0
10.2
5.6
4.5
6.0
3.4
6.4
7.4
4.5
9.2
2.3
3.0
4.4
5.3
4.9
4.4
8.1
6.2
8.5
7.8
5.5
5.8
6.2
4.9

3.9
5.1
3.1
3.0
2.4
2.9
3.2
5.3
7.0
9.2
10.4
5.5
4.5
6.4
5.4
6.8
6.0
5.0
7.7
3.5
4.5
4.9
3.0
5.8
5.8
8.2
6.7
8.7
6.6
5.3
4.9
4.8
4.6

3.2
4.5
2.4
2.3
1.9
2.4
2.1
4.7
6.4
8.7
9.6
6.2
4.6
5.7
5.1
6.0
5.0
4.2
5.6
3.4
3.5
4.9
4.5
5.6
5.0
7.5
6.2
7.7
7.0
5.3
5.1
5.1
3.9

3.5
4.6
2.8
2.7
1.9
2.5
3.0
4.8
6.1
8.1
8.7
6.5
5.0
5.5
5.2
5.5
5.0
4.0
4.0
3.8
3.5
4.8
4.3
5.8
4.7
7.0
6.5
7.2
6.5
5.4
4.9
5.4
4.3

7.3
6.1

6.8
5.1

7.0
5.5

6.4
4.9

6.1
4.9

4.7

3.0

4.5

2.9

6.2
5.5

3.4
8.5

10.7

0.6

5.5

2.2

5.9

4.0

3.7

5.4

4.4

2.2

5.1
6.6

4.2
2.3

2008–30

2.9
2.4

4.0
5.1

2.7

3.0

3.6

4.7

3.3

Source: World Bank.
Note: PPP ⫽ purchasing power parity.
a. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
b. In local currency, aggregated using 2000 GDP weights.
c. Simple average of Dubai, Brent, and West Texas Intermediate.
d. Unit value index of manufactured exports from major economies, expressed in U.S. dollars.
e. GDP in 2000 constant dollars; 2000 prices and market exchange rates.
f. GDP measured at 2000 PPP weights.

3

G L O B A L

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2 0 0 7

housing sector. Importantly profits, nonresidential investment, and consumption remain robust and inflation and unemployment
low. As a consequence, although growth is expected to remain subdued, it should not decline in the fourth quarter and the strong firstquarter means that output for the year as awhole is expected to increase 3.2 percent.
In high-income Europe, following several
years of weakness, growth also accelerated in
the first half of 2006. GDP expanded byabout 3.3 percent in the first two quarters of
the year, as private consumption and investment spending took over from exports as themain drivers of the recovery. Growth slowed
to a 2 percent pace in the third quarter, withgrowth in France having stalled as investment expenditures turned negative and exports weakened. However, both in France
and in the rest of Europe, consumer demandremained robust and consumer and businesssurveys suggest that economic activity should
be robust in the fourth quarter, leading to an
estimated 2.5 percent increase in GDP for theyear as a whole (2.4 percent for the EuroArea).
In Japan, the acceleration in output
that began in 2005 has continued, with GDP

estimated to have expanded by 2.9 percent in2006. A slowdown in exports contributed to
weaker growth in the second quarter of theyear, but growth rebounded in the third quarter
led by a surge in investment spending. As of
August, exports were up 11 percent from a year
earlier, partly reflecting a 25.6 percent increasein sales to China, where import volumes havestrengthened markedly.
Developing economies grew 7 percent in2006. Much stronger European and continued
robust Japanese growth, combined with low
real interest rates and interest rate spreads,
made for robust activity among the world’s
developing economies, which are expected tohave expanded by 7 percent in 2006. This represents the fourth consecutive year that their
growth rates have exceeded 5 percent.
The expansion was particularly robust in
China and India, where output is estimated tohave increased by 10.4 and 8.7 percent, respectively. But the strong performance wasbroadly based, with all developing regions
growing by close to or by more than 5 percent(figure 1.2). Despite further substantial increases in the price of oil during the first halfof the year, growth among the remaining oilimporting developing countries actually

Figure 1.2 Regional growth trends
Percent change in GDP
10
2004
2005
2006
2007
2008

9
8
7
6
5
4
3
2
East Asia andthe PacificSource: World Bank.

4

Europe andCentral Asia

Latin America
and theCaribbean

Middle Eastand North
AfricaSouth Asia

Sub-SaharanAfricaOil exporters

Oil importers(excluding
China)

P R O S P E C T S

strengthened and is expected to come in at
5 percent for the year as a whole.

Developing economies to outperform
high-income countries in 2007–08
High oil prices are expected to continue toweigh on growth in industrialized countries.
The slowdown that they and higher interest
rates (working through residential investment
and household consumption) have already initiated in the United States is projected to continue into the first half of 2007 before an expected relaxation of monetary policy permits
the economy to pick up. Overall, GDP in the
United States is projected to increase 2.1 percent in 2007 and 3 percent in 2008. Weakerdomestic demand is expected to be reflected inslower import growth and should result in a
decline in the trade and current accountdeficits of the United States, with the lattercoming in around 5.5 percent of GDP in 2008.
Continued accommodative macroeconomic
policy and pent-up investment demand following several years of very weak growth should
maintain the pace of the expansion in most
European countries, without exacerbating
underlying inflationary pressures. However, aplanned 3 percent increase in the German
value-added tax (VAT) is projected to slow
demand in that country in 2007, with knockon effects elsewhere in the continent. The
higher VAT can also be expected to prompta one-time increase in inflation, although its
effect should be attenuated by slower growth.
Overall, GDP in high-income Europe is projected to slow to about 2.1 percent (1.9 percent
for the Euro Area) in 2007 and 2008.
In Japan, vigorous growth in developing
East Asia, renewed consumer and business confidence, and reduced drag from consolidation
are positive factors expected to maintaingrowth at about 2.5 percent in 2007 and 2008.
The recent return to positive inflation is projected to persist, allowing short-term interest
rates to gradually rise to around 2 percent by
the end of 2008. At the same time, domestic demand is expected to firm as unemployment

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E C O N O M Y

declines toward 3.5 percent of the labor force.
As a result, the current account surplus should
decline to about 3 percent of GDP in 2008.
In most developing regions, high oil prices,
rising interest rates, and the maturation of thebusiness cycle are expected to restrain growthin 2007–08. As a group, however, low- andmiddle-income countries should again outperform high-income economies by a wide
margin—and this strong performance willcontinue to be a critical driver of global
growth. Administrative restrictions on investment and slower export growth are expected
to bring Chinese growth down to a more sustainable 8.7 percent by 2008. Higher interest
rates and some further fiscal tightening are expected to slow the expansion in India to about
7.2 percent over the same period, helping to
unwind some of the inflationary tensions thathave built up in that country.
Prospects for the remaining oil importers
are varied. Many, particularly in Eastern andCentral Europe, are overheating and haveentered a phase of policy tightening. These
countries are expected to decelerate. Others,
including Brazil and Mexico, are projected toaccelerate or enjoy high but stable growth
rates as they continue to benefit from a favorable external climate, including low long-term
real interest rates and interest-rate spreads.
Overall, developing-country oil importers, excluding China and India, are projected toenjoy broadly stable growth of about 4.8 percent in 2007–08.
For oil exporters (and other large commodity exporters) strong revenue inflows
should continue to fuel robust domestic demand growth despite lower prices and lessrapid increases in global demand for commodities, resulting in rapid growth of both
imports and the noncommodity sectors ofthese economies. Overall, the pace of the expansion in developing-country oil exporters
is expected to decline from 6 percent this year
to 4.9 percent in 2008, as capacity constraints
slow growth in the resource sector and a rising
share of demand is met by imports.

5

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2 0 0 7

Regional outlooks
More detailed descriptions of economic developments in developing regions, including regional forecast summaries and country-specific forecasts,
are available online at http://www.worldbank.org/
globaloutlook. Country-specific forecasts are reported
in the appendix.

East Asia and the Pacific 2
An emerging growth pole.
The economies of the East Asia and Pacificregion continued to expand at robust rates in2006, with regional GDP growth expected toaccelerate to 9.2 percent in 2006 from 9 percent
the year before. In China, continued rapid investment growth, in conjunction with an unexpected surge in exports as new capacity came on
stream, led to a 10.7 percent year-over-year increase in GDP over the first three quarters. The
overall contribution of the external sector to
GDP growth was up because, even though import growth accelerated, increased output from
China’s import-competing sectors prevented
import volumes from expanding as rapidly as
exports. Investment spending has been spurredby growth in credit and the money supply aswell as strong profits. Concerns about excessive investment creating potential overcapacity
in specific sectors led the authorities to reinforce administrative measures aimed at containing investment growth.
The expansion in the rest of the region remains robust. A rebound in global high-tech demand and stronger import demand from China
prompted an acceleration in exports that began
in the second half of 2005 and continued into
2006. Vietnam’s growth is expected to reach 8
percent, backed by across-the-board strength inexports, domestic consumption, and investment. In Indonesia, growth slowed in the firstsix months of 2006 following a substantial reduction of fuel subsidies and monetary tightening in the latter part of 2005. Activity appears
to be picking up now, with monthly indicators
suggesting a strong rebound in domestic consumption and investment in the third quarter.
For the year as a whole, GDP is expected to increase by about 5.5 percent. Growth in

6

Malaysia and the Philippines is also expected
to come in at around 5.5 percent, while in
Thailand it is expected to reach only about 4.5
percent, because, despite strong export growth,
consumption and investment have been depressed by high oil prices, rising interest rates,
and continued political uncertainty.
High oil prices and rapid growth haveraised inflation in the region, prompting ageneral tightening of monetary policies during
2005. As a result, both headline and core inflation are now easing in most of the larger
economies in the region. Regional equity markets were subject to the general correction
affecting many emerging markets during
May–June 2006. However, spreads on bonds
remain low, and equity markets began recovering in August, suggesting that the earlier
correction did not represent a reassessment of
the region’s economic fundamentals.
Growth is expected to moderate only somewhat. In China, investment growth and domestic demand are projected to remain robust.
However, with investment at some 50 percent
of GDP, more forceful policy action may beneeded to keep credit and investment growth incheck. Moreover, the country’s large and persistent current account surplus suggests theneed, over the longer term, to promote a moreconsumption-oriented pattern of growth. In
Indonesia, the ongoing recovery in growth isprojected to continue, with GDP expanding by
6.5 percent in 2008.
Economic pressures for the revaluation ofdeveloping Asian currencies are likely tointensify. In addition to reducing global
imbalances, revaluation would also reduce inflationary pressures, improve domestic macroeconomic management capabilities, steadyasset markets, and improve living standards
for local populations.
Finally, the region remains susceptible tooutside risks, including a worsening of theavian influenza epidemic—either throughwider effects on domestic animals or because
transmission to (or between) humans becomes
more efficient (World Bank 2006).

P R O S P E C T S

Europe and Central Asia
Oil exporters and European Union integration
underpin strong growth.
Economic activity in the Europe and Central Asia region is estimated to have increased
by 6.4 percent in 2006, up from 6 percent in2005. This acceleration comes despite slower
growth in Turkey, where a significant tightening of monetary policy following this spring’s
financial market turbulence is projected to reduce growth from 7.4 percent last year to
6 percent in 2006.
Faster growth in Europe and low real interest rates have helped to maintain growth athigh levels elsewhere in the region. Among thelargest economies, growth in the Russian Federation is estimated to have picked up to
6.8 percent in 2006, supported by high oil
prices. Improved incomes and activity in themining sector boosted growth in Ukraine to an
estimated 6 percent pace in 2006 versus
2.6 percent in 2005, while rising wages andfalling unemployment increased growth in
Poland from 3.4 percent in 2005 to an
estimated 5.4 percent in 2006. Elsewhere,
rebounding demand in industrial Europe, coupled with rapidly growing demand from regional oil exporters, notably Russia, bolsteredexports among smaller oil importers, whose
economies grew 6.1 percent, up from 5.8 percent in 2005. Higher oil prices and the coming
on stream of oil projects lifted the GDP growthamong oil exporters to 7.3 percent.
The pace of demand growth in many countries in the region continues to exceed supply
and, as a result, 13 countries have currentaccount deficits in excess of 5 percent of GDP,and inflation is rising in 12. Strong capital inflows, predominantly in the form of foreign
direct investment (FDI), coupled with extremely rapid domestic credit expansion, areat the root of excess demand in several countries (the Baltic countries, Bulgaria, Hungary,
Romania, the Republic of Serbia, and Turkey).
Although FDI flows are less easily reversed
than portfolio and equity investments and are
more likely to be associated with physical

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investments, more volatile capital flows arealso increasing, and a substantial portion of
the FDI is going into the banking sector, where
it may be more volatile than in other sectors.
While such flows are likely to remain strong,motivated by investment opportunities associated with European Union (EU) integration,
the real-side disequilibrium that these inflows
are provoking may make these countries sensitive to a change in investor sentiment. Indeed, as events in the spring of 2006 highlighted, countries with large current accountdeficits are particularly vulnerable—especiallythose with pegged exchange rates (Hungary
and Latvia) and currency boards (Bulgaria,
Estonia, Lithuania)—because sharp reductions in inflows may require very large anddisruptive real-side adjustments. In Hungary,a budget deficit of close to 10 percent of GDP
poses further challenges.
Excess demand has also contributed to inflationary pressures and a tightening of monetary policy. Overheating remains a risk boththere and in Azerbaijan, the Baltic states,
Belarus, Bulgaria, the Czech Republic,
Kazakhstan, Romania, Russia, the Slovak
Republic, Turkey, and Ukraine. Other factors
contributing to the slower growth include aslump in manufacturing activity (especiallymining) in Armenia, a marked deceleration ofexport growth in Latvia, and rising capacity
constraints combined with declining competitiveness in Belarus. Growth is continuing at amodest pace in the former Yugoslav Republicof Macedonia (4 percent in 2006), where domestic demand is recovering slowly following
a period of fiscal consolidation and violent
conflict in 2001.
Growth in the region is expected to slow
somewhat over the next two years, coming inat about 5.5 percent in 2008. Slower growth
in industrialized Europe and higher short-term
interest rates are expected to cause regional
export growth to decline for both oil importers and oil exporters. In the case of thelatter, domestic demand growth is expected toease but remain strong, because, although oil

7G L O B A L

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P R O S P E C T S

2 0 0 7revenues will decline, they will remain high.
Lower prices will contribute to the expected
slowdown in oil exporters’ GDP growth from
7.3 percent in 2006 to 6.2 percent in 2008. In
addition, it will also slow demand for exports
from regional oil importers, which, in combination with weaker export demand from
Germany and the United States in 2007, is
expected to reduce their GDP growth to about
5.2 percent in 2008.
The combination of rising inflation and elevated current account deficits poses a persistent challenge for regional policy makers. To
the extent that the contractionary influence of
higher interest rates continues to be offset bycapital inflows, further fiscal tightening may
be unavoidable—even if it means pushing government balances into surplus in some countries. For many countries in the Commonwealth of Independent States, future prospects
will be dependent on continued strong demand from Russia. Prospects for the poorer
countries in the region will also depend on theextent to which these countries are able tostrengthen domestic institutions so as to sustain high growth rates.

Latin America and the Caribbean
Improved performance but still underperforming.
Economic activity in Latin America and the
Caribbean has picked up and GDP is estimated to have increased by 5 percent in 2006.
The faster growth reflects favorable international financial conditions, strong commodity
prices, and a relaxation of monetary policy inBrazil and Mexico, two of the region’s largest
economies.
In Mexico, GDP accelerated sharply in thefirst half of 2006, growing 5.5 and 4.7 percent(year-over-year) in the first two quarters as
lower interest rates boosted domestic demandand construction activity. Stronger sales of cars
to the United States and oil exports also contributed. Brazil, too, benefited from a more relaxed monetary policy stance, although real interest rates remain high at 11 percent. GDP
accelerated to about 5.2 percent in the first8

quarter, and although it slowed in the second
quarter, growth for the year as a whole isexpected at 3.5 percent.
In contrast, demand in Argentina andRepública Bolivariana de Venezuela, which
had been expanding at unsustainable rates,
slowed. Nevertheless, demand in each country
remains very strong, and GDP is projected to
expand by 7.7 and 8.5 percent, respectively,
well beyond potential. Unsurprisingly in these
conditions, inflation has picked up and now
exceeds 10 percent in both countries. In eachcase, this surge occurred despite price freezes
in a number of sectors that are hurting sectoral
investment and supply (inflation of uncontrolled goods and services is running at 16 percent in Argentina). The rapid expansion of demand in República Bolivariana de Venezuela
has been fueled by ballooning governmenttransfers. The growth in supply has been concentrated in the non-oil sector, as reductions ininvestment by the government’s oil company
and by private oil firms (discouraged by hightaxes and royalties and antibusiness policies)
have caused oil production to decline.
Other countries in the region are also
growing relatively rapidly. In Chile, a waning
investment boom and higher imports havecontributed to a slight slowing of growth in2006. In Central America, growth is expectedto accelerate in most countries in 2006,
boosted by exports and investments associated with free trade agreements (Costa Rica,
the Dominican Republic, El Salvador,
Guatemala, Honduras, and Nicaragua), strong
remittance inflows, increased agricultural
production due to better weather, and posthurricane investment spurts (El Salvador). In
the Caribbean, growth in Jamaica and theDominican Republic has picked up, reflecting
foreign investments in the tourism and mining
sectors (Jamaica) and a growth rebound following the 2003 currency crisis (Dominican
Republic). Uncertainty over the results ofelections in Nicaragua has hurt investor
confidence, partially offsetting the beneficial
effects of a relatively buoyant agricultural sector and the writing off of $975 million in debt.

P R O S P E C T S

Electoral uncertainty and concerns about
the future path of U.S. interest-rate policy contributed to volatility in financial markets inthe spring of 2006. The currencies of a number of countries depreciated, following earlier
appreciations in some cases (Brazil andColombia). Stock markets also underwent a
major correction. However, the improved fiscal stance and reduced indebtedness of many
countries meant that the region was not particularly affected by this episode. Risk premia,
after rising somewhat, have once again declined and currently are just 20 points above
their historical minimums.
Prospects for countries in the region reflect
a number of offsetting influences. The projected slowdown in global activity is expected
to moderate demand for commodities, resulting in a modest decline in their prices andslower volume growth. As a result, while revenues from this sector will remain elevated,
they will decline, as will their contribution to
the growth of domestic demand in commodityexporting countries. Overall, GDP among
commodity exporters (excluding República
Bolivariana de Venezuela, see below) is projected to slow to about 3.8 percent in 2008.
Commodity importers also will feel the effectof slower global and U.S. growth. In the caseof Mexico, the anticipated cycle in the UnitedStates is expected to be reflected in slower
exports and growth. For most commodity importers the slowdown is expected to be lessmarked (from 4.6 to 4 percent, excluding
Mexico), in part because many countries haveconsiderable spare capacity.
As indicated above, unsustainably rapid
growth in Argentina and República Bolivariana
de Venezuela, boosted by a dangerously expansionary fiscal and monetary policy, hasalready strained capacity in these countries. In
the baseline projection, this unsustainable demand stimulus is expected to continue, withdomestic demand increasing at double-digit
rates. The inability of domestic supply to keep
pace means that GDP will grow less quickly,
declining to 4 percent in Argentina and 5.5 in
República Bolivariana de Venezuela in 2008,

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as imports and inflation rise rapidly. Unlesssignificant policy restraint is introduced in
the near future, these developments will result in a deterioration of current account balances, leading to an erosion of Argentina’s
current account surplus to about 0.9 percent
of GDP and a much-reduced surplus of
7.6 percent in República Bolivariana deVenezuela by 2008. The longer the two countries’ aggressively expansionary macroeconomic policies keep demand growing inexcess of supply, the sharper and more disruptive will be the recession required toreestablish equilibrium.

Middle East and North Africa3
Riding the oil boom.
High oil prices and strong oil demand
continue to be key drivers for the developing
economies of the Middle East and North
Africa.4 Overall, these countries’ GDP increased by an estimated 4.9 percent in 2006,
the fastest pace in some four years. Amongdeveloping-country oil exporters, growth isexpected to reach 4.9 percent, up from lastyear’s 4.7 percent.
Reflecting strong investment and remittanceflows from high-income oil exporters andthe Euro Area, output among regional oil importers has strengthened. For the year as awhole, output is expected to come in at 5 percent. Strong Suez Canal revenues in the Arab
Republic of Egypt, better crops following a
drought in the Maghreb, hefty tourism receipts
throughout the region, and a pickup in
European demand are additional factors explaining this relative strength. An exception is
Lebanon, where the war and political uncertainty weighed heavily on activity in the first
three quarters. While reconstruction efforts are
expected to give a fillip to growth toward theend of the year and into 2007/08, Lebanese
GDP is expected to contract by about 5.5 percent in 2006.
Generous fuel subsidies are pervasive
throughout the region. For countries that do
not benefit from large oil revenues, these subsidies have strained fiscal balances. Countries

9

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2 0 0 7such as Egypt, Jordan, Morocco, and Tunisia
saw fiscal deficits pick up within a range of
0.5 to 2 percent of GDP over the course of2005, in part linked to oil subsidies. Since
then, Jordan reduced subsidy expenditures by
59 percent in the second quarter. In Egypt,these and other steps have helped reducethe consolidated government deficit from
9.1 percent in fiscal year 2005 to 6.5 percent
in 2006. Nevertheless, such subsidies remain
important in the region and threaten the fiscal sustainability of some countries. They
also impede adjustment, although their balance of payments consequences have been
mitigated by strong remittance and investment flows.
Rising oil prices during the first eightmonths of 2006 bolstered revenues of the
major exporting countries in the region. Oilrelated revenues were up 33 percent in theIslamic Republic of Iran and 30 percent in
Algeria, and many governments boosted
spending. Measures included substantial
investments to augment oil-sector capacity, infrastructure projects, and other non-oil-sector
investments in human and social capital, allof which should help boost future supply.
However, a significant share of the additional
spending, such as substantial civil service
wage increases in several countries and increased spending on fuel subsidies, merely
stoke demand and may prove difficult to sustain should oil prices decline further.
The surge in oil revenue and government
spending among oil exporters has yet to generate substantial inflationary pressures. However, inflation is up in a number of countries,
including Egypt, Jordan, Oman, and Tunisia.
In the Islamic Republic of Iran, although inflation is declining, it still exceeds 10 percent.
Moreover, regional stock and housing markets have appreciated enormously throughout
the region. While local markets lost as muchas 25–33 percent of their value in the
May–June 2006 market correction, valuations remain high, and there are concerns
about increased leverage in private sector balance sheets (IMF 2006).

10High oil prices are expected to continue
feeding domestic demand in oil-producing
countries, causing imports to continue rising
rapidly, even as growth of export revenue
slows. Capacity constraints and strong import
growth is projected to slow GDP growthamong developing oil-exporting countries to
4.7 percent in 2007 and 4.5 percent in 2008.
Their current account surpluses should decline
from 11 percent of GDP in 2005 to about
5.3 percent of GDP in 2008. In the oil-importing
economies, growth is expected to gradually
pick up from 5 percent in 2006 to 5.3 percent
in 2008, reflecting assumed improvements incrop conditions, stronger European growthand continued robust investment and remittance inflows from regional oil exporters.

South Asia
Rapid growth is pushing against capacity
constraints.
Despite a tightening of both monetary andfiscal policy, real interest rates remain low, andgrowth in the South Asia region picked up to an
estimated 8.2 percent in 2006. Direct and indirect subsidization of consumer energy prices
have helped contain inflationary pressures but
are keeping government deficits high and contributing to strong domestic demand.
With the exception of Nepal, which is only
now emerging from political strife, growththroughout the region was strong in the firsthalf of the year. In India, GDP increased by
9.3 percent in the first quarter, supported bystrong industrial and service-sector production, while in Pakistan industrial production
was up 12 percent. Partly reflecting improved
sales of textiles and clothing after the restrictions on Chinese exports were reintroduced,
merchandise exports in the region increased
more than 30 percent in the first half of 2006
(on a year-over-year basis). A good start to themonsoon season suggests that agricultural
output (and incomes) will be strong also.
Overall, regional GDP is projected to increaseby 8.2 percent for the year, or 6.4 percent if
the two largest economies (India and Pakistan)are excluded. In the Maldives a rebound inP R O S P E C T S

tourism and post-tsunami reconstruction efforts are expected to contribute to a 19 percent expansion in GDP, while a new hydroelectric plant may help boost output in Bhutan
by 10 percent.
Notwithstanding robust export demand
and a first-quarter current account surplus
in India, strong domestic demand is expected
to result in a small further deterioration ofregional current account deficits in 2006,
particularly in Pakistan, where increased government spending (tied to the Kashmir earthquake and ongoing military expenditures) is
projected to push the current account deficit
to 3.9 percent of GDP. In contrast, strong remittance flows and robust exports are expected to propel the current account of
Bangladesh toward balance.
Rapid growth and the relatively expansionary stance of fiscal and monetary policies in
the region have provoked a rise in inflation.
Successive hikes in policy rates in India haveincreased interest rates, but higher inflationmeans that real rates were negative in August.
In Pakistan, tighter monetary policy brought
inflation down to 6.2 percent in April, but it
picked up again and was 8.1 percent in October. Ample domestic and international liquidity has also contributed to substantial increases in local stock market valuations (upabout 45 percent in both India and Pakistan).
Throughout the region, higher international
oil prices have yet to be fully passed throughto consumers, placing a strain on government
accounts and implying significant additional
inflationary pressure in the pipeline.
Despite tighter monetary and fiscal policies
in India and Pakistan, and weaker export
demand from the United States, low realinterest rates, strong international capital
inflows, and high government deficits are
expected to keep domestic demand expanding
rapidly. When added to the delayed passthrough of higher oil prices, this should maintain inflation pressures in the region andsustain rapid import growth. As a result, theexternal sector is expected to make a significant
negative contribution to growth, and regional

F O R

T H E

G L O B A L

E C O N O M Y

GDP growth should moderate to about 7 percent by 2008. Owing to continued strong
growth, the region’s current account deficit isprojected to deteriorate further despite falling
oil and non-oil commodity prices.

Sub-Saharan Africa
Another good year.
GDP in Sub-Saharan Africa expanded by an
estimated 5.3 percent in 2006. Oil-exporting
economies are expected to grow 6.9 percent
in 2006, about the same as last year. Among oil
importers (excluding South Africa), the expansion has been sustained, and growth is estimated to have increased 4.7 percent.
South Africa, the region’s largest economy,
expanded at growth rates above its potential forthe third consecutive year. Household expenditure has been exceptionally strong, benefitingfrom low nominal interest rates, rising real incomes, and wealth effects. As a result, domestic
demand and output growth in the manufacturing and service sectors have been very strong.
Despite a large positive terms-of-trade shock as
metal prices soared, the external sector’s contribution to growth was negative, owing to strong
import growth fueled by robust household consumption and the stronger rand. The surge inimports caused the current account deficit todeteriorate to 6.2 percent of GDP in the first halfof 2006, which contributed to the sharp depreciation of the rand during May–June. Overall,
the rand has depreciated 20 percent on a tradeweighted basis since the beginning of the year,
and this has contributed to inflationary pressures. Nevertheless, consumer confidence anddemand remain at historically high levels.
In Nigeria, the region’s second-largest
economy, attacks on oil infrastructure slowed
growth, as oil production fell by 25 percent
during the first five months of 2006. It has
since picked up but remains down 6.5 percent
from a year ago. Nevertheless, the non-oil
economy is expanding rapidly (up 12.8 percent in the second quarter) and supplementarybudgetary spending is expected to bolster
growth, perhaps leading to a buildup in inflationary pressures.

11

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 7

The regional expansion is broadly based,with a third of the countries experiencing
growth in excess of 5 percent. Among oil
exporters, growth was particularly strong in
Angola (16.9 percent), Sudan (11.8 percent),and Mauritania (17.9 percent), which began oil
production in February. In addition to a strong
expansion in oil production, buoyant domestic
demand is projected to spur rapid growth in the
non-oil sectors of most oil-exporting countries.
The aggregate stability and strength ofgrowth among the region’s oil importers reflects divergent patterns. A number of countries that recently emerged from conflict areexperiencing very strong growth rates(Burundi, the Democratic Republic of Congo,
Liberia, and Sierra Leone). Elsewhere strong
international metal and mineral prices are
generating revenue streams and prompting additional investments, which have contributed
to strong growth. However, drought-related
crop failure, high fuel costs, and energy rationing have resulted in weaker results for
East African oil-importing countries. In addition, although both the numbers and the intensity of conflicts in Africa have subsided, therisks associated with political turmoil remainhigh and are undermining growth in Chad,
Côte d’Ivoire, the Democratic Republic ofCongo, Eritrea, Lesotho, the Seychelles, Somalia,
Swaziland, and Zimbabwe.
Current accounts have come under pressure in several oil-importing economies in theregion, although higher commodity prices andincreased official and private transfers havehelped contain the deterioration. The mostnotable decline in the current account came inSouth Africa, where an initial appreciation of
the rand boosted imports and dampened exports, driving the current account deficit to
6.2 percent of GDP in the first half of 2006.
Debt relief from Paris Club creditors under theMultilateral Debt Relief Initiative should reduce debt-servicing cost by substantial margins in several countries, which, in combination with the expected easing in oil prices, isprojected to provide some relief to current
accounts over the projection period.

12

Inflation is up in a number of countries because of higher international oil prices and seasonal and drought-induced increases in foodprices. In the case of South Africa these factors
have been exacerbated by excessive domestic
demand. Inflation there is projected to exceed
6 percent, above the upper limit set by the
Reserve Bank. In Nigeria, year-over-year inflation remains high but is declining rapidly,
owing in part to the appreciation of the naira.
GDP growth for the region as a whole isprojected to remain broadly stable, coming inat about 5.4 percent in 2008, with weaker
growth in South Africa offsetting a pickup
among oil exporters and stable growthamong smaller oil importers. In South Africa,
higher interest rates are projected to overcome strong mining and manufacturing
growth in 2007, before the latter forces generate a recovery in 2008. In the baseline projection, emerging electrical shortages due toinsufficient generating capacity are expected
to constrain growth in Burundi, Kenya,
Malawi, Rwanda, Tanzania, Uganda, andZambia, but improved rainfall in East andWest Africa should help replenish hydroelectric dams, thereby improving electrical supply
and manufacturing output. An end to
drought should also boost agricultural output
and domestic incomes, although weaker agricultural prices and high fertilizer prices may
negatively affect agricultural crops and could
represent a drag on growth.

Financial markets
Some signs of emerging inflationarypressuresHigh oil prices and the rapid pace of global
growth have contributed to a gradual increase
in median inflation among developing countries, from about 1.7 percent in 2002 to
3.2 percent during the third quarter of 2006
(figure 1.3). The acceleration was not consistent across the globe. Inflation has been stableor declining in half of the developing regions
over the past year, falling to an averagelevel of 5.3 in the third quarter. In contrast, inP R O S P E C T S

F O R

T H E

Figure 1.3 Inflation has increased
moderately

Figure 1.4 Inflation is rising in
high-income countries

End of period, year-over-year
monthly inflation rate (%)

Percent change, year-over-year
5.0

10

Sept. 2006

9

2005

8

2004

7

2003

6

2002

G L O B A L

E C O N O M Y

U.S.: All goods
and services

4.5
4.0
EU: All goods
and services

3.5
3.0
2.5
2.0

5
4

1.5

3

1.0

2

0.5

1

Eu

Jan.
2003

Jan.
2004

Jan.
2005

Jan.
2006

Sources: World Bank; Datastream.

an

d

th

e

Ea

s
Pa t As
ci ia
fic
C ro
en p
La tra e al A ndtinsth Am ia
e er
C ic
ar a
ib an
M
be d
id
an
dl
e
N E
or as
th t
Af an
ric d
So a
ut
h
As
Su
ia
bSa
ha
Af ra
ric n
H
a
ig
hco inc
un om
tri e
es

0

EU core inflation

U.S. core inflation

0
Jan.
2002

Source: World Bank.

high-income countries it rose from 1.3 to
2.7 percent before falling to 1.4 percent in
October as oil prices declined.
Most of the increase appears to reflect the direct impact of higher oil prices. Until recently,
core inflation in high-income countries has been
relatively stable (figure 1.4). Core inflation in
the United States was rising much of the year,
but it has been easing recently and stood at 2.7
percent in October 2006. In many developing
countries, inflation first picked up in response
to higher oil prices, but it has since declined, reflecting both solid productivity growth and theimpact of more credible monetary policies thathave helped anchor inflation expectations.
However, developments in a number of lowand middle-income countries run counter tothese general trends. In these countries, inflation is rising, reflecting the combined influenceof several years of above-trend growth andsteep increases in global commodity prices(figure 1.5). Higher inflation would appear toreflect overheating in Argentina and several
countries in Europe and Central Asia, theMiddle East, North Africa, and South Asia.
Inflation has also picked up in Sub-SaharanAfrica. There, in addition to several years of

Figure 1.5 Signs of overheating in somedeveloping countries
Percent change in consumer prices,
year-over-year monthly
16

Botswana

14
12
10

Argentina
TurkeyBulgaria

8
6
4
2

India
Thailand

0
Jan.
2004

Sept.
2004

May
2005

South Africa

Jan.
2006

Sept.
2006

Source: World Bank.

rapid growth, high food prices following successive droughts are playing a role. The concern is that if an inflationary spiral develops,
because the credibility of monetary policy is
not yet well entrenched, it could have serious
consequences for macroeconomic stability andaffect the ability of those economies to sustain
the strong growth of the past several years.
In countries such as India, regional imbalances in the distribution of growth contribute13

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 7

to difficulties because inflationary pressuresand capacity constraints are concentrated in
rapidly growing cities and co-exist with considerable slack elsewhere in the economy.

bonds and nonindexed bonds, which has remained relatively stable at around 2.5 percentage points.

Rising short-term interest rates

More volatile financial conditions
for developing countries

Higher inflation throughout the developed
world has translated into rising short-term
interest rates and the gradual removal of themonetary policy stimulus that has characterized the past several years. Although policy
rates are increasing throughout the developed
world, the process is most advanced in the
United States, while at relatively early stages
in Europe and Japan. Many developing countries also have acted to restrain credit expansion and contain inflation. Policy rates haverisen sharply and appear to be slowing inflation in Bulgaria, Indonesia, Thailand, andTurkey. In others (Argentina, India, Pakistan)
the tightening cycle is less advanced and, as aresult, real interest rates remain low and inflation high.
Long-term interest rates (see figure 1.8) remain low and the yield curve flat, suggestingthat markets are confident that the monetary
authorities will be successful in containing
inflationary expectations—a contention supported by the spread between inflation-indexed

Despite high short-term interest rates, financial conditions for developing countries remain highly favorable. Several years of veryloose monetary policy, an ample supply of
global savings (due to aging populations in
Europe and rapidly increasing incomesamong oil exporters), business-sector consolidation in the United States and Asia, andhigh savings rates in the fastest-growing sectors of the world economy have combined tobuoy global liquidity. This helps explain the
low long-term bond yields and the search foryield that has boosted the flow of private
capital to developing countries. That flow, in
combination with improved fundamentals,
has brought interest spreads down to historically low levels.5
However, conditions have become morevolatile (figure 1.6). The transition from a slow
and widely anticipated tightening of U.S. monetary policy toward a more data-driven approach increased uncertainty in financial markets during the second quarter of 2006. Initially,

Figure 1.6 Despite turbulence, financing conditions remain favorable
Emerging-market spread as compared with 10-year U.S. T-billa. Long-term decline

b. Recent volatility

1,600

400

1,400

350

Global

1,200

300

1,000

Zoom in

200

600

150

400

100

200
Jan.
2000

Jan.
2002

Turkey50

South Africa
Jan.
2004

Sources: Datastream; JP Morgan; World Bank.

14

250

Turkey

800

0
Jan.
1998

Global

Jan.
2006

0
Jan.
2005

South Africa
May
2005

Sept.
2005

Jan.
2006

May
2006

Sept.
2006

P R O S P E C T S

the prospect that dollar-denominated returns
would no longer be rising resulted in a surge offlows into emerging market stocks, commodity
markets, and currencies. As values of theseassets rose, the market reassessed long-term
prospects, resulting in a substantial correction.
For the most part, this volatility failed todisrupt growth, and net private capital flows todeveloping countries are expected to rival lastyear’s record highs (figure 1.7). However, inFigure 1.7 Private capital flows todeveloping countries remain strong
Total net private capital flows to developing countries
Projected$ billions
550
500
450
400
350
300
250
200
150
100
50
0

F O R

T H E

G L O B A L

E C O N O M Y

some countries, particularly those with large
current account deficits (such as South Africa
and Turkey) and relatively heavy debt burdens, the correction was more severe and is
expected to result in much slower growth in2006 and 2007, as the real side of these
economies adjusts to weaker financial inflows.
The combination of several years of low interest rates has increased global liquidity substantially (see earlier versions of Global Economic Prospects and Global Development
Finance). Despite the increase in short-term
interest rates, the persistence of low long-term
interest rates, due in part to high savings rates
among oil-exporting countries, has kept
global liquidity abundant. The OECD (2006)
estimates that depending on the measure employed, high-income liquidity exceeds historical norms by between 15 and 17 percent (figure 1.8). In the baseline, although interest
rates are projected to rise somewhat, liquidity
is projected to remain relatively abundantand continue to be a factor behind strong
developing-country growth.

19
9
19 0
9
19 1
9
19 2
9
19 3
9
19 4
9
19 5
9
19 6
9
19 7
9
19 8
9
20 9
0
20 0
0
20 1
0
20 2
0
20 3
0
20 4
0
20 5
06

Global imbalances are stabilizing

Source: World Bank.

The imbalances in global spending patterns
that have characterized the world economy
over the past five years began to show signs of

Figure 1.8 Ample liquidity keeps long-term interest rates low
a. Global liquidity

b. Long-term interest rates

Percent deviation from long-term trend

Percent

20
15
Monetarymeasure10

Creditmeasure

5
0
⫺5
⫺10
1980

1985

1990

1995

2000

2005

15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
1980

U.S. 10-year T-bill

Germany 10-year
government bond

1985

1990

1995

2000

2005

Sources: OECD (liquidity measures); World Bank.

15

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 7

Figure 1.9 Global demand shifts from theUnited States to Europe and developing
countries
Contribution of domestic demand to growth
Percent
9
8
7
2004
2005
2006
2007
2008

6
5
4
3
2
1
0
United States

Japan

EuropeDeveloping
countries

Source: World Bank.

stabilizing in 2006. Weaker domestic demandin the United States, the acceleration of economic activity in Europe, and continued
recovery in Japan helped to stabilize the U.S.
current account deficit, which is expected tocome in at about $850 billion, roughly thesame share of GDP as in 2005.

An important component of this story has
been the slowing in U.S. domestic demand
and the simultaneous increase in developingcountry domestic demand (figure 1.9). Thisrotation of growth, plus the lagged effect ofpast depreciations, contributed to a 13 percent increase in the volume of U.S. exports inthe first half of 2006, almost twice the growthrate for imports (7 percent). Nevertheless, theU.S. trade balance declined further, in part
because of very high oil prices during the firsteight months of the year. The subsequentdecline in oil prices should reduce the value ofU.S. imports, resulting in an improved tradebalance during the fourth quarter. Because ofthis strong volume performance and declining
oil prices, global imbalances are not expected
to deteriorate significantly over the projection
period—in stark contrast to the recent
past, when they deteriorated sharply eachyear (figure 1.10).

Exchange rates are broadly stable
Despite the substantial financial flows required
to finance the U.S. current account deficit, thedollar has remained broadly stable against major
currencies during 2006—up about 2 percent

Figure 1.10 A start to orderly adjustment?
Current account balance, 2002, 2006, and 2008
$ billions
400
200
0
⫺200

2002
2006
2008

⫺400
⫺600
⫺800

Oil importers

Oil exporters⫺1000
UnitedStates

Source: World Bank.

16

EuropeJapan

Other high- East Asia
incomeand thecountries
Pacific(excluding
China)

China

Europe and
Other
HighLow-income
Central developing income
exporters
Asia
importers exporters

P R O S P E C T S

3-month and 10-year bond yield
Percent
610-year U.S. yield
5
4
10-year euro yield2
3-month euro yield
1
3-month U.S. yield
0
Jan.
2003

July
2003

Jan.
2004

July
2004

Jan.
2005

July
2005

Jan.
2006

T H E

G L O B A L

E C O N O M Y

surpluses (China and several oil exporters)
have resisted upward pressure on their currencies with respect to the dollar.
The depreciation against the euro occurred
despite a substantial premium currently being
offered on both short- and long-term U.S.
bonds (see figure 1.11). With U.S. monetary
policy nearing or at the end of its tightening
cycle, these differences are expected to narrow. In the baseline forecast, this narrowing
and slower growth in the United States areprojected to cause the dollar to depreciate bya further 5 percent against the euro in each of2007 and 2008, which should further facilitate the unwinding of global imbalances.
However, should downward pressures bemore severe, the depreciation could be stronger
or interest rates in the U.S. may have to risefurther (see the section on risks).
Currency developments for the remaining
developing countries were dominated by thereemergence of financial market volatility inthe first half of 2006 (figure 1.12). Downward
pressure on the dollar toward the end of 2005
and at the beginning of 2006 saw the currencies

Figure 1.11 Interest rate spreads support
the dollar

3

F O R

July
2006

Sources: World Bank; Datastream.

against the yen and depreciating by about 5 percent against the euro. In real-effective terms it
has lost only 2 percent of its value. In part, thisrelative strength is explained because many of
those countries running large current-accountFigure 1.12 Turbulence resulted in sharp depreciations for some developing countries
Index of euro exchange rates
Index Jan. 1, 2006 ⫽ 100
85
BrazilIndonesia

95

105
United States
115

Colombia
Depreciation

125
TurkeySouth Africa

135

145
Jan.
2006

Feb.
2006

March
2006

April
2006

May
2006

June
2006

July
2006

Aug.
2006

Sept.
2006

Oct.
2006

Nov.
2006

Source: World Bank.

17

G L O B A L

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2 0 0 7of many developing countries appreciatestrongly. For many countries that appreciation
was reversed in May and June as investors reassessed their positions. While disruptive, andprovoking a sharp rise in interest rates in somecountries, the volatility was short-lived and in
most cases merely served to unwind earlier
appreciations that had been out of step withcountries’ underlying fundamentals.

World trade

S

tronger industrial activity was mirrored inworld trade. Merchandise trade growth
grew 11 percent during the first eight monthsof 2006, up from 6 percent the year before.
Most of the acceleration occurred in China,
Japan, and the United States and was concentrated in the first quarter. Weaker U.S. consumption and investment demand, and growing domestic demand in the developing worldcombined with the lagged effects of past depreciations to boost U.S. export volumes byan annualized rate of 13 percent in the firsthalf of 2006, compared with 7 percent in thelast half of 2005. Measured on the same basis
and over the same period, exports in Japanand China increased by 10 and 30 percent, respectively. Trade flows weakened in the second quarter but show signs of picking up once
again in the third quarter.
Over the medium term, growth in merchandise trade volumes is projected to ease toabout 9 percent, in line with slower global
GDP growth. The recent relative strength of
U.S. export volumes is projected to persist(figure 1.13). Those volumes are projected torise by more than 9 percent in 2007 and 2008
as the cumulative effect of past and expected
future depreciations increase the international
competitiveness of U.S. products. For developing countries, weaker U.S. import demandshould be partially compensated by stronger
demand from Europe, but, overall, developingcountry export growth is projected to slow
from an estimated 12.2 percent in 2006 to
10 percent in 2008, even as countries continue
to increase their market share.

Trade outlook—continued expansion
Developing-country trade reached a landmark
in 2006. Following 25 years of solid growth,
the value of China’s exports overtook thoseof the United States, making China the world’s

Figure 1.13 Rotation in global trade
Merchandise trade volumes
Percent change
20
Developing countries

Developing countries (excluding China)

15
105Europe
0
⫺5
⫺10
2000

United States

2001

Source: World Bank.

18

2002

2003

2004

2005

2006

2007

2008

P R O S P E C T S

F O R

T H E

G L O B A L

E C O N O M Y

Figure 1.14 China’s exports exceed those of the United States
Merchandise exports$ millions, log scale
10,000,000

Other developing countries

High-income Europe
1,000,000

BrazilChina
100,000
10,0001,000
1960

United States

1965

1970

India

1975

1980

1985

1990

1995

2000

2005

Source: World Bank.

second-largest exporter. Increasing exports inother developing countries, notably Brazil andIndia, have further increased the weight ofdeveloping countries in world trade (figure 1.14). Over the long term, as these trends
continue, the share of developing countries inworld trade is projected to reach some 45 percent by 2030 (see chapter 2).
While the phenomenal success that China
has enjoyed in expanding its world market
share since the introduction of market reforms
has increased competitive pressure on bothdeveloping and developed countries (seechapter 4), Chinese imports also have grownvery rapidly (up 477 percent in value terms overthe past decade), and China is a growing destination for the exports of other developing countries (Dimaranan, Ianchovichina, and Martin
2006). Sixty-three percent of China’s imports
are intermediate goods, 31 percent in the formof parts and components. Overall, 79 percent ofChina’s imports are sourced from developing
countries. Partly as a result of China’s rapid
increase in imports, the value of other developing countries’ non-oil exports has risen by
153 percent, and their global market share has
increased by 2.3 percentage points.
In addition to these direct effects, the expansion of developing-country commercemeans that these countries are increasingly

becoming privileged destinations for FDI,
both as an export platform for multinational
companies and because they represent thefastest-growing market segment.
The extent to which other developing
countries will be able to take advantage of the
expected continued strong growth of China
and India (see chapter 2) will depend on theirability to expand exports. This requires
eliminating the anti-export bias in their incentive framework, reducing costs of produced
services, and improving customs proceduresthat undermine competitiveness. It also
requires investments in transport systems to
reduce transit times (Newfarmer 2005) and inother forms of infrastructure, such as electrical generators so as to facilitate the expansionof capacity. In addition, as discussed in chapter 4, countries need to reduce rigidities
in product, labor, and financial markets sothat firms can react with agility to newopportunities to expand the range of products
they produce and sell.
On the multilateral front, the suspension oftalks on the Doha Round in July 2006 posessignificant challenges. Weakened confidence inthe multilateral system could lead to trade disputes, rising protectionist sentiment, and trade
diversion arising from proliferating bilateraland regional trade agreements. To capitalize on

19

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2 0 0 7

progress already made in the Doha Round,such as the offer to end agricultural export subsidies by 2013, it is important that parties return to the negotiating table with the necessary
flexibility to conclude an ambitious deal.

Commodity markets

S

trong global growth, and especially the
rapid expansion of output in developing
countries, is largely responsible for the run-up
in commodity prices over the past several years.
Improvements in technology and new discoveries are expected to preclude any major disruptions to growth over the long term (see chapter2), but increased demand for energy and othernatural resources may generate significant environmental pressures (see chapter 5).

Non-oil commodities
Metals and minerals take off.
While oil-price increases have received thebulk of media attention, the rise in the price of
metals and minerals during the course of 2006
has been much stronger (figure 1.15). Continued rapid growth in global output, speculative
demand, low stocks, and numerous supply
disruptions have pushed metals and minerals
prices up by some 48 percent since the beginning of 2006. Agricultural prices also posted

Figure 1.15 Diverging trends incommodity prices
Index, Jan. 2003 ⫽ 100
350
300

Metals and minerals

250
200
Energy150
100

Agricultural products

50
0
2001

2002

Source: World Bank.

20

2003

2004

2005

2006

gains in dollar terms, up 7 percent by the beginning of November, but were broadly stable
if expressed in euros.
The biggest increases in metals prices were
those of copper (up 64 percent), zinc (up110 percent), and nickel (up 144 percent).
High prices and continued strong demand
have prompted significant destocking ofcopper and nickel in China—suggesting thatprices may remain high even as supply disruptions ease. Nevertheless, stocks of other products such as aluminum, lead, and tin haverecovered, and their prices have eased or stabilized, suggesting that a peak in the metals
market may have been reached.
Financial sector activity also played a bigrole in price developments during 2006. Recent estimates suggest that more than $19 billion flowed into retail commodity funds during the first eight months of the year, when
prices were rising. More recently, these flows
have reversed sharply. Outflows from exchange-trade commodities totaled $12 billion
during the first two weeks of September, when
prices were falling (Norman and Shen 2006).
With global growth projected to slow somewhat but remain strong, the overall metals andminerals index is expected to decline in 2007
and 2008, but remain elevated.
Moderate gains in agricultural prices.
Agricultural prices have risen an estimated
11 percent in 2006 compared with 2005, reflecting a weaker dollar and the impact ofhigher energy and fertilizer prices. Other factors, such as crop-specific supply shortfalls
and droughts, low carryover stocks, andstrong demand growth contributed to theprice increases. Real agricultural prices haveincreased 35 percent since their cyclical lowsin 2001.6 This increase is well below the increases in oils and metals, in part because
agricultural demand is less sensitive thanindustrial demand to economic growth, andbecause agricultural supply responds more
quickly to increased demand and prices.
High energy prices have contributed directly
to the surge in the price of some agricultural

P R O S P E C T S

commodities that are either used as energy
crops (biofuels) or compete with synthetic
products made from petroleum. The price ofsugar, which is being diverted to ethanol production for automotive fuel, more than doubled from late 2004 until early 2006, whilethat of natural rubber (a substitute for synthetics produced from petroleum products) rose
60 percent between December and June 2006.
The price of maize, which is used as the feedstock for ethanol production in the UnitedStates, is expected to rise 8 percent in 2006.
High energy costs also have contributed toincreasing agricultural prices by raising thecost of fertilizers. This prompts an increase in
the cost of production of agricultural goods,
but also induces a reduction in yields because
farmers use less fertilizer. As a result, energyand fertilizer-intensive crops such as grains are
expected to show reduced yields and higher
prices in 2006. These factors, plus low carryover stocks and poor harvests in several important producing areas, are projected to pushwheat prices up 28 percent in 2006 and evenhigher next year before production increases
enough to rebuild stocks. In the case of rice,
higher costs and reduced yields are expected
to boost prices by 8 percent.
In contrast, prices of fats and oils are expected to be 5 percent lower, because markets
appear to be well supplied. Drought in Kenya is
keeping tea prices high (up 14 percent from2005). Robust coffee prices are expected to average 18 percent higher in 2006, a continuationof the price increases that began in 2002. Timber
prices are projected to increase 14 percent owing
to strong demand, particularly from China,
while international supplies remain limited because of controlled logging and export quotas.
Prospects for agricultural prices in 2007
are mixed, with grains and oilseeds higher,
while beverages and raw materials prices will
be lower. Overall, agricultural prices are expected to decline by about 1 percent in 2007
and 2.8 percent in 2008 as higher prices begin
to moderate demand and induce increased
supply. Should oil prices rise further, agricultural prices could also strengthen because of

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cost-push factors and because higher energy
prices make biofuel more economically viable,
generating an additional source of demandfor products such as maize and sugar cane.
Already, 20 percent of the U.S. maize crop and
50 percent of the Brazilian sugar cane crop areused to produce ethanol. Should this trend
continue, demand for other commodities,
especially grains, will increase to substitute forcrops used for biofuels.

Oil market
Rising supply and slow demand cause prices
to ease.
After showing signs of stabilizing in the fallof 2005, the price of oil shot up once again in
the first half of 2006 (figure 1.16). Prices havesince declined and were below $60 in lateNovember—bringing the price of oil below
the level at which it began the year. Expressedin euros, the price has declined 7 percent since
the beginning of the year and stands at about
the same level as before the hurricanes of lastsummer and fall.
High prices slowed the growth in demandfor oil despite the acceleration in economic
activity in 2006. Oil demand increased by
0.5 million barrels per day (mbpd) in the threequarters of 2006, compared with 3.2 mbpd

Figure 1.16 Oil prices continue to rise
Price of oil, World Bank average$ and € per barrel

Nov. 16, 2006

75
65
Dollars
per barrel

55
45

Euros
per barrel

35
25
15
Jan.
2000

July
2001

Jan.
2003

Aug.
2004

Feb.
2006

Sources: Datastream; World Bank.

21

G L O B A L

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2 0 0 7

Figure 1.17 Higher prices slow oil demand
Change in apparent oil demand

Figure 1.18 A disappointing supply
response
Change in global oil deliveriesMillions of barrels of oil per day
5Millions of barrels of oil per day
5

4
Total

3

World

4
3

2

2

1

1
0

0

⫺1
1
⫺1

⫺2
2

⫺2
2002
Other

2003

2004

Other Asia

2005
China

2006

2002

OECD

Source: International Energy Agency.

in 2004 (figure 1.17). Demand among OECD
countries actually declined by about
0.5 mbpd, and although demand in developing countries continued to increase by justunder 1 mbpd, this was much slower than
the increases recorded in 2003 and 2004.
Econometric estimates suggest that had
prices remain unchanged, oil demand would
have increased by some 2–2.5 mbpd.7
Notwithstanding some three years of higher
prices since the recent upward trend in oil prices
began in early 2003, and the arrival on streamof new fields in Africa and elsewhere, aggregate
non-OPEC (Organization of Petroleum Exporting Countries) oil supply was relatively
slow to increase (figure 1.18).8 Most recently,
there has been a pickup in deliveries from theformer Soviet Union and other non-OPEC
sources, with the result that supply rose by
0.8 mbpd during the first nine months of 2006.
Despite the limited responsiveness of supply in the first half of 2006, growth of final oil
demand was even weaker, and as a result inventories and global spare capacity increased
somewhat (figure 1.19). However, sparecapacity remains low (at just 3 mbpd), leaving

22

⫺3
3
2003

Other

2004

OPEC

2005

2006

Former Soviet Union

Source: International Energy Agency.

Figure 1.19 Spare production capacity
remains low
OPEC spare production capacity
Millions of barrels per day
7
6
5

excluding Iraq

4

Total

3
2
1
0
Jan.
2002

Oct.
2002

July
2003

April
2004

Jan.
2005

Oct.
2005

July
2006

Sources: World Bank; International Energy Agency.

the world vulnerable to a significant supply
shock (see the section on risks below). It isthat vulnerability, plus concerns about future
Middle East supplies, that provides the best
explanation for the increase in oil prices
observed during the spring and early summer.

P R O S P E C T S

Financial market speculation also likely
played a role, especially in the first half of2006, when a weakening dollar coincidedwith a significant run-up in emerging-market
assets (among them the prices of some commodities), followed by a significant reversal in
May and June. An indication of the importance that such forces may have played wasthe 30 percent fall in U.S. wholesale gasoline
prices in August following the decision ofGoldman Sachs to reduce the share of gasoline
in its commodity indexes.
Over the near term, limited spare capacity
and strong global growth suggest that oil
prices will remain volatile. However, highprices should continue to moderate demand
growth, while investments in new capacity already in the works are projected to increase
output by about 15 mbpd by 2010, implying a
3 mbpd annual increase—well above expected
increases in demand of between 1.5 and 2 mbpd
annually. As a result, the price of oil is projected
to decline modestly over the next two years,
reaching an average level of $53 in 2008.

Downside risks predominateAnumber of factors suggest the soft-landing
scenario outlined above as the most likely
outcome. Tighter monetary policy in highincome and a number of developing countries
is slowing growth in those countries andshould alleviate inflationary tensions. Meanwhile, still-low long-term interest rates andemerging-market spreads are expected tomaintain favorable external conditions for developing countries, allowing them to grow ata slower but still robust pace of 6 percent.
While the soft landing is the most likely
scenario, the global economy is at a turning
point following several years of very strong
growth—and such periods are fraught withrisk. Indeed, as described in chapter 2, the lastcentury began under similarly auspicious
circumstances, characterized by an extended
period of strong growth buoyed by technological change and ample liquidity. Rather thancontinuing forward as anticipated by leading

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economists at that time, the world plunged
into the Great Depression. Thus, while muchin the current environment is reassuring, anote of caution is merited.
The remainder of this chapter explores fourmain risks to the outlook.

Overheating could provoke
a sharper slowdown
The world economy and, in particular, developing countries have been expanding at nearrecord rates over the past few years. So far, theinflationary effects of fast growth have been
largely confined to the markets for global
goods, such as commodity markets. The
inflationary response at the national level has
been remarkably muted. Improved monetary
policy has succeeded in anchoring inflationary
expectations at low levels, while competitive
pressures induced by the entry into the global
marketplace of the countries of the former
Soviet Bloc and China, with their relatively
high skills and low wages (see chapter 4), haveboosted global productivity and kept the pricing power of firms in check. In the baseline projection these factors are assumed to continue tohold sway, while tightening of monetary policy
and slower growth in countries where signsof a pickup of inflation have emerged are assumed to prevent inflation from rising further.
However, long-term interest rates are projected to remain low and international financial conditions relatively loose. As a result,global growth is expected to remain strong
and further inflationary pressures may yet
emerge. In particular, given projected levels ofglobal demand, further price hikes in commodity markets cannot be ruled out.
Moreover, should measures to slow growthin several key developing economies(Argentina, China, India, and many European
and Central Asian economies) fail, as they
have to varying degrees in recent years, inflation in those countries could pick up. That
could lead to a more marked slowdown lateron, either because of a much sharper tightening of policy or because of endogenous factors
such as a loss of external competitiveness.

23

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2 0 0 7

A housing market crisis could
cause a recession
Growth in the United States and several otherhigh-income countries9 has been bolsteredover the past several years by rapidly rising
housing prices. In the United States, rising
housing prices increased household wealth by
14.6 percent of GDP between 2000 and mid2006. The pickup in housing valuations was
spurred by low interest rates and the introduction of new interest-only variable-rate
mortgages. Higher valuations in turn generated a boom in home-equity withdrawals,
which boosted consumer spending and residential investment.
As short-term interest rates rose, demandfor variable-rate mortgages dried up, and therate of increase of housing prices cooled substantially10 (figure 1.20). By the third quarterof 2006, the contribution to growth of residential investment had swung from a strong
0.5 percentage points in 2005 to a strongly
negative ⫺1.1 percentage points. That swing,plus the end of the additional consumption
demand generated by home-equity withdrawals, underlies the slowdown in U.S.

Figure 1.20 After rising rapidly, housing
price growth slows sharply
Increase in the price of existing U.S. houses
Percent
25
20
Year-over-year growth rate15
10
5

A disorderly unwinding of global
imbalances remains possible

0
⫺5
1976

Quarterly growth rate at annual rates
1981

1986

1991

1996

2001

2006

Sources: World Bank; Office of Federal Housing Enterprise
Oversight.

24

growth observed in the second and third
quarters, which is projected to continue into
the first half of 2007.
The risk is that the slowdown may be much
more severe, either because house prices decline more sharply or because the indirect effects of the anticipated 9.3 percent decline inresidential investment has wider impacts on
the rest of the economy. A much steeper slowdown following a sharp decline in housing
prices11 could accentuate the decline in residential investment, driving it down by asmuch as 20 percent from its level in mid-2006,
while the reversal in the trend to household
wealth could cut as much as 1 percent fromgrowth in personal consumption. On the plusside, Australia, the Netherlands, and theUnited Kingdom have all observed substantial
decelerations and even declines in housing
prices without recession (see OECD 2006 formore details).
Such a shock could prompt a recession in the
United States, with growth slowing to as little as–0.2 percent of GDP in 2007 and 2.7 percent in2008. Slower growth would weaken inflationary pressure in the United States, allowing forlower interest rates in the course of 2007, helping to spur a recovery toward the end of 2008.
Such a U.S. recession would affect developing economies through three channels: reduced
exports to the United States, lower commodity
and oil prices owing to slower global growth,and more favorable financing conditions. Thebalance of these forces would vary across regions and countries. Regions with the tightest
trade ties, such as Latin America and East
Asia, would suffer the greatest negative impact. The combination of weaker domestic
demand in the United States and less marked
slowdowns elsewhere would help to reduce
global imbalances.

The rotation of growth away from the UnitedStates and increased consumption demand inEurope and the developing world are welcome
developments that mark the beginning of an

P R O S P E C T S

orderly adjustment of global imbalances. In
particular, they signal an end to a troubling
trend of rapidly rising U.S. current accountdeficits. While relative stability should reduce
financial market concerns, the financing of the
gap in the U.S. current account, at 6.5 percent
of GDP, remains a challenge. Such a deficit is
not sustainable over the long run. Each year, it
augments the net international debtor positionof the Unites States and its financing costs. The
United States has already become the world’s
largest net debtor, with the value of foreignowned U.S. assets exceeding that of U.S.-owned
foreign assets by 21 percent of U.S. GDP in
2005. In addition, the balance of the interest
payments on these debts was ⫺$8.8 billion
during the first three quarters of 2006, the firsttime in some 30 years that the United States
paid out more than it received on internationally held financial assets. Unless savings in the
United States increase substantially, even assuming further improvements in the trade balance, the net asset position of the United States
will continue to deteriorate, potentially reaching between 65 and 48 percent of GDP by 2015
(Higgins, Klitgaard, and Tille 2005).
As long as the trend toward real-side adjustment (increased savings in the UnitedStates and increased domestic demand andimports abroad) continues, the resolution of
global imbalances should proceed in an orderly manner, even though it may take several
years beyond our medium-term projection
period (2006–08) before the U.S. current
account deficit reaches sustainable levels.
That said, the medium-term risk to the global
economy remains that adjustment will occur
not on the real side but on the financial side,
either because investors rapidly lose confidence in the dollar—thereby provoking a currency crisis, much higher U.S. interest rates,
and financial market turmoil—or because
they increasingly demand higher interest rates
on U.S.-denominated assets. While this would
help increase U.S. savings and therefore hasten adjustment compared with an orderly adjustment, it would do so at greater cost interms of growth in high- and low-income

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countries, both because of its dampening effect on investment and potential output andbecause a rapid adjustment would inevitably
result in greater short-term misallocations ofresources.
In the baseline scenario, financial sector adjustments are assumed to be benign. The expected narrowing of short-term interest-ratedifferentials is projected to prompt investors
to continue shifting assets into euros, placing
downward pressure on the dollar. This should
be offset somewhat by a tendency for U.S.
long-term rates to rise relative to those inEurope. While the relative depreciation of thedollar should be smooth, the dollar could
weaken quickly if investors were to react nervously. That would provoke much higher U.S.
interest rates and a sharper slowdown. Such arisk can be reduced by collaborative policy actions to increase public and private savings in
the United States, strengthen demand in therest of the world, and provide for more
flexible management of exchange rates.
However adjustment occurs—be it a sharp
adjustment led by the financial sector or a more
gradual real-side adjustment—the process islikely to be relatively short-lived in the context
of the 25-year projections reported in chapter
2. Although a disorderly adjustment would
imply up to two years of substantially belowtrend growth for the global economy, thiswould have minimal effects on the average
long-term growth rates reported there.

An oil-sector supply shock could
disrupt growthWith spare production capacity at only
3 mbpd, the world oil market remains vulnerable to a supply shock. Because no country
can easily ramp up production, if output in a
producing country were to fall significantly,
world supply would fall, provoking a decline
in economic activity.
Simulations presented in last year’s Global
Economic Prospects (World Bank 2006) suggest that a negative supply shock of two million barrels per day that caused oil prices todouble for a period of three months and then25

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2 0 0 7

remained at $80 for nine further months
would cause global output to shrink initiallyby about 1.5 percent of GDP, as comparedwith the baseline scenario.12 Inflation would
pick up rapidly, and on average the current
account position of oil-importing countries
would deteriorate by about 1.1 percent of
GDP. The impact would be more severe inlarge low-income and middle-income countries, both because of higher energy intensities
and a greater inflationary impact, which requires a larger contraction to eliminate.
While the impact in terms of GDP for
current-account-constrained low-income countries is smaller, it is more severe in terms ofdomestic consumption and investment. Suchcountries have limited access to international
capital markets and their capacity to pay
higher oil prices is limited by their export revenues. If these revenues are stable, such countries would be forced to reduce domestic
demand and non-oil imports in order to pay
their higher oil bill. As a consequence, when oil
prices rise, oil consumption remains relatively
constant in terms of volume (being generally
inelastic in the short run), but the oil bill rises.
To compensate, non-oil imports and domestic
demand tend to decline in unison—leaving
GDP relatively unchanged. For these countries,
the terms-of-trade-shock of the initial increasein oil prices is estimated at 4.1 percent of theirGDP, which would translate into a 2.7 percent
decline in domestic demand, with potentiallyserious impacts on poverty.

Notes
1. Housing prices, which had been rising by 10 percent a year, declined at a 1.2 percent annualized pacein the third quarter of 2006. As a result, increases inhousehold wealth slowed, and home-equity withdrawals, which boosted GDP growth by as much as
1 percentage point during 2000–05, turned negative.
At the same time, the contribution of residential investment to GDP growth fell from 0.5 percentage
points in 2005 to ⫺0.7 and ⫺1.1 percentage points inthe second and third quarters of 2006, respectively.
2. In addition to the Prospects for the Global
Economy Web site (www.worldbank.org/outlook) the

26

World Bank’s East Asia update provides more detailed
information on recent developments and prospects for
the East Asia and Pacific region (www.worldbank.org/
eapupdate/).
3. In addition to the Prospects for the Global
Economy Web site (www.worldbank.org/globaloutlook),which describes regional developments in more detail,the World Bank’s Middle East and North Africa
Web site, Economic Developments and Prospects(www.worldbank.org/mena) provides an even morecomprehensive discussion of recent economic developments, projections, and policy priorities.
4. For the purposes of this report the developing
countries of the region are Algeria, the Arab Republic of Egypt, Jordan, the Islamic Republic of Iran,
Morocco, Oman, the Syrian Arab Republic, Tunisia,
and the Republic of Yemen. Djibouti, Iraq, Lebanon,and Libya were excluded from the projections because of a lack of data. Important regional players
such as Bahrain, Kuwait, Qatar, Saudi Arabia, andthe United Arab Emirates are included in the highincome aggregate.
5. As of early November 2006, the credit ratings of
34 emerging market countries have been upgraded.
Only 3 have been downgraded.
6. Agricultural prices are quoted in U.S. dollars andtherefore have been deflated by U.S. inflation.
7. The short-term price elasticity of oil demandis estimated at between ⫺0.01 and ⫺0.2 percent(Burger 2005), implying that immediately following a
100 percent increase in oil prices, such as observed
between 2002 and 2005, oil demand would be
expected to decelerate by between 1 and 20 percent.
Long-term elasticities are larger (between ⫺0.2 and⫺0.6 percent), implying that the negative effect ofhigher prices over the past few years will continue tobe felt.
8. In the three years following both the 1973 and1979 oil price hikes, non-OPEC and non–former
Soviet Union oil producers increased their output bysome 3.5 million barrels per day. In contrast, since
2002, production from these sources has actually declined. OPEC did increase its deliveries during 2004 by
drawing down its spare capacity, but so far investment
to increase that capacity has been limited.
9. Robust increases in residential investment andrising housing prices have been important drivers ofgrowth in recent years in Canada, Denmark, France,
Ireland, Spain, and the United States.
10. As of September 2006 the median sales price ofhouses in the United States had fallen 1.2 percent (yearover-year). This measure, produced by the National Association of Realtors, differs from data provided by the
OFHEO, which are reproduced in figure 1.20, because it
does not control for the quality of the houses being sold.

P R O S P E C T S

11. Girouard and others (2006) estimate that U.S.
housing prices have a more than 75 percent chance offalling if interest rates rise by 100 basis points.
12. Studies suggest that the likelihood of such a disruption occurring over the next several years may be as
high as 70 percent (Beccue and Huntington 2005).

References
Beccue, Phillip C., and Hillard G. Huntington. 2005.
“An Assessment of Oil Market Disruption Risks.”
Final Report of Energy Modelling Forum & SR 8,
Energy Modeling Forum. October.
Burger, Victor. 2005. “House Prices in Developing
Countries.” World Bank, Washington, DC.
Dimaranan, Betina, Elena Ianchovichina, and Will
Martin. 2006. “Competing with Giants: Who
Wins, Who Loses?” In Dancing with Giants:
China, India, and the Global Economy, ed. L. Alan
Winters and Shahid Yusuf. Washington, DC, andSingapore: World Bank and Institute of Policy
Studies.
Girouard, N. and others. 2006. “Recent House Price
Developments: The Role of Fundamentals.”

F O R

T H E

G L O B A L

E C O N O M YOECD Economics Department Working Papers
No. 475.
Higgins, Mathew, Thomas Klitgaard, and Cedric Tille.
2005. “The Implications of Rising U.S. International Liabilities.” Current Economic Issues (Federal Reserve Bank of New York) 11(5).
Institute for International Finance. 2006. Capital
Flows to Emerging Markets.
IMF (International Monetary Fund). 2006. World Economic Outlook: Financial Systems and Economic
Cycles. Washington, DC: IMF.
Newfarmer, Richard. 2005. Trade, Doha, and Development: A Window into the Issues. Washington,
DC: World Bank.
Norman, John, and Lei Shen. 2006. “How Much
Money Has Left Commodities?” Global Currency & Commodity Strategy (JP Morgan, NewYork), September 18.
OECD (Organisation for Economic Co-operation andDevelopment). 2006. OECD Economic Outlook
80 (December).
World Bank. 2006. Global Development Finance2006: The Development Potential of Surging
Capital Flows. Washington, DC: World Bank.

27

2
The Coming Globalization

The emergence of China, India, and the former communist-bloc countries implies thatthe greater part of the earth’s population is
now engaged, at least potentially, in the
global economy. There are no historical antecedents for this development.
—Ben Bernanke, August 25, 2006
The last quarter-century, a time of unprecedented integration for the global economy,
has witnessed a dramatic rise in standards ofliving around the world. The fall in transportand communications costs and in barriers totrade paved the way for productivity increases associated with the integration of
emerging economies into global markets. Add
to these forces the fall of the Berlin Wall, thesubsequent lifting of the Iron Curtain, and theprogressive opening of the Chinese and thenIndian economies—and the stage was set for
a new wave of globalization of production,
trade, and finance. While the associated benefits have been uneven over time and space,
average living standards across the globe haverisen markedly. Global income has doubled
since 1980, 450 million have been lifted outof extreme poverty since 1990,1 and life expectancy in developing countries is now 65 on
average.2
Can one expect these trends to continue
for the next 25 years, and if so, what are thekey forces that will shape the world economy
of tomorrow? If globalization continues, what
does it mean for the allocation of production

in rich and poor countries? What role will developing countries play—particularly thosewith large populations, such as China andIndia? Finally, what forces could accelerate
growth and globalization—and what could
derail them?
This chapter explores these questions by
developing a long-term scenario to 2030. The
scenario is anchored in trends already evident
in recent years, and ones unlikely to be reversed in the foreseeable future. The results
describe a world in which the gross domestic
product (GDP) in high-income countries isslated to nearly double and that of developing
countries will more than triple. The progressive expansions of China and India, the twolargest developing economies and home tohalf the people of the developing world, areprojected to drive the process. Their impact
on the global economy will be increasingly
felt as their exports and energy use, for example, approach the levels of the European
Union and the United States.
The next 25 years will undoubtedly bringsignificant surprises that cause outcomes todeviate from the central scenario in this chapter. Growth in parts of the world may well be
more robust than projected in this scenario;
other countries or whole regions may faceserious setbacks. Many imaginable and evenunimaginable shocks are likely. The chapter
thus includes a discussion of various shocks
that could propel growth higher than thecentral scenario—or depress growth with29

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2 0 0 7

impacts devastating for poverty. Developing
countries are likely to become more importantin the global economy. Indeed, if anything, thelikelihood that developing countries will experience higher rises in incomes seems greaterthan the downside risks. Although outcomesless sanguine than those in the central scenario
are possible, it would take disruptive seachanges in the structure of the global economy
to produce large deviations from, much lessreversals of, the strong underlying trends
toward globalization.
The good performance of developing countries in recent years, combined with the stillhuge difference in relative incomes between developing and developed countries, points tostrong potential growth across the developingworld during the coming decades. The central
scenario assumes a world growth rate of 2 percent per capita, slightly faster—by 0.6 points
per capita—than in 1980–2005. It also assumes growth in developing countries of
3.1 percent, compared with 1.9 percent in developed countries. There are two main reasonsfor this. First, policy is far better on average
today in developing countries than it was earlier, say in 1980. Second, technological dissemination is far faster. Indeed, in the last five years,
growth in developing countries has been substantially higher—4.6 percent—than the assumption of 3.1 percent in the central scenario.
Whatever the scenario, challenges willabound. Growth and integration will lead tostructural changes, job losses, uneven income
growth, and other painful transitions. Fast
growth could lead to ever-increasing competition for scarce resources and put additionalstrains on the environment. And some regions
could continue to lag behind, owing to weak
institutions, fragile states, and inadequate infrastructure. Many of these challenges will be
dealt with at the national level, but some require global leadership. Perhaps one of thebiggest challenges will be shaping a new
global architecture that can take into accountthe increasing diversity of countries and interests and allow for peaceful resolution of
emerging global tensions.

30

The evidence of globalization

G

lobalization has been present since thedawn of modern humans nearly 50,000
years ago in Africa (see Wade 2006). The
Roman Empire stretched from Great Britain
to the Middle East nearly 2,000 years ago and
500 years ago the age of discoveries led to the
expansion of European outreach to the western hemisphere and East Asia. Two distinct
periods in more modern times are often cited
as intensified phases of globalization—the
20–30 years before World War I and the years
since World War II. Both witnessed sharp increases in trade, international migration, andflows of finance, accompanied by rapidchanges in technology—electricity, trains, andsteamships in the first period, and planes,
containers, and telecommunications in thesecond. While technology was a key factor,
policies were also important—such as the reductions in trade and financial barriers. Thissection reviews some of the key evidence ofthe most recent period of globalization hinting
at what trends can be anticipated over the
next 25 years. The section will highlight
trends in four broad categories that define
globalization—trade in goods and services,international migration, capital flows, andtechnology and information.

Huge expansion of trade
World trade has exploded since the early
1960s. World exports have grown from justunder $1 trillion a year (in 2000 dollars) tonearly $10 trillion a year, annualized growthof some 5.5 percent per year (figure 2.1).3
They are clearly outpacing global output,
which increased at some 3.1 percent per year
over the same period. Between 1970 and
2004, the share of exports relative to global
output has more than doubled and is now
over 25 percent. Throughout the early part ofthis period the export elasticity (the rate of
growth of exports relative to output) was running at about 1.5, but around 1986 the elasticity picked up substantially, peaking at morethan 2.5 a decade later. This acceleration cameon the heels of the collapse of the Iron Curtain

T H EC O M I N G

G L O B A L I Z A T I O N

Figure 2.1 World trade has expanded dramatically…
Export to GDP elasticity

Export to GDP share (%)

3.0

30

2.5

25

Share

Elasticity

04
20

02
20

00

98

20

96

19

94

19

19

92
19

90
19

19

19

19

19

19

19

19

19

19

19

88

0

86

0

84

5

82

0.5

80

10

78

1.0

76

15

74

1.5

72

20

70

2.0

Sources: World Bank Development Data Platform (DDP) and staff calculations.
Note: Elasticity is calculated as the percent change in real exports relative to the percent change in real GDP. The export share is
calculated in nominal dollar terms. Data are smoothed using five-year moving averages.

Figure 2.2 …and become more diversified…
Share of developing-country exports, by broad commodity grouping
Percent
100
80
60
40
20
0
1962

1967

Agriculture & Food

1972
Minerals & Fuel

1977

1982
Chemicals

1987
Textile & Apparel

1992

1997

Machinery & Equipment

2002
Other

Source: World Bank World Integrated Trade Solution (WITS).

and moves by China and India to open theireconomies and pursue an export-led strategy.
Other countries also abandoned inwardlooking strategies and saw their exports jump.
A large part of the opening of domestic
economies can be attributed to unilateral decisions, as in China and India, but regional andmultilateral reductions were also important inpromoting global trade. Multilateral negotiations under the guise of the General Agreement on Tariffs and Trade (GATT)—now
the World Trade Organization (WTO)—
undertook stepwise reductions in trade policies known as rounds, the latest of which, the31

G L O B A L

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Figure 2.3 …than increase in migrants—in particular toward high-income countries…
Millions of migrants% host population

120

12

Migrants to high-income countries

100

10

80

8

Migrants to developing countries,
excluding Europe and Central Asia

60

6

40

4

20

2

0

0
1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Sources: World Bank 2006a; World Bank 2006c; staff calculations.
Note: Bars are measured on the left axis; lines are measured on the right axis.

Figure 2.4 …and a sharp rise in capital flows.
$ billions

% GDP

1,200

12
Gross private capital flows
to developing countries

1,000

10

800

8

600
400

6
Net inflows of FDI todeveloping countries

4

200

2

0

0
1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Sources: World Bank DDP and staff calculations.
Note: Bars are measured on the left axis; lines are measured on the right axis. FDI ⫽ foreign direct investment.

Doha Development Agenda is the ninth in theseries. Though initially largely the realm of developed countries,4 with the expansion of
trade and WTO membership, 149 countries5
are now involved, perhaps complicating theability to achieve agreement given the more diverse set of objectives. Since 1990 there has
also been an explosion in regional trade agreement notifications, many involving the newtransition economies, but also including
expansion of the European Union (EU), theNorth American Free Trade Agreement, and32

the Southern Cone Common Market among
others, with many others in the pipeline.
Though most of these agreements have tended
to be trade-creating, they can also divert tradefrom excluded countries.
Technological breakthroughs—particularly
in transportation and communications—emerging business practices, capital flows, andthe growth in a skilled workforce have led to anincreasing proportion of developing-country
exports in manufactured goods that are more
traditionally the realm of developed countries

T H EC O M I N G

G L O B A L I Z A T I O N

Figure 2.5 Diffusion of traditional technologies has been slow, except inhigh-growth regions…
Fixed phone line subscribers per 100 persons
70
60
50
40
30
20
10
0
High-income
countries
1995

East Asia andthe Pacific
1996

1997

South Asia

1998

Europe andCentral Asia
1999

2000

Middle East andNorth Africa
2001

Sub-SaharanAfrica2002

2003

Latin America
and the Caribbean
2004

Sources: World Bank DDP and staff calculations.

Figure 2.6 …but the uptake of new technologies has been faster.
Mobile phone subscribers per 100 persons
90
80
70
60
50
40
30
20
10
0
High-income
countries
1995

East Asia andthe Pacific
1996

1997

South Asia

1998

Europe andCentral Asia
1999

2000

Middle East andNorth Africa
2001

Sub-SaharanAfrica2002

2003

Latin America
and the Caribbean
2004

Sources: World Bank DDP and staff calculations.

(figure 2.2). Goods as diverse as car parts, airplanes, semiconductors, and consumer electronics are being sourced in developing countries. For many developing countries this has

reduced their dependence on volatile commodities, though in some cases the ease ofmoving capital has also induced economic
volatility, as in apparel manufacturing.

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Table 2.1 Services exports rise in line with goods exports
Levels ($ billions)

Growth rate (percent)

Percentage of GDP

Regions and trade

1984

1994

2004

1984–94

1994–2004

1984

1994

2004

Exports of services
World
High-income countries
Developing countries
East Asia & PacificSouth Asia
Europe & Central Asia
Middle East & N. Africa
Sub-Saharan Africa
Latin America & Caribbean

357.8
303.7
54.1
9.1
4.7
7.9
10.7
4.5
17.2

978.2
803.9
174.2
49.5
9.9
47.5
19.3
8.4
39.6

2,009.5
1,614.2
395.3
115.0
32.3
124.6
36.7
20.8
65.8

10.6
10.2
12.4
18.5
7.7
19.6
6.1
6.5
8.7

7.5
7.2
8.5
8.8
12.5
10.1
6.6
9.5
5.2

3.0
3.3
2.0
1.9
1.8
—
—
2.0
2.5

3.7
3.6
3.8
4.7
2.3
5.1
6.7
3.0
2.5

4.9
4.9
4.7
4.3
3.7
7.0
6.7
4.0
3.3

External factor income
World
High-income countries
Developing countries
East Asia & PacificSouth Asia
Europe & Central Asia
Middle East & N. Africa
Sub-Saharan Africa
Latin America & Caribbean

330.4
295.2
35.2
5.6
0.8
1.0
15.4
1.4
11.1

782.4
734.5
47.9
15.5
1.3
7.3
7.1
1.9
14.8

1,578.3
1,476.7
101.5
33.7
4.8
30.5
8.1
4.6
19.9

9.0
9.5
3.1
10.8
4.9
21.8
⫺7.4
3.2
3.0

7.3
7.2
7.8
8.1
14.0
15.3
1.3
9.3
3.0

2.8
3.2
1.3
1.2
0.3
—
—
0.6
1.6

2.9
3.3
1.0
1.5
0.3
0.8
2.4
0.7
0.9

3.8
4.5
1.2
1.3
0.5
1.7
1.5
0.9
1.0

Sources: International Financial Statistics (IFS) and staff calculations.
Note: Service exports corresponds to “services credit” from the balance of payments table in IFS (code 78ADDZF). External
factor income corresponds to “income credit” from the balance of payments table in IFS (code 78AGDZF). Owing to lack ofdata, some countries are excluded from regional aggregations. — ⫽ not available.

Trade in services has been growing at apace similar to trade in goods at the global
level (table 2.1).6 Rising from $358 billion in1984 to $2,000 billion in 2004, the share ofservices exports in total exports of goods andservices has advanced modestly from 16 percent to 17.5 percent. For developing countries
in aggregate, services exports have risen from$54 billion in 1984 to nearly $400 billion in
2004, raising its share of GDP from 2 percent
to 4.7 percent. The corresponding figure forexports of goods and services is an increase
from 19.8 percent of GDP in 1984 to 35.1
percent in 2004 (with no smoothing in thetrend). Though South Asia is often mentioned
as the main source of the growth in trade inservices, the largest contributors to the rise indeveloping-country service exports over thelast two decades have been East Asia and thePacific and Europe and Central Asia. The latter region has benefited from its opening up
to the global economy, its merger with theEuropean Union, and the rapidly rising shareof services in its economies.

34

For developing countries the growth in factor income from abroad has been much lesspronounced than the growth in the export ofservices—and as a share of GDP, it has declined. This is linked to the as yet relatively
low level of outbound investments by developing countries. For developed countries, theexpansion of foreign income has been on a parwith the expansion of service exports driven
by rapid investments abroad.

Rapid increase in migration toward
high-income countries
A second component of the recent globalization is the rise in international migration, particularly in developed countries. The share of
migrants in developed countries (from both
high-income and developing countries) has
nearly tripled, going from 4.4 percent in 1960
to 11.4 percent in 2005—equivalent to an estimated 112 million persons out of a total number of migrants worldwide of some 190 million(figure 2.3). It is harder to discern the impactsof policies on the level of migration. Much of

T H Ethe South-to-North migration is predicated on
the huge income differentials between the two,even taking into account differences in the costof living. And one would expect that in the absence of (more or less) tight border controls on
the movement of people, the number of migrants would increase substantially.7 Pull factors are also in evidence in developed countries: slowing or declining labor force growth
combined with aging and higher education levels is giving rise to labor shortages for certain
skill levels and/or in certain sectors. Migrationlevels in developing countries (excluding thecountries of the former Soviet Union) havemore or less stayed constant over this time
period at about 40–45 million and have declined as a percentage of the population.

More integrated financial and capital
markets
The pace of opening of capital markets has
been slower than for trade—even among themore homogeneous developed economies.
Many countries still maintain restrictions on
capital flows but the world has nonethelessseen a huge increase in financial flows both ingross and net terms. Foreign direct investment(FDI), which is particularly attractive for developing countries because it tends to be lessvolatile than other capital flows and also has
other potential externalities such as embodied
technology, has risen both globally and in developing countries. From a low initial level of$22 billion in 1990, FDI toward developing
countries is currently running at about $200
billion a year, some 2.5 percent of developingcountry GDP (figure 2.4). Developing countries currently attract about one-third of total
global inward FDI, as FDI into developed
countries is running at some $400 billion ayear after peaking at over $1,300 billion in2000 at the end of the dot-com boom. Total
private financing of developing countries wasnearly $1,000 billion in 2004, over five times
the amount in 1990. The aggregate numbers
fail to show the wide diversity across developing countries—both in terms of levels (or as
shares of GDP) and externalities. For example,

C O M I N G

G L O B A L I Z A T I O N

FDI in natural resource sectors does notnecessarily have the employment and technological impacts compared with FDI in the electronics sector. A more recent phenomenon has
been the increase in outward FDI from developing countries from a low base of about$2.2 billion in 1990 to $41.1 billion in 2004
(World Bank 2006b).

Faster pace of technological take-up
and diffusion
Technology has been advancing rapidly—
particularly technologies that shrink theworld, easing the flows of goods, capital, andtechnology. The improvements in telecommunications are the most striking example. The
expansion of computer networking has vastly
changed the way large companies organize
production and has permitted the introduction of production networks that span the
globe. These same networks also open up
market opportunities for small firms that are
no longer limited to regional markets. Mobile
telephony is having the same impact. As thecosts of developing mobile networks are much
lower than that of traditional fixed-line networks, they have expanded rapidly even in thepoorest regions of the world, opening up newmarket opportunities for once-isolated communities.8 Though fixed-line telephony continues to be important, at least until wirelesstechnologies mature, its growth has been limited by high fixed costs (figure 2.5) except in
the high-growth countries. Mobile technology,
by contrast, has taken off (figure 2.6)—
perhaps even more sharply than shown by thedata, given that the numbers probably vastly
understate access since many users are nonsubscribers.
Improvements in transportation technology have also been impressive. The introduction of the container in the 1950s dropped thecost of loading a ship from $5.83 per ton to
15.8 cents, and even more savings came fromthe vast reduction of time ships spend in port
for loading and unloading (see Levinson2006). The advent of the jumbo jet airplane in
the late 1960s led to the rise of cheaper air

35

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2 0 0 7

freight, a key component of the integrated
global supply networks. It has enabled farmers in developing countries to export theirtime-sensitive produce—such as green beansor flowers—to high-income markets. The improvements in transportation and the adventof supply networks and global markets go
hand in hand with the improvements intelecommunications and networking.
Looking forward, one would conclude thatmany of these forces are likely to provide thesame impetus to globalization as they have inthe past—some with diminishing power, andothers perhaps with more. Trade policies havecome a long way toward more integrated markets for goods, though tariffs remain high inmany developing countries and in some
sectors—such as agriculture. Other forms ofprotection are ever present such as unreasonable product standards or ad hoc safeguard
measures. The service sectors have also been
largely untouched by the GATT/WTO disciplines, and their reform would likely provide
additional impetus to further trade growth.
The same could be said for capital flows andthe movement of people. However, the greater
driver of globalization is likely to be in thetechnological field, because the telecommunications revolution is still in its infancy. Adoption, though rapid, has still bypassed many,and the technology is evolving—with greater
speeds and the broader implementation of
wireless broadband expected. And individuals
and firms are still learning to adapt to the newtechnologies and leverage them to open newopportunities and increase productivity.

The world in 2030—the big
picturePreface: assumptions
The central scenario is built up from a numberof key driving forces—notably demographic
trends, savings, and investment behavior, andthe role of technological change, and how thesetrends interact with globalization (see box 2.1).
Some of these forces are, in turn, influenced by36

the quality of domestic and international policies. Population is expected to add 1.5 billion
people to the planet by 2030, and virtually allof the increase will be in developing countries.
Moreover, today’s high-income countries andChina will become significantly older. Changing demographics weigh heavily on the results
influencing the growth of employment, demand trends, and changes in savings and investment behavior (and even productivity).
While demographic trends are fairly predictable, assumptions about productivity
growth are subject to a wider band of possibilities. There is no agreement on how to interpret recent productivity growth, let alone
how to anticipate future patterns. For example, in the view of Gordon (2000), recent
inventions—such as cell phones, the internet,
or new drugs—are relatively normal incremental changes to productivity and are unlikely to have the same impact as the new technologies at the beginning of the 20th
century—electricity, the internal combustion
engine, telephones, radio, television, and indoor plumbing. Other observers, for example
David (1990), suggest that it takes time for
new discoveries to have their full impacts—
either because initial costs are too high, or
because there are network externalities, or because it takes time for organizations to change
their management practices to fully benefit
from the new technologies. Whether one takes
a sanguine view of new technologies or not,large parts of the developing world have yet tobenefit from “old” technologies.
The macro assumptions on productivity
built into the forecast are largely consistent
with the estimates of total factor productivity(TFP) growth from the literature (see, for example, Bosworth and Collins 2003). The
world saw a period of very rapid TFP growthin the 1960s, followed by a decade of stagnation coinciding with the energy crisis of the
1970s, recovery to an estimated rate of 0.8 percent per year in the 1980s and 1990s, and an
acceleration in the 2000s. There have been
large variations across regions and time. The
central scenario assumes a long-term rate of

T H EC O M I N G

G L O B A L I Z A T I O N

Box 2.1 Inside the box—the components
of scenario buildingT

he long-term scenarios described in this chapter
are based on the World Bank’s Linkage modelwith a dynamic core that is essentially a neoclassicalgrowth model—similar in concept to models used inother recent scenario work (see Goldman Sachs 2003
and PricewaterhouseCoopers 2006, for example).
Aggregate growth is predicated on assumptions regarding the growth of the labor force, savings/
investment decisions (and therefore capital
accumulation), and productivity.
The Linkage model, unlike the aforementioned
models, has considerably more structure—see vander Mensbrugghe (2006a) for a detailed descriptionof the model and van der Mensbrugghe (2006b) fora summary description of the model and the assumptions underlying the baseline scenario.
First, it is multisectoral. This allows for more
complex productivity dynamics including differentiating productivity growth between agriculture, manufacturing, and services and picking up the changing
structure of demand (and therefore output) as
growth in incomes leads to a relative shift into
manufactures and services.
Second, it is linked multiregionally, allowing for the
influence of openness—through trade and finance—on
domestic variables such as output and wages. The
model is also global, with globally clearing markets forgoods and services and balanced financial flows.
Third, the Linkage model has a more diverse setof productive factors, including land and natural resources (in the fossil fuel sectors), and a labor split
between unskilled and skilled.
The Linkage model has a 2001 base year and relies on the Global Trade Analysis Project (GTAP)TFP growth in the range of 1.0–1.4 for thehigh-income countries, somewhat on the highend of the Bosworth and Collins estimates. The
range for developing countries is somewhat
wider—between 0.7 and 2.9 toward 2015 anddeclining slowly thereafter as the positive impacts of rural-to-urban migration fade.
The central scenario is also predicated on
only modest changes in the policy environment.

database (release 6.1; see www.gtap.org) to calibrate
initial parameters. A scenario is developed by solving
for a new equilibrium in each subsequent year through2030 with the following key assumptions:
The growth in the labor force is driven bydemographics—essentially given by the growth of theworking-age population. Differentiated growth ofskilled versus unskilled workers is partly driven by demographics and partly driven by changes in education
rates. As education levels rise (in the younger populations), they eventually drive higher relative growth ofskilled workers once they enter the labor force (andolder unskilled workers retire).
Savings decisions are partly driven bydemographics—rising as youth dependency ratios
fall and falling as elderly dependency ratios rise. Investment rates are driven by changes in growth rates(the accelerator mechanism) and differential rates ofreturn to capital. Net foreign savings is the difference
between domestic savings and investment.
Productivity is derived by a combination of factors,
but is also partially judgmental. First, agricultural productivity is assumed to be factor-neutral and exogenous and is set to estimates from empirical studies (forexample Martin and Mitra 1999). Productivity in
manufacturing and services is labor-augmenting and aconstant wedge is imposed between productivity
growth in the two broad sectors with the assumptionthat productivity growth is higher in manufacturing
than in services.
The model assumes that energy efficiency improvesautonomously by 1 percent per year in all regions
and that international trade costs decline by 1 percent
per year.

Over the last 25 years, the world has seen adramatic drop in trade barriers for goods. And
although they remain high in some countries
and for some sectors (for example, in agriculture), the dismantling of remaining barriers will
not have the same impact as in the past. A possible exception: dismantling barriers in services
that remain high could produce significant economic gains.

37

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Figure 2.7 World population growth will
be concentrated in developing countries
in coming decades
Population, billions
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
Other
developing
countries

China

India

High-income
countries

2005

2010

2015

2020

2025

2030

Sources: UN Population Division; World Bank Development
Data Group; staff calculations.

World population will increase
As noted above, the world will add 1.5 billion
persons to its population between 2005 and2030—going from (about) 6.5 billion to
8 billion (figure 2.7).9 Roughly 12 percent
will be living in high-income countries—down
sharply from the 18 percent in 1980 and 14.5
percent in 2005. All but 40 million of thisgrowth in population will occur in developing
countries. While this represents a substantial
increase in the number of persons—with concomitant effects on already scarce resources—
it also represents a slowing of world population growth that added 2 billion persons
between 1980 and 2005. The global population growth rate, between 1.7 and 1.8 percent
in the 1980s, will slow to 1 percent by 2015
and dip to 0.7 percent toward 2030.
High-income countries would start observing actual population declines—Japan by2010 and the EU countries soon thereafter.
Japan’s population under current projections
would fall from about 128 million in 2005
to 117 million in 2030. The EU15 would

38

likewise lose about 10 million persons, fallingfrom 412 million to 402 million. The UnitedStates will see a decline in the population
growth rate, but fertility is still much higher in
the United States than in other high-income
countries—owing in part to immigrants’higher fertility. If current trends hold, the U.S.
population will climb by 45 million to
345 million in 2030.
The population growth pattern is more
highly varied across developing countries.
Many of the countries in Europe and Central
Asia are already confronted with declining
populations—including the Russian Federation, which is losing population and will continue to do so unless trends are reversed—at arate of about 0.5 percent each year. In the new
EU accession countries, population declines
average about 0.2–0.3 percent per year
through the entire period. At the other end of
the spectrum are Sub-Saharan Africa and the
Middle East and North Africa, with population growth rates currently hovering at about
2 percent, declining toward 1.1–1.4 percent
per year toward 2030.
The largest contribution to the nearly 1.5
billion increase in developing regions can be
attributed to India, representing 320 million
additional persons, and to Sub-Saharan Africa
excluding Nigeria and South Africa, with asimilar increment of 320 million—eachcontributing 20 percent to the global increase.
Despite China’s one-child policy and overall
aging population, the momentum of thecurrent population will generate 170 million
additional Chinese by 2030, another 11 percent of the global increase.

The global economy will morethan double
It is important to keep in mind, turning to theeconomic projections, that these are a combination of reasoned quantitative analysis andinformed judgment and not predicated onstandard statistically based econometricmodels, as are the short- and medium-term
forecasts described in chapter 1. They areintended to highlight certain key aspects of the

T H EC O M I N G

G L O B A L I Z A T I O N

Figure 2.8 Developing countries will account for a larger portion of world output incoming decades
Real GDP, 2001 $ trillions

Growth index: 2005 = 100
400

80
70

High-income countries

Developing countries

World
350

60

300

50

250

40

200

30

150

20

100

10

50
0

0
2005

2010

2015

2020

2025

2030

Source: World Bank simulations using the Linkage model.
Note: Bars are measured on the left axis; lines are measured on the right axis.

baseline scenario that could be robust to acertain number of alternative assumptions—though none that imply highly nonlinear divergence from current trends.
If growth scenarios obtain, the share of
output (in real terms) produced by developing
countries would shift rather steadily. The
global economy would grow from about$35 trillion in 2005 to $75 trillion in 2030, an
overall increase of some 2.1 times (figure 2.8).10 The developing-country share
would jump from $8 trillion to $24.3
trillion—effectively tripling its output between
2005 and 2030 and increasing its global shareof output from 23 percent to 33 percent.
This represents a modest acceleration ofwhat was observed between 1980 and 2005.
The global economy has increased by a factorof 2.1. For high-income countries the projection represents a slight decrease (from 2 to1.9) but a more significant acceleration fordeveloping countries (from 2.4 to 3.1). Partof this acceleration is due to compositional
factors—higher-growth developing countries
have higher weights today than back in 1980.
However, it is mostly based on the chapter
authors’ judgment that many developing
countries are on an accelerated growth path

as a consequence of the combination of improved initial conditions, better policies, andthe still wide gap in productivity—relative tohigh-income countries. Moreover, developing
countries have greater capacity and incentives
to adapt new technology as communications
technology continues to improve, FDI remains a force in overall development, andeducation and skill levels improve. If one
decomposes the last 25 years in two
periods—1980–2000 and 2000–2005—
average growth in developing countries
jumped from 3.2 percent per year in the first
period to 5 percent per year in the second.
This recent acceleration has not been sharedby all countries—nor is it exclusively a China
and India phenomenon.
Perhaps somewhat surprisingly, these differentiated growth rates will have only relatively
modest impacts on the ranking of countries/
regions based on the volume of output.11 The
rankings of the top six countries/regions would
remain identical to those of today led by theUnited States, the European Union, Japan,
China, the newly industrializing economies(NIEs), and Latin America (excluding Brazil
and Mexico). India would jump three spots
from its current 10th ranking, essentially

39

G L O B A L

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2 0 0 7swapping spots with Canada. Other countries/
regions moving up include the rest of East Asia
aggregate, Indonesia, and Iran. Sub-SaharanAfrica, with its assumed more modest growth
rates, would fall further behind with the rest of
Sub-Saharan Africa aggregate losing an additional three spots by 2030.

Looking behind again, one sees that there
have been some spectacular jumps in the past
25 years as well as some spectaculardeclines—most reflected by the fall of the Iron
Curtain (table 2.2). The clear winners havebeen Ireland, Singapore, Sri Lanka, Costa
Rica, El Salvador, Equatorial Guinea, andTable 2.2 Country rankings—1980–2005
Country

1980

2005

ChangeCountry

1980

2005

ChangeCountry

1980

2005

ChangeUnited StatesJapan
Germany
United Kingdom
FranceChina
Italy
CanadaSpain
MexicoKorea, Rep. ofIndia
BrazilAustralia
Netherlands
Russian Federation
Switzerland
Taiwan, China
SwedenAustria
TurkeySaudi Arabia
Indonesia
NorwayPolandDenmark
GreeceSouth Africa
Argentina
Hong Kong, China
Finland
IrelandIran, Islamic
Rep. Of
Portugal
ThailandIsraelVenezuela, R. B. de
Malaysia
Singapore
Colombia
Czech Republic
Egypt, Arab Rep. ofPakistan
Chile

1
2
3
5
4
10
6
8
12
13
23
11
9
14
16
7
19
32
18
24
27
15
20
28
26
29
36
22
21
42
31
53
17

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33

0
0
0
1
⫺1
4
⫺1
0
3
3
12
⫺1
⫺4
0
1
⫺9
2
14
⫺1
4
6
⫺7
⫺3
4
1
3
9
⫺6
⫺8
12
0
21
⫺16

7
⫺6
2
⫺14
⫺16
1
⫺14
4
⫺23
⫺4
5
⫺21
⫺3
3
⫺2
4
2
11
4
4
⫺7
⫺11
2
18
⫺3
⫺8
23
0
5
19
⫺5
5
⫺6
10
⫺3
⫺3
⫺2
⫺8
⫺8
7
44
⫺21
8
⫺1
⫺4

Jamaica
Bolivia
Azerbaijan
Ghana
Albania
BotswanaParaguay
Honduras
Ethiopia
UgandaSenegalNepal
Gabon
Mauritius
Madagascar
Namibia
Nicaragua
Burkina Faso
Mali
Congo, Rep. ofGeorgia
Benin
GuineaChad
Armenia
Niger
Kyrgyz Republic
Malawi
Swaziland
Togo
RwandaCentral African
Republic
Sierra Leone
Lesotho
Mauritania
BelizeBurundiSeychelles
Gambia, The
Guinea-Bissau
Vanuatu

6
7
⫺12
⫺4
8
22
⫺12
0
⫺15
4
0
0
⫺12
12
⫺12
1
⫺7
1
3
⫺5
⫺28
2
⫺2
6
⫺5
⫺10
⫺9
⫺3
5
1
⫺8
1

11
3
12
⫺12
5
20
⫺1
0
4
1
3

45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89

90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
119
120
121

34
35
36
37
38
39
40
41
42
43
44

52
40
49
34
33
51
37
56
30
50
60
35
54
61
57
64
63
73
67
68
58
55
69
86
66
62
94
72
78
93
70
81
71
88
76
77
79
74
75
91
129
65
95
87
85

96
98
80
89
102
117
84
97
83
103
100
101
90
115
92
106
99
108
111
104
82
113
110
119
109
105
107
114
123
120
112
122

45
38
48
25
43
59
39
41
46
44
47

Hungary
Philippines
New Zealand
Algeria
Nigeria
Peru
Romania
Bangladesh
Ukraine
KuwaitMoroccoVietnam
Kazakhstan
Slovak Republic
Croatia
Slovenia
Ecuador
Oman
GuatemalaTunisia
Syrian Arab Republic
Bulgaria
Dominican Republic
Sri Lanka
Sudan
BelarusCosta Rica
Lithuania
Kenya
El Salvador
Uruguay
AngolaCôte d’Ivoire
PanamaCameroon
Trinidad and Tobago
Yemen, Republic of
Zimbabwe
LatviaBahrainEquatorial Guinea
Tanzania
IcelandJordanEstonia

116
124
121
126
118
127
125
128
130

122
123
124
125
126
127
128
129
130

⫺6
1
⫺3
1
⫺8
0
⫺3
⫺1
0

Source: World Development Indicators, World Bank.
Note: Based on five-year moving average centered on 1982 and 2003, respectively. Rankings based on GDP in current dollars.

40

T H E

Botswana.12 More modest, but still substantial improvements include the Republic ofKorea, Taiwan (China), Hong Kong (China),
Israel, Oman, Panama, Portugal, andMauritius. There is little obvious commonality
across these economies with the exception thatnone (save Equatorial Guinea) is an oil producer or a transition economy. China’s GDP increase has been fast, but it has only moved
from 10th place to 6th over the 25 years andIndia has lost a spot, with both Mexico andKorea jumping over India in the rankings.
Many of the countries, having lost groundin the global ranking, are concentrated among
oil producers and transition countries including the Russian Federation, Saudi Arabia,
Indonesia, the Islamic Republic of Iran,
República Bolivariana de Venezuela, Nigeria,
Romania, Bulgaria, Gabon, and Georgia.
However, other countries have also fared
poorly—for example Brazil, Argentina, andUruguay in Latin America, and Ethiopia,
Tanzania, and Zimbabwe in Sub-SaharanAfrica—though it is generally the case thatcountries that have avoided conflict havemanaged to maintain their ranking.

C O M I N G

G L O B A L I Z A T I O N

Per capita income growth is what matters
Economic size and ranking have their importance, not least in terms of determining power
relations, be it at the global, regional, or bilateral level. But from a welfare point of view,
what really matters is income per capita, notthe overall size of an economy.13 Using themarket dollar exchange rate of an economy
provides a biased estimate of individual wellbeing because prices differ substantially acrosseconomies—particularly for nontraded goods
such as personal and housing services. For thisreason, it is more appropriate to use the PPP
exchange rates, which take into account thesedifferences in prices.14 Even using PPP exchange rates, the speed of convergence between developing- and developed-country
incomes would be modest under this scenario.
At today’s income in PPP terms, the averagedeveloping-country resident receives about
16 percent of the average income of highincome countries—$4,800 versus $29,700(figure 2.9). This ratio would rise to 23 percent
in 25 years’ time, representing an averagedeveloping-country income of $12,200 versus$54,000 for high-income countries.

Figure 2.9 In some developing regions, per capita incomes will begin to converge withthose in high-income countries
Index: high-income countries = 100
40
35
30
25
20
15
10
5
0
East Asia andthe PacificSouth Asia

2005

Europe andCentral Asia

2010

Middle East andNorth Africa

2015

2020

Sub-SaharanAfrica2025

Latin America
Low- andand the Caribbean middle-income
countries
2030

Source: World Bank simulations using the Linkage model.
Note: Ratio of PPP-adjusted per capita incomes relative to high-income average. PPP is fixed at base year (2001) level.

41

G L O B A L

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2 0 0 7

There is, perhaps needless to say, great variance across countries. Chinese incomes would
rise from 19 percent of the average highincome level to 42 percent, a significant narrowing of the gap and would achieve an average income close to the lower range of today’spoorest high-income countries. There would
be a further falling behind in Sub-SaharanAfrica with its modest per capita growth
below the high-income average, and Latin
America would see little if any convergence on
average. As the previous 25 years have shown,
there is plenty of scope for surprises and countries doing significantly better, even compared
to countries with similar initial conditions.15
The rather modest level of convergence
overall nevertheless obscures the fact thatmarket opportunities for both developed anddeveloping countries will increase dramatically as the sheer size of the population of developing countries ensures the growth of avery significant middle and upper class likely
to rival the purchasing power of today’s highincome consumer (see chapter 3). Thus,
notwithstanding the challenge that poverty
will continue to hold on the global community, the wider spread of wealth globally will
also provide greater means to deal more substantively with poverty and other global concerns such as the environment and health.
The next sections delve more in depth into
the underlying assumptions of this central
scenario and some of the policy implications
that can be derived from them and theirpotential alternatives.

Demographics are central to thegrowth scenario
Two significant demographic changes are occurring at the moment. Developed economies
have seen a huge decline in fertility rates (wellbelow replacement rate), a stable labor force
that will begin to decline, and rapidly aging
populations. Developing countries—some earlier than others—are now also seeing significant declines in fertility rates and a substantial
reduction in the number of youths relative tothose in the labor force. Labor forces are still42

growing rapidly in most countries owing to
the large number of births over the last two
decades and most are only seeing modest increases in the share of the elderly in the population because rising life expectancy largely
impacts current (and larger) generations
rather than past.
For developed economies, the standard
economic impacts of slowing population
growth and aging suggest that aggregate
savings will decline, all else being equal, as
aging populations tend to dis-save or consume
out of existing assets. This would tend to decrease the amount of savings available fordeveloped countries. The evidence for this dissaving is mixed and other factors—such as
current levels of public and/or international
indebtedness—may influence the long-term
patterns of savings and investment. On theother hand, lower rates of employment
growth could have mixed impacts on investment. Lower labor supply could lessen theneed for investment in sectors where labor andcapital are close complements.16 But more intense investment may counteract this effect insectors where labor and capital are substitutes
and labor-saving technology is an option.17
Aging populations can have other consequences. Productivity growth could be higher
in economies with rapid increases in the number of youth joining the labor force. They canalso be associated with changes in consumer
behavior with less demand for food and educational services and more demand for leisureand health services (McKibbin 2005; Bryant
2004; Helliwell 2004; Tyers and Shi 2005).
There could also be fiscal implications aspromises to earlier generations in terms of social welfare benefits prove hard to finance witha lower tax base. This eventually may involve a
combination of lower benefits and delay of retirement age or other forms of higher laborforce participation rates by the elderly.
For developing countries, some of these impacts are reversed. With a lower proportion ofyouth to care for—including provisions forhousing, education, and nourishment—more
can be saved and invested, particularly because

T H E

many countries still have a low proportion ofelderly. To the extent that available savings
from developed countries decline, the higher
savings in developing countries would tend tooffset the decline.
Starting with employment, developedcountry employment growth, though positive
through 2010 at about 1.2 million new jobs per
year, becomes negative thereafter, with an average loss of about 700,000 jobs between 2010
and 2015, jumping to an annual average loss ofover 3.2 million between 2025 and 2030 (figure 2.10).18 This latter number represents a
decline of about 1 percent per year. Amongother things, this negative employment
growth implies—through standard growthaccounting—that combined capital accumulation and productivity will have to accelerate tocompensate if aggregate growth of 2–3 percent
per year is to be maintained. The start of thedecline in the labor force varies across countries, already (potentially) observable in Japan,
beginning in the European Union shortly after
2010, and delayed in the United States (andAustralia and New Zealand) until sometime

C O M I N G

G L O B A L I Z A T I O N

between 2020 and 2025—somewhat later thaneven for the NIEs of East Asia.
Labor force growth is still rapid in developing countries—though on a declining trend
throughout the period. Currently, developing
countries need to increase employment by
nearly 50 million jobs per year to keep up
with working-age population growth under
the proviso of no change to the labor force
participation rate including females. Thislatter assumption may be dubious in light of
the fact that fertility is declining rapidly in developing countries. The largest needs are in
the largest countries, with China and India
needing to create 8–10 million jobs each year.
This may be easier in these rapidly growing
economies. Countries in Sub-Saharan Africa
also need to create close to 10 million jobs
each year. With their lower economic growth
rates and relatively small urban populations,the task appears to be much harder.19
The trends for China also show the impacts of its decades-long population policies
limiting births. In a relatively near future,
employment growth will decline precipitously

Figure 2.10 Labor force growth is slowing
Average annual change in employment, millions of persons
16
14
12
10
8
6
4
2
0
⫺2
⫺4
⫺6
High-income
countries

East Asia andthe Pacific2005–10South Asia

2010–15

Europe andCentral Asia
2015–20

Middle East andNorth Africa
2020–25

Sub-SaharanAfricaLatin America
and the Caribbean

2025–30

Sources: UN Population Division; World Bank Development Data Group; Global Trade Analysis Project (GTAP) Database; WorldBank simulations using the Linkage model.

43

G L O B A L

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2 0 0 7from over 5 million between 2010 and 2015
to under 500,000 between 2015 and 2025
and will turn negative thereafter. The only
other region affected by negative employment
growth is Europe and Central Asia, whose
population is more similar in structure to theEuropean Union than to the average developing country.
In summary, employment growth initiallywill provide significant stimulus to economic
growth, but its share will decline rapidly inmost developing regions as the current generation of youth join the workforce and leavebehind a smaller pool of potential workers as
fertility continues to fall.
The demographic projections for youths
and the elderly are distinctly different in nature mainly because the future elderly are allalive today and thus the projection is based onchanges to mortality rates that tend to beeasier to gauge than changes to fertility rates.
In fact, the UN population forecasts—thebasis of the World Bank’s forecasts—are predicated on all countries converging toward
population replacement levels of fertility by
2050. This implies an increase in fertility inmany high-income countries, where fertility
has dropped to between 1 and 1.5 births per
woman.20
Over the longer term, the increase indeveloped-country fertility would lead to aslight rise in the share of the population aged
15 and below, and even an absolute rise,sometime after 2020 (figure 2.11).
The growth in the number of youths in developing countries will stay more or less constant on average over the entire time horizon—
though again highly variegated across regions,with large declines in East Asia and the Pacificand Europe and Central Asia offset by positive
if declining growth rates in Sub-Saharan Africa
and to a lesser extent South Asia. But even in
Sub-Saharan Africa, the assumption of replacement-level fertility will lead to a sharp decline in births. Between 2005 and 2030, theshare of youths in Sub-Saharan Africa will
drop from 44 percent to 35 percent. Despite
this leveling, the pressure to educate (and provide health services) for the young in SubSaharan Africa will be a challenge in a region
that is significantly off-track in terms ofachieving the Millennium Development Goals

Figure 2.11 Due to the demographic dividend, fewer resources will be needed for a declining
youth population
Youth as a share of total population (%)
50
45
40
35
30
25
20
15
10
5
0
High-income
countries

East Asia andthe Pacific

2005

South Asia

2010

Europe andCentral Asia

2015

2020

Sources: UN Population Division; World Bank Development Data Group.
Note: Youths include those who are 0–14 years old.

44

Middle East andNorth Africa

2025

Sub-SaharanAfrica2030

Latin America
and the Caribbean

T H E(MDGs) by 2015. The number of young people
in Sub-Saharan Africa will jump by 100 million
from 300 million currently, so it is not simply aquestion of building new classrooms and training new teachers for today’s population, butalso taking into account the bulge in thestudent-age population as one looks forward.
Potentially, the resources to take care of the
youth will improve as the number of workers
grows more rapidly than the number ofyouths in developing countries. The dependency ratio—defined as the number of youths
per 100 workers—will drop pretty steadily between 2005 and 2030, starting at a level of 60
and falling to 47. Even with the sharp drop in
the youth dependency ratio in developing
countries, they will still have an average ratio
considerably higher than the average in highincome countries centered at around 35.21
These ratios will reach developed-country
levels in East Asia and the Pacific and inEurope and Central Asia—pretty rapidly inboth cases—by about 2015. Both Middle Eastand North Africa and Sub-Saharan Africa
stand out as having particularly high youth
dependency rates—85 and 93 (per 100 workers), respectively, well above the average for

C O M I N G

G L O B A L I Z A T I O N

developing countries. These ratios will drop,
but even in 2030 will remain at 60 or above.
The number of elderly will more or lessdouble over the next 25 years—from 464 million in 2005 to about 910 million in 2030.
By and large, future population aging isa developed-country phenomenon—though
only one in three elderly currently lives in developed countries and another one in three
lives in China or India. The number of elderly
per 100 workers in developed countries
would rise from 30 to 53 between 2005 and2030 and reach 63 in Japan and 59 in the EU(figure 2.12). Even in the United States therate could nearly double from today’s low of
23 to 44 in 2030. This will undoubtedly necessitate forceful policy changes because existing unfunded promises to future elderly would
require unprecedented taxes on workers.
For developing countries, aging populations(as defined by the number of elderly per 100
workers) will rise only slowly from current
levels through about 2020, but will start accelerating modestly afterwards to reach a levelof nearly 19 starting from 12 in 2005. This is
still well below the developed-country averageof 30 today and differs widely across regions.

Figure 2.12 More resources will be needed to take care of a growing elderly population
Elderly persons per 100 workers
60
50
40
30
20
10
0
High-income
countries

East Asia andthe PacificSouth Asia

2005

2010

Europe andCentral Asia

2015

2020

Middle East andNorth Africa

2025

Sub-SaharanAfricaLatin America
and the Caribbean

2030

Sources: UN Population Division; World Bank Development Data Group.
Note: Elderly include those who are 65 or older.

45

G L O B A L

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2 0 0 7China will see a sharper rise in its elderly
dependency rate, moving from 12 currently
to 25 by 2030. This could be contrasted with
India, which has a level similar to China’s at 11,
but rising to only 16 by 2030. As mentioned
earlier, population-wise Europe and Central
Asia is more similar to high-income regions andthe elderly dependency ratio will hit 34 by
2030. What moderates this to some extent inEurope and Central Asia is the inclusion ofTurkey with its relatively young and large population and, more unfortunately, the precipitous decline in life expectancy in some parts ofEurope and Central Asia.
These demographic trends provide a significant opportunity for many developing countries22 that will be able to devote less resources
to their youth and that do not yet have to devote significant resources to their elderly—
although they would be well advised to avoid
making some of the choices that developed
countries have made regarding long-term
commitments to their elderly without adequately making provisions for them.

The four channels of globalizationW

hat follows is a discussion of the four key
channels of globalization and how theyinteract with the development process—tradein goods and services, movement of persons, financial flows, and technological diffusion.

Trade integration will accelerate
The trade dimension of globalization has perhaps been the most prominent, especially withthe emergence of Asia and the transition
economies over the last two decades. Growthin trade has outpaced growth in output by afactor of two or more and the causes behind
this phenomenon are in place to sustain it overthe next two decades.
Income growth, changing comparativeadvantage, and the push toward greater
openness—the impasse in the Doha Roundnegotiations notwithstanding—will continue
to lead to expanding global trade over the
next two decades. Though import tariffs have46

dropped dramatically since 1980, they still remain stubbornly high in some sectors, for example in agriculture and services, or in somecountries. Protection can also take otherforms, for example antidumping, questionable
standards, or variable levies (as bound tariffs
are typically well above applied tariffs).
Progress in opening markets has stalled at themultilateral level, but countries continue topursue liberalization either unilaterally or
through bilateral and regional agreements.
While the standard theory of trade has focused on comparative advantage, new trade
theory places much more emphasis on the roleof specialization. Specialization is manifested
in two ways. The first is consumers’ desire forgreater varieties of the same categories ofgoods. Whereas 25 years ago consumers had arelatively modest selection of automobiles orfashion, today’s range of consumer goods ishuge. This love of variety has provided producers from a diverse set of countries with opportunities to export. A second form of specialization is represented by production
networks that allow for the breaking up of the
production process across multiple firms
and/or countries. The growth in production
networks has been predicated on many technological advances—both physical, as intelecommunications and transport, and management processes, such as supply chain logistics. There is little evidence that these factors
will subside anytime soon.
Under the central scenario, the level of exports would more than triple—from about$9 trillion in 2005 to over $27 trillion in 2030—
with a concomitant rise in the world export-tooutput ratio, jumping to 34 percent from
25 percent currently. For developing countries
exports will increase from about $3 trillion toover $12 trillion, reflecting in part these countries’ greater output growth. These baseline
numbers are predicated on the assumption of
no change to current trade policies.23 Under abroad reform scenario whereby all countries reduce tariffs on merchandise goods (and domestic agricultural protection) by three-quarters,
exports by developing countries would increaseT H Eby an additional $2 trillion in 2030, a jump ofsome 18 percent over the baseline.

The push and pull factors driving
international migration will persist
International migration has risen substantially
recently—though the lack of reliable data, particularly of irregular migration, makes it difficult to assess the actual number of migrants ineither developed or developing countries. Current estimates are that 11.4 percent of developed countries’ population are foreign-born,up from 6.2 percent in 1980. South-South migration is also an important phenomenon, butdata prove even less reliable.
While developing countries on average will
see improvements in living standards relative
to high-income countries, the forces underlying South-to-North migration will continue tohave a strong impact. First, there is the existing, considerable wage gap (even taking into
consideration differences in purchasing
power) that will shrink, but will still be substantial well into the future. Second, the combination of existing migrant stocks (and thepush to reunite family and friends) with potential reductions in migration costs will provide ongoing impetus for South-to-North migration. Third, the slowing growth of theworkforce in developed countries and theaging of populations will be a pull factor in increasing migration over the next two decades.
However, unlike the trade in goods and services, or the flow of capital, migration is
subject to considerable regulation and control
and is also fraught with many additional considerations. Sending countries are concernedwith the social and family aspects of outward
migration, or in some cases with brain drain.
The receiving countries may also be concernedwith the social implications of migration andthe economic and fiscal consequences, particularly for those whose populations compete
directly with the migrants.
Notwithstanding these legitimate concerns,
in a global context, the economic impacts ofincreasing South-to-North migration can behighly beneficial. Any form of economic

C O M I N G

G L O B A L I Z A T I O N

restriction on the exchange of goods and services has an economic cost and migration is nodifferent. Global Economic Prospects 2006
(World Bank 2006a) explored in depth themain impacts of such migration, illustrating inparticular that the greatest beneficiaries are themigrants themselves, though through remittances, the sending countries could also gain
substantially. The aggregate impacts for the receiving countries are also on balance positive,
though they could have negative distributional
consequences.
This chapter’s central scenario uses the underlying UN methodology and projections forthe growth in country population and makes
no additional assumptions as regards international migration. Though migration can makea significant impact for the migrants themselves, in the context of a 25-year scenario, international migration is unlikely to have large
macroeconomic impacts save perhaps for a
handful of smaller economies or countries thatreceive high levels of remittances. The United
Nations forecasts the net number of migrants
to developed countries to increase by 98 million between 2005 and 2050, or about
2.2 million annually. This is expected to moreor less offset the net natural population decrease in developed countries (that is, the excess of deaths over births). For developing
countries, this represents only 4 percent of
total incremental population between 2005
and 2050 (and thus a small fraction of thetotal population) (see UN 2004).

Financial integration will intensify
Savings, investment, and finance. The global
financial system is likely to change dramaticallyover the course of the next 25 years, as
technological innovations and even greater
integration of markets expand the reach ofglobal financial intermediaries. Some of thesechanges are impossible to anticipate. For
example, it is not clear whether the futurecommunications technologies will favor acontinued concentration of financial intermediation, or encourage the growth of global
banks and other financial institutions in a

47

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2 0 0 7

wide range of markets, or lead to even greater
decentralization as smaller investments are
required to obtain the information necessary to
carry out financial transactions. Other changes
can be partially anticipated. For example, as
developing countries take up a greater share of
global output, it is likely that their importancein financial markets will continue to grow.
Some decline is already apparent in thedominance of the dollar as a currency oflending and reserves (World Bank 2006b), butwhether currencies from developing countries
will play a major role in global financial
markets is not yet apparent.
One major issue facing developing countries
over the next quarter-century is the impact ofdemographic trends on the countries’ access toexternal savings. The rise in old-age dependency ratios in industrial countries, and insome developing countries, is likely to be associated with a decline in saving, a rise in interest
rates, and a fall in their current account surplus. All else being equal, the elderly tend tosave less or even dis-save, as they live off of savings earned during their working years. While
forecasts of saving rates are uncertain, and estimations of the relationship between aging
and saving rates vary widely, the prospect of
reduced global saving over the coming decades
needs to be considered seriously.
The coming savings decline. The life-cycle
theory of consumption argues that saving rates
are low during young adulthood to provide forchildren, rise as individuals save for retirement,
and then fall as retirees live off of theiraccumulated assets. This theory is subject tosignificant qualifications, as individuals also
save to provide a bequest for their children andto maintain a stock of wealth to deal withadverse shocks. Saving rates also are influenced
by a host of macroeconomic factors, including
growth, interest rates, inflation, borrowing
constraints, fiscal policy, pension systems, andincome distribution (Loayza, Schmidt-Hebbel,
and Servén 2000). Econometric estimateshave provided mixed support for the viewthat savings behavior is governed by life-cycle

48

considerations.24 On balance, some decline insavings can be expected as elderly dependency
ratios increase.
This simple theory of individual behavior,in conjunction with demographic trends set
off by the baby boom after World War II and
the impressive increases in longevity in the developing world, has dramatic implications forthe global economy. For Europe, Japan, andEast Asia, which have relatively high saving
rates and supply a large share of global financial flows, the rise in dependency ratios should
lead to a decline in savings.25 By contrast, thevery low saving rates in Sub-Saharan Africa
may be at least partially explained by the region’s very high youth dependency ratios. Saving rates should rise as these young people
move into the workforce, boosting investment
and growth.
The decline in saving rates is not expected
to follow a smooth trend over the next
25 years. In industrial countries, saving rates
should rise in the near future, as the bulk of
the baby boom generation remains in theworkforce during peak saving years. However,
over the next 20 years this generation will retire, and saving rates will go down. Russia andsome of the other countries of the former Soviet Union are likely to see a decline in thelabor force, and thus savings, owing to risingelderly dependency ratios shortly after the industrial countries, followed closely by China
and some other parts of East Asia. Latin
America and South Asia may see some effectof rising elderly dependency by the end of theforecast period. By contrast, Sub-SaharanAfrica and the Middle East and North Africa
have relatively young populations and should
see increasing labor force participation andsavings through 2030. Overall, the forecast
drop in global saving is quite substantial, from
21.6 percent of income in the first half decadeof this century to 19.9 percent by 2030.
Demographic influences also imply a decline in investment demand, as fewer workers
are available for each unit of investment.26
Other aspects of aging may boost investment
demand. Aging may spur investments in

T H E

human capital to compensate for reduced
numbers of workers (Fougère and Mérette1997). The decline in the labor force is likely
to lead to higher wages, thus increasing investments that save on labor, either in productive processes or in the supply of services at
the household level. Similarly, aging may accelerate technical progress by increasing incentives to innovate. Cutler and others (1990)
estimate that a decline of 1 percentage point inlabor force growth in 29 countries for
1960–85 was associated with a 0.5 percentage
point increase in TFP growth. On the other
hand, older workers may be less innovative,
reducing technical progress (Börsch-Supan
1996).
On balance, it is likely that investment will
decline in regions where elderly dependency
ratios are rising, but not by as much as savings, leading to a decline in these countries’
current account surplus (or a rise in theirdeficit), along with a rise in global interest
rates. This is roughly consistent with findings
in Helliwell (2004), where half the impact ofdemographic change was matched by a corresponding change in investment, and half
showed up in the current account. Estimatesof reduced form relationships between demographic ratios and current account balances(Bryant 2004), cross-country time-series
analysis (Lührmann 2003), and forecastingmodels based on estimations from historical
relationships (IMF 2004; Turner and others
1998; Higgins 1998) find that countries withdependency ratios that are rising relative toother countries’ tend to experience a weakening of current account balances.27
Implications for developing countries’ accessto finance. According to this chapter’ssimulations, the high-income countries’
current account surplus is likely to deteriorate
by $800 billion by 2030, or 1.7 percent of
GDP. The decline in capital flows todeveloping countries and the rise in interest
rates on developing countries’ loans may begreater than anticipated by this demographic
model. Developing countries are likely to

C O M I N G

G L O B A L I Z A T I O N

remain relatively risky investments. If risk
aversion rises with age, the aging of the richcountries will imply a greater premium forrisk, and thus less willingness to lend todeveloping countries. Higher risk premia
could result either because older individuals
control a greater share of investment funds, or
because the share of pensions and otherinstitutional investors in financial systems
increases.28 In the United States, the numberof Americans aged 65 and over will double
between 2000 and 2030, so the asset holdingsof the elderly are likely to grow substantiallycompared with total holdings (Bellante andGreen 2004).
It is likely that risk aversion does rise withage. Older individuals have less time to makeup any shortfall in savings owing to the highvolatility of investment returns. In the standard models of portfolio choice, the only
factor that explains age-related differences in
portfolio allocation is differences in risk aversion (Poterba and Samwick 1997). Bodie,
Merton, and Samuelson (1992) show thatolder individuals will place a smaller share of
their portfolio in risky assets than will
younger individuals if the latter can vary their
supply of labor to offset volatility in asset
returns. Kimball (1993) argues that facing
increasing risks in general, for example higher
medical risks, should make individuals lesswilling to bear other risks, for example financial risks. Samuelson (1989) concludes that,assuming that one must ensure a minimum
level of wealth (to ensure subsistence) at retirement, younger individuals will be more
willing to take risks than older.
Despite this theoretical support, empiricalestimates of the relationship between age andrisk aversion are inconclusive (Ameriks andZeldes 2004).29 Measuring whether aging is
associated with a shift to less risky assets isfraught with difficulty because it is hard to
distinguish the impact on portfolio allocationof age, of the person’s date of birth (different
age cohorts may behave differently), and of
the date of observation.30 Moreover, the dataon household allocation, even in the United49

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2 0 0 7

States, are incomplete and subject to measurement error.
One way that developing countries could
adjust to account for increased risk aversion
in financial markets is a greater use of securitization, particularly of future receivables,such as export revenues, remittance receipts,
and diversified payment rights (DPRs). Securitization or structured finance techniques indeveloping countries are designed to enhance
the credit ratings of debt issued by borrowers,
typically to an investment grade status. Thiscan allow sub–investment grade borrowers topierce the sovereign “rating ceiling,” which
often constrains the access of subsovereign
entities in developing countries to international capital markets (Ketkar and Ratha
2001). Securitization usually results in reduced spreads and longer maturities for
emerging market debt issues, compared toconventional or unstructured debt. While traditional items such as oil and gas and mining
receivables were among the first to be securitized, other assets (such as remittances andDPRs) have increasingly taken their place inrecent years (figure 2.13).
Fundamentally, however, developing countries will need more than innovative financing
techniques to deal with the coming decline in
Figure 2.13 Future-flow securitizations indeveloping countries, 1990–2004
Telephone receivables
3%

Airline ticket receipts
3%

Export receivables:
other
10%

Credit card
receivables
20%

Exportreceivables:
oil and gas
37%

Remittancesand DPRs
19%
Export receivables:
mining8%

Source: Ketkar and Ratha 2005.

50

savings in high-income countries. They willneed to improve creditworthiness throughsound fiscal and monetary policies, maintenance of an appropriate exchange rate, open
trade policies, and institutional reform to improve the efficiency of investment. Relatively
youthful countries in Sub-Saharan Africa andthe Middle East and North Africa can benefit
from the coming rise in savings in theireconomies, but only if an appropriate investment climate provides secure financial instruments for keeping savings, and efficiently allocates saving to productive investment. As
capital becomes scarcer in the global economy,
many developing countries will have the opportunity to improve financial returns and diversification through capital outflows, while
low-income countries in particular could benefit from South-South flows. South-South capital flows have risen greatly over the past
decade (World Bank 2006b), and demographic trends will provide a further impetus
over the next quarter-century. In short, policy
reform and a strengthening of the institutional
environment should enable developing countries to maintain their access to the savings required for growth in the face of a decline inexternal finance from industrial countries anda rise in global interest rates.
The transition to the medium term.
Expectations of the decline in industrial
countries’ savings over the medium term
may have important implications for shortterm instability in financial markets. The
sustainability of the U.S. current account deficit
is an important vulnerability. As outlined inprevious editions of Global Economic
Prospects, there is a danger that investors willlose confidence in the ability of the UnitedStates to finance continued, large deficits,
leading to a sharp decline in external financeand thus some combination of large increases ininterest rates and a sharp depreciation of thedollar. Anticipated demographic trends would
exacerbate the shortfall between the existinglevel of the U.S. current account deficit andwhat foreigners are willing to finance.

T H EThe basic issue is that the baby boom generation in the United States is now passing
through what should be its period of highest
saving—if baby boomers are to ensure that they
have adequate financial resources to sustain
themselves through retirement. While highimmigration rates (relative to those in other industrial countries) should continue to support
labor force growth for the next decade, the U.S.
labor force is forecast to slow to 0.5 percent
from 2005 to 2015 (compared with 1.3 percent
from 1995 to 2005) and should actually decline
beginning about 2020. At the same time, U.S.
personal saving rates are at their lowest point
since the government began compiling consistent statistics in 1959.31 If saving rates do notrise in the near term, the country will be in avery poor position to face rising dependency
ratios, a declining labor force, and hence an
impetus for further declines in savings.
More generally, unfunded pension liabilities
combined with anticipated demographic trends
pose a considerable challenge to industrialcountry policy makers that could imply
slow growth, economic instability, or both.
Industrial-country governments may impose
higher taxes to cover unfunded pension costs,
eroding incentives to work and invest. Alternatively, governments may accommodate theconflicting demands of pensioners and current
workers through monetary expansion, leading
to inflation and a more pronounced economic
cycle. In any event, an inability to appropriately deal with the challenges posed by the
demographic transition would have serious
consequences for the global economy.

Technological diffusion: productivity,
information, and knowledge
It has long been recognized in the economic
literature that higher incomes are produced in
the long run primarily through productivity
growth rather than factor accumulation. Withdeclining labor forces in some countries anddeclining labor force growth in all, productivity will play a more prominent role in maintaining economic growth over the next
25 years.

C O M I N G

G L O B A L I Z A T I O N

Trade, FDI, foreign travel and education,and improvements in mass communication
have all played a significant role in the past
25 years to enhance productivity in many
parts of the world—and a reinforcement ofthese trends is likely to continue.
More than ever before, all countries haveaccess to a large share of the world’s mostadvanced technology through improvements incommunications technology and access to theWorld Wide Web.32 The capacity to harness
these technologies has enabled countries suchas China and Thailand to quickly advance up
the technology ladder and evolve from exporting natural resource– and/or low-skilled, laborbased goods toward exporting advancetechnology–laden goods such as microprocessors and flat panel displays. Given the greater
availability of information and technology,
what will differentiate countries is their ability
to adopt these technologies—the skill level of
their workforce, the appropriate capital and infrastructure, openness to trade and FDI, andmore generally the investment climate.
Some technologies actually allow firms andeven individuals to overcome these obstacles.
Mobile telephony and access to the Internet
have the potential to transform and raise information sharing to unprecedented levels,
particularly for the poorest and most isolated
in the global economy. For example, SubSaharan Africa has long lagged most developing countries in telecommunications infrastructure. Mobile telephony penetration has
been impressive (figure 2.6)—and as noted
above, the number of subscribers most likely
largely understates the actual access because
small-scale mobile service firms have madeservice available to a much broader share of
the population through the selling of access tosmall time slices of mobile phone service.
A significant portion of productivity growth
can be captured by technology embodied inimported inputs and capital, or through learning by doing or imitating. At the same time thelarger and more diverse developing economies
have built considerable, if yet infant capacity inresearch and development. But one particular51

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2 0 0 7challenge for the global community will be to
improve the research and development potential for underfunded regions and sectors—for
example to jumpstart a green revolution in SubSaharan Africa or in medical research to alleviate the scourge of tropical diseases.33

would have fewer resources to tackle themand be more reluctant to compromise in undertaking multilateral action. Faster growthwould likely ease distributional concerns andlabor market adjustments, but increase pressures on the global environment. The brightside of faster growth for the environment isthat an accelerated pace of technologicalchanges and investments in capital stockmeans that abatement technologies can be
adopted sooner and at lower costs than withslower growth.

What will happen if growth isslower—or faster—in the next
25 years?

H

istory has shown that past trends are not
immutable over time. In fact, the only
thing certain about the future is that surprises
will occur. However, even if growth rates turnout to be faster or slower than in the central
scenario, the demographic and globalizationrelated strains in the global economy identified in that scenario are likely to persist—if
in somewhat different form. If developing
countries grow by only by 1.5–2 percent percapita over the next 25 years, a glum scenario
from any point of view, globalization-related
problems would remain—including the issues
examined in subsequent chapters, such as
income distribution, labor market adjustments,
and the environment. Slower growth is likely toheighten all of these problems, as countries

A slow-growth scenario
The last quarter-century has shown a diversity of growth trends across regions, but
trends have been less volatile in the global aggregates. It is hard to identify in the global
aggregates well-known systemic crises such as
the Latin America debt crisis, the fall of the
Berlin Wall, or the more recent Asian financial crisis and its aftermath—with the one notable exception of the energy crisis of the
1970s. Figures 2.14a–c show the evolution of
long-term per capita growth rates over theperiod 1970–2005. The growth rates reflect
the 10-year period average growth rate foreach year. That is, the 1970 number reflects
the average annual growth rate between 1960

Figure 2.14a Past global growth…
10-year per capita income annual growth rate, percent per year, 1970–2005
4.5
4.0
3.5
Developing countries

High-income countries

3.0
2.5
2.0

World

1.5
1.0
0.5

Source: World Bank DDP.

52

04
20

02
20

00

98

20

96

19

19

94
19

92
19

90
19

88
19

86
19

84
19

82
19

80
19

78
19

76

74

19

72

19

19

19

70

0

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G L O B A L I Z A T I O N

Figure 2.14b …has been around 2 percent per capita for high-income regions…
10-year per capita income growth rates, percent per year, 1970–2005
10
Japan

9
8

Korea, Rep. of

7
6
5
High-income countries43
2

United States

1

EU15

04
20

02
20

00

98

20

96

19

19

94
19

92
19

90
19

88
19

86
19

84
19

82
19

80
19

78
19

76

74

19

72

19

19

19

70

0

Source: World Bank DDP.

Figure 2.14c …and much more volatile in developing countries
10-year per capita income growth rates, percent per year, 1970–2005
8
6

East Asia and the PacificSouth Asia

42

All developing countries0
Latin America
Sub-Saharan Africa⫺2Middle East and North Africa

Europe and Central Asia

04
20

02
20

00

98

20

19

96
19

94
19

92
19

90
19

88
19

86
19

84
19

82
19

80
19

78
19

76

74

19

19

72
19

19

70

⫺4

Source: World Bank DDP.

and 1970 in per capita terms. By 2005, thegrowth rate for developing countries had
accelerated to 3.4 percent.
If instead of the 3.1 percent growth in percapita incomes assumed for developing countries in the central scenario, developing countries were to grow at their average for the entire 25-year period of 1.9 percent (with world
growth a meager 1.4 percent), their incomes

would be about 25 percent lower per capita.
This translates into a reduction of GDP in
2030 by some $5.5 trillion, nearly $800 perperson. This would be disappointing, and it
underscores the importance of competentcollective global economic management—andwell-conceived domestic policies.
Still, it would take a sharp set of shocks todepress growth rates to this level. And only if

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2 0 0 7these shocks were to occur in tandem, in morethan one region, and with some adverse policy
feedbacks would rates likely be depressed substantially below this level. Even then, the reversal in the growth and global integration
process worldwide would likely be relatively
short-lived. One reason is that one sees muchgreater stability on average for the three major
economies of the world—Japan, the European
Union (EU15), and the United States (figure 2.14b). Together, they make up more than
two-thirds of the global economy. The European Union, and even more so Japan, benefited
after the end of World War II from catching up
to the United States and rebuilding after thedevastation of the war. The oil crisis of the
1970s made a dent in the long-term growthrate in the early 1980s, but after a period ofadjustment, long-term growth was fairly
steady throughout much of the remaining
period. The exception is Japan, which had along period of adjustment during the 1990s,
perhaps in part related to its changing
demographics—occurring earlier than elsewhere. Korea, which in 1980 was not yet considered a high-income country, continued toshow the process of catch-up that is only now
beginning to show signs of fading. The figuresuggests that it would take a really major
event to shove the high-income countries off
their relatively steady rate of 2 percent growth.
The early energy crisis was such an event for a
few years, but the long-term stagnation in
Japan has not had the same impact.
It is always possible that nonlinear disturbances may cause a break in trends. The
downside risks are also potentially considerable. As history has shown, countries could
backtrack on their commitment to openness.
Failure to address the negative consequencesof a more integrated global economy could
generate domestic pressures to reverse theprocess of opening. International tensions
might degenerate into tit-for-tat tariff escalation or competitive devaluations. This wascertainly an important factor in driving theworld into recession in the 1930s. The worldis probably more integrated today than in the54

1930s, with many more actors having a muchgreater stake in an open global economy. But
in many countries, domestic pressures to reverse the trends toward greater openness are
ever present and one can never be too complacent about the strength of existing international institutions.
A key downside risk for high-income countries may come from the transition from aregime of steady economic growth and relatively stable labor force to one with a declining labor force and a rising and dependent
population of elderly. The long stagnation ofJapan through the 1990s and early part of thisdecade may be an indication of the pressureshigh-income countries will face in the next
decades. The pressures are already being felt
in Europe and the United States as economic
policy makers attempt to deal with the impending “transfer” crisis—the benefits
promised to aging baby boomers will translate
into ever-higher tax rates on ever-smaller
workforces unless benefits are modified. The
way out will most likely involve a package ofsteps, in order to minimize the overall costs,
but there is no guarantee that these steps will
be politically acceptable.
The history of the 20th century, if not earlier, has also shown the danger to the global
well-being from the competition for everscarcer resources, for example energy or
minerals. The overall outlook for resources, atleast through 2030, suggests the ability tocope with a growing global economy.
Smoothly functioning markets should be able
to allocate resources and/or provide the rightsignals for developing and supplying alternatives. Nonetheless, interference with markets
that lead to substantial market disturbances
could lead to a rise in international tensions
and pressures to use military force. Over thelast 50 years, conflicts that have arisen havebeen relatively contained, but in a changing
global environment where economic andpolitical objectives do not necessarily align,
the chance for miscalculations could lead tobroader-based conflict with significant global
implications (see box 2.2).

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Box 2.2 Challenge of geopolitical shifts for long-term
economic forecasts: lessons of historyThe economy does not exist in a vacuum; it is affected in myriad ways by the political, historical,
and social context in which economic agents act, andhistory shows that to ignore this geopolitical context
can lead the economic forecaster awry. For example,
at the beginning of the 20th century the prevailingmood in Europe and its offshoots (such as the UnitedStates) was one of optimism and confidence. Per
capita growth in Europe had accelerated to an unprecedented 1.5 percent between 1896 and 1913 on
the heel of 1.1 percent growth between 1820 and1896 coming after three centuries of near-zero
growth. This growth was sustained by a relatively
peaceful geopolitical environment thanks to the Pax
Britannica and a stable balance of power in Europe,
rapid technological change brought about by the first(steam) and second (electricity) industrial revolutions, and policy changes that enhanced openness,such as Britain’s decision to reduce protectionism.
However, this rapid economic growth was accompanied by important political, social, ideological, andmilitary changes, and by 1913 there was a growing
sense that war was somehow inevitable.
Based on the historical growth of the 30 years to1900 and using standard econometric estimates, one
would have predicted a fairly optimistic GDP trend
for the “G-5” (France, Germany, Japan, the United
Kingdom, and the United States) for the first half ofthe 20th century. The box figure shows the central
prediction and the upper and lower bounds. The
prediction is calculated by assuming yearly shocks
similar in nature to those observed between 1870
and 1899 and implicitly on the strength of economic dynamics generated by continued globalization and technological progress. With the geopolitical shocks of the early 20th century, however,
economic development followed a very different
path. In fact, by 1949, actual GDP (of the G-5) was
almost $300 billion (in 1990 international dollars)
below the lower-bound prediction, an amountequivalent to 13 percent of actual output, highlighting the substantial and persistent effects of adverse
geopolitical events.

Predicted G5 GDP, 1990 International$ millions (ln)Prediction using ARMA(1,1) with time trend
Log GDPGreat
Depression
WWI

31

WWII
Upper bound30

Centralprediction

29
Lower bound28
Actual GDP
27

1860

1880

1900

1920

1940

1960

Sources: Maddison 2001; staff estimates.

By 1913 the political environment had deteriorated
and led to outbreaks of conflict that ultimately escalated into World War I. In its aftermath, the Great Depression arose from a severe real economic shock thatwas exacerbated and propagated worldwide owing topoor economic management, an unprepared financial
system, and weak institutions. In the long run, however,the forces pushing worldwide economic integration forward dominated the adverse impact of political shocks
and globalization recovered powerfully after WorldWar II. Policy was decisive in facilitating postwar resurgence: to keep “history at bay” in the words of a noted
historian, domestic and international institutions werebuilt that have allowed globalization to flourish in anenvironment of relative global peace.

Source: Fardoust and Goldberg 2006.

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2 0 0 7

The ability of the planet to carry a growing
population with rapidly growing demand forgoods and services may be put to a severe test
as the world moves forward. And even if catastrophes are largely avoided in the years to2030, there is growing evidence that actionneeds to be taken soon, if not immediately, toavoid catastrophe in some future not far away.
Rising incomes provide an opportunity—andthe desire—to deal with many environmental
issues, but this is no guarantee that the rightdecisions will be taken. Major changes in theenvironment, such as higher-than-predicted
temperatures and/or dramatic changes inweather patterns could seriously impact regional economies, if not the global economy,
with lower productivity, or worse yet, sickness
and deaths.
Deviations from the central scenario are
more likely to be in the form of extended periods of very rapid growth in some countries andregions and extended periods of stagnation inothers, such as those witnessed over the past
25 years. A cataclysmic event that affects theentire globe for an extended period has a low
probability—though from a geopoliticalpoint of view, the world is likely in a period oftransition. The end of the Cold War has shifted
the world’s major stress point and was, to alarge extent, a conflict among the industrial
countries—even if it had global spin-offs. New
tensions are more likely to arise between the
traditional industrial powers and developing
countries—those that are rapidly rising andwill ask for an increased voice in global discussions and decision making and those fromfailed states and/or regions. The already extensive integration of many countries in a global
economy raises the stakes for all, but also provides an incentive to find a resolution throughpeaceful methods rather than through violence.

What if the world grows faster?
The global economy is benefiting from another period of sustained and broad-based
growth. Among reasons are improved macroeconomic conditions (such as less inflation andinflationary expectations), more sustainable

56

debt levels (at least for developing countries on
average), more diversified economies with lessreliance on volatile commodities, a muchgreater role for services (which tend to be lessvolatile), much improved production management with lower inventories (which tended to
be a major factor in past business cycles), andbetter macroeconomic management, particularly monetary policy.
The past 25 years have had numerous setbacks afflicting growth in the developing countries. Four of the six regions have suffered fromvery long bouts of stagnant or even negative
growth—Sub-Saharan Africa, the Middle Eastand North Africa, Latin America, and Europe
and Central Asia. They each had specific reasons for these periods of depressed growth
ranging from Latin America’s debt crisis in the
1980s, the Middle East and North Africa’s(and, to a lesser extent, Africa’s) energy decline, and Europe and Central Asia’s emergence from its transition toward market-based
economies. Nonetheless, growth has beenmuch improved overall since 1998, in almost
all regions, significant crises notwithstanding,and the decade-long run to 2005 produced increases per capita of some 4.6 percent annually.
Therefore the upside potential is evenhigher for developing countries, not only fortechnological and policy reasons, but also because the current momentum in the global
economy remains strong. Developing-country
growth could exceed 3 percent in 2020 and be
down to 2.2 percent by 2030 in the central
scenario (figure 2.15).
The upside potential for the high-income
countries, however, is much more muted. This
scenario therefore implies greater income convergence between developing countries anddeveloped countries. It would also imply
much greater weight for developing countries
in the global economy. Instead of rising to37 percent from an initial share of 21 percent in2001, the developing-country share in global
output would be 43 percent. More remarkably,
China’s share would climb to 15 percent,almost on a par with Europe, from its share of
3.7 percent in 2001, whereas the share for the

T H EC O M I N G

G L O B A L I Z A T I O N

Figure 2.15 More acceleration in growth is possible
Average annual growth in per capita incomes between 2010 and 2030 (%)
8
7

Baseline

6

High

5
4
3
2
1

As

ia

na
hi

ut

h

C

In
di
a
E
C uro
en p
t e
M ral A an
id
si d
dl
a
e
N E
or as
Su
th t
A an
bSa fric d
a
ha
ra
n
Af
La
ric
tin
a
th Am
e er
C ic
ar a
ib an
be d
an

in

So

te

d

St
Lo
at
w
es
co - a
m nd
e
m
co id
un dl
Ea trie esstth Asi
e a
Pa an
ci d
fic

n
pa
ni

pe
ro
Eu

Ja
U

H

W
or
ld

ig
h
co -inc
un om
tri e
es

0

Source: World Bank simulations using the Linkage model.

United States would drop to less than 25 percent from an initial position of 32 percent.
At the global level, the difference in the two
scenarios—the central and the high-growthscenario—translates into an additional $11
trillion in 2030, of which $10 trillion is additional income for the developing countries—that is, an overall increase of 44 percent. Thus,
much is at stake. This difference in outcome isabout the same as one would have calculated
in 1980 using the previous 10-year growth topredict where developing countries would bein 2005.
A number of discrete policy changes canhave significant impacts on long-term growtheven if they do not individually imply large
deviations from baseline growth rates—
particularly as seen from a regional or global
level. The aforementioned trade liberalization
scenario that is limited to merchandise goods
only would raise the average developing-country growth rate by 0.2 percentage points and as
high as 0.5 percentage points for some regions.
Cumulatively over a 25-year period, this additional growth would end up as significantly
higher incomes for many. This illustrates the importance of making progress in the current
round of multilateral negotiations known as

the Doha Development Agenda—without evendescribing the considerable distributional
impacts of removing protection in the most distorted sectors, such as agriculture, could have inmany developing countries.34
There are many other choices facing policy
makers—most going well beyond the abilityof this chapter’s analytical framework to capture, such as improving institutions and the investment climate, deepening infrastructure,and implementing policies to achieve or surpass the MDGs and make for a healthier andmore productive labor force. Cumulatively,
making the right policy choices could dramatically change the growth prospects for a large
number of countries. There are a number ofcountries that have demonstrated the ability
to achieve very high growth rates for very long
periods even with very different initial conditions in terms of endowments—human andnatural—and institutions. In the same vein,
getting “everything” right may not necessarily
lead to the kind of high growth rates thatmany countries in East Asia have been able togenerate.
The potential nonlinearities could also surprise on the upside. This chapter may be seriously underestimating the potential for further

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2 0 0 7technological change because the world is stillat the dawn of the information age, thebiotechnology revolution, and other innovations. The chapter also assumes a rather benign policy environment even though barriers
to trade in some instances, for example agriculture and services, are still prohibitively
high, and many countries can still make vast
improvements in domestic policies that could
improve the investment climate and lead tocapital deepening. Cumulatively some of thesechanges could have the same impact as thatwitnessed in East Asian economies startingwith Japan in the 1950s and 1960s, followedby the newly industrializing economies, andnow more recently by China.

Challenges of the coming
globalizationThe discussion suggests that an abrupt reversal in current trends—particularly toward a global economic collapse—has a very
low probability. The central scenario—and any
reasonable upward or downward deviation
around it—will generate mostly positive consequences, but not exclusively. Globalization andgrowth will have uneven impacts leading tostructural change, job losses in some sectors
and regions, and the risk of some being left behind. And virtually any growth scenario will
put stress on natural resources in the absenceof corrective action.

Income distribution and jobs
As mentioned, incomes rise rapidly in developing countries—increasing an average 3.6
percent per capita across all regions, with thefastest growth in East and South Asia.35 Thisis some 1 to 1.2 points more than income
growth in developed countries, so there issome overall convergence in incomes—withsome important exceptions, for example SubSaharan Africa and Latin America.
The distributional gains across households
will largely reflect household endowments—ofcapital, land, and skills—and changes to theunderlying returns to these endowments. The

58

returns to endowments could also be influenced by sectoral changes such that a migrant
moving from rural to urban areas and from a
low-wage country to high-wage country may
benefit from higher wages even given the same
intrinsic endowment (that is, skill level), albeit
perhaps with a correction in welfare due tochanges in prices.
The central scenario includes labor market
segmentation between agricultural and nonagricultural sectors (for unskilled labor alone).
The segmentation is only partial because agricultural workers seek higher-paying jobs inurban areas. All else equal, this would tend toraise wages in rural areas and cap wage rises inurban areas (compared with a no-migration
scenario). The scenario suggests that the rural
exodus could be a significant factor in the years
ahead with the share of agricultural workers
dropping from about 51 percent currently toless than 35 percent in 2030. Owing to population increase, this leads to only a small decrease in the agricultural labor force, but to anincrease of over 1 billion in urban workers.
The outward movement of agricultural workers is highest in East Asia and the Pacific andleads to a decline in the urban wage premium.
Another critical dimension in determining
distributional outcomes is the change in the socalled skill premium, that is, the ratio of skilledwages relative to unskilled wages. According to
the estimates (and definitions) of the authors of
this study, the share of skilled workers is approximately 32 percent in developed countries
and less than 10 percent in developing countries. The scenario assumes an acceleration ofskilled workers relative to unskilled workers.
Despite the acceleration in numbers, the skill
premium tends to increase in most regions
under this scenario. This reflects the assumption that skilled labor is a complement to capital, so demand for it increases more rapidly
than supply. The skill premium increases most
rapidly in those countries with a high investment rate. A second factor is the relative glut of
unskilled workers as the rural exodus—largely
an unskilled phenomenon—continues. A third
factor is the relatively higher concentration of

T H Eskilled workers in high-income elastic sectors,
notably services.
In summary, the increase in value added forall developing countries can be decomposed
into volume and price effects and further
differentiated by factor of production. The
average annual increase is 4.0 percent overthe entire period. There is a rotation in value
added toward skilled workers, their total
share increasing from 11 percent to 17 percent,largely taken from capital’s share that declines
to 47 percent from 59 percent in 2005. Thirty
percent of the increase is determined by the increase in unskilled wages and 15 percent by theincrease in skilled wages (figure 2.16). The former is more important because of the relative
weight of unskilled workers in total value
added. Combined, wage increases account for
44 percent of the total increase in value added.
The next-largest segment is the increase in thecapital stock, representing 44 percent of thegrowth in value added (with changes in the return to capital not a factor). The results suggest
a modest improvement for workers in developing countries over 25 years relative to ownersof capital, but with a somewhat better outcome
for skilled workers.
Under the baseline scenario, the poverty
MDG is reached in 2015 at the global level,with the headcount index falling to 11.8 percent

Figure 2.16 Wages outpace profit income
CapitalSkilled workers

Volumes

Unskilled workers
Return to capital
Skilled workers

PricesUnskilled workers
0

10

20

30

40

Percent
Source: World Bank simulations using the Linkage model.
Note: Decomposition of growth of value added fordeveloping countries, 2005–30.

50

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in 2015 from 20.2 percent in 2003 (table 2.3).
The MDG target is just under 14 percent.36 The
poverty MDG is met broadly in all regions withthe glaring exception of Sub-Saharan Africa,
which will miss by a wide margin. By 2030, thepercent of poor living on $1 a day or less will benear 8 percent of the developing-country population, or roughly 550 million persons.37 Even
with the longer term horizon, it is unlikely thatthe 2015 poverty MDG will be met in SubSaharan Africa without an acceleration in
growth and more targeted interventions.

The global environment will come underincreasing stress
While incomes, inequality, and poverty are at
the heart of the debate on globalization and its
impacts, energy and more specifically environmental impacts are lurking not far behind.
Though the energy issue had been somewhat
relegated to a less prominent position during
most of the 1990s and early 2000s, the recent
run-up in fossil fuel prices and the more alarming evidence of global warming have returnedenergy and environment to the front pages.
With world growth in the central scenario
running at about 3 percent per year on average,
primary energy demand (coal, oil, and naturalgas) runs at about 2 percent per year. Under
standard assumptions, this would not generate
any significant tension on energy markets, withprices rising at about 1.4 percent per year inreal terms from base year levels. Demand fornatural gas would tend to outpace demand foroil and coal as policies and technology tend tofavor this relatively cleaner fuel. Renewable
and nuclear energy would tend to see somewhat higher growth rates (see chapter 5), butfrom a low base and therefore making only amodest impact. To accelerate their adaptation
requires a more significant push from policies
to increase investment in these technologies
and taxes on conventional fuels to induce
greater substitution.
Stagnant or declining production in highincome countries and high growth in somedeveloping countries would lead to some (perhaps dramatic) changes in net trade in fossil

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Table 2.3 Regional breakdown of poverty in developing countries
Millions of persons living on
less than $1 per day

less than $2 per day

Region

1990

2003

2015

2030

1990

2003

2015

2030

East Asia and the Pacific
China
Rest of East Asia and the Pacific
Europe and Central Asia
Latin America and the Caribbean
Middle East and North Africa
South Asia
Sub-Saharan Africa

472
375
97
2
49
6
462
227

213
179
34
9
49
5
472
320

57
50
7
5
38
3
273
345

18
16
2
3
30
1
159
337

1,116
825
292
23
125
51
958
382

745
531
213
71
134
62
1,131
530

317
229
88
40
118
45
1,017
613

148
108
40
26
103
31
902
653

Low- and middle-income countries
Excluding China

1218
844

1,068
889

721
671

547
531

2,654
1,829

2,671
2,140

2,150
1,921

1,863
1,755

Percent of the population living on
less than $1 per day

less than $2 per day

Region

1990

2003

2015

2030

1990

2003

2015

2030

East Asia and the Pacific
China
Rest of East Asia and the Pacific
Europe and Central Asia
Latin America and the Caribbean
Middle East and North Africa
South Asia
Sub-Saharan Africa

29.6
33.0
21.1
0.5
11.3
2.3
41.3
44.6

11.5
13.9
6.0
1.9
9.1
1.7
33.2
45.0

2.8
3.6
1.1
1.0
6.1
0.7
16.2
37.4

0.8
1.1
0.2
0.6
4.1
0.2
8.1
29.9

69.9
72.6
63.2
4.9
28.4
21.4
85.5
75.0

40.2
41.2
37.7
15.0
24.9
21.0
79.5
74.5

15.5
16.5
13.5
8.4
18.8
12.3
60.2
66.5

6.7
7.3
5.4
5.5
14.2
6.5
46.0
58.0

Low- and middle-income countries
Excluding China

27.9
26.1

20.2
22.2

11.8
14.2

7.8
9.7

60.8
56.6

50.5
53.5

35.1
40.6

26.7
31.9

Source: World Bank.

fuels. The high-income countries may be subject to an increase in their energy imbalance
amounting to some $400 billion in 2030 (in2001 dollars), more than a doubling from$175 billion in 2001. China’s small deficit
could balloon to over $100 billion and India’s
to $50 billion. The positive counterparts on aregional basis would be the Middle East andNorth Africa, Sub-Saharan Africa, Russia,
and Latin America. Dutch-disease-type effects
combined with the political economy of natural resource–rich countries may make it
difficult for some to diversify their economies
and prepare for a post-energy future.
Relatively benign economic impacts as regards energy do not imply that the negative
externalities associated with continued dependence on carbon-based fossil fuels will notlead to severe environmental consequences—
if not immediately, at some point in the
future. There is mounting evidence that the60

impacts of rising greenhouse gas concentrations are accelerating—at least in some partsof the world, notably at the two poles. Even
accelerated penetration of clean energy islikely to leave the world largely fossil fueldependent—at least over the next two
decades—thus technologies need to be developed that limit the damage from burning
conventional fuels, such as carbon sequestration. Such technologies combined with policies to accelerate the use of renewable fuels
and improve energy efficiency would form
the basis of a package to deal more forcefully
with greenhouse gas emissions. These aredeveloped further in chapter 5.

These three problems will require policy
responses
The purpose of this chapter has been to outline a plausible evolution of the global economy and to highlight some of the key findings

T H E

from the forward-looking exercise. Irrespective of whether growth rates exceed or fallshort of the central scenario, it has exposedseveral problems that require further analysis
and policy response. Three of the most important problems—income distribution, tensions
in labor markets, and environmental risks that
require multilateral response—are the subjectsof the next three chapters.

Notes
1. Measured as the difference in the number ofpoor in 2002 using the 1990 poverty incidence (headcount) and the actual number of poor (at the $1/day
poverty line).
2. World Development Indicators 2006, table 2.19.
3. Unless otherwise stated, historical growth rates
are calculated using a log-linear regression growthmodel.
4. The first five rounds, concluding with the Dillon
Round in 1961, involved 13–38 countries at most.
5. As of December 11, 2005 (www.wto.org).
6. The comparisons with goods trade are not necessarily straightforward. First, there are no price indexes for trade in services, so they are measured onlyin current dollar terms. Second, it is more difficult toevaluate trade in services, so their level is likely to beunderestimated.
7. There is recent evidence that migration from the
new EU member countries is higher than analysts had
anticipated. See John Kay, “How the Migration Estimates Turned Out So Wrong,” Financial Times, September 5, 2006.
8. Anecdotal evidence is provided in Sharon
LaFraniere, “Cellphones Catapult Rural Africa to 21stCentury,” New York Times, August 25, 2005; Rodrique
Ngowi, “Africa’s Cellphone Explosion Changes Economics, Society,” Associated Press, October 16, 2005;
and Kevin Sullivan, “For India’s Traditional Fisherman,
Cellphones Deliver a Sea Change,” Washington Post,
October 15, 2006.
9. To avoid repetition, unless stated otherwise, allincremental values represent changes between 2005
and 2030—either absolute levels or average annualcompound rate changes.
10. All prices are at 2001 levels—the base year of
the scenario. Volume growth will therefore reflect 2001
weights. Prices and values reflect changes with respect
to the model numéraire, which is a price index of manufactured exports from the high-income countries—
similar in concept to the World Bank’s manufactured

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G L O B A L I Z A T I O N

unit value (MUV) index. This index is set to 1 in thebase and all subsequent years. Thus future values, forexample of GDP, do not integrate the normal secularincrease in prices that are generated by changes inmoney supply. Technically the price of manufactured
exports of high-income countries is fixed and onlychanges in relative prices matter. Say for example thatworld GDP is 100 in 2001 and 200 in 2030 in realterms, that is, the volume of output has doubled. Say
that relative to the numéraire, the price of GDP isunchanged so that the value is also 200. If instead there
were a steady increase in nominal inflation, say prices
would have increased by an average of 2.5 percent per
year, the price of GDP would have more or less doubled between 2001 and 2030 and nominal GDP would
be 400, not 200. There would of course be no change
in volume growth, and assuming super-neutrality, allrelative prices would also be identical to assuming zeronominal inflation.
11. The rankings refer to the model-based aggregation, not at the actual country level.
12. To attenuate the problems with exchange rate
movements, the rankings are based on a five-year moving average of dollar-based GDP centered on 1982 and2003.
13. Here welfare is equated with income percapita, but of course the authors recognize that there
are many other variables that affect individual wellbeing—such as health, family and friends, and so on.
14. One such commonly used index is the so-called
Big Mac index popularized by the Economist. This
index compares the cost of purchasing a Big Mac in avariety of cities across the world. While McDonald’s
prides itself on selling a well-recognized and largely homogeneous product across the world, the raw inputs in
a Big Mac—perhaps priced the same everywhere if one
assumes that they are perfectly traded on world
markets—only represent a small portion of the cost of
the final product. A large portion of the Big Mac will
be composed of the wages paid to local workers andmanagers and the rent on land and buildings. These arelikely to be much lower in many developing countries
and hence represent an approximation of the PPP exchange rate. Thus if a Big Mac sells for an average of$4 in the United States but $1 in China, the PPP exchange rate would be 4. When this calculation is scaledup, if China’s GDP is evaluated at 8 trillion renminbi
and converted to U.S. dollars at a rate of 8 renminbi
per $1, its GDP in dollar terms (at the market exchangerate) is $1 trillion. Using a PPP exchange rate of 4, theChinese economy would then evaluate to $4 trillion.
However, this chapter argues that this conversion islargely valid to make intercountry welfare comparisonsand not for making judgments about the relative size ofthe respective economies.

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15. There is recent theoretical and empirical workon what makes countries grow that could provide
more practical implications for policy makers than the
widely discussed cross-country panel regressions. Bothof these strands rely on complementarities across policies and other development-related necessities such as
infrastructure needs. In the theoretical literature thishas been referred to as the O-ring theory of growth andcomes from the analogy with the U.S. space shuttle disaster. In that disaster, it was a simple and cheap O-ringthat failed. So despite the billions of parts and scientificknow-how that goes into putting the shuttle in space,
the failure of any part, no matter how simple orinexpensive, is enough to bring it down. In growth theory, the same can be applied. A country can have, say,
9 out of 10 growth-related necessities absolutely perfect, but if the 10th is a failure, there will be no takeoff because of the complementarities across these necessities. Recent empirical work by Hausman, Rodrik,
and Velasco (2004) has used so-called growth diagnostic tools to assist in finding the bottlenecks to growthand providing a road map for the appropriate sequencing of policies to overcome the bottlenecks.
16. For example, fewer office workers could reduce the need for office space, computers, furniture,and the like.
17. Car manufacturing in Japan is much less labor
intensive than in other countries owing to the scarcity(and hence the price of) labor. Agriculture in the UnitedStates could become more mechanized in the absenceof abundant cheap labor (“The Worker Next Door” by
Barry Chiswick, New York Times, June 3, 2006).
18. These numbers are based purely on the growthrate of the working-age population, defined as the population aged between 15 and 65. In effect it currently
assumes that labor force participation rates are zero forthe rest of the population and that the participation
rates for the 15–65 group are fixed. Further, it makes
no explicit assumption regarding migration, though
one could infer that the proportion of migrants as ashare of the population remains constant.
19. Much of the recent turnaround in Sub-SaharanAfrica is also largely based on increased global demand
for natural resources—whose labor intensity in mostcases is relatively low, save for agriculture.
20. The standard replacement rate, that is, the rateof fertility that would keep population at a steady-statelevel is 2.1 births per female, to take into accountaverage mortality rates and other factors.
21. Of course, this represents a relatively narrow
definition of dependency because an increasing numberof youths pursue education well beyond high school
and often with parental support.
22. Several additional points are worth highlighting
regarding the demographic scenario. Though most of62

the macroeconomic literature refers to the youth and elderly dependency ratios, it could also be true that there
are macroeconomic dimensions to the gross dependency
ratio, that is, the ratio of all nonworkers to workers.
Countries that have had high births in the recent pastand that have relatively low labor force participation
rates will tend to have higher total dependency ratios,
all else being equal. Sub-Saharan Africa, for example,
has relatively greater declines in the total dependency
ratio than the Middle East and North Africa despite its
more rapid population growth because the labor force
participation rate is higher. In fact, on this score, SubSaharan Africa has a lower dependency ratio than Latin
America, which has lower workforce participation anda more rapidly aging population. Altering assumptions
on labor force participation—for example a rise infemale and/or elderly participation—could affect these
total dependency ratios.
23. The baseline does track changes in policies between the base year of 2001 and 2005, notably China’s
commitments following its accession to the WTO, EU
expansion, and the removal of the textile and apparelquotas.
24. The literature on empirical studies of the lifecycle theory is voluminous. Studies of macroeconomic
data in industrial countries have found significant relationships between dependency ratios and saving rates(see for example Masson and Tryon 1990; Meredith
1995; IMF 2004; Higgins 1998; Masson, Bayoumi,
and Samiei 1998; Lee and Kim 2005). By contrast,
household survey evidence typically finds only weak,or even positive effects, of dependency ratios on savings (Turner and others 1998). The difference is likely
due to weaknesses in the survey data (for example, thesurveys often do not include pension data), the failure
to adequately assess the disproportionate impact of thewealthy on aggregate savings, differences in age cohort
behavior, and the failure to consider interactions
among households, firms, and government.
25. This would reverse the trend of past decades.
Bloom and Canning (2004) estimate that one-third of
the East Asian economic miracle may be accounted forby a demographically induced rise in savings and investment. Higgins and Williamson (1996) find thatmuch of the rise in Asian saving rates since the 1960s
is due to a decline in youth dependency ratios.
26. On the other hand, Börsch-Supan, Ludwig, andWinter (2001) claim that the elasticity of substitution between capital and labor is close to one in industrial countries, meaning that production processes can be modified
easily to substitute labor for capital, which would limit
the impact of demographic change on investment.
27. OECD (2005) notes that the model-based simulations typically assume that labor is immobile, that
capital is perfectly mobile, and that investors have

T H E

perfect foresight. Allowing for immigration, capital account restrictions, and risk aversion would reduce themagnitude of capital flow shifts in response to aging.
28. The share of institutions, defined as pension
funds, insurance corporations, and mutual funds inhousehold portfolios in OECD countries has risen
from 17 percent in 1970 to 38 percent in 2003 (OECD2005). World Bank (1997) shows that regulations also
limit the share of investments by institutional investors
in foreign assets.
29. Morin and Suarez (1983) and Bakshi and Chen
(1994) find evidence that risk aversion rises with age;
Riley and Chow (1992) and Halek and Eisenhauer(2001) find that risk aversion declines with age until
65, but then increases; while Bellante and Saba (1986)
and Jianakoplos and Bernasek (1998) find that risk
aversion falls with age. Bellante and Green (2004) findthat risk aversion tends to increase with age, for any
given level of wealth.
30. For example, Poterba and Samwick (1997)
find significant differences in asset ownership of different birth cohorts. Older households today are more
likely to hold relatively risky stock, and less likely tohold tax-exempt bonds, than younger households. But
this says nothing about how the current, oldergeneration attitudes will change as they age.
31. Considerable controversy exists concerning theappropriate measure of personal savings in the UnitedStates, the determinants of the steady decline in saving
rates, and the extent to which low saving representshousehold dependence on the rise in housing assets orreliance on pensions. Whatever the actual level of saving, there is little doubt that appropriately measured,it has fallen significantly over the past two decades.
32. Not all technologies are freely available, ofcourse. Patents and other forms of intellectual property
protection imply that still significant portions of technological transfers will come through joint ventureswith firms holding the rights to those technologies.
33. The philanthropic efforts of the Bill andMelinda Gates Foundation and others provide somereason for optimism that progress can be made in someof these areas.
34. Significantly more detail on the potential impacts of various Doha scenarios is available in Anderson and Martin (2006).
35. Per capita growth is somewhat higher whenmeasured at PPP exchange rates owing to different
weights—notably for China.
36. The 2015 forecast represents some changes fromlast year’s poverty forecast published in Global Economic Prospects 2006. The first notable difference is thechange in the base year for the forecast—now 2003 instead of 2002. Despite the more recent year, both thenumber and percentage of poor (at the $1-a-day level) is

C O M I N G

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higher in the base year, respectively 1,068 and 20.2 percent compared with 1,011 and 19.3 percent. (A printing
error appeared in last year’s report regarding the 2002
numbers for the $1-a-day poverty indicator.) Principally
this is due to three factors. (1) Population figures havebeen revised. (2) The new estimates for the base year incorporate 38 new surveys covering the 2003/04 period.
Many of the new surveys include large countries such as
Argentina, Brazil, Mexico, and the República Bolivariana de Venezuela in Latin America; Pakistan in SouthAsia; and Nigeria in Sub-Saharan Africa. (3) Adjustments to a common base year incorporate the latest information on price inflation and growth in private consumption. These same factors also impact the forecast to2015, since the new surveys will be associated with new
estimates of the poverty-to-growth elasticity and the revised population forecasts will impact the estimate of theabsolute number of poor. One additional factor has beena revision to the Chinese estimate of the poverty elasticity with respect to changes in the income distribution (asmeasured by the Gini coefficient). The estimate of thiselasticity has been revised upward so that more poverty
is associated with a rise in inequality. While for mostcountries, the 2015 forecast assumes distribution neutrality, in the case of China, both the rural and urban
Gini coefficient is assumed to deteriorate by 10 percent.
Thus, a rise in this elasticity leads to a worsening ofpoverty, all else remaining constant, though counteracted, nonetheless, by relatively high income growth.
37. The 2030 poverty forecast does not use thesame methodology as the poverty forecast for 2015
and instead is based on a straight poverty and growthelasticity approach. The 2015 forecast uses all of theavailable household information at the country levelcombined with a country-specific forecast of per capita
consumption growth. The 2030 forecast uses the elasticity approach at the regional level. It combines theimplicit growth elasticities from the 2003/2015
poverty forecast with the regional per capita growthrate between 2015 and 2030 as anticipated in the central scenario. The projection is meant to be broadly indicative of potential improvements and to highlightregional differences.

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———. 2006b. “Scenario Building through 2030 with
the Linkage Model.” World Bank, Washington, DC.
Wade, Nicholas. 2006. Before the Dawn: Recoveringthe Lost History of Our Ancestors. New York:
Penguin.
World Bank. 1997. Private Capital Flows to Developing Countries: The Road to Financial Integration.
New York: Oxford University Press.
———. 2006a. Global Economic Prospects: Economic
Implications of Remittances and Migration.
Washington, DC: World Bank.
———. 2006b. Global Development Finance. Washington, DC: World Bank.
———. 2006c. “South-South Migration and Remittances.” World Bank, Washington, DC.

65

3
Income Distribution, Inequality,
and Those Left BehindOver the past 20 years, the global distributionof income has undergone significant structural shifts. While aggregate measures ofglobal inequality have changed little between
the 1980s and today, the relative positions ofcountries and the welfare of millions of theworld’s citizens have experienced much more
dramatic transformations. The sustained highgrowth rates of China and India (and to alesser extent, those of other Asian nations)lifted millions out of poverty, while the stagnation in many African countries caused them
to fall behind. In comparing the world income
distribution in 1980 with that in 2002, one
study notes that the poorest country in 2002
had a lower income per capita than the poorest country in 1980 (Bourguignon, Levin, andRosenblatt 2004). The same is true for the entire bottom 6 percent of the world income distribution. Are these trends likely to continue
in the future? Who will be the poor and therich of 2030 under the global scenarios developed in the previous chapter?
Average incomes of people in developing
countries are expected in chapter 2’s baseline
scenario to converge slowly toward levels inhigh-income countries. But for households inparticular countries and particular socialgroups, improvements in living standards

For details on the methods used to project the world income distribution in 2030 please visit www.worldbank.
org/prospects/gep2007.

over the coming decades are likely to bemuch more dramatic than those suggestedby the averages—and other households arelikely to benefit less than average. This chapter explores future trends in income distribution to identify households positioned tobenefit most and least, and suggests policy interventions to help spread the benefits of the
anticipated growth over the next several
decades. Building on the demographic andeducational trends described in the previous
chapter, it explores whether incomes arelikely to become more equal across andwithin countries. It also examines the role ofglobalization in producing these outcomes,
through the lens of microanalysis at thehousehold level (see box 3.1; see also Bussolo
and others [forthcoming], available atwww.worldbank.org/prospects/gep2007, formethodological details).
Findings for any specific country or region
should be taken with a grain of salt. First, microsimulation techniques used here mimic
markets’ adjustments and agents’ responses
only imperfectly. Furthermore, potentiallylarge measurement errors and comparability
issues affect the income and consumption
data used in the microsimulation model. Second, the focus on income (or consumption)
inequality deals with inequality of outcomes
and not inequality of opportunities. This isbecause it is less difficult to measure income
inequality than to measure inequality ofopportunities.

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Box 3.1 Changes in demographic structure,occupational choices, and factor rewards determine theauthors’ hypothetical 2030 world income distributionT

his chapter’s forward-looking exercise is basedon methodologies developed in recent literature,including Bourguignon and Pereira da Silva (2003);
Ferreira and Leite (2003, 2004); Chen andRavallion (2003); and Bussolo, Lay, and van der
Mensbrugghe (2006). The objective of the exercise isto create a hypothetical income distribution for all
countries of the world in 2030. The starting point isglobal income distribution in 2000, assembled using
data from household surveys for 84 countries anddata on income groups (usually vintiles) for the remaining countries (see this book’s Web site for a fulldetailed list). The hypothetical 2030 distribution isthen obtained by applying three main exogenouschanges to the initial distribution: (a) demographic
changes, including aging and shifts in the skill composition of the population; (b) shifts in the sectoralcomposition of employment; and (c) economic
growth, including changes in relative wages acrossskills and sectors.
In reality these changes take place simultaneously,
but in this chapter’s simplified framework they are accommodated in a sequential fashion. In the first step,
total population in each country is expanded until itreaches the World Bank’s projections for 2030. The
structure of the population is also changed; for example, as fertility rates decrease and life expectancy increases, older age cohorts will become larger in many
countries. To accommodate these changes in the surveys data, larger weights have been assigned to older
people than have been assigned to younger individuals. In the next step, workers move from traditional
agricultural sectors to more dynamic industrial andservice sectors, and new incomes are estimated forthese movers. Finally, consistent with an overall
growth rate of real income per capita, changes inlabor remuneration by skill level and sector are

applied to each worker in the sample depending on
their education and sector of employment. The numberof workers changing sectoral occupation and the differential growth rates in wage rewards used to “shock”
the study’s micro-data are consistent with the results ofthe global computable general equilibrium (CGE)model described in the previous chapter. (Note that theoutcomes of the CGE model are also influenced by thesame demographic changes described above.)
The sequential changes described above reshape national income distribution under a set of strong assumptions. In particular, income inequality within population
subgroups formed by age, skills, and sector of employment is assumed to be constant over the period. Moreover, data limitations affect estimates of the initial inequality and its evolution. In particular, consumption
data are not available for all countries’ surveys, so, toget a global picture, the study had to include countries
for which only income data were available. Consumption expenditure is a more reliable welfare measure thanincome, and its distribution is normally more equal thanthe distribution of income. Finally, measurement errors
implicit in purchasing power parity (PPP) exchange
rates, which have been used to convert local currency
units, also affect comparability across countries.
The resulting income distribution should thus not
be seen as a forecast of what the future distribution
might look like; instead it should be interpreted as theresult of an exercise that captures the ceteris paribus
distributional effect of demographic, sectoral, and economic changes. Although the results of this exercise
provide a good starting point for debating potential
policy trade-offs, they should not be used as the basis
for detailed policy blueprints.

Note: For details see www.worldbank.org/prospects/gep2007.

Therefore policy conclusions based on income inequality scenarios in this chapter
should be considered with caution. For example, some degree of inequality can be the68

reflection of efficient incentive structures, eventhough excessive levels of inequality areoften associated with market distortions andprotection of vested interests. Moreover, theI N C O M E

D I S T R I B U T I O N ,redistribution of opportunities has to include“deep” institutional reform often accompaniedor “financed” by some redistribution of outcomes. These concerns notwithstanding, individuals’ economic status can shape the opportunities they have to improve their situation(World Bank 2005), so income levels are often
correlated with access to better education andhealth, which in turn are key determinants offuture earnings. To reiterate a central messageof the 2006 World Development Report (WorldBank 2005: 10), “equity-enhancing redistributions can often be efficiency-increasing.”
With these limitations in mind, the chapter’s exploration of the distributional effects offuture scenarios in the global economy raises
some broad policy issues. It highlights five key
messages:• For a large number of people in developing
countries, the convergence to Organisation
for Economic co-operation and Development (OECD) income levels will comemuch faster than the average numbers suggest. In 2030, 16.1 percent of the world
population will belong to what can becalled a “global middle class,” up from
7.6 percent in 2000. That is, in 2030 morethan a billion people in developing countries will buy cars, engage in international
tourism, demand world-class products,
and require international standards forhigher education. Compare that with only
400 million people in developing countries
who had access to these kinds of living
standards in 2005. Assuming faster income
convergence in a scenario where developing countries continue for the next 25 years
the sustained pace of growth in recent
years, the share of the global middle class inthe world population will rise even further,to 19.4 percent. This large middle class will
create rapidly growing markets for international products and services—and becomea new force in domestic politics.
• Poverty will decline worldwide, but theremaining poor are likely to be more

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concentrated in Sub-Saharan Africa. At
present, almost half of the poorest tenth of
the world’s people live in South Asia; by2030 this could be reduced to just onefifth. By contrast, Africa, now home to
one-third of the world’s poorest people,
may see its share double by 2030. The likelihood of this outcome is high, even if favorable developments in Africa continue.
• In a given growth context, individuals
will realize most of their income gains bymoving from one social group to another. The income gains that people
achieve by migrating out of agriculture
into manufacturing and services or by attaining higher skill levels surpass by far
the gradual increases of those who do
not move. Consequently, and conditionalon higher sustainable growth rates, policies that reduce restrictions to mobility
across sectors and that provide broader
access to education are key to spreading
the benefits of growth.
• Although general indicators of global income distribution will probably change
little, growth will generate pressure toward increasing inequality within a number of developing countries, calling forpolicy interventions to offset theseforces. Trade integration, a key aspect of
globalization and important for efficiency, does not seem to systematicallyincrease inequality. As average incomesrise, the number of poor will shrink andthe tax base will grow, making effective
assistance easier to provide and social
safety nets a viable remedy for increasing
inequality.
• Although investing in education may
not by itself be enough to spur growth,
improved access to education at any
given level of growth can limit the risein income inequality and reduce poverty
by facilitating the movement of poor
people from low-paying jobs in agriculture to higher-paying jobs in industry
and services.

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The global distribution of income
Assessment of past inequality trends
is contentious
Assessing what has happened to global income distribution in the last two decades—
and what will happen in the next 25 years—
presents challenges. Part of the difficulty lies
with choosing an appropriate measure of inequality. The literature identifies three main
approaches to measuring income inequality,
all of which have strengths, but each of whichmeasures a slightly different thing.1• Intercountry inequality is a concept favored by macroeconomists. It measures relative movements of per capita incomes
across countries and gives each country an
equal weight in the world distribution (thatis, population size does not matter). This
literature tends to conclude that in the lasttwo decades, income distribution has
become more unequal.
• International inequality takes into accountthe relative sizes of countries (that is, results are population-weighted). Its proponents (such as Theil and Seale 1994) pointout that failing to use population weights
will cause, for example, the fast growth of
China to be exactly offset by the anemic
growth rates of Malawi or Honduras, eventhough the number of Chinese citizens
who experienced improvements in theirincomes far exceeds the populations of either of the other two countries.2 The
broad consensus in this literature is that income inequality has decreased, although
this finding is mostly driven by the fast
growth in China and India.3• Global inequality, which compares individual incomes regardless of countryof citizenship, is a fairly recent concept(Milanovic 2002). It takes into accountwithin-country inequality, which is ignored by the international inequality approach, where each individual is deemed
to earn the country’s average income. To
a large extent, fast growth in the large
emerging economies tends to offset the70

increases in inequality within countries;
therefore by this measure, global inequality has remained roughly constantsince the late 1980s.
Even though these three methodologies canyield quite different pictures of past and future
trends, and none is clearly preferable to theothers (Ravallion 2004), it is worth elaborating on some general trends.4
Intercountry measurements of inequality
suggest that the last five decades of development have done little to bring the average incomes of developing countries closer to thoseof OECD countries. For example, Quah (1996,1997) finds “emerging twin peaks” in the
global distribution, supporting the argumentthat the relative distance between the top andthe bottom of the global income distribution
has increased since the 1950s. More generally,
Pritchett (1997) has concluded that a “bigtime” divergence in incomes occurred between
1870 and 1990, evidenced by a doubling of thegap between the per capita incomes of the richand poor countries.5 Underlying this general
pattern is a large degree of variation in individual country performance, with growth peaks
and valleys across various regional groupings
and time periods. However, the overall trend isof an increasing distance between countries indifferent income brackets, although Pritchett(1997) also shows evidence of convergence atthe top of the distribution (that is, among thegroup of today’s high-income countries).
Once different weights are assigned tocountries based on their population (using theinternational inequality approach), the global
income distribution appears to have improved. For example, Bourguignon, Levin, andRosenblatt (2004) demonstrate a decrease inworld income inequality between 1980 and
2002, as long as the relevant inequality measures are not too sensitive to the distance ofmean income from the bottom.6 A similar decrease is observed by Atkinson and Brandolini(2004).7 However, these approaches do nottake into account inequality within countries(see box 3.2 for the importance of accounting
for within-country distributional changes),I N C O M E

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Box 3.2 Aggregate economic performance:
distribution mattersIn measuring social welfare, economists have struggled to provide simple statistics that reflect changes
in both aggregate income (that is, the gross national
product—GNP) and distribution. This box presents
a graphic approach—the growth incidence curve(GIC)—that, by jointly measuring size and distribution effects, provides an intuitive evaluation of
welfare changes.
The basic idea behind the GIC was already present
more than 30 years ago in a well-known study entitled “Redistribution with Growth.” In this study,
Chenery and others (1974) proposed to use theweighted sum of the growth of all income groups as asummary measure for changes in social welfare. In atypical developing country the top two quintiles—therichest 40 percent of the population—would normallyaccount for about three-quarters of total GNP. Therefore the GNP growth rate, the most commonly used
index of performance, measures the income growth of
the richer minority and “is not much affected by what
happens to the income of the remaining 60 percent of
the population” (Chenery and others 1974: 40). The
trends observed in aggregate economic performance
will differ according to the weights associated to thevarious income groups. Chenery and others (1974)
found that when using GNP growth rates, where theweights are income shares of the initial distribution,

Brazil, Mexico, Panama, and República Bolivariana
de Venezuela showed strong positive growth.
However, because of their worsening income distributions, when equal weights (0.2 for each quintile) orpoverty weights (0.6 for the poorer 40 percent, 0.3
for the next 40 percent, and 0.1 for the richest quintile) are used, these countries display much lower welfare increases. Conversely, countries enjoying improving income distribution during the 1960s and 1970s,
such as Colombia, El Salvador, Sri Lanka, andTaiwan (China), scored better when their performance was measured with indicators that gave moreweight to poorer individuals.
This weighting idea underlies the GIC, originallyproposed by Ravallion and Chen (2003). The GIC isa graphical representation of the growth rate in income or consumption at each percentile of the distribution. It can summarize the distributional effects ofincome growth by plotting the cumulative share of
the population (the x-axis) against the income
growth rate of the nth percentile of the distribution(the y-axis) when the population percentiles areranked in ascending order of income. Ravallion andChen (2003) show that a measure of pro-poor
growth can be obtained by integrating under the
GIC. However, a simple comparison of the growthrate of the poorest percentiles against the mean

Growth incidence curves
MexicoBrazil% per capita income growth% per capita income growth015Doha rural
FTAA
urban

⫺1

FTAA all10
Doha urban
Doha all

FTAA
rural

⫺2

5

⫺3

0
0

20

40

60

80

% population, ranked by per capita income

100

0

20

40

60

80

100

% population, ranked by per capita income

Source: Bussolo and Medvedev 2006.
Note: FTAA ⫽ Free Trade Area of the Americas.

(continued)

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Box 3.2 (continued)
Global growth incidence curve: base% per capita income growth200

Growth incidence

150

100

Average income gain

50
0

20

40

60

80

100

% population, ranked by per capita income
Source: Authors’ calculations.

growth rate of the entire distribution already demonstrates whether income growth is biased for oragainst the poor. For example, consider the effects oftrade liberalization on the income distributions of
Mexico and Brazil (obtained from Bussolo andMedvedev 2006). While both reforms (the Free
Trade Area for the Americas in Mexico and theDoha Round in Brazil) produced similar gains inaggregate gross domestic product (GDP), poor
Mexicans gained much less than poor Brazilians.
In other words, the GIC for Mexico shows that
trade reform can be somewhat regressive, whereasstrong progressivity is observed for Brazil. This implies that focusing exclusively on changes in macro
variables cannot convey the full amount of information needed to evaluate different policy alternatives.
Now consider the global GIC in the microsimulation here, obtained by comparing the initial situationin 2000 with a final distribution in 2030. It showsthat for 81 percent of the world’s population, percapita income will rise faster than the global average.
The growth incidence curve shows that the pattern of expected growth is not clearly pro-poor,
since the poorest 2 percent of households gain lessthan half of the global average. Instead, futurechanges in the global economy are likely to particularly benefit the households in the third, fourth, andfifth world income deciles. Although these changes
do not favor the extremely poor (because the benefits are not concentrated at the bottom of the income distribution), the poor and the middle class,taken together, benefit much more than the rich.

which has been steadily increasing since the late1980s (World Bank 2005). Nonetheless, the extent to which increases in inequality withincountries have offset the decreases in inequality
between them is a hotly debated subject.8
Therefore the overall direction of change inglobal inequality since the 1980s is not clear.9
Bourguignon, Levin, and Rosenblatt (2004)
offer a “mobility” argument to reconcile theseemingly divergent strands of the literature on
intercountry and international inequality.
Most of the improvement in global income distribution since the mid-1980s has been driven
by increases in the incomes of millions of people in East and South Asia. So the individuals at
the bottom of the income distribution today
are not the same as the poor of 20 years ago.
Therefore, “those who insist upon equalweights inequality and corresponding worsening of the distribution have in mind the implicit

72

mobility argument. For them, the fact thatsome world citizens lost (for example, in SubSaharan Africa or the Former Soviet Union) is
not necessarily compensated by the fact that
others, initially poorer, in China or India havegained. The initial income position matters andthe social cost of falling incomes is not compensated by the social gain of increasing incomes, even if these changes take place in thesame income range” (Bourguignon, Levin, andRosenblatt 2004: 21).
Using the global inequality approach(which takes into account within-country
inequality), Milanovic and Yitzhaki (2002)
proposed disaggregating world income distribution into three categories irrespective of country of citizenship—the poor, the middle class,and the rich, where the middle class is defined
as individuals earning an income falling between the per capita income of Brazil and the

I N C O M E

D I S T R I B U T I O N ,per capita income of Italy. They then showed
that, in 1993, the resulting middle-class groupaccounted for 8 percent of global populationand 12 percent of global income, and that
income differences between the rich, the poor,and the middle class captured 90 percent ofinequality between countries and almost
70 percent of total global inequality.10
The next section turns to the future anduses the concept of global inequality and threeglobal classes to identify the characteristics of
those whose fortunes are likely to improve—the new global middle class—and of those
who risk falling behind.

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The results of table 3.1 are based on an
absolute definition of the “global middle
class”: the per capita income thresholds areapproximately equal to $4,000 and $17,000(in 2000 international dollars) and remain
the same in 2030.13 Since an average middleclass family from a developing country has
4.3 household members, these income boundaries imply annual household earnings of$16,800 to $72,000 in PPP terms. This absolute definition implies that today (as of2000) many of the relatively rich in developing countries are in the global middle class,while the vast majority of the absolutely rich(per capita incomes above $17,000) live inOECD countries. Since the study projections
contain only positive growth rates for all
countries in the world, there is some “natural” expansion in the absolute size of the
middle class. However, since these growth
rates represent growth in real incomes, it is
not appropriate to eliminate this “natural”
expansion by setting higher thresholds for2030 relative to the thresholds of 2000.14
The study’s definition of the global middle
class is based on real purchasing power,
which remains constant throughout themodel horizon and is therefore equally
relevant in 2000 and 2030.15

The future: an emerging global middle
class
While the global middle class’ share in the population remained largely the same from 1993
to 2000, its income share rose from 12 percent
to 14 percent (table 3.1). By 2030, the size of
this group is projected to surpass one billion,
making it the fastest-growing segment of theworld’s population.11 Meanwhile its income
share will remain largely unchanged, indicating that inequality between countries is falling.
Today 56 percent of the members of the middle
class reside in developing countries; in 2030
this share should reach 92 percent.12

Table 3.1 The global middle class is growing, its composition changing
Percentage shares
1993

2000

2030

Pop.

IncomePop.

IncomePop.

Income

76

29

82.0

28.7

63.0

17.0

13.8
6.8
7.0
2.0
1.3
2.7
0.6
0.1
0.3
57.5

16.1
1.2
14.9
7.3
2.2
2.6
0.8
1.6
0.5
20.9

14.0
1.0
12.9
6.4
1.9
2.2
0.7
1.3
0.4
69.0

100.0

100.0

100.0

Poor (per capita income below the average of Brazil)
Middle class (per capita income between Brazil
and Italy)
High-income country nationals
Low- and middle-income country nationals, of which:
East Asia and the PacificEastern Europe and Central Asia
Latin America and the Caribbean
Middle East and North Africa
South Asia
Sub-Saharan Africa
Rich (per capita income at or above the average of Italy)

8

12

16

58

7.6
3.4
4.2
1.3
0.8
1.5
0.4
0.1
0.2
10.5

Total

100

100

100.0

Source: Authors’ calculations.
Note: Totals may not sum to 100 because of rounding. Estimates for 1993 are from Milanovic (2002).
Thresholds of Brazil and Italy are annual per capita incomes (2000 PPP) of US$3,914 and US$16,746.

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There are several reasons behind the dramatic increase projected in the size of the middle class and the major shift in composition infavor of the low- and middle-income countries.
Faster population growth in the developingworld is responsible for some of the change inthe composition. Thus regions with population
growth above the world average (for example,
South Asia and Sub-Saharan Africa) will increase their share in the global middle class.
The main determinant of joining the middle
class ranks, however, is not population growth
but income growth. Although East Asia’s population grows more slowly than the world average, this region is projected to increase its
share of residents in the global middle class bya factor of five, compared with a doubling for
Africa. The difference is due to the fact that annual per capita income growth in Asia is forecast to be more than twice the growth in SubSaharan Africa, easily offsetting the decline in
the former’s population share.
Another determinant of the changing composition of the middle class is the (unequal)
shape of the initial income distribution by region. South Asia, which could see a dramaticincrease (87-fold) in the share of its residents in
the global middle class, is currently the least
unequal region in the world. This means thatthe benefits of its projected per capita growthof 3.9 percent per year (roughly equal to that ofEast Asia) are distributed across the populationmuch more equally than in other regions. SubSaharan Africa, by contrast, has an initial inequality level that is twice as high. Therefore
the same amount of growth would be muchless effective at moving large numbers of people up the ladder of income distribution.
Most developing-country members oftoday’s (as of 2000) global middle class earn
incomes far above the averages of their own
countries of residence. In other words, beingclassified as middle class at the global level isequivalent to being at the top of the distribution in many low-income countries. For example, in our sample, as of 2000, 165 million(out of the total 231 million) developingcountry citizens in the global middle class are74

in the top 20 percent of earners within theirown countries. By contrast, only 10 percent of
global middle-class members occupy the lower
seven deciles of their national income distributions. Thus, for many nations, the correspondence between the global middle class and thewithin-country middle class is quite low.
The situation will change quite dramaticallyby 2030. A full 42 percent of developingcountry members of the global middle class will
be earning incomes in the seventh decile or
lower at the national level. Consider the example of China, where 56 million people belonged
to the global middle class in 2000—each ofthem earning more than 90 percent of all Chinese citizens. By 2030, there will be 361 million
Chinese in the global middle class, and theirearnings will range from the sixth to the ninth
decile of the Chinese national income distribution.16 They will no longer be among the richest Chinese citizens but will probably be considered upper middle class. Another example isBrazil, a country that grows one-third as fast as
China in per capita terms. Even with slower
growth, the number of Brazilians in the global
middle class will expand by more than onethird by 2030. The compositional change is also
important. In 2000, the Brazilians in the global
middle class were split evenly across the eighthand ninth income deciles of their national distribution. By 2030, 75 percent of the membersof the global middle class will earn the incomesof the sixth and seventh deciles in Brazil, and nomember of that class will earn more than
80 percent of the country’s population.
Consistent with these data, by 2030 the
middle class, together with the rich, will account for a larger share of the population ina greater number of countries. In 2000, themiddle class and the rich exceeded 40 percentof the population in just six developing countries, and these countries were home to
0.7 percent of the population of the developing world. By 2030, the middle class and therich will exceed 40 percent of population in
30 countries, and these countries will accountfor 36 percent of the world’s developingcountry population. Therefore, although the

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Figure 3.1 Middle-class expansion is sensitive to growth assumptions
40

Middle-classincome range
Global income
distribution
in 2000

30

Global income distribution
in 2030 (high growth)

20
Global income distribution
in 2030 (baseline)

10Rich (84% OECD)

0
0

7

55

400

3,000

22,000Monthly household per capita income (1993 PPP)
Source: Authors’ calculations.

ability of the global middle class (together
with the rich) to influence policy in many
low- and middle-income countries is initiallylimited by its small size, this group is likely to
become a much stronger political force atboth the global and national levels by 2030.
The increase in developing-country nationals
in the global middle class may also
strengthen developing countries in the global
policy arena.
It is important to emphasize that the projected expansion in the global middle class is
not a formal forecast. Alternative assumptions
about income and population growth, as wellas effects of policy interventions, can have asignificant impact on the estimates of table 3.1.
Figure 3.1 illustrates some of these possibilities
by plotting the income distribution of theworld in 2000 and in 2030 under different
growth assumptions.17 The size of the global
middle class is represented by the area under
the distribution curve between the two middleclass boundaries. Faster growth shifts the peakof the distribution closer to the middle-classthreshold, although even the optimistic scenario here—which increases growth to 1.6 percent above the baseline growth rates—falls
short of moving the thickest part of the distribution into middle-class territory. Still, under
the high-growth scenario the global population
share of the middle class rises to 19.4 percent,allowing an additional 235 million people togain access to middle-class standards of living.
In addition to growth assumptions, policy
intervention at the global and national
levels—such as trade liberalization—can also
affect the rate of middle-class expansion. The
effects of policy reforms are considered in thepolicy section at the end of this chapter.

The growth of the global middle class may
have far-reaching consequences
The ascent of hundreds of millions ofdeveloping-country nationals into the global
middle class will produce a large group of people in the developing world who can afford,
and will demand access to, the standards ofliving that were previously reserved mainly forthe residents of high-income countries. Thishas two major implications: the demand forinternational goods and services will rise, andpressures for policies that favor global integration will increase.
Goods and services. Much of the effect of the
middle-class expansion on the world economy
will be realized through a changing demand forgoods. The fact that the middle class will be
growing twice as fast as the overall population
implies that multinational enterprises will beable to market their products to a much larger
audience in 2030 than they do today.

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Furthermore, the rules of this new global
marketplace will be increasingly determined by
the tastes and preferences of the developingworld, particularly the desires of consumers inEast and South Asia. Therefore, while most of
the world’s purchasing power will continue tobe concentrated in the OECD countries, theglobal economic influence of those countries
will vastly diminish. By 2030 marketing to thedeveloping world will be a much more
important strategy for multinationals than it istoday.
The rise of the global middle class will also
affect demand for services. For example, given
the strong correlation between education levels
and income, the growing middle class is likely
to demand more and better education. The
share of the global middle class in developing
countries with less than a secondary school certificate is projected to decline from 47 percent
in 2000 to 38 percent in 2030. This is roughly
comparable to the mean education levels
among rich individuals in 2000, when 32 percent of the working-age population had notcompleted secondary school. Furthermore, by
2030 the likelihood of completing at least primary school will be virtually the same for therich and the middle class.18 The increased emphasis on education among the middle classwill help establish the foundations for continued growth in the developing countries, as rising educational attainments and growing demand for schooling deepen the human capitalstocks across the developing world.
Demand for health services is also likely torise with the growth in the global middle class.
The ability to afford better care is a major determinant of health outcomes: the World Bank
(2005) estimates that eliminating withincountry differences in infant health would prevent 3.1 million infant deaths in developing
countries—more than three-quarters of thetotal reduction that could be achieved by lowering mortality to the OECD averages. However, the increasing demand for education andhealth is likely to put pressure on the budgets ofdeveloping-country governments and will require heightened policy attention in the future.

76

The rise of the global middle class is also
likely to increase the demand for international
tourism services. Already in 2004, 20 percent of
all outbound tourism came from East and SouthAsia, with an additional 6 percent from Africa
and the Middle East (World Tourism Organization 2006). By 2020 the overall number oftourist arrivals is expected to double to
1.5 billion, with a growing share coming fromdeveloping regions (figure 3.2).
Integration policies. A significantly larger
global middle class composed mainly ofdeveloping-country nationals will exert astronger influence on international anddomestic policy making. As shown above, by
2030 these middle-class members will constitutea significant share of their home country
populations, allowing them to have a greater
say in the policy process.
Some evidence points to a correlation between rising incomes and a shift in demand
toward more globalization-supportive policies.
Recent literature has found that pro-trade preferences are significantly correlated with an individual’s skill level and the relative abundanceof skilled labor in a given country (Scheve andSlaughter 1998; O’Rourke 2003). These results link pro-trade attitudes to the predictionsof the Stolper-Samuelson trade theorem, whichstates that wage rates for skilled workers rise(relative to the returns of other factors) in skillabundant countries as international trade increases. Mayda and Rodrik (2005) confirm
these findings, while showing that individuals’
relative economic and social status is highly
correlated with pro-globalization preferences.
Therefore, not only will the new global middle
class possess the means to purchase products
previously targeted mainly toward consumers
in the OECD countries, but their demand forthese products is likely to become a major driver of calls for further openness.
The literature on the political economy oftrade policy proposes that the direction ofpolicy is determined by the preferences of themedian voter (Mayer 1984).19 Today the median voter in most developing countries is

I N C O M E

D I S T R I B U T I O N ,I N E Q U A L I T Y ,A N D

T H O S E

L E F TB E H I N D

Figure 3.2 World tourism is expected to double between 2004 and 2020
Millions of outbound tourists, 1950–2020, by region
Millions

Forecasts
1.6 billion

Actuals

1,600
1,400

1 billion
1,200
1,000
694 million

800
600
400
200
0
1950

1960

1970

South Asia

Middle East1980
Africa1990
East Asia and the Pacific

2000

2010
Americas

2020

EuropeSource: World Tourism Organization.

unlikely to be a member of the middle class,which may help explain why some studies finda negative relationship between pro-market
policies of the incumbent party and its performance at the ballot box (Olivera and Lora
2005). However, the near-tripling of the
global middle class by 2030 increases the likelihood that the median voter in many countries will have a pro-openness stance.
These changes are likely to have an impact
not only on the domestic policy arena (for example, increased pressure for unilateral lowering of tariffs) but also on negotiations in
multilateral forums such as the World Trade
Organization (WTO). Countries with arapidly growing middle class could emerge asstrong proponents of improved dialogue andfaster progress on multilateral liberalization of
trade in goods and services.
However, as calls to remove trade restraints
become stronger in some countries, they may
turn weaker in others. Liberalization of trade
may also lead to an antiglobalization backlashfrom lower-income citizens of industrial countries, who will experience increased wage andemployment competition from developingcountry nationals entering the global middle
class. Therefore understanding and managing
the effects of globalization on within-country
distribution of income are likely to become
more important in the future; this point will
be revisited later in this chapter.
Other policy goals—among them improved
transparency, intensified anticorruption
efforts, and demand for a more open society
and cleaner environment—are also likely tomove to the forefront of the policy agenda withthe expansion in the size of the middle class. Although most of these issues are usually moreeasily addressed by domestic policy, multilateral efforts can assist the progress. For example, Bonaglia, Braga de Macedo, and Bussolo(2001) found a strong link between increased
trade openness and lower corruption in a large
sample of countries between 1980 and 1998.
Other challenges, such as improving the quality of the environment, require at least as muchcooperation on the multilateral front as they
do in domestic policy circles. (See chapter 5 fora discussion of these issues.)77

G L O B A L

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2 0 0 7

Africa may fall behind
Even though a rising share of the global
population will have access to living standards
currently reserved mainly for OECDnationals, more than half the world in 2030
will continue to earn less than middle-classincomes. Although the share of people whose
living standards fall below those of the middle
class will decline from 82 percent in 2000 to
66.5 percent in 2030, those left behind arelikely to become increasingly concentrated in
Sub-Saharan Africa, revealing geographic
polarization in the lower ranges of the global
income distribution. By 2030 Sub-SaharanAfrica alone could be home to almost
55 percent of the poorest decile of the world
income distribution—an 80 percent increase
from its initial share in 2000 (figure 3.3). In
other words, in 25 years the likelihood that arandom person in the bottom decile will live inAfrica may increase twofold, indicating asignificant deterioration of relative living

Figure 3.3 The world’s poor may beconcentrated in Africa
Population share of each region in the bottom decile ofglobal income distribution
Percent
100
90
80
70
60
50
40
30
20
10
0

1.9
6.2

1.6

17.8

9.2
6.3

29.5

55.3

1.0
13.7
7.0
53.1

42.6

2000

23.5

19.7

2030 (baseline)

2030(high growth)

Europe andCentral Asia

Middle East andNorth Africa

Latin America andthe Caribbean

East Asia andthe Pacific

Sub-Saharan Africa

South Asia

Source: Authors’ calculations.

78

5.5

4.1
2.0

standards in Sub-Saharan Africa compared toother regions. 20
There are three main factors driving
Africa’s decline: high initial income inequality,
relatively high population growth, and thelowest per capita income growth amongdeveloping-country regions. The second andthird reasons imply that more and more
Africans are falling behind the rest of theworld, while the first compounds the problem
by limiting the ability of the poor to enjoy thegrowth benefits equally. Similar mechanisms
operate in Latin America, which also is expected to increase its share in the bottom
decile. Slower growth of income per capita relative to other regions means that the share of
Latin America in the bottom decile could riseby 50 percent in 2030—a much slower increase than that of Sub-Saharan Africa, but
significant nonetheless. This underscores theuniversal importance of growth and growthoriented policies, which are equally relevant
for low- and middle-income regions.
The bleak outlook for Sub-Saharan Africa(and to a lesser extent Latin America) is notforeordained or immutable. Policies that raise
growth rates, both international and domestic, as well as policies aiming at efficiencyenhancing redistributions, can lead to different outcomes. Consider the third column offigure 3.3, which represents the high-growthscenario described in chapter 2. In this
scenario, Sub-Saharan Africa performs slightly
better because it experiences a larger-thanaverage increase in per capita growth. By contrast, Latin America falls further behind. It is
important to keep in mind that figure 3.3 summarizes a relative measure of performance andthat everyone’s living standards improveunder high growth relative to the baseline.
However, the important point is that while
growth is effective in raising living standards,
closing the income gap with wealthier countries requires faster-than-average growth—which is successfully achieved in South Asia
but not in Sub-Saharan Africa, even under thischapter’s optimistic growth scenario. Similarly, maintaining one’s relative standard of

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D I S T R I B U T I O N ,I N E Q U A L I T Y ,A N D

T H O S E

L E F TB E H I N D

Figure 3.4 By 2030, East and South Asia are likely to move up the global income distribution
ladder, while other regions will lag
Population of each region by deciles of global income distribution
Percent
100
80
60
40
20
0
2000

2030

Sub-SaharanAfrica2000

2030

South Asia

2000

2030

2000

2030

Middle East and Latin America
North Africa and the Caribbean

Deciles of global income distribution:

Low (1–3)

2000

2030

Europe andCentral Asia
Medium (4–7)

2000

2030

East Asia andthe Pacific

2000

2030

High-income
countries

High (8–10)

Source: Authors’ calculations.

living is also conditional on growing at least as
fast as the global average.
The relative stagnation in Africa and Latin
America is not limited to the poorest 10 percent of the world. Virtually all Africans are at
risk of underperforming their counterparts
from other regions. For example, in 2000,
59 percent of the population of Sub-SaharanAfrica and 25 percent of the population of
East Asia were in the bottom third of theworld income distribution (figure 3.4). By
2030, more than three-quarters of the population of Sub-Saharan Africa is likely to beamong the world’s poorest, while only 16 percent of East Asia’s residents will remain in thebottom third. This contrasting performance islargely a function of the difference in percapita income growth rates. South Asia willcontinue to be the largest group in the threebottom deciles in 2030 owing to the very highinitial poverty rates. But its citizens are moving up through the ranks of the global distribution at a fast pace owing to high per capita
growth and, unlike in the initial situation,

most of South Asia’s poor will earn incomes inthe second and third deciles in 2030. The
growth effect is exactly the opposite in SubSaharan Africa, where an average African is
30 percent more likely to be in the threebottom deciles in 2030 than in 2000.
Moving away from geographic regions, it ispossible to identify alternative typologies ofcountries whose citizens could fail to improveor even lose their position in the world income
distribution. One group includes low- andmiddle-income energy exporters, defined ascountries whose exports of oil or natural gas
exceed 20 percent of their total value of exports.21 In 2000 citizens of energy-exporting
countries made up 15 percent of the first (bottom) decile of the global income distribution.
By 2030, the population share of energy exporters in the poorest decile could rise to27 percent. Similarly, agricultural exporters
may fall behind by 2030.22 While in 2000
their citizens accounted for just one-tenth ofthe poorest global decile, that share could riseto 23 percent in 30 years. Although everyone

79G L O B A L

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2 0 0 7in the above countries will be better off in2030 than they are today in absolute terms,
these developments imply a large deterioration in the relative living standards of a large
share of the population.23
The outlook for Sub-Saharan Africa
underlines the importance of international
efforts to reduce poverty. International development policy is already focused on the problems facing Sub-Saharan Africa, but still more
attention is needed. One avenue for improving
the lot of countries left behind will be the increased demand for multilateral trade liberalization. Another mechanism of global income
redistribution that has the potential tohelp the poor is represented by international
aid. (These two global policies are discussed
in more detail in the final section of thechapter.)

Within-country inequality
and poverty reductionT

he moderately sanguine conclusions about
the expansion of the middle-class population and the increasing access of developingcountry residents to living standards currently
reserved to OECD nationals are only one partof the global income-distribution story.
Changes in the distribution of income withincountries are no less important. Worsening
inequality can mute the positive effects ofgrowth on poverty reduction in both theshort and long run, increase the risk of social
alienation of people at the bottom of theincome distribution, and perhaps produce
counterproductive backlashes against further
integration with the global economy.

On balance, past trends of inequality
are mixed
When one looks backward, clear trends of rising or falling inequality are difficult to identify, but recent evidence casts doubt on theview of unchanging inequality. Some empiricalstudies concerned with the intertemporal
evolution of inequality and its possible

80

determinants have found that income inequality within countries shows no time trend. Li,
Squire, and Zou (1998), using the Gini coefficients for 47 developing and developed countries covering the period 1974–94, found no
significant time trend. Bruno, Ravallion, andSquire (1998) found very few countries that
had recorded discernible long-term changes ininequality in either direction.
More recently, however, this view of constant income inequality has been challenged
by some new evidence. Focusing on the OECD
countries between the 1970s and 1995,
Osberg (2003) concluded that inequalitychanged relatively little in Canada, Sweden,
and Germany, but that income distribution in
the United Kingdom and the United States saw
substantial increases in polarization.24 Similar
conclusions were reached by Atkinson (2003).
In the developing world, inequality has
generally increased in many, if not most, countries since 1980, even though a sizable minority of countries have exhibited the opposite
trends toward greater equality. In East Asia,
inequality has increased significantly over thelast several decades—and more so during therecent period of high growth in China andVietnam than in the earlier years of growth of
the East Asian “tigers” (World Bank 2005).
However, Ravallion and Chen (2004) caution
against drawing a causal relationship between
growth and inequality in China, since inequality increased fastest during periods ofslow growth. In South Asian countries, theevolution of inequality in India is difficult toascertain owing to data problems, but othercountries in the region experienced very large
increases in inequality during the 1990s(World Bank 2005). For the countries of Latin
America, de Ferranti and others (2004) showthat inequality increased almost uniformly
during the 1980s (a period of volatile and low
growth coupled with high inflation), but thatin the 1990s (a period of improved macroeconomic stability) the deterioration was lesspronounced and limited to approximately half
the countries in the region.

I N C O M E

D I S T R I B U T I O N ,Is trade a cause of changes in inequality?
One potential determinant of inequality is theincreasing integration of developing countries
into the global economy, which, while raisingoverall incomes, may also increase the return
to more mobile factors of production such as
capital and highly skilled workers. But the impact of trade (one channel of globalization) on
income inequality shows no consistent pattern. Another source of the past decade’s increase in inequality could be increases in thepremium for skills generated by technologicalchange. The effects of trade are difficult to isolate from technological diffusion and foreign
investment, and the combination may raise
the relative wages of skilled workers andwiden the distribution of income (for moredetails see the “Policy Implications” section
below and chapter 4).

Demography and social mobility affectequality and poverty
Another determinant of inequality is demographic change. The aging of the world’s population may increase inequality, as older
workers often earn higher salaries (Deaton
and Paxson 1997) and inequality tends to behigher among older age cohorts (Jenkins
1995; Mookherjee and Shorroks 1982).25 The
mixed rise in inequality in developing countries has been accompanied by a fall inpoverty, largely driven by high growth rates in
East and South Asia. Nevertheless, rising inequality will hamper further poverty reduction, particularly in Africa, where poverty isrising and inequality remains high. This section
and the next one assume circumstances ofhealthy growth in the modern sectors, whichgive rise to new jobs in industry and services.
The role that intersectoral mobility can play in
reducing poverty is then considered, as well as
how policies can help the poor move between
occupations and take advantage of the newopportunities offered by growth.
Moving from low-paying jobs in agriculture, where poverty rates are often high, tohigher-paying jobs in industry or services is a

I N E Q U A L I T Y ,A N D

T H O S E

L E F TB E H I N D

major avenue for individuals looking to escapepoverty. The size of the migration-related
reduction of poverty depends on the initialpoverty rate in agriculture, and the income differential between households whose heads are
employed in agriculture and those whose heads
are employed in nonagricultural activities. For
all developing countries in the sample, theheadcount poverty ratio falls by 2 percentage
points (calculated as an unweighted average)
when 10 percent of the agricultural population
moves to industry or services. In Sub-SaharanAfrica, where agricultural households accountfor 75 percent of national poverty andagriculture-related incomes are only 47 percent
of incomes earned in the other sectors of theeconomy, the equivalent reduction in povertyis 4 percent. This reduction could be larger,
but not all migrants are poor, and not all of thepoor who migrate escape poverty.26
Although migration does not lead to a large
reduction in poverty at the national level, theimprovement in welfare of individuals migrating from agriculture can be quite large. Evenfor impoverished migrants who fail to escapepoverty, an increase in income from migration
can reduce the poverty gap. Other long-term
effects can also be attributable to the migration
process. By reducing the labor supply in the
agricultural sector, wages of nonmovers in this
sector tend to rise, exerting a direct positive
impact on relatively poor households.

Education facilitates mobility
To help the poor take advantage of new
growth opportunities, governments can implement measures ranging from expanding relevant infrastructure to increasing poor people’s
access to credit and insurance. This section focuses on how education can improve the propoor effects of the described employment shift
out of agriculture.27 To the extent that thepoor lack access to education, intersectoralmigration may be limited. The unequal accessto education in many developing countries
is documented in World Bank (2005) andworks cited therein. Among the relevant81

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2 0 0 7findings: family members of households headed
by women and of rural households havemarked disadvantages in attaining higher levelsof education. Additionally, parents’ initial
wealth and education greatly influence theirchildren’s educational achievements and their
expected earnings, thereby contributing to future income inequalities. For many countries,
the correlation between the education level ofthe head of the household and the average levelof education of the other members of the household was observed to be very high. The averagevalue for this correlation in the developingcountry sample is almost 0.4.
The influence of education on the povertyreducing impact of intersectoral migration is
illustrated in figure 3.5 for a sample of developing countries. For the majority of these

Figure 3.5 Migration out of agriculture reduces poverty more when education is moreequally distributed
Poverty reduction due to intersectoral migration, expressed as percentage of initial poverty
ThailandTurkeyVietnamIndonesia

Nicaragua

Cambodia

GuatemalaPeru

Yemen, Rep. of
MexicoEgypt, Arab Rep. of

Jamaica
India

El Salvador

Bangladesh

BrazilPakistan

Paraguay
Honduras

Burkina Faso

Venezuela, R. B. deMadagascar

Dominican Republic

Cameroon

Chile

RwandaBolivia
Sierra Leone
Haiti

UgandaColombia

South Africa⫺8 ⫺7 ⫺6 ⫺5 ⫺4 ⫺3 ⫺2 ⫺1

0

1

BurundiGuyanaZambiaArgentina

Mozambique

Panama2⫺8 ⫺7 ⫺6 ⫺5 ⫺4 ⫺3 ⫺2 ⫺1

Percent012Percent
Biased selection

Simulated selection

Unbiased selection

Source: Authors’ estimates based on country-specific household surveys.
Note: The three bars in the figure represent the percentage reduction of poverty headcount ratios due to intersectoral employment
migration (equivalent to a 10 percent decrease in initial agricultural employment and a corresponding increase in nonagricultural
employment). The reductions depicted by the teal bars (biased selection) occur when workers switching occupation are selectedaccording to their personal characteristics (the selection bias is estimated using a logit model). White bars represent a similar
estimation, except that the effect of education is netted out (simulated selection). In the case of the gray bars (unbiased selection),movers are chosen randomly.

82

I N C O M E

D I S T R I B U T I O N ,countries, heads of households who are moreeducated, younger, and already in urban areas
are more likely to migrate from agriculture—and less likely to be poor.28 Thus poverty
reduction through intersectoral mobility islimited, reflecting a phenomenon known asbiased selection, represented by the teal barsof the figure.29 By contrast, if heads of households were randomly selected to move out ofagriculture, poverty reduction would begreater, as a larger share of the poor would
move (shown in the gray bars of the figure).
One way the government could improve
the poverty-reducing impact of intersectoral
mobility would be to increase access to education. Consider this thought experiment. If
every individual initially employed in agriculture were given the same level of education,
poverty reduction would rise closer to the random selection case (referred to as “simulated
selection” and represented by the white barsof figure 3.5). For example, in Burkina Faso, amigration out of agriculture of 10 percent of
those employed in agriculture reduces poverty
by 5.5 percent in the best-case scenario, thatis, when the poor and nonpoor have the samechances of moving. Poverty decreases by asmaller amount, 4 percent, when movers are
selected according to their characteristics andthe nonpoor have a greater chance to move. If
Burkinabe policy makers were able to grant
the same education level to all citizens employed in agriculture, the intersectoral migration considered here would approach theoutcome of the best-case scenario: poverty
reduction would be 5.4 percent.
It is important to reiterate that complementary policies are necessary to exploit fully thepoverty-reducing impact of expanding accessto education. As already said, in many countries a poor investment climate limits the ability of the economy to absorb newly educatedworkers. Improvements in economic policies
and institutions are often critical to encouraging the higher investment required to employ
graduates. And care must be taken to maintain quality standards. Raising access to education means providing the trained teachers,

I N E Q U A L I T Y ,A N D

T H O S E

L E F TB E H I N D

infrastructure, and materials required for a
useful educational experience, not just enrolling everyone in school.

By 2030, inequality within countries may
rise, leaving the unskilled poor farther
behindMore than two-thirds of low- and middleincome countries in the study sample, comprising 86 percent of the population in thedeveloping world, are projected to experiencea rise in inequality by 2030. For some countries
the increase is quite significant (figure 3.6).
Rising inequality is worrisome because
there is an inverse relationship between inequality and poverty reduction.30 Even if
growth is distribution-neutral (that is, if theincomes of the poor rise by the same amountas average incomes), inequality can still hamper the ability of growth to reduce poverty.
This point is illustrated in the left panel of
figure 3.7, which plots the relationship between the partial (neutral) poverty elasticity ofgrowth and the Gini coefficient for a sample
of 84 developing countries (see also WorldBank 2005). This elasticity has been calculated by simulating a counterfactual income
distribution, where the income of each person
in a given country rises by 1 percent, and calculating the resulting percentage change in thepoverty headcount. The results show that
there is a robust positive relationship between
the level of initial income inequality and theabsolute value of the poverty elasticity. At low
levels of income inequality, a 1 percent increase in per capita growth generates a morethan-proportional change in the poverty headcount. However, as inequality rises to the highlevels of Lesotho or Haiti, the ability ofgrowth to reduce poverty approaches zero. A
similar relationship is observed for the totalelasticity of growth (the right panel of figure3.7), which is calculated using observed income growth rates and therefore allows inequality to vary within the sample period.
These results show that, while growth is the
major vehicle of lifting individuals out ofpoverty (see Dollar and Kraay 2002), it is83

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2 0 0 7

Figure 3.6 Changes in inequality are mainly due to economic shifts
Change in Gini coefficient for individual countries
Gini coefficient
0.08
Total change
0.06

Change due todemographic shift

Change due toeconomic shift

0.04
0.02
⫺0.01
⫺0.03

D
om

in

ic

H
B ait
Ja oliv i
m ia
ai
an
c
R Bra aep z
Pa ub il
Ar na lic
El ge ma
Sa ntil n
Li vad a
th o
ua r
ni
U Pe a
ru ru
gu
ay
Ec Ch
ua ileTu do
Pa r rk
C rag ey
os u
ta ay
M Ric
o
N ld a
Ve
ic o
ne
a v
zu Ho rag a
R Kyr ela ndu ua
us gy , R r
si z .B as
an R .
Fe epu dede bliR rati co oC ma n
ol ni
om a
M bia
e
Si G xic
er uy o
ra an
Le a
A
G rm oneua enC tem iaam ab la
So Vie odi
ut tn ah am
AfBa Hun rica
ng ga
la ry
I
n
M do desoz n ham esi
Ta biq an u
Th zan e
Y
Eg e M ai ia
yp me au lant, n, rita d
Ar R nab ep ia
R .o
ep f.
.
N of
Et ige
hi r
op
ia
I
Bu nd
ia
Pa lgarki ia
s
Po tanlaB nd
Za eni
m n
N bia
ig
e
C
ôt N ria
M e d epa
ad ’Iv l
ag oi
a re
U sc
C ga ar
am n
e da
B roo
Sr uru n
i L nda i
Al nka
Bu R banrk wa ia
in nd
a a
Fa
G s
u o
Se ine
ne a
Jo ga
rd l
an

⫺0.05

Less

Total change in income inequality

More

Sources: Authors’ calculations based on survey data and microsimulation results.
Note: Total change represents the Gini level for income distribution in 2030 minus the level in 2000.

Figure 3.7 Inequality hampers the potential of growth to reduce poverty
Total elasticity vs. Gini (headcount ratio, US$2 PPP)

Partial elasticity vs. Gini (headcount ratio, US$2 PPP)
Gini coefficient
.2
0

.3

.4

Gini coefficient.5.6

MNG-R MNG-U

NGA

⫺1

.2
0

.3

NER

VEN

PNG

HTI
NGA
PNG
MDG

TZA

⫺.4

⫺.6

⫺.8

NER

BRA
ZWE
KHM
LKA
RWA
GTM
CHN-R
BOL
LAO
MYS
BDI UZBPHL
CHN-U BGD
NIC
GHA
MWI
ZAF
NPL YEM
SLV
IRN
THA
SEN
IDN
KAZ
TUR UGA
COL
AZE
PAK
MEX
EGY
HND
ARG
LTU
TUN
MDA
JAM
PRY
BFA
KEN
MRT
TJK
BLR
PER
ETH
ECU
YUG
ARM
TKM
LVA
CHL
GEO
CMR
UKR
BGR

CIV

KGZ
ROM

ALB

EST

RUS

MAR

⫺1

84

ZMB

IND

DOM

Source: Authors’ calculations.

DOM

LSO

CIV

VEN

.7

SLE

⫺.2

ZMB

JOR

Poverty elasticity of growth

.6

SLE

ZWE
VNM LKA NIC
EST
CHN-U
PHL
KAZ
LAO
MYS
ZAF
BDI
CHN-R KHM
MWI
GHA UZBIND
BGD NPLYEM IRNIDN
COL SLVAZE LTU THA
GTM
MEX
MDA
HND BOL
TUN
TUR BFA
PAK
ARG
PRY BRA
KEN
MRT
TJK
EGY
ECU
BLR LVA ETH
CHLSEN
ARM UKR YUG
GEO TKM
JAM
ROM
ALB
BGR
CMR
PER
CRI
PAN
KGZ
RUS
MAR

⫺1.5

.5

VNM

MDG

RWA

.4

MNG-R MNG-U

HTI

TZA

⫺.5

.7

JOR

Poverty elasticity of growth

CRI

PAN

LSO

I N C O M E

D I S T R I B U T I O N ,more likely to be pro-poor when initial inequality is low.
Figure 3.7 thus demonstrates the long-term
benefits of reducing income inequality: in addition to a contemporaneous reduction inpoverty that may be expected from lowering inequality, policies that promote a more equal
distribution of income are likely to enable theeconomy to realize greater poverty reduction
from future growth. The projected rise in inequality would imply that in 2030 poverty elasticities will be lower and, with more unequal income distribution in 2030, countries will needhigher growth rates than they need today toachieve a given reduction in poverty. If higher
growth rates cannot be achieved, the countries
will need more active redistribution policies.
Within-country inequality in 2030: two main
drivers
In each country, income distribution is affectedby two sets of factors: shifts in the demographic structure of the population, in terms ofaging and education attainment, and changes
in rewards for individuals’ characteristics, suchas their education level, experience, sector of
employment, and so on. Although in the realworld these demographic and economic
shocks occur simultaneously and jointly determine inequality changes, this analysis applies
each of them sequentially and decomposes thetotal change into various components.
This study’s view of the demographic structure of the world in 2030 is based on theWorld Bank’s population projections by age
group and a simple model of human capital
accumulation that assumes a continuation of
the educational trends observed over the
1980–2000 period. Controlling for other factors, both the level and dispersion (inequality)of household income tend to increase with theage and education of the household head.31
Therefore as the population shares of groups
with more income inequality rise, one may expect to see higher inequality.32 However, as
shown by teal tick marks in figure 3.6, there isno clear pattern in changes in inequality driven by demographic forces. One explanation

I N E Q U A L I T Y ,A N D

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L E F TB E H I N D

is that countries with relatively large public
sectors and relatively high education levels(such as countries in Eastern Europe and theCommonwealth of Independent States) tend
to have more egalitarian distribution of income among skilled workers, possibly because
their governments and other bureaucracies
have more compressed wage structures.
Hence, changes in the demographic structure
work to reduce income inequality. By contrast,
many countries in Latin America and SubSaharan Africa experience an increase in inequality as the shares of older and moreskilled workers rise, since wage dispersion
within these groups tends to be high.
Although aging and the accumulation ofhuman capital imply important changes in the
demographic structure of many countries, theoverall effect of demographic changes on inequality varies within a narrow band (figure3.6). On the other hand, widening gaps in factor rewards, and particularly in the premium
paid for higher skills, tend to produce largerchanges in inequality and generally determine
the overall direction of the effect. This isshown in figure 3.6, where for large changes
in inequality, the distance between the blackand teal marks—that is, the change in inequality attributable to changes in economic
factors—increases, a sign that economic
factors are the most important determinant
for the final level of inequality.33
The initial skill premia and the pattern ofgrowth experienced by each country determine the consequences for inequality of theeconomic factors. Those consequences are obtained by applying the changes in the factor
rewards of the model in chapter 2 to the income sources of individual households. For
example, countries in Latin America arecharacterized by high initial income inequality
and relatively slow growth rates. This implies
a slower transition to a service-oriented economy and lower rates of capital deepening—both of which dampen the growth of thewages of skilled workers, whose labor is acomplement to capital and is highly demandedin the service sectors.

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2 0 0 7Since initial wage gaps are high—the percapita income of a household headed by an unskilled worker in Brazil is only 27 percent ofthat of a household headed by a skilledworker—and growth is relatively unskilledintensive, unskilled wages rise faster thanskilled incomes and inequality tends to fall (figure 3.6).34 The reduction in inequality is compounded by the diminishing rural-urban wage
differentials in countries with a comparative advantage in agriculture, which tends to be relatively unskilled-intensive. For example, farmworkers in Brazil—a country with one of thelargest decreases in the Gini coefficient—earned
40 percent of the average manufacturing wage
in 2000 but will likely earn more than 72 percent of the average industrial wage in 2030.
By contrast, countries in East and South
Asia will experience increasing inequality, driven by low initial skill premia and high per
capita growth rates. Faster income growth
generates more demand for skill-intensive
products and requires higher rates of investment, both of which increase the returns toskilled labor. For example, one of the largest
increases in inequality in the sample is observed in India—a country with low initialinequality (the incomes of unskilled-headedhouseholds are 52 percent of the skilled-headed
incomes) and an average per capita growth of
more than 4 percent, which leads to a substantial rise in the skill premium. The rise ininequality is somewhat mitigated by convergence between farm and nonfarm incomes,
but this effect is quite small because growth isconcentrated in the nonagriculture sectors.
In sum, changes in income inequality overthe next 30 years are likely to be driven mainly
by changes in the rewards for individual characteristics and investment in education—rather
than globalization in isolation. Countries with
low initial inequality and fast growth are likely
to experience a worsening distribution of income, while countries with slower growth rates
and greater initial inequality in income arelikely to see inequality fall. The results therefore
illustrate a “convergence” of income distributions across countries, which can be interpreted
as a manifestation of the Kuznets hypothesis or
as a consequence of the globalization-induced
equalization of factor prices.
It must be borne in mind that these trends
are driven by the assumptions of the baseline
scenario and are far from inevitable. Figure 3.8

Figure 3.8 Restricting intersectoral mobility can lead to large increases in inequality
Change in Gini coefficient for individual countries
Gini coefficient
0.15

0.10

Change attributable to lowmobility scenario

0.05

0Change attributable
to high-growth scenario

Total change frombaseline scenario

D
om

in

ic

H
B ait
Ja oliv i
m ia
ai
an
c
R Bra aep z
Pa ub il
Ar na lic
El ge ma
Sa ntil n
Li vad a
th o
ua r
ni
U Pe a
ru ru
gu
ay
Ec Ch
ua ileT d
Pa ur ork
C rag ey
os u
ta ay
M Ric
o
N ld a
Ve
ic o
ne
a v
zu Ho rag a
R Kyr ela ndu ua
us gy , R r
si z .B as
an R .
Fe epu dede bliR rati co oC ma n
ol ni
om a
M bia
e
Si G xic
er uy o
ra an
L a
Ar eo
G m neua enC tem iaam ab la
So Vie odi
ut tn ah am
AfBa Hun rica
ng ga
la ry
I
n
M do desoz n ham esi
Ta biq an u
T za eEg Ye M hai nia
yp me au lant, n, rita d
Ar R nab ep ia
R .o
ep f.
.
N of
Et ige
hi r
op
ia
I
Bu nd
ia
Pa lgar
ki ia
st
Po an
la
B nd
Za eni
m n
N bia
ig
e
C
ô N ria
M te d epa
ad ’Iv l
ag oi
a re
U sc
C ga ar
am n
e da
B roo
Sr uru n
i L nda i
Al nka
Bu R banrk wa ia
in nd
a a
Fa
G s
u o
Se ine
ne a
Jo ga
rd l
an

⫺0.05

Less

Total change in income inequality

Sources: Authors’ calculations based on survey data and microsimulation results.

86

More

I N C O M E

D I S T R I B U T I O N ,illustrates the inequality consequences of twoalternative scenarios: the high-growth scenario introduced earlier (gray marks) and alow-labor-mobility scenario (teal marks),
where unskilled workers are not allowed tomove from farm to nonfarm activities. By increasing rural incomes, the high-growth scenario reduces within-country inequality, although the overall magnitude of the changes is
not very large. On the other hand, limiting theintersectoral mobility of workers markedly increases income inequality for the majority ofcountries. For example, India experiences an
11-point increase in the Gini coefficient,which makes its level of income inequality
approximately the same as that of República
Bolivariana de Venezuela.
The inability of workers to take up jobs inthe urban sector counteracts the naturalprocesses of growth and urbanization, applying upward pressure on nonfarm wages while
depressing earnings in agriculture. Even in suchcountries as Brazil, which has a comparativeadvantage in agriculture, labor-market rigidities in the low-mobility scenario result in a significant increase in inequality. Because distortions can have severe effects on inequality,
policy makers must be careful not to erect barriers to labor mobility.35 On the other hand,
as is argued below, public intervention cancounteract the tendencies toward rising inequality by creating new opportunities that
benefit low-income groups.
Who is left behind: the face of the poor in
2030. As is true today, in 2030 most people
in the lowest income decile will be without
primary school education, will work inagricultural sectors, and will live in rural areas.
Lack of education appears to be the single
most important characteristic common topeople at the bottom of the distribution.
Completing primary education reduces theprobability of being in the lowest income decile
in every developing country in the forecast.
However, the magnitude of this effect varies
dramatically across countries. Consider, forexample, the cases of Rahmane and Ali, two

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L E F TB E H I N D

young men who live in rural areas of Senegal
and Yemen, respectively. Rahmane and Ali
have not completed primary education, workin agriculture, and belong to families whose
per capita income is in the poorest decile. Aftercompleting his primary education, Rahmane’s
probability of remaining in poverty would be
reduced by more than 13 percentage points.
This is explained, to a great extent, by the
40 percent increase in his income produced bycompleting his primary school education. Ali’s
efforts to combine his hard work in the fieldwith elementary studies will not be met with as
great a reward. Once he gets his primaryschool degree, his probability of escaping
poverty will fall by less than 1 percentage
point, because his income will increase only
6 percent.
This example illustrates the large variationin the welfare effects of education among
different countries in different geographical regions. In Europe and Central Asia, for example, completing primary school reduces theprobability of being in the lowest income decile
by 11 percentage points and increases income
by less than 3 percent (table 3.2). By contrast,
in Sub-Saharan Africa, completing primary education reduces the probability of being in thelowest income decile by 7.2 percentage points
and increases income by more than a third.
Even among countries in the same region, there
is heterogeneity. For example, in the Middle
East and North Africa, as mentioned, a Yemeni
who obtains a primary education is only
slightly less likely to end up in the lowest income decile (a difference in probability of lessthan 1 percentage point), whereas Egyptians
with a primary education improve theirchances of escaping the bottom decile by morethan 10 percentage points. Nevertheless, there
is a strong negative correlation within all regions between the returns to education and themarginal effect of primary school education on
the probability of being in the lowest decile:where the return to education is high, the probability of remaining poor is low.
Additional variables, such as the numberof elders in the household and the gender and87

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2 0 0 7

Table 3.2 Where the return to education is high, its poverty-reducing impact is also highPoverty and income effects due to completing primary education (regional averages)

RegionSub-Saharan Africa
East Asia and the Pacific
Europe and Central Asia
Latin America and the Caribbean
Middle East and North Africa
South Asia

Marginal effect on
probability of being in thelowest decile

Marginal effect on
returns to primaryschooling

Within-region correlation
between effect of primary school
completion on poverty and returnto primary schooling–0.072–0.079–0.111–0.066–0.056–0.068

0.340
0.242
0.264
0.431
0.229
0.257

–0.674–0.733–0.743–0.464–0.996–0.946

Source: Authors’ estimates based on country-specific household surveys.
Note: For each country, the income of a head of household and the probability of the head of household being in the bottom
income decile depend on individual and household-specific characteristics—among them education, age, gender, and sector of
employment. As simple averages for all the countries within the six developing regions, the first two columns represent themarginal effect of completing primary school on the probability of being in the bottom decile and on income, respectively.

Table 3.3 Some factors affect the probability of being in the lowest income decile more thanothers—and the differences are changing over time
Poverty effects of specific characteristics (developing-country averages)

FactorPrimary school
Secondary school
Gender (women  1)
Age
Age squared
Number of elderly in the household

Marginal effects on
probability of being
in the lowest decile(2000)

Marginal effects on
probability of being
in the lowest decile(2030)

Difference(2000–30)–0.066–0.110
0.020
0.002
0.000
0.021

–0.081–0.100
0.017
0.002
0.000
0.020

0.016
–0.011
0.006
0.000
0.000
0.003

–0.028–0.066–0.066–0.060–0.076–0.065–0.065–0.067–0.0110.011–0.0130.008–0.007–0.025–0.023–0.014–0.0180.020–0.038–0.054–0.071–0.057–0.051–0.050–0.047–0.052–0.026

Industry effects

MiningManufacturing
Public services
Construction
Retail, Hotels
Transport communications
Finance services
Other services
Others not well specified

Source: Authors’ estimates based on country-specific household surveys and microsimulation results.
Note: For each country, the probability (estimated with a probit model) of the head of household being in the bottom income
decile depends on individual and household-specific characteristics—among them education, age, gender, and sector of employment. As simple averages for all the developing countries, the first two columns represent the marginal effect of each independent
variable estimated at the initial and final years, respectively. For each country, the difference between the marginal effects between
the two years has been calculated for each factor and the factor’s average across all countries is shown in the last column.

the sector of employment of its head, among
others, affect the likelihood of being poor
(table 3.3). Everything else being equal,
households headed by a woman are more
likely (by 2 percentage points) to be in the88

lowest income decile than are households
headed by a man. A similar difference is observed between workers in agricultural sectors
and those in nonagricultural sectors. Working
in the former increases the probability of being

I N C O M E

D I S T R I B U T I O N ,in the lowest income decile by 5 percentage
points.
The correlations between poverty and individual characteristics change over the forecast
period. Owing to a slightly increasing skill
premium, completing primary education reduces the probability of a person being in thelowest income decile by 6.6 percentage points
in 2000; it could reduce that probability by
8.1 percentage points by 2030. Hence lack of
education is likely to become a more important determinant of who is left behind in thenext 25 years. By contrast, the gender of thehead of household will become less important. As just noted, in 2000, households
whose head was a woman were 2 percentage
points more likely to be found in the lowest
income decile than were male-headed households. That difference could shrink to 1.7 percentage points in 2030. Finally, as agricultural
incomes approach those generated in othersectors,36 disparities in the probability ofpoverty of workers in the agricultural sector
and those in other industries may be less in2030 than they were in 2000.

Policy implicationsThese forecasts of growth, demographic
shifts, and trends in inequality point tosignificant challenges—and opportunities.
Developing countries’ growing participationin the global middle class will represent a substantial improvement in welfare for hundredsof millions of people, increase the weight ofdeveloping countries in the global economy
and in international policy, and possibly evenincrease support for open economic policies
that could further improve growth rates.
While poverty will fall quite sharply, hundredsof millions of people, concentrated in Africa,
will continue to live on less than $1 a day. Demographic shifts, coupled with unequal accessto both wealth and services, are likely toincrease inequality within countries, thus
further hampering the potential for overall
growth to reduce poverty. Policy can help
lessen the effects of these tendencies.

I N E Q U A L I T Y ,A N D

T H O S E

L E F TB E H I N D

Global policies: is development assistancea useful instrument to reduce inequality?
The improving fortunes of the developingworld raise the question of whether official
development assistance (ODA) is still necessary. It is—for the following reasons.
Aid flows can have a significant impact on
the global distribution of income when theyraise the incomes of the poorest countries. To
be sure, aid has to be well invested and relatively free of corruption to be fully effective.
Bourguignon, Levin, and Rosenblatt (2006)
show that as long as aid is distributed
equally—that is, it does not change the national income distribution—in recipient countries, its effect can be particularly beneficial tothe poor: 41 percent of all aid accrues to thebottom decile of the global income distribution
and another 25 percent to the second decile.37
Furthermore, empirical evidence demonstrates
that aid can lead to additional growth in the recipient countries, although some studies reachthe opposite conclusion (Easterly, Levine, andRoodman 2004), and others show that aid canenhance growth only in the presence of good
institutional characteristics (Burnside andDollar 2000; Collier and Dollar 2002).
To illustrate the potential effect of aid onincomes by region, consider a simple exercisethat adopts the same methodology that
Bourguignon, Levin, and Rosenblatt (2006)
used to estimate the global redistribution
effects of aid flows. This chapter calculates
growth rates without aid using the empirical
relationship between annual income growthand ODA estimated by Collier and Dollar(2002).38 It is further assumed that the shareof aid in developing countries’ GDP does notchange between 2000 and 2030, that institutional quality39 remains constant, and that aid
is distributed equally within recipient countries.40 By removing all aid, the forecast
growth rate for Sub-Saharan Africa would fallby more than 0.5 percentage points a year, or
almost one-third of projected per capita income growth. By contrast, the complete cessation of aid flows would have small effects on
growth in East Asia and Latin America.

89

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2 0 0 7

Figure 3.9 Ending aid would hurt the poor
Percent income loss, by centiles of global distribution
if ODA were to cease (expressed as difference frombaseline scenario of chapter 2)% population, ranked by per capita income
0

20

40

60

80

100

0

⫺4
⫺8
⫺12
Growth incidence⫺16

Averageincomeloss⫺20
Percent

Source: Authors’ calculations.

Figure 3.9 extends this approach to the fullset of countries in the microsimulation
model.41 For the world as a whole, per capita
income gains are 2 percent lower than in thebaseline. Distributional effects are much more
pronounced, with 87 percent of the world experiencing greater-than-average losses, although no one ends worse off in 2030 thanthey were in 2000. The bottom 1 percent of
the income distribution experiences an income
loss of 17 percent relative to the baseline. Expressed positively, the poorest 1 percent will
see their incomes rise by 37 percent between
2000 and 2030 if aid levels remain unchanged, versus a 20 percent real income gain
if their countries receive no aid.
These results are only illustrative. The exercise assumes that the allocation of aid andthe effectiveness of aid in promoting growthfollow their historical patterns. The growth
penalty of aid removal is thus constantthrough the forecast period—and such fastgrowing countries as China and India appear
to be penalized for not receiving developmental assistance, even though they may requiresignificantly less of it by 2030. In reality, improvements in the allocation of aid to thepoorest countries and to countries with good
policies could boost aid effectiveness and90

enable larger reductions in poverty than thoseanticipated in this study’s forecasts. On theother hand, efforts to reduce poverty could be
hampered by conflict, macroeconomic instability, or high levels of corruption that afflict
many of the poorest countries.42
A final limitation of the approach followed
here is that it does not consider the generalequilibrium effects of removing aid. In fact, thedifferent without-aid growth rates may have
implications for global trade (among othereffects) and thus may affect relative prices ofgoods and factors: these second-order effects
are not considered here. However, even withthese limitations, the conclusion that aid canbe powerfully pro-poor, combined with theworsening outlook for Sub-Saharan Africa inthe baseline, underscores the importance of focusing the aid flows on Africa and improving
its effectiveness.

Global policies: further liberalizationof trade stands to benefit everyone
The lowering of trade barriers around theworld would benefit all segments of the world
population, including the poor. Previous estimates showed that full multilateral trade reform could lift roughly 100 million people outof extreme poverty (defined as living on lessthan $2 a day)—see Anderson, Martin, andvan der Mensbrugghe (2006). Increased preference for free trade, combined with greater visibility of the plight of the poor, may help implement the global reforms that can be effective in
elevating the living standards of the poor.
Unfortunately, as illustrated by the impassein the multilateral Doha negotiations, theprogress toward freer trade is currently
stymied and will take a major effort among
the rich and poor countries together to realize
even its limited progress.
This section illustrates the potential effects
of a successful global trade reform by implementing a scenario with a 75 percent cut intariffs and domestic support in all countries by2025,43 thus projecting into the future the liberalization trend of the past few decades. The
resulting income gains, which include theI N C O M E

D I S T R I B U T I O N ,Figure 3.10 Global trade reform can bepro-poor
Percent income gain from trade liberalization, by
centiles of global income distribution (difference frombaseline scenario of chapter 2)
Percent
24
20

Growthincidence

16
12
8
Average income gain

4
0
0

20

40

60

80

100

% population, ranked by per capita income
Source: Authors’ calculations.

positive effects of increased trade openness on
productivity, are quite modest: average percapita income (in PPP terms) in the final year
rises by 7 percent relative to the baseline. The
distributional consequences of trade reform
are summarized in figure 3.10, which for eachcentile of the global distribution shows the income gains experienced over and above thebaseline improvements in income.44 Despite
the modest overall gain, trade reform is decidedly pro-poor in the sample because the poorest households experience income gains above
the global average. Furthermore, the bottom
30 percent gain slightly more than the four
middle deciles, and more than twice the increase in incomes experienced by the top
30 percent of the world.45 In absolute terms,
these income gains translate into a 13 percent
increase in the size of the global middle classand reduce the number of people earning lessthan middle-class incomes by 231 million
relative to the baseline.

Domestic policies: powerful instruments
to attain mutually reinforcing growthand equity objectives
Well-designed domestic policies are likely tobe the most powerful instruments to reduce

I N E Q U A L I T Y ,A N D

T H O S E

L E F TB E H I N D

both inequality and poverty in any specificcountry. Such policies need not interfere withsustainable long-term growth. In fact, as
clearly shown by World Bank (2005: 10), the“dichotomy between policies for growth andpolicies specifically aimed at equity is false,”
and governments should be able to design
equity-enhancing policies that can also increase efficiency. Even so, potential trade-offs
may arise. Raising direct taxes to excessive levels to finance social services, such as education,
targeted to the poor may create disincentives
and even curb investment. However, in thelong run, once access to education has become
more equitable, a larger share of the population will be educated; growth should also behigher. These long-term benefits of redistribution should be considered when assessing
trade-offs between equity and efficiency.
In addition, specific policies that may boost
growth, such as trade liberalization, may insome cases negatively affect the poor. In manycases, the solution consists of designing complementary policies that mitigate the adverse
poverty consequences of reform rather thanabandoning or modifying the pro-growthpolicy, either of which may have even worse
consequences for equity. In the trade-liberalization example, mitigation policies may
range from investing in access roads to improve access by the poor to markets, to setting
up or improving safety nets, and to better
labor-market policies and institutions.
The design and successful implementationof a development strategy that positively reinforces growth and equity objectives is highly
country-specific. It will depend, among otherthings, on countries’ initial conditions in termsof equity, institutions, and economic structures. Yet from recent literature, and throughone’s consideration of the scenarios describedin this and the previous chapters, some policy
lessons emerge that may be relevant for a large
number of countries.
A first lesson can be inferred by observing
that with increasing incomes and the expansion of the middle class, governments shouldbe able to collect larger revenues and thus91

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2 0 0 7

gain fiscal space for redistributive spending.
Furthermore, the composition of tax sources
also changes with a shift toward more direct
taxes and fewer indirect taxes. Unfortunately
the distributional impact of such a shift cannot
be tested directly on this study’s household survey data, which do not report tax payments,
but the available literature is not overly optimistic. For example, ex post studies for Chile,a country with one of the most effective tax systems in Latin America, estimated that in 1996
the after-tax Gini coefficient was 0.496—
slightly higher than the before-tax index of
0.488.46 Lopez and others (2006) show that income inequality in European countries isbarely affected by taxes and social security
contributions, indicating that the overall distributional effect of taxation is almost equivalent
to that of a proportional (flat-rate) tax. The
same study also shows that redistribution takes
place mainly through transfers rather than
through taxes: in most European countries
transfers seem to be almost equally distributed
across the population, thus contributing to a
substantial reduction in income inequality before tax and transfers.
This evidence suggests that although taxation can be redistributive, at least in principle,
transfers and expenditures (for education, forexample) may be governments’ preferredlevers of redistribution. This chapter has emphasized the critical role that education canplay in reducing poverty. Improving access to
education can reduce poverty both by increasing individual productivity and by facilitating
the movement of poor people from low-paying
jobs in agriculture to higher-paying jobs in industry and services. Even more important,public spending on education (as well as on
health and other human capacity), when targeted toward the poor, can produce a double
dividend, reducing poverty in the short run
and increasing the chances for poor children toaccess formal jobs and thus break free fromthe intergenerational poverty trap. Empiricalevidence of the double advantages of targetededucation programs has been emphasized byother studies. Morley and Coady (2003) state

92

that “a good deal of the success of these
programs stems from their system of targeting[. . .] On average 71 percent of conditional[for education] cash transfer program benefits
go to the bottom 40 per cent of families.”
Evidence on the educational impact of these
programs is sparser, and given their relative
recent implementation, very little is known
about the long-term earnings benefits accruing to the recipients. However, the existing
evidence is strongly positive: most reviewed
programs have achieved their objectives ofincreasing enrollment rates among theirtargeted population.47
Increasing educational levels must be accompanied by a strong investment climate toensure productive jobs for the newly educated,
and the quality of education needs to be maintained. The shift from agriculture should beundertaken within a wider context of improving agricultural productivity and expanding
opportunities in modern sectors, not throughpolicies that discriminate against agriculture.
Labor-market policies are important in aiding
worker adjustment and enhancing mobility,
but too often such policies end up raising
the cost of hiring labor and push workers into
informal sectors or unemployment. World Bank
(2005) emphasizes the role of labor unions in
improving worker conditions, but cautions that
product markets must be competitive to preventthe unions from commanding rents at the expense of consumers. Success stories include
unionizing landless export agriculture workers
in northeastern Brazil, which resulted not only
in better worker protections but also enhanced
productivity and quality of output.
Government intervention is another mechanism for improving working conditions.
Cambodia was able to significantly limit laborabuse in the textiles sector through a monitoring program designed to improve labor
standards in exchange for higher U.S. importquotas. The Slovak Republic lowered employment taxes and increased labor-market
flexibility through concentrated efforts by areform-minded government seeking to join theEuropean Union.

I N C O M E

D I S T R I B U T I O N ,I N E Q U A L I T Y ,A N D

T H O S E

L E F TB E H I N D

Figure 3.11 The inequality effects of trade liberalization are not large and depend on the
structure of initial protection
Change in Gini coefficient for individual countries
Gini coefficient
0.06

Change due to tradeliberalization scenario

0.04
Total change frombaseline scenario

0.02
0.00
0.02

D
om

in

ic

H
B ait
Ja oliv i
m ia
ai
an
c
R Bra aep z
Pa ub il
Ar na lic
El ge ma
Sa ntil n
Li vad a
th o
ua r
ni
U Pe a
ru ru
gu
ay
Ec Ch
ua ileT d
Pa ur ork
C rag ey
os u
ta ay
M Ric
o
N ld a
Ve
ic o
ne
a v
zu Ho rag a
R Kyr ela ndu ua
us gy , R r
si z .B as
an R .
Fe epu dede bliR rati co oC ma n
ol ni
om a
M bia
e
Si G xic
er uy o
ra an
L a
Ar eo
G m neua enC tem iaam ab la
So Vie odi
ut tn ah am
AfBa Hun rica
ng ga
la ry
I
n
M do desoz n ham esi
Ta biq an u
T za eEg Ye M hai nia
yp me au lant, n, rita d
Ar R nab ep ia
R .o
ep f.
.
N of
Et ige
hi r
op
ia
I
Bu nd
ia
Pa lgar
ki ia
st
Po an
la
B nd
Za eni
m n
N bia
ig
e
C
ô N ria
M te d epa
ad ’Iv l
ag oi
a re
U sc
C ga ar
am n
e da
B roo
Sr uru n
i L nda i
Al nka
Bu R banrk wa ia
in nd
a a
Fa
G s
u o
Se ine
ne a
Jo ga
rd l
an

0.04

Less

Total change in income inequality

More

Sources: Authors’ calculations based on survey data and microsimulation results.

Domestic policy reforms can also strongly
influence the final effects on inequality andpoverty of multilateral trade reforms. As
shown above, multilateral trade liberalization
has a discernible impact on global income
distribution; however, the “pure” trade policy
effect on within-country inequality does notseem to be very large (figure 3.11). Withincountry inequality will change according to theinitial pattern of protection, the evolution of
global prices, and the sectoral and factorspecific productivity impacts (see Winters,
McCulloch, and McKay 2004 and Bussolo andRound 2005). For example, in a scenario where
global trade barriers are eliminated and international prices for agricultural goods increase,
Brazil, which currently protects skill- (andcapital-) intensive industries more than it does
agriculture, will likely experience a reductionof within-country inequality. Conversely, India
or Mexico, countries with tariff structures that
protect unskilled workers (especially in agriculture), will probably have to face pressure toward increasing inequality. Because they assume that other factors will remain equal, thesehave been labeled “pure” trade effects. Clearly,

well-designed additional policy interventions,especially those that improve education and infrastructure and address other “behind theborder” investment climate reforms, can militate against the inequality changes that may
result from trade liberalization.
Such policies are likely to play an increasingly important role in the future, not least because the coming globalization will include
two new challenges—the integration of large
emerging economies such as China and India,
and the global sourcing of services. While theabove scenario explores the impact of reductions in tariffs on goods, the global sourcing ofservices, enabled by new advances in technology, is leading to an increasing number ofservices-related tasks—and increasingly higherskilled tasks—being undertaken in developing
countries. This will bring new implications forwage distribution along the skill spectrum,and most likely change the inequality results
shown in figure 3.11. The implications of thiscombination of technological advance andtrade integration for workers in developing
and developed countries are discussed in moredetail in chapter 4.

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2 0 0 7Notes
1. In this discussion the authors have adopted thenaming conventions of World Bank (2005). Milanovic(2005) refers to the following different measurements
as inequality concepts 1, 2, and 3.
2. Bourguignon, Levin, and Rosenblatt (2004) pointout that using the intercountry concept may represent animplicit welfare judgment, whereby the rising incomesof more populous countries cannot offset the losses ofsmaller countries when their incomes are falling.
3. The influence of China and India is so large thatomitting these two countries would reverse the conclusion: international inequality excluding China and India
has increased in the past two decades (World Bank 2005).
4. It should also be noted that measurement of inequality is sensitive to both the precise indicators used
to measure it and the time horizon chosen.
5. The ratio of per capita incomes of the richestand poorest country in the sample has grown by afactor of more than five.
6. Bourguignon, Levin, and Rosenblatt (2004)
show that it is possible to produce rising inequality
statistics if, for example, the sensitivity of the Atkinson
inequality index to deviations from mean income at thebottom of the distribution is set sufficiently high(over five).
7. Atkinson and Brandolini (2004) use the Gini
coefficient, the Theil index, and mean logarithmic
deviation to show that income inequality declined
between 1970 and 2000.
8. Bourguignon and Morrison (2002) argue that
inequality between countries has been responsible formost of the time-series variation in global inequality.
See also Milanovic (2002), who shows that in 1993,
inequality between countries accounted for threequarters of global inequality.
9. Some of the studies examining global inequality
have relied on parameterized Lorenz curves to add thewithin-country dimension to the analysis: see forexample, Sala-i-Martin (2002a, 2002b), and Bhalla(2002). Others, such as Milanovic (2002) and WorldBank (2005), have built up the global distribution fromhousehold surveys.
10. The between-group decomposition is accomplished by giving each person within the group thatgroup’s average income. As a result, differences between
the average incomes of the rich, the poor, and the middle
class account for 68 percent of total world inequality.
On the other hand, if every person in the world is assigned the average income of his or her country of residence, income differences between countries account for
76 percent of global inequality. Thus, income differentials between the rich, the poor, and the middle class are
responsible for the bulk of global variation in incomes.

94

11. The size of the middle class doubles between
2000 and 2030. In comparison, the number of the richincreases by 75 percent and the number of the poor
decreases by 19 percent.
12. The number of developing-country citizens in
the global middle class increases 3.25 times between
2000 and 2030. The share of low- and middle-income
country nationals among the rich rises even faster(4.7 times), but their influence in this group is likely
to be moderate, as OECD citizens will still constituteone-half of the category.
13. Note that this is not true for the first column oftable 3.1, which is based on 1993 international dollars.
14. This study’s qualitative conclusions about thecomposition of the middle class hold even if the authors adopt a relative definition of the middle classand confine their attention to the fifth decile of
the world’s income distribution—that is, the “median”
individuals.
15. The authors’ global middle class concept is in
this sense similar to a poverty line, which is the amountof real income required to buy a fixed amount of calories. Poverty lines do not move through the periods ofgrowth and decline, since the latter do not affectcaloric intake requirements. Similarly, the study’s definition of the middle class is based on the ability to afford a certain basket of goods and services, and anyone
who can purchase this basket (whether in 2000 or in2030) is a member of the middle class.
16. Note that the simulation design for China differsfrom the majority of countries in this study’s sample. Because the authors do not have information on individual
earnings, they cannot pass the changes in skill premia
from the CGE model to the microsimulation. All othersteps, including demographic change and growth in percapita incomes, remain fully consistent with the standard simulation approach. See box 3.1 and Bussolo andothers (forthcoming) for more details.
17. The distribution is plotted as a kernel density
function of the household per capita incomes.
18. In other words, the study results show that
13 percent of the middle-class population in 2030 will
have completed less than a full cycle of primary education. The relevant population share for those earning
more than middle class incomes is 12 percent.
19. As cited in Mayda and Rodrik (2002).
20. Note that the Africans of 2030 will be better
off in absolute terms than in 2000, since the study forecasts non-negative real growth rates even at the bottomof the distribution.
21. There are 12 developing energy exporters inthe study’s 114-country database. These include three
countries in the Middle East and North Africa, two in
Sub-Saharan Africa, three in Latin America and the
Caribbean, and four in Europe and Central Asia.

I N C O M E

D I S T R I B U T I O N ,22. There are 15 developing-country agriculture
exporters in the study sample. A country is defined as
an agriculture exporter if its exports of any one agricultural commodity exceed 20 percent of total exports.
23. This is another case showing that this chapter’s
results should not be considered “forecasts” but ceterisparibus scenarios; a forecast should include at least
some countries with negative performances.
24. Osberg (2003) measures polarization by theshares of population earning less than 50 percent andmore than 150 percent of the median income. In boththe United States and the United Kingdom, the sharesof low and high earners increased substantially overthe sample period.
25. These effects are somewhat ameliorated because with population aging, older and more experienced workers tend to become less scarce, reducing theirwage premium (Higgins and Williamson 1999). Also, in
45 percent of the developing countries in the study sample, younger household heads tend to earn more thanolder ones, owing in part to higher education.
26. The maximum poverty elasticity (assumingthat all migrants are poor and all poor migrants increase their incomes sufficiently to escape poverty) for
developing countries is about 2—see table below, column (a). However, on average, of every 100 migrants
only 20 are below the poverty line (column b). These
results are based on the case where movers are selectedaccording to their characteristics (that is, with a logit
selection model). Furthermore, of the average 20 poor
migrants among the movers, 7 remain in poverty intheir new occupation (column c). This results in an
observed poverty elasticity of 0.2 (column d).

I N E Q U A L I T Y ,A N D

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L E F TB E H I N D

27. By facilitating access to higher-paying jobs, education contributes to reducing poverty even for thoseworkers who do not move across sectors.
28. This finding is informed by country-specific regression analysis focusing on the determinants of employment in farm and nonfarm sectors (probit models).
Although this pattern is true for most countries, insome cases migrants tend to have different characteristics. For example, in a recent study for Brazil, Bussolo,
Lay, and van der Mensbrugghe (2006) used a more
complex behavioral model to show that, with only a
few exceptions, poorer individuals are more likely to
migrate to nonfarm occupations.
29. The authors of this study assume that, once themigrants are selected, in one way or another, they finda job in the rest of the economy and earn the modern
sector’s higher wage adjusted to take into account theirpersonal characteristics.
30. See, for example, World Bank (2005) and
Lopez and others (2006).
31. The relationship between household income
and age of the household head is positive in approximately 70 percent of the sample countries, while
the age-income profile is positive in 60 percent of thecountries.
32. The literature on the evolution of income inequality identifies three channels that determine the effects of demographic change: first, given an upwardsloping age-earnings (incomes) profile, aging will
increase inequality between old and young groups(Deaton and Paxson 1997); second, different age
groups are characterized by different within-group inequality, and inequality tends to be higher among older

Moving from agricultural to nonagricultural occupations reduces poverty in some regions
more than others
Migration-poverty elasticity when 10 percent of the population employed in agriculture migrates

RegionSub-Saharan Africa
East Asia and the Pacific
Europe and Central Asia
Latin America and the Caribbean
Middle East and North Africa
South Asia
Average in the developing world

Maximumpoverty elasticity(a)Poverty among
migrants
before moving(b)Poverty among
migrants after
moving(c)

Observedpovertyelasticity
(d)

1.60
3.78
4.45
1.74
1.18
1.81
2.03

0.35
0.11
0.03
0.19
0.26
0.23
0.19

0.14
0.09
0.01
0.08
0.01
0.07
0.07

0.36
0.48
0.03
0.09
—
0.15
0.20

Source: Authors’ estimates from household surveys.
Note: Column (a) shows how much poverty could be reduced in percent terms with respect to the initial poverty headcount if all
migrants are initially poor and all escape poverty after the move. Column (b) represents the actual poverty headcount of movers(accounting for the fact that many nonpoor migrate). Column (c) shows the poverty headcount among movers calculated after
they are assigned the income of the new occupation. Column (d) is the actual migration-poverty elasticity (for a 10 percent
migration rate). —  not available.

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2 0 0 7age cohorts (see Deaton and Paxson 1997; Jenkins
1995; and Mookherjee and Shorroks 1982). With
everything else remaining constant, when older cohorts
become more populous, as is the case with lower population growth rates, aggregate inequality increases.
These two channels affect aggregate inequality without
any change in the age premium, that is, with a fixed
age-earnings profile; however, the third channel considers changes in inequality due to changes of the lifecycle income profile. As the population ages, older
high-wage and more experienced workers tend to become less scarce and the wage premium they initially
receive will be reduced (Higgins and Williamson
1999). This third channel works through the labormarket and contributes to attenuating the inequality
increases brought about by the first two channels. This
channel is explored in more detail as part of the
discussion on price-wage adjustments.
33. Some of the changes in inequality shown in figure 3.6 may seem implausible when compared withsome ex post evidence; however, the aim of this figure
is not to present forecasts of income inequality, butrather to show what may happen, ceteris paribus, to inequality in a specific scenario for the evolution of the
global economy.
34. The simulated reduction of the gap between
skilled versus unskilled workers’ wages for Latin America
is plausible and in line with recent evidence. Manacorda,
Sanchez-Paramo, and Schady (2005), using micro-data
for five Latin American countries, show that the relative
rewards of workers who completed tertiary school haveincreased but, apart from Mexico, relative wages ofworkers who completed secondary school have decreased. In this study’s micro-simulation the authors define a worker as skilled when his or her level of educationis, at least, completed secondary. In Latin America, about
25 percent of heads of household have secondary education (without tertiary) compared with 12 percent of heads
with tertiary schooling. Therefore, even with an increaseof the tertiary-educated workers’ wages, the average
wage for the group defined in the study as skilled would
still be reduced.
35. Notice that this is not the same as encouraging
mobility by means of “forced urbanization,” which is
known to generate negative consequences. The
focus here is on removing distortions rather thanadding them.
36. These income dynamics—that is, the changesof the premia received by agricultural workers versus
nonagricultural ones, as well as those obtained byskilled versus unskilled—are consistent with the CGE
results of chapter 2.
37. Bourguingon, Levin, and Rosenblatt (2006) also
show that although aid is often viewed as a zero-sum
game, that is not the case if aid flows are measured in

96

PPP terms, which account for lower prices of nontradable goods in the recipient countries.
38. This is given by the equation:
Gi  {Set of variables not related to aid}  0.54
2
* (ODAi/GDPi)  0.02 * (ODAi/GDPi) 0.31 * (CPIAi * ODAi/GDPi)
39. Institutional quality is captured by the WorldBank’s Country Performance and Institutional Assessment (CPIA) ratings. For International Development
Association (IDA) member countries, CPIA scores areavailable online starting with 2005.
40. The assumption of equal distribution of ODA
implies that the removal of aid flows does not change
the income distribution within countries. On the one
hand, assuming equal distribution may be too
optimistic—aid may not reach the desired recipientsowing to a host of factors including corruption and lackof access to infrastructure. On the other hand, it may be
too pessimistic, since the rich in the recipient countries
are assumed to derive some benefits from the aid thatthe donors never intended for them to obtain.
41. In estimating this effect, this study’s methodology and the approach of Bourguignon, Levin, andRosenblatt (2006) differ in two important ways. First,
this study uses growth rates generated by the model ofchapter 2 rather than historical growth rates. Second,
while Bourguignon, Levin, and Rosenblatt (2006) disregard the within-country distribution of income (byassigning every individual within a country thatcountry’s per capita gross national income—GNI), thisstudy’s approach explicitly takes into account both
between- and within-country distributions.
42. In 2004 only 10 of 66 low-income aid recipient
countries received a “good enough” rating of theirbudget system according to the CPIA indicators (WorldBank 2006). In the presence of bad policies, conventional aid delivery methods are unlikely to benefit theintended recipients, even if the aid is targeted toward
human development–intensive sectors such as education and health (World Bank 1998). This is because aid
is often fungible and can be easily reallocated awayfrom target activities once it enters the public budget.
At the same time, even the most distorted policy environments are likely to have “pockets of reform,” which
can become the focal point of donors’ efforts to improve
the overall policy environment. For example, efforts toimprove public procurement—the mechanisms throughwhich governments purchase goods and services—lie at
the heart of the ability of aid to deliver the desired
outcomes (World Bank 2006).
43. Notice that this implies a larger absolute cut inprotection for developing countries, whose initial tariff
levels are significantly above the high-income average.
44. In other words, figure 3.10 represents the difference between the growth incidence curve of the

I N C O M E

D I S T R I B U T I O N ,trade reform scenario and the growth incidence curveof the baseline scenario. The horizontal line is theincrease in the global average per capita income.
45. Figure 3.10 shows the dynamic gains from tradereform, which allow for feedback from increases intrade openness (exports-to-output ratio) to total factor
productivity. Since low-income countries tend to havehigher trade barriers, the trade reform scenario resultsin larger absolute tariff cuts in these countries and therefore greater increases in trade flows. The CGE model
used to simulate the trade reform scenario does not capture the possibility of imperfect pass-through of priceshocks to different individuals (because they are in remote areas, involved in subsistence activities and thelike), and accounting for these imperfections would
dampen the pro-poor potential of trade liberalization.
46. Engle, Galetoviv, and Raddatz (1998), cited in
Lopez and others (2006).
47. Morley and Coady (2003) even attempt to estimate the future earnings of poor children receiving
transfers under programs in Mexico and Nicaragua. In
their words: “under the reasonable assumption that thewage structure of the future labor force will be thesame as it was in the year of the most recent survey, we
estimate that the additional education would add
about 8 per cent to the average earnings of the poor in
Mexico and about 9 per cent in Nicaragua.”

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4
New Pressures in Labor Markets:
Integrating Large Emerging
Economies and the Global
Sourcing of Services
Rapid technological progress, trade in goods,
and international sourcing of services come together to put new pressures in labor markets,pressures that will only become more acute in
the next 25 years. Through these channels,
globalization is creating a progressively more
integrated global market for labor. The impact
is tempered by differences in the skills, technology, and know-how available to workers.
Globalization offers opportunities for export growth and access to a wider range ofcheaper imported products that can fuel productivity growth and rising average living
standards. But globalization also imposes
adjustment costs on certain groups withincountries, primarily through labor markets byinfluencing wages and job security and by
demanding retraining, and the upheaval ofmoving between jobs. The unskilled have seen
their wages worsen relative to skilled workers
and their jobs become less secure. This is true
even in developing countries—contrary to expectations that the unskilled benefit relative
to the skilled as labor-intensive manufacturing
moves to low-wage countries. The projectionsin this report offer little reason to believe that
this will change in the coming decade.
Two challenges are particularly demanding:one is the rise of China, India, and other emerging economies as manufacturing powerhouses,
and the other is the emergence of global sourcing of services. While the qualitative implications of increasing exports of manufactured
products from India and China are the same as

for the emergence of the Asian tigers, India andChina’s sheer size raises the specter of surging
new export competition. Many developing
countries fear that exports from these large
new players may swamp their domestic markets, squeeze them out of the global market,
foreclose avenues of diversification in manufactures as a road to higher growth, and gobble
up all the investment flows. And high-income
countries worry that if the large emerging
economies can readily acquire and master thenewest technologies, their exports may soontake over high-tech markets.
Global sourcing of services exerts pressures in the same direction. The transfer ofrelatively skilled service activities to firms indeveloping countries is putting new pressureson white-collar employment in both the highincome countries and advanced developing
countries. This puts higher-paying and higherskill jobs at risk in both high- and middleincome countries. Unlike displacement inlow-skilled manufactures trade, services offshoring has the potential to destroy the previous investments of white-collar workers in
firm-specific knowledge.
The analysis here suggests that three factors are likely to mitigate these effects in themedium and long term.
• First, the growth of the Chinese, Indian,and other emerging markets offers enormous offsetting opportunities for otherdeveloping and developed countries to101

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2 0 0 7increase exports. As China and India increase their exports, they will have toincrease imports of intermediate inputs,
energy, technology, and investment
goods. Driven by China, Asia was theprincipal destination for accelerated exports from Africa and Latin America in
the late 1990s and the early 2000s.
• Second, accompanying the rising value ofexports and domestic living standards inemerging economies will be rising wages.
This—together with the inevitable exchange rate adjustment to the rise inglobal demand for these countries’ products and services—will create space forlow-income countries to move into thelowest-skill activities vacated by producers in the large emerging countries.
• Third, developing the social institutions
that support a dynamic market economy
in China and India will take time,
providing an opportunity for smaller,
more flexible countries to progress fasterin institutional development—and forrich countries to continue to lead inproductivity-enhancing innovation. The
flow of services activities from rich topoor countries, which entails some transfer of know-how, will be slowed to theextent that institutional frameworks discourage foreign direct investment (FDI)
and in particular fail to protect the ownership of such assets.
The policies that countries adopt will
determine whether they will be able to takeadvantage of these new opportunities. Effective policy responses will need to position
countries to harness the opportunities fromglobalization while also addressing the adjustment tensions that inevitably arise from theunprecedented magnitude and speed ofchange in labor markets.
Policies to embrace, rather than resist, global
integration will lay the foundations for future
growth and job creation. Openness to tradeand FDI will become ever more critical if thepoorest countries are to absorb technologies

102

and know-how from abroad and seize the opportunities created by rising demand from—and production shifts in—India and China.
But openness will not foster integration in theabsence of an attractive investment climate,
one with sound institutions and policies thatallow labor, capital, and knowledge to flowfrom low-return to high-return sectors. Developing knowledge-intensive activities as future
drivers of growth will require investing in theinstitutions and policy frameworks that foster
innovation, and in education and lifelong
learning for all workers. Developing countries
with wages currently higher than those in
China and India will have to place greater attention on their institutions and on education
policies to create a climate for greater innovation and skill enhancement.
Social policies should focus on protecting
workers rather than protecting jobs. Even in themost propitious policy and institutional environments, rapid growth, globalization, andlabor-market flexibility are likely to quicken thepace of job creation and job destruction. This
demands policies to cushion the adjustment
costs associated with increased volatility and involuntary dislocation. The returns to skilledlabor will continue to increase faster than thoseto unskilled labor, perpetuating a natural wagewidening tendency in many (if not most) countries and underscoring the need for measures tosupport workers at the low end of the scale.
Rising wage inequality, together with volatilelabor markets, are heightening insecurity
among workers throughout the world.

The impact of globalization:
the story so far

Globalization, coupled with technologicalchange, has driven growth in the world
economy, bringing new employment opportunities and enabling millions of people to escapeabsolute poverty. That said, impacts havevaried across and within countries—and not all
workers have benefited equally. While many
countries have seized the opportunities offeredN E Wby greater integration of markets in goods andservices, others, especially in Sub-SaharanAfrica, have remained marginalized. Meanwhile demand for skilled labor has increased inboth developed and developing countries andgreater global competition has become associated with a growing sense of insecurity formany workers worldwide.

Product markets are rapidly integrating . . .
with a geographical redistribution of
manufacturing
Developing countries’ trade has accelerated
over the last few decades. In the markets ofdeveloped countries, the share of developing
countries in imports of manufactured products grew from barely 14 percent in 1973 tonearly 40 percent in 2003 (figure 4.1).1
Imports of developing countries have grown
just as quickly as their exports to the rest of theworld (Ghose 2003). Developing-country imports grew at about 2 percent per year during
the 1980s, accelerating to 9.5 percent per year
during the 1990s (Bhorat and Lundall 2004).

Figure 4.1 Developed countries’ importsof manufactures increasingly come fromdeveloping countries
Share of high-income countries’ imports ofmanufactures originating in developing countries
Percent
45
40
35
30
25
20
15
10
5
0
1973

1983

1993

2003

AfricaEurope and Central Asia

Middle East

China

Latin America

Other Asia

Sources: Data from World Bank World Integrated Trade
Solution (WITS) and staff calculations.
Note: Excludes trade among EU15 countries.

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M A R K E T SThis increased two-way trade reflects thegrowth of outsourcing and global production
chains (see Global Economic Prospects 2003).
Enabled by falling barriers to trade and FDI,
lower transport and communication costs, andnew technologies, global chains break down
goods into their constituent parts, each produced where it can be done most efficiently andat least cost, whether by an affiliate or by an independent supplier. Ghose (2003) sees a correlation between countries’ share of world merchandise exports and their share of FDI inflows:
between 1982 and 1999, foreign affiliates oftransnational corporations increased their shareof world exports from 31 percent to 45 percent.
At the same time, manufacturing employment has been redistributed between developed
and developing countries. While the precise
numbers are debated, the gain in the latter has
been much larger than the loss in the former(Sapir 2005; Ghose 2003).2 Overall, employment in manufacturing in developed countries
declined from 28.7 percent in 1995 to 24.8 percent in 2005, while most developing regions
saw gains (table 4.1).
Not all developing countries have experienced gains in manufacturing employment,
however. Consider, for example, the striking differences between East Asia and Latin America.
Over the 1990s, employment in manufacturing
increased in China (by just under 15 percent
cumulatively), India (by about 38 percent),
Malaysia (40 percent), and Thailand (about
49 percent). In Latin America, however, aggregate manufacturing employment declined overthe 1990s; increases in Chile (about 10 percent)were more than offset by declines in Brazil(about 50 percent) and Argentina (14 percent)(Bhorat and Lundall 2004).3
Services employment has increased inboth developed countries and all developing
regions, except the Middle East andNorth Africa, where it has remained the same(table 4.1). Over the 1990s, large increases
in services employment were seen in Brazil(57 percent) and Mexico (62 percent), withsmaller increases in China (about 13 percent)and India (25 percent) (Bhorat and Lundall

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Table 4.1 Employment in developing countries has shifted out of agriculture into
manufactures and services
Trends in sectoral shares in employment, 1995–2005 (percent)Agriculture

Industry

Services

World region

1995

2005a

Change (%)

1995

2005a

Change (%)

1995

2005a

Change (%)

World
East Asia
South East Asia andthe PacificSouth Asia
Latin America and the
Caribbean
Middle East andNorth Africa
Sub-Saharan Africa
Developed economies andthe European Union
Central and Eastern
Europe and CIS

44.4
54.4
55.3

40.1
49.5
43.3

⫺9.7
⫺9.0
⫺21.7

21.1
25.9
15.4

21
26.1
20.7

⫺0.5
0.8
34.4

34.5
19.7
29.3

38.9
24.4
36

12.8
23.9
22.9

64.1
23.4

61.2
17.1

⫺4.5
⫺26.9

13.4
20.2

14.1
20.3

5.2
0.5

22.5
56.4

24.6
62.5

9.3
10.8

30.8

26.3

⫺14.6

20.3

25

23.2

48.9

48.7

⫺0.4

70.1
5.1

63.6
3.7

⫺9.3
⫺27.5

8.2
28.7

8.9
24.8

8.5
⫺13.6

21.7
66.1

27.5
71.4

26.7
8.0

27.9

22.7

⫺18.6

27.5

27.4

⫺0.4

44.6

49.9

11.9

Source: ILO 2006; Bank staff calculations.
CIS: Commonwealth of Independent States.
a. Indicative.

2004). Also worthy of note are the relatively
high levels of female employment in the sector.
To some extent, this increase may reflectchanges in business organization, where functions once performed inside manufacturing
companies are now outsourced to other firms
on a contract basis, resulting in their reclassification as services. This change in businessorganization has also crossed borders, withmultinational companies sourcing activities
from subsidiaries or external firms around theglobe. (The global sourcing of services will berevisited below.)

Globalization has generally been
associated with rising average wages—but
not all workers are benefiting equally . . .
While an economy’s openness to trade and investment is in general associated with faster
growth of average wages over the longer
term, short-term impacts can vary. Although
the initial impact of trade liberalization on
wages may be negative in some countries, it
becomes significantly positive over time. For
FDI, the picture is reversed: an initial positiveeffect on wages is reduced to nothing after
five years. This highlights the importance of104

the investment climate—if opening the economy does not attract FDI, potential shortterm wage losses from opening the economy
may not be offset (World Bank 2002).
While average wages rise more rapidly inopen economies than in closed ones, increasing
relative demand for skilled labor is widening
the wage gap between skilled and unskilledworkers in both developed and developing
countries.4 The latter is contrary to expectations based on traditional trade theory that
globalization will increase the relative returnto abundant unskilled labor in poor countries.
While available evidence attributes wage
widening primarily to technology, trade is also
important. The relative impacts are hard todisentangle since technology can lead to trade,and technological innovation in turn can be a
response to increased competition from trade(box 4.1).
A widening wage gap between skilled andunskilled workers is particularly evident in the
United States, where lighter labor-market
regulation permits faster adjustments inwages. In Europe, where labor markets are
more tightly regulated, the outcome of rising
relative demand for skilled labor has been

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Box 4.1 What causes the gap between skilled andunskilled labor—technology or trade?

Traditional theory expects trade with low-wagecountries to result in a shift in the compositionof employment toward skilled labor between sectors(as industries expand or contract in response to foreign competition). In both developed and developing
countries, however, labor composition within sectors
has moved toward skilled labor (also reflected in a
dramatic increase in their relative wages), suggestingthat technological change has been the major force atwork. Moreover, the sectors shifting toward skilledlabor in developing countries in the 1980s had done
so in the United States in the 1960s, suggesting amigration of technological change from developed
to middle-income countries.
Technological change is generally viewed as themost important force in terms of the rising demand
for skilled labor (Krugman 1995), as evidenced by the
positive correlations between technology and growthof employment of skilled workers within industries,
and by the fact that increases in the relative wages(cost) of skilled workers have been accompanied byan increase in their relative demand (Helpman 2004).
Trade, by contrast, is a less important force—
although estimates vary. Feenstra and Hanson (2003)
conclude that the offshoring of manufacturing accounts for 15–24 percent of the shift toward moreskilled labor. Anderton and Brenton (1999), on theother hand, find that, when only offshoring to lowwage countries is included, trade may actually accountfor about 40 percent of the rise in the wage bill shareof skilled workers and approximately one-third of theincrease in their employment in the U.K. textiles sector. The OECD (2005d) finds that the average decline
in employment in 15 Organisation for Economic Cooperation and Development (OECD) countries was
27 percent in industries characterized by high international competition compared with 16 percent in total
manufacturing. Evidence from developing-country
studies also suggests that technology and FDI, rather

reflected in higher unemployment among theunskilled.5 In the United States, increased demand for skilled workers since the mid-1980s
has led to a relative increase in their employment and wages (Katz and Autor 1999).

than trade, is the most important factor in wage
inequality—for example in Chile (Reinecke andTorres 2001) and South Africa (Edwards 1999).
Trade plays an important role in disseminating
new technologies, however. Robbins (1997), for example, finds that the amount of capital equipment
imported into a subset of developing countries is asignificant factor in raising the demand for tertiaryeducated workers relative to demand for those completing only primary school. Moreover, technologicalupgrading can itself be a response to trade competition; there is substantial evidence that firms improve
productivity following competition from imports(Hoekman and Winters 2005). Companies in highwage countries facing import competition fromlower-cost developing-country suppliers may engage
in “defensive innovation,” moving up the value
chain and into more capital-intensive production.
They may also respond by offshoring more production to reduce costs—generally the low-skilled activities, with the high-skilled activities remaining in thehome market (Anderton, Brenton, and Whalley2006).a This can occur in both high-skill-intensive
and low-skill-intensive sectors so that trade with
developing countries can thus potentially have an
impact on a wide range of sectors—and even within
low-skill-intensive sectors, the higher-skilled activities
could still expand. In this sense, offshoring can havethe same effect as technology in reducing the relative
demand for unskilled labor within an industry(Feenstra and Hanson 2003), and reallocating awayfrom high-wage economies to low-wage economies.

aCurrency and exchange rate movements can also prompt a
shake-out that leaves only higher technology firms in a sector.
Disproportionate increases in offshoring can be seen during large
exchange rate appreciations and the costs and difficulty of reversal may see offshoring remain after the currency has stabilized.

Hence, while average U.S. real wages did notchange significantly between the late 1970s
and the mid-1990s, real wages of high-wage
workers increased and those of low-wage
workers declined (Helpman 2004)—despite

105

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Figure 4.2 In many developed countries
the gap between high- and low-income
earners has widened
Percent change in gap between 90th- and10th-percentile earners, late 1970s to mid-1990s
Percent
30
25
20
15
10
5
0
⫺5

ad
a
et
he
rla
nd
s
Fr
an
ce
N
or
w
ay
G
er
m
an
y
N

an
C

nd

Ita

la

do
ng

Ze
a

Ki

ew

U

ni

te

d

t

ni

U

N

St

m

es

at

ed

ly

⫺10

Source: Katz and Autor 1999.

the fact that the relative supply of skilledworkers grew over the same period.6
The same decline in the relative wages of
low-skilled workers is found in other developed countries, although to a lesser extent.
While the gap increased by 29 percent in the
United States and 27 percent in the United
Kingdom (figure 4.2), it was only 15 percent
in New Zealand, 14 percent in Italy, and9 percent in Canada (Katz and Autor 1999).
The relative wages of skilled workers increased in developing countries in the late
1990s, along with a rise in their relative
employment levels (Majid 2004; Bhorat andLundall 2004). There are several possible
reasons for this.
First, in some developing countries, notably in
Africa, increased demand for low-skilled labor
did not lead to wage increases because there wasa large surplus of labor to be absorbed (Ghose
2003; Wood 1997; Fox and others 2004). Studies in Latin America and the Caribbean also suggest that the increased participation of womenin the labor market may have contributed to awidening wage distribution. In that region,

106

women’s skills tended to be lower than averageand hence their entry in the 1990s depressed
earnings to lower-skilled workers (although
overall it raised the income of poor households)(de Ferranti and others 2002).
Second, demand for skilled labor increased(World Bank 2002). The share of skilled workers in total employment and the relative demand for these workers increased between theearly and late 1990s in a range of countries—
including Brazil, Chile, Malaysia, the Philippines, Singapore, and Thailand, with Mexico
experiencing a slight decline. In all cases, including Mexico, the growth rate of relative
wages of skilled workers exceeded that ofunskilled workers.
The demand for skilled labor depends on theskill intensity of the export sector. In many countries in Latin America, increased exports basedon abundant natural resources raised demandfor complementary skilled labor and capital(Perry and Olarreaga 2006). Furthermore, activities considered relatively low skill in developed countries may nonetheless be relatively
skilled in developing countries, especially in
manufacturing. Transfer of activities consideredrelatively low skill in developed countries to developing countries raises the relative demand forand relative earnings of high-skilled workers in
the latter (Feenstra and Hanson 2003).
Additionally, enhanced competition fromtrade can affect the relative demand forskilled labor by reallocating resources within
sectors away from less productive, unskilledlabor-intensive firms toward more productive
firms using more skilled labor. Trade also facilitates the transmission of skill-biased technological change. Protection in many developing
countries favored unskilled-labor-intensive sectors, hence liberalization led to expansion ofskilled-labor-intensive industries (Perry andOlarreaga 2006). Foreign direct investment canalso increase the demand for skilled labor.
In Eastern Europe, for example, privatization
and FDI helped bias employment composition
and relative wages significantly toward skilledlabor as production facilities were upgradedwith new technologies.7

N E W

Even outside the traded sector, globalization
may have an impact on low-skilled workers inother ways. In all countries, wages in the nontraded sector may be affected by wages and employment in the traded sector if there is mobility
between the two. In addition, international

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mobility in the form of migration may also havean impact on low-skilled workers, although
there is considerable debate on this issue. Most
studies focus on developed countries and tend tofind small overall impacts—or indeed positive
impacts—from migration on wages (see box 4.2).

Box 4.2 Workers in the nontraded sector—therole of migrationE

ven where workers do not experience increased
competition from international trade, they may
be affected by an increase in the supply of workers
resulting from migration, although this impact may
be positive. As immigration increases labor supply,and wages are reduced, more capital may be attracted
and more jobs created. Moreover, consumption by
migrants also increases the overall demand for nativelabor and capital. That said, many studies identify
redistributional effects, with the impact of immigration concentrated on the lowest-skilled workers. The
impact depends critically on the extent to which
migrants and natives are substitutes for one another;that is, whether they are competing for the same jobs
or operating in segmented markets (for a fuller
discussion, see Global Economic Prospects 2006).
Borjas (2003) finds negative impacts on workers up
to some college level, with immigration harming theemployment prospects and lowering the wage of competing native workers (a 10 percent increase in supply
reduces wages by 3–4 percent). The lowest-skilledwere hardest hit: wages fell by 8.9 percent for highschool dropouts, 4.9 percent for college graduates,and 2.6 percent for high school graduates while barelychanging for workers with “some college.” However,this analysis ignores, among other things, the long-run
capital adjustments induced by immigration. If thecapital stock does adjust, overall wages are unaffected
and the loss of wages to high school dropouts is cut tobelow 5 percent (The Economist, “Economics Focus:
Myths and Migration,” April 8, 2006).
Borjas, Freeman, and Katz (1997) argue that the effect of immigrant-induced increases in relative labor
supply are strongly concentrated on U.S. workers withless than 12 years of schooling, many of whom work in
the nontraded sectors. Migration increased the supply
of workers with less than high school education by 15 to
20 percent over 1980–95, leading to a 27–55 percent

decline in the relative wages of high school dropouts
over 1980–95 (depending on wage elasticity). The
effect of immigration is diffused throughout the economy, as natives move in response to immigration.
Large immigrant flows to one region may discourage
flows to that region of native workers, but may encourage flows of capital. Ottaviano and Peri (2005) findthat migration increases total employment by 10 percent, and increases U.S.-born workers’ wages by
3–4 percentage points, largely because U.S.- andforeign-born workers are not perfectly substitutable,
even when they have similar observable skills.
College graduates, high school graduates, and college
dropouts all gain (about 2.4 percent real wage increase), but the low-skilled lose (by the same amount).
Cortes (2005) also sees sizeable wage effects on the
low-skilled, but these are concentrated on other immigrants, as low-skilled immigrants and low-skilled
natives are far from perfect substitutes. A 10 percent
increase in the number of low-skilled immigrants ina city reduced the wages of low-skilled natives by
0.6 percent and of low-skilled immigrants by 8 percent. But migration also reduces the prices of nontraded goods and services. A 10 percent increase in
the average city’s share of low-skilled immigrants inthe labor force decreases the price of immigrantintensive services such as housekeeping and gardening
by 1.3 percent, with about 50–80 percent of this net
effect caused by reduction in wages.
Card (2005) argues that the wages of natives withless than a high school education relative to native highschool graduates have remained nearly constant since1980. This is despite immigrant inflows that have increased the supply of workers with less than highschool education and despite the growing wage gap between other education groups. Most of the absorptionof unskilled workers occurs in the form of city-specific,
within-industry increases in low-skilled intensity.

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. . . and workers are feeling less secure
Individuals are concerned not only about thelevel but also the security of their earnings.
Greater global competition, along with more
rapid technological change and diffusion, canincrease wage and employment volatility,8although separating the effect of trade fromtechnological change in volatility is difficult.
Labor turnover is high in many countries,
fueling individuals’ perceptions of economic
insecurity. Available data show gross sectoral rates of job creation and destruction of
between 5 and 20 percent, adding up to an annual job turnover of up to 40 percent in somecountries. A significant part of that turnover(often 30–50 percent) can be traced to theentry and exit of firms, important for output
and productivity growth. About 20 percent offirms are created and destroyed each year inmany countries, involving 10–20 percent of
the workforce (World Bank 2005). Whileevidence is not uniform, some studies ofOECD countries find that increased trade exposure is associated with more labor churning(Hoekman and Winters 2005). Overall it isestimated that 3 to 5 percent of the OECD
workforce experiences involuntary layoff inany given year (Kuhn 2002).
In the United States, more than 7 million
jobs have been destroyed on average every
quarter over the last decade as a result of thenormal functioning of the economy (OECD2005b), matched for the most part by equal or
greater job creation. Among the unemployed,
about 45 percent were laid off, 10–15 percent
are persons voluntarily between jobs, and theremainder are persons entering or reentering
the labor market as new job-seekers (Kletzer
2001). Voluntary attrition may account for up
to two-thirds of employment reduction in the
United States (OECD 2005d).
Falling transport and communication costs
are creating new opportunities for developing
countries to participate in global production
chains by providing specific activities and tasks(see box 4.7). However, discrete activities arelikely to be more footloose than whole sectors,
so that while globalization can bring better108

job prospects to developing countries, it canalso bring greater volatility and insecurity.
Bergin, Feenstra, and Hanson (2006) find thatwhile offshoring of production from theUnited States to Mexico has been an important source of growth in Mexico, there is ahigh degree of volatility in these activities.
Domestic demand shocks in the United States
are amplified when they are transmitted to theoffshored activities in Mexico. In this way, offshoring has led the United States to export to
Mexico some of the employment fluctuations
that it experiences over the business cycle.
In Latin America, overall labor turnover ishigher than in OECD countries. However,turnover depends on education, per capita
income, and other demographic and growthvariables. For example, young workers change
jobs more frequently than older workers andlower levels of education can imply lower levels of firm-specific capital and hence a higher
incidence of voluntary separation. Adjustingfor these factors, the region does not show
conditionally higher turnover. There is only
mixed evidence that either greater trade liberalization or exposure to technological change
leads to greater overall turnover in the region;
however, to the degree that trade liberalization
has expanded the share of tradables in total
output, it may have led to more churning in
the job market (de Ferranti and others 2000).
To the extent that it reflects labor-market
flexibility and the reallocation of resources tomore productive sectors, increased turnover
can be a sign of healthy adjustment, linked
to further growth and job creation. However,churning can also be negative—for example,
where job creation lags well behind job
destruction, where high turnover lowers
workers’ and employers’ incentives to invest
in education and training (thus ultimately
reducing productivity in a sector), or wherechurning results in labor moving into lessproductive sectors. In the absence of social
safety nets, workers in developing countries
may be unable to finance job searches
and may be forced into the informal sector(where productivity is generally lower) orN E W

into low-productivity, relatively low-growth
sectors such as agriculture.
The extent and nature of churning dependon the policy environment. Onerous labormarket regulations and restrictions on entry
and exit of firms can discourage firms fromhiring new regular workers, and workers fromsearching for jobs in the formal sector. They
can also limit the movement of resources outof low-productivity sectors. Overly restrictive
employment protection (such as restrictions
on hiring and firing) tends to have the effect ofprotecting only some workers (insiders, usually prime-age males) at the expense of others(outsiders, usually youth, women, and lowskilled workers). Strict employment protection
is associated with higher income disparities
and a greater incidence of informal work
(World Bank 2005). It also raises the costs ofworkforce reorganizations, thereby reducing
incentives for innovation and implementationof new technologies (Arias and others 2005).9
The precise impact of strict employment
protection on job creation depends on whobears the cost: where wages absorb less of thecost than firms, the disincentives to create employment are greater. In Latin America, firms
can bear up to 50 percent of the cost of nonwage benefits, resulting in reduced wages,
greater informality, or both (World Bank
2005). In the OECD countries, partial reforms
have tended to reinforce labor-market inequality, with temporary contracts for new
entrants (youth or women) but only limitedaccess to more permanent jobs. Strict employment protection is also associated with agreater feeling of insecurity, perhaps because
workers realize that their chance of long-term
unemployment is higher (OECD 2005d,
2004).10 A benefit of globalization is the pressure it exerts on institutions that cramp productivity growth and on governments to develop efficient safety nets that cushion
workers from the worst aspects of economic
insecurity, while preserving job creation andflexibility.
Today’s global labor market is characterized
by volatility, shifts in employment between

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developed and developing countries, andincreasing wage gaps between low- and highskilled workers worldwide. What will be theimpact of the key challenges now facing global
labor markets—namely absorption of large
emerging economies and the global sourcingof services?

New challenge I—absorbing
large emerging economies into
the global market
By 2030 China and India together willaccount for about 40 percent of theworld’s workforce, which will remain
predominantly unskilled
By 2030 the world’s labor force will number
some 4.1 billion workers, 90 percent of whom
will live in the developing world. The global
labor force is predicted to grow by about
1 percent per year over 2001–30, with higher
growth in developing countries offset by some
contraction in developed countries (table 4.2).
East Asia, the Pacific, and South Asia together
will account for just over half the world’s
workforce, with China and India alone representing 40 percent—although China’s labor
force will grow far more slowly than that ofIndia. Sub-Saharan Africa will experience thehighest rate of growth (about 2.4 percent peryear) and will be the third-largest developing
region.
Worldwide, the supply of skilled workers is
likely to grow faster than that of unskilledworkers, but the vast majority of the world’s
workforce will remain unskilled in 2030.11 In
the developing world, rates of growth in thenumber of skilled workers will be highest in
Sub-Saharan Africa, South Asia, and the
Middle East and North Africa. Given the largepool of unskilled labor, however, these increases will raise the share of skilled workers
in developing countries’ workforces only
slightly (from 9.6 percent to 11.3 percent).
There will be significant regional variationsin the developing world. The Middle Eastand North Africa, Latin America and the109

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Table 4.2 In 2030 most workers will be in developing countries and unskilled
Growth in the global labor force 2001–30
All workers (millions)

Unskilled workers (millions)

Growth(% per
year)

2001

2030

Growth(% peryear)

Skilled workers (millions)

2001

2030

Growth(% peryear)

World region

2001

2030

World total

3,077

4,144

1.03

2,674

3,545

0.98

403

598

1.37

High-income countries
Developing countries
East Asia & the Pacific
China
South Asia
India
Europe & Central Asia
Middle East & North Africa
Sub-Saharan Africa
Latin America & the Caribbean

481
2,596
1,060
773
632
473
236
119
313
236

459
3,684
1,279
870
1,005
712
233
205
617
345

⫺0.16
1.21
0.65
0.41
1.62
1.42
⫺0.04
1.88
2.36
1.32

327
2,347
988
740
589
441
195
87
293
194

276
3,269
1,163
816
925
653
192
144
573
273

⫺0.58
1.15
0.56
0.34
1.56
1.36
⫺0.06
1.74
2.33
1.19

154
249
71
33
42
32
41
32
20
42

183
415
117
54
81
59
41
61
44
72

0.60
1.78
1.70
1.72
2.27
2.10
0.02
2.25
2.74
1.85

Source: World Bank staff calculations.

Caribbean, and Europe and Central Asia continue to have relatively high rates of skilledworkers (30, 21, and 18 percent, respectively),compared to East Asia and the Pacific (9 percent), South Asia (8 percent), and SubSaharan Africa (7 percent). But in absolute
numbers, India and China each have moreskilled workers than Europe and Central Asia
or Sub-Saharan Africa, and almost as many as
the Middle East and North Africa. Overall,developing countries have more than twice as
many skilled workers as developed countries,
even though the proportion of skilled workers
in the workforce is four times higher in thedeveloped world.
Agricultural workers will constitute ashrinking share of the world’s labor force,
declining from about 43 percent in 2001 toabout 30 percent in 2030. While the share of
agricultural workers will fall by about half indeveloped countries, the stark decline is froman already low base (from 4 to 2.6 percent).
The more significant change will occur indeveloping countries, where agricultural
workers will shift from about 50 percent of
the workforce in 2001 to 34 percent in 2030.
The most notable shifts will occur in SubSaharan Africa (61 to 47 percent), East Asiaand the Pacific (62 to 39 percent), and South
Asia (55 to 35 percent)—with the latter110

two driven by large changes in China (67 to
42 percent) and India (54 to 34 percent).
Moreover, while average incomes will continue to increase with new opportunities for
growth, the skill premium—the ratio of skilledwages to unskilled wages—will also increase.
Projections from the model developed in chapter 2 suggest that the skill premium in developing countries will rise from 3.5 on average in2001 to 4.2 in 2030. In India the premium rises
from 4.3 to 4.9 in 2030 while in China the increase is even larger, from 5.4 to 7.7. Developments in Sub-Saharan Africa are similar, with arise from 5.1 to 6.8. The Middle East and North
Africa sees only a modest increase in the skill
premium from 1.3 to 1.5, while the premium
remains constant at 2.2 in Latin America.

Pressures on unskilled workers will
intensify in both developed anddeveloping countries . . .
Between 1995 and 2005 the global labor force(employed and unemployed) grew by some
438 million workers, or 16.8 percent (ILO
2006). However, the effective increase in the
global labor market is considerably larger,
because many workers in the emerging
economies were previously only weakly connected to the global economy. Freeman (2005)
calculates that the integration of China, India,

N E Wand the former Soviet Union has led to a
“great doubling” of the global labor force.
The increasingly competitive global market
for labor may be the most important issue
facing workers worldwide. Freeman (2005)
argues that because the workers in these countries brought little capital with them into theglobal labor force there has been a massive
drop in the overall global ratio of capital tolabor. In response to the huge amounts of new
low-wage labor, therefore, capital should
hemorrhage from rich countries and flow to
China, India, and the ex-Soviet bloc. At themargin, new investment should take place in
China and India, where returns should behighest.
The prognosis from this view is that developing countries with wages higher than thoseBox 4.3

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in China and India risk losing ground following the entry of these countries into global
commerce. The sheer size of China and India
may also preclude the diversification of thepoorest countries into manufactures and so
close off a route to growth and development(Cline 2006). In rich countries, low-skilledlabor is expected to lose as well, and future
growth opportunities will depend on whether
the rich countries’ comparative advantage inhigh-technology sectors can be maintained.
According to this view, it is the quantity of
new entrants from China and India that risks
swamping the global market, undermining theprospects of unskilled workers in all othercountries, both rich and poor. This may not be
the case, however; competition is not always
what it appears (box 4.3).

Is the world flat . . . or just smaller?

n The World Is Flat, Thomas Friedman (2005) examines the rise of China and India in global supply
chains for both goods and services, describing theincreasing pace and intensity of competition acrossskilled activities as the “flattening” of the globe.
But, as Leamer (2006) asks, is flatness the rightmetaphor? What if the world is not flat, but justsmaller?
In the past, geography—physical, cultural, andinformational—had limited competition by creatingcost-advantaged relationships between proximate
sellers and buyers. Three revolutionary forces are
now driving a smaller world: (a) the presence ofmore unskilled workers in the global labor market
resulting from liberalizations in China, India, theRussian Federation, and Latin America; (b) new
equipment for knowledge workers (the Internet,
computers) that has raised productivity, emphasized
talent, and reduced the need for helpers; and(c) communications innovations that extend thegeographic reach of suppliers and the competition
for routine work and standardized products. In asmaller world, exchanges are more contested andrelationships between buyers and sellers weaker.
In a small world, wages in Los Angeles are set in

Shanghai. Does everyone now live in a world inwhich distance—physical, linguistic and cultural—nolonger isolates jobs from competition? Is the world
flat or are jobs protected from competition by relationships and geography?

Competition is not always what it appears . . .
Smallness may confer a larger market without
generating many new competitors in sectors where
there are highly localized economies of scale,agglomeration (or cluster) effects, and first-moveradvantages (consider the success of Hollywood in
the global market for cultural products). Where
you are still matters. Economic activity is dispersing
around the globe, but with very strong clustering tobenefit from agglomeration effects. Commerce still
declines dramatically with distance (although cultural or linguistic forms of closeness can compensate for physical distance), and trade remains aneighborhood phenomenon, close to home both
geographically and organizationally. Consumer
preferences and trust contribute to this pattern—
U.S. Web surfers still favor foreign sites close to
the United States, particularly when financialtransactions are involved.
(continued)111

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Box 4.3 (continued)
Moreover, competition in knowledge products is
not necessarily a win-lose proposition: knowledge
products have their value enhanced by the existenceof other products (software is an example). And
not all work is commoditized and sold in global
markets. Most exchanges still rely on long-term
relationships between buyer and seller—relationshipsthat create the language needed to communicate,that establish the trust needed to carry out theexchange, that allow ongoing servicing of implicit
or explicit guarantees, and that monitor andenforce the truthfulness of both parties. This is
the difference between negotiated rather than contestable exchanges. Reliability—and liability—form
limits to the contestability of high-skilled jobs. To
date, global sourcing of intellectual work has beena small drop in a very large bucket, and the developed countries remain extremely well-positioned tocompete in the Internet-based segment of theeconomy.

. . . but competition—or the threat of it—matters for routine tasks
Global competition is tight for standard tasks forwhich global markets exist, both in manufacturing
and services. Movement of jobs is not the only
indicator of global competition—contestability
may be reflected in a deterioration of wages andworking conditions, rather than the movement ofjobs. That is, the possibility of factor mobility
creates competitive pressure even in the absence ofactual movement. Once this is factored in, the realeffect of contestability—of global competition—ishard to assess.

Innovation is key, but innovation moves
around the world, and its pace is quickening
Ideas stowaway with goods. As manufacturing workmoves to China, so naturally do process innovations—as those closest to production are best placed towork out how to do it better. But will product innovation also move? The Internet has increased the
speed and reduced the cost of distributing ideas(subject to the constraints of infrastructure andliteracy). Add the integration of former outsiders
that has increased the size of the global brain by112

two-thirds, and the pace of innovation in the 21st
century will be unlike anything previously seen.

Education, infrastructure, and safety nets are
essential, but technology guarantees that
inequality will persist
Global sourcing of services presents issues similar
to those posed by manufacturing. The lessons areclear—make the education and infrastructure investments needed to keep high-paying, noncontestable,
creative jobs at home, and argue for strong protection of intellectual property rights (IPRs) to preserve
the value of knowledge goods sold abroad. But it isimportant to recognize that technology can accentuate inequality by magnifying the importance of talent and enabling it to reach a much larger customer
base. Education may help to remedy the incomeinequality problems caused by technology, but there
are limits. First, if training is more effective for thetalented, they are likely to receive more of it—andthe amount of training needed to equalize incomesmay be enormous and a great social waste. (Howmuch training does it take to turn a World Bankeconomist into a Pavarotti? And is this a good useof resources?) Second, many jobs involve jobspecific tacit knowledge gained only through on-thejob experience. But will workers invest in acquiring
these skills if the job is likely to disappear? Will
the incentives for skill acquisition also disappear?
Policies are needed to facilitate the formation of
long-term relationships between workers andemployers and so instill the confidence to makerelationship-specific investments from which great
returns can flow.

Metaphors matter
The landscape of global competition is not flat, atleast not much of it. The flat plains of open competition for mundane tasks certainly exist, but much of
the landscape is hills and mountains—where endowments, human capital, and policy matter. That landscape is also constantly changing—today’s hill might
be tomorrow’s plain, creating new opportunities andobstacles and demanding continual adaptation.
Source: Leamer 2006.

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Figure 4.3 Average wages in China haveincreased more than in other countries
Internationally comparable average wage rates,indexed, 1998 ⴝ 100
230

China

180
MexicoSouth Africa

India

130

80
Philippines

00

01
20
02
20
03
20
04
20
05

20

99

20

98

19

97

19

96

19

19

95

30

19

Productivity differences matter. Firms inrich countries combine unskilled workers in production with more and better capital and technical know-how than do firms in poor countries.
What matters is whether the wage gap is greaterthan the difference in productivity—and
whether productivity differentials can be maintained. Similarly, the least developed countries inAfrica that have lower wages than China andIndia will be able to compete in the global
market—but only if their levels of productivity
are close to those in India and China. The
sources of productivity differences across countries will be discussed in more detail below.
There is another problem with the viewthat the global market will be swamped byproducts from China and India. The law ofcomparative advantage implies that there will
always be opportunities for other countries toexport, even though China and India will
come to dominate certain sectors. In general,
as the global demand for Chinese manufactured products increases, dollar-denominatedwages in China will tend to increase, in response to higher wage demands from Chinese
workers (especially if the rural and urban
labor markets remain partially segmented)
and from the inevitable additional upward
pressure on the yuan.
There is evidence that this process isalready underway (figure 4.3). In 2004, real
wages in China were 2.11 times the level of
1989, and the rate of wage increase accelerated in 2004–05, especially in the coastal regions (Yusuf, Nabeshima, and Perkins 2006).
In 2005 alone, according to the People’s Bankof China, average wages for Chinese workers
rose by 14.8 percent (China Daily, “Worker
Shortage Drives Salary Rise,” May 27, 2006).
Thus China’s development should not keep
the poorest countries from being able toexport low-skill-intensive products, as long as
these countries can manage to create and sustain a business climate that supports investment and trade. In Africa, competitivenessbased on low-cost labor is undermined byhigh indirect costs, with the main barriers
being corruption, crime, and inadequate

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Sources: China Statistical Yearbook 2005, People’s Bank of
China, International Labour Organization (Philippines, South
Africa), IBGE (Brazil), Banco de Mexico, Ministry of
Statistics and Programme Implementation (India); exchange
rates from IMF International Financial Statistics. Wages areaverage wages for China, the Philippines, and South Africa,
average private sector wages in Brazil, and manufacturing
wages for India and Mexico.
Note: 1998–2000 wages for the Philippines have been
estimated using observed wages from 2001 and projecting
them backward using GDP per capita growth rates.

infrastructure (Eifert, Gelb, and Ramachandran2005). The poor business environment leads
to lower returns to labor in production,
depressing labor demand and real wages.
Even within sectors where China is
expected to dominate world trade, there areexamples of growing exports of other developing countries. The removal of quotas in the
United States and the European Union on
imports of textiles and clothing products from
China and India was expected by some todecimate exports of these products from otherdeveloping countries. For example, it was suggested that one million jobs would be lost in
Bangladesh and that half the factories in theindustry in Sri Lanka would close down
(Oxfam 2004). However, exports of clothingfrom both of these countries to the UnitedStates have increased since the quotas weredismantled. Sri Lankan exports in 2005 were
6 percent higher than in 2004 (with a further
growth of 3 percent over the first six monthsof 2006 relative to the same period in 2005).

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Exports of clothing from Bangladesh to theUnited States increased by 21 percent in 2005
and by a further 28 percent over the first six
months of 2006.
Nevertheless, the growth of Chinese
exports of textiles and clothing has had negative impacts on other countries. Many jobs
have been lost in Mexico’s maquiladoras
because activities in sectors such as clothing
have been unable to compete with China in
the U.S. market. Clothing exports fromAfrican countries have declined substantiallysince 2004, amid reports of substantial lossof jobs in the sector. It is clear, therefore, thatthe emergence of China and India as major
exporters will entail significant adjustment insome sectors in some countries. The adjustment costs are likely to be higher in countries
that offer a less favorable climate for businessand investment and that suffer from morerigidities in product and labor markets.
It should not be forgotten that trade and
FDI have contributed to unparalleled reductions in poverty in China and can continue todo so. The poverty rate (people living on lessthan $1 a day) in China fell from almost
60 percent in 1980 to 17 percent in 2003.
While lifting more than 400 million people
out of poverty is a remarkable achievement,close to 200 million people still live on lessthan $1 a day, many of whom stand to benefit from China’s continued trading strength.
For other countries the impact of the integration of the large emerging economies
should not be qualitatively different from thepressures that globalization has exerted onlabor markets over the past 30 years, as summarized above. Unskilled workers in both richand developing countries are likely to face
greater volatility of employment and continuing downward pressure on relative wages.
The following section will discuss how policy
makers can help to ameliorate these costs.

. . . but opportunities for export andgrowth will remain for all countries
The entry of large economic entities into theglobal market offers opportunities as enormous

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as the challenges it poses for developed and developing countries. The large markets of China
and India have changed the dynamic of SouthSouth trade and offer developing countries aroute to decreased dependence on rich countries,
whose demand for products produced in thepoorest countries has been relatively stagnant for
years. Demand in Asia, and primarily in China
and India, has been the main source of the acceleration in African exports since 1990. Asia also
has been a key source of recent export growth for
Latin America. Overall, China’s share of theworld’s non-oil imports grew from 1.8 percent in1990 to 6.5 percent in 2004, implying substantial opportunities for its trading partners to expand exports and create jobs (figure 4.4).
As a result of Asia’s increasing demand forresources there is an increasing correlation
between growth in China and India andgrowth in developing countries that have acomparative advantage in natural-resourceintensive products (Lederman, Olarreaga,
and Soloaga 2006). Even resource-abundant
countries that have not increased exports
to Asia—such as Bolivia, Colombia, andFigure 4.4 China’s imports fromdeveloping countries have surged overthe last two decades
Non-oil imports, $ billions
140
120
100
80
60
40
20
0
1985

1990

1995

2000

2005

AfricaLatin America

South Asia

Europe and Central Asia

Middle Eastand North Africa

East Asia and the PacificSources: WITS and World Bank staff calculations.

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Ecuador—have seen benefits from higher
world prices for their exports. Lederman,
Olarreaga, and Soloaga (2006) also findfairly strong complementarity rather thansubstitutability between the exports of Chinaand Latin America to third markets. They
attribute this complementarity to the growing
importance of production networks and theability of Latin American firms to join
them, the impact of cheaper imports of intermediate inputs on export competitiveness, andlearning by exporting larger amounts to
China. Nevertheless, they suggest that if Latin
American and Caribbean countries were torefrain from protectionist policies that prevent
them from using cheap inputs from China
and India and were to invest more in skills,
research and development (R&D), and institutions, they would be able to further exploit
opportunities in the new global economy.
The surging demand in Asia for minerals
has been the primary driver of growing SouthSouth trade. But China and India offer huge
potential for a range of other products as well,including agricultural products. However,trade restrictions keep many developing countries from gaining market access for manysuch products.12 For most developing countries multilateral trade negotiations are potentially a major route to better access to growing
markets in Asia and to better prices for traditional exports. The key feature of access tomarkets in Asia for developing countries inAfrica and Latin America is that accessshould occur on a most-favored-nationbasis—that is, each country should be entitledto the best trade terms an importer offers to
any nation. Therefore market access is best
addressed through multilateral trade negotiations, so that tariff concessions made by
China and India are immediately available toall developing countries, regardless of theirsize and global importance.
Lower duties in Asia can buoy the export
prospects of other developing countries inthree ways. The first is through lower tariffs
on products currently exported by these developing countries or that are the focus of

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export-diversification efforts. Markets in Asia
are very large, but key products for developing
countries face high tariff barriers. For example, cocoa beans face applied tariffs of 30 percent in India and 8 percent in China (incontrast to zero protection in developed countries). Second, for traditional commodities,
even if the reduction in tariffs in Asia does notlead to new exports for a specific developing
country, there will be a positive effect throughthe impact on world prices. Third, it is important to consider the tariffs on the final
products that use resource-intensive inputs
exported from developing countries. Reducing
such protection will expand the demand for
those inputs. It would also reduce tariff escalation and ease one of the constraints that
limit higher value–added activities from being
undertaken in developing countries.
Moreover, both China and India havebecome significant sources of FDI for bothdeveloping and developed countries. India’s
outward FDI stock grew from $0.6 billion
in 1996 to $5.1 billion in 2003. China andIndia now occupy positions 54 and 72 (out of
132 economies) in terms of outward FDI performance (UNCTAD 2005).13 About twothirds of cumulative Indian FDI has gone toother developing countries, but developed
countries (in particular the United States) are
important markets at the moment. The leading developing country is Mauritius, which
attracts about 10 percent of Indian investment
flows. In the information technology sector,
Indian firms’ success in global sourcing exposed them to new knowledge and businessmethods from developed-country companies
and induced outward FDI through demonstration and spillover effects. Liberalization of
the Indian government’s policies on outward
FDI since 2000 also proved critical. Restrictions on maximum overseas investments as apercentage of net worth have been removed,
as have the requirement to obtain prior approval for investments from the Reserve Bankof India and prohibitions against overseas
investments in the same activity as the company’s core activity in India (UNCTAD 2004).

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Fears that China and India will quickly
dominate high-technology sectors aremisplaced
Some worry about the impact of the risingnumbers of skilled workers in China andIndia.14 Freeman (2006) suggests that theincrease in these numbers together with increased capacity for technological advancement will undermine the advantage that richcountries have in high-tech, high-productivity
activities. Trefler (2005) has put this issue
concerning long-run comparative advantage
in the following way: will China and India
dominate high-tech goods and services to thewest, leaving, for example, “Americans tomend the socks of Chinese business executives”? The prognosis that China and India
will swamp the global market not only withlow-skilled-intensive products but also skillintensive high-tech products is based on theassumption that success in high-tech sectors
depends on the absolute number of scientists
and engineers rather than the relative numberof such workers in the overall workforce. Thisview also fails to take account of a well-established literature that identifies the critical importance of domestic institutions in driving
and sustaining innovation-based growth.15
Much evidence supports the view thatgrowth and income levels do not depend
solely on the physical amounts of capital andlabor that are available in a country; instead,they depend on how those factors are combined in production. Cross-country variations in per capita income cannot be accounted for by differences in endowments ofcapital and labor, but by variations in productivity. For example, in 1988 output per
Chinese worker was about 6 percent of thatof the typical U.S. worker. Most of that difference was due to lower productivity in
China rather than lower capital per worker
or lower levels of human capital. If productivity levels had been the same, output per
worker in China would have been more than
50 percent of that in the United States (Halland Jones 1999).

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Innovations matter. To understand differences in levels of income across countries anddifferences in rates of growth of per capita
income, it is necessary to explain the sourcesof variations in productivity. Innovation isat the heart of such explanations. In recent
models of endogenous growth, innovations
lead to new products and processes that are tosome extent protected by patents and otherinstitutional mechanisms that return profit to
the innovator and bolster the incentive toinvest. Where protection of the innovationis less than full, a certain amount of“disembodied” knowledge becomes accessible
to other innovators and so adds to the stock ofknowledge available to all, reducing the costsof future research and development (seeHelpman 2004 for a survey).
Some of a country’s R&D effort may thus
be accessed by other countries, even as it
augments the national stock of knowledge. The
main conduits for such technology transfer
are FDI and trade. In this way the innovative
efforts of rich countries push out the global
technology frontier and support the growthof their total factor productivity. Developing
countries, which invest little in R&D, canachieve long-run productivity growth througha process of continually catching up to thetechnology frontier. Policies that attract FDIfrom rich countries, openness to technologyintensive imports, and learning by exporting
into the most demanding markets are crucial
for this catching up. This learning can also beenhanced by temporary movement of people.16
Multinational firms exhibit the highest
levels of total factor productivity and create
more knowledge inputs than other types offirms. Criscuolo, Haskel, and Slaughter (2004)
find that globally engaged firms generate moreideas than their purely domestic counterparts,
not only because they employ more researchers, but also because they have access toa wider pool of knowledge. That pool is deepened by contacts with suppliers and customers
and, for multinationals, by the intrafirm
stock of ideas. Others (Bernard, Knetter, andN E W

Slaughter 2004, cited in Criscuolo, Haskel,
and Slaughter 2004) find that the parents of
U.S.-based multinationals perform about twothirds of all private R&D in the United States
but are a small fraction of 1 percent of thetotal number of U.S. firms. Thus, it appears
that openness to trade is important not only
for poor countries to absorb new technologies
created by firms in developed countries, butalso for wealthier countries to stimulate investment and productivity growth.
So do institutions. Even after taking into
account innovation efforts, a substantial
amount of the variation in per capita income
levels and growth rates across countries
remains unexplained. What accounts for the
rest of the variance? Institutions and institutional quality are now accepted as the reason
why some countries have higher productivity
than others and why growth rates havediffered across countries, even when factor
endowments and rates of innovation are
similar (Helpman 2004). For example, Halland Jones (1999) conclude that “a country’s
long-run economic performance is determinedprimarily by the institutions and government
policies that make up the economic
environment within which individuals andfirms make investment, create and transfer
ideas, and produce goods and services.”
To compete with the United States, theEuropean Union, and Japan in innovation andhigh-tech products, China and India will
require institutions similar to those of theOECD countries. The two countries are a longway from having such institutions at present.
Moreover, building them takes a long timeand is unlikely to occur within 25 years(Trefler 2005). Thus the United States leads ininnovation-based growth not because it has
more scientists and engineers, but because it
has an institutional framework that allows
companies such as Microsoft, Apple, andYahoo to exploit new ideas.
Recent research has highlighted how institutional quality can determine comparative

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advantage and so influence the commodity
structure of trade. Nunn (2005) shows thatcountries with a good institutional environment for contract enforcement will tend to havea comparative advantage in producing and exporting goods that require relationship-specificinvestments.17 Countries with poor contract
enforcement will suffer from underinvestment
and thus higher costs of production forgoods that require relationship-specific investment. Such investments are more likely to benecessary in industries in which firms havesome form of firm-specific asset, which in turnare more likely to be high-technology andinnovation-intensive industries. The same isequally true for services.
The structure of all countries’ exports isthus influenced by the nature of domestic institutions. The growth of exports from China
and India in some products and services that
require relationship-specific investment has
been facilitated by having good institutions
in particular enclaves of the economy such as
special economic zones. The ability of thesecountries to substantially increase exports ofthese goods and services further will dependon the ability to engender economywide
institutional change, something that will bemuch harder to achieve and will occur more
slowly.
Continual technological innovation andchanges in demand make comparativeadvantage a dynamic concept. It is very difficult to predict in which sectors and tasks
countries will be efficient producers. Thirty
years ago, who could have predicted theemergence of the iPod or known how thevalue added in production and the returnto knowledge would be distributed acrosscountries (box 4.4)?
The opportunities of global production
chains will encourage the upgrading ofdomestic institutions, as countries compete
on quality and efficiency as well as price—justas they have for another set of domestic institutions related to labor standards. Rather
than a race to the bottom, with declining

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Box 4.4

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Global production and the iPodake just one component of the iPod nano, thecentral microchip provided by the U.S. company
PortalPlayer. The core technology of the chip islicensed from British firm ARM and is modified byPortalPlayer’s programmers in California, Washington
State, and Hyderabad. PortalPlayer then works withmicrochip design companies in California that send
the finished design to a “foundry” in Taiwan (China)that produces “wafers” (thin metal disks) imprinted
with hundreds of thousands of chips. The capitalcosts of these foundries can be more than $2.5 million. These wafers are then cut up into individual
disks and sent elsewhere in Taiwan (China) where
each one is tested. The chips are then encased inplastic and readied for assembly by Silicon-Warein Taiwan (China) and Amkor in the Republic ofKorea. The finished microchip is then warehousedin Hong Kong (China) before being transported tomainland China where the iPod is assembled.
Working conditions and wages in China are low
relative to Western standards and levels. Many
workers live in dormitories and work long hours.

It is suggested that overtime is compulsory. Nevertheless, wages are higher than the average of theregion in which the assembly plants are located andallow for substantial transfers to rural areas andhence contribute to declining rural poverty.
PortalPlayer was only established in 1999 but
had revenues in excess of $225 million in 2005.
PortalPlayer’s chief executive officer has argued thatthe outsourcing to countries such as India andTaiwan (China) of “non-critical aspects of your business” has been crucial to the development of the firm
and its innovation: “it allows you to become nimbler
and spend R&D dollars on core strengths.”
Since 2003, soon after the iPod was launched, theshare price of Apple, the company that produces andsells the iPod, has risen from just over $6 to over$60. Those who own shares in Apple have benefited
from the globalization of the iPod.
Sources: C. Joseph, “The iPod’s Incredible Journey,” Mail on
Sunday, July 15, 2006; “Meet the iPods’s ‘Intel,’” Business
Trends 32(4)(April), 2006.

wages and standards as countries compete on
trade and investment, globalization is encouraging gradually higher labor standards, both
directly in terms of attracting FDI and indirectly, through higher growth (box 4.5).18
Implications for middle-income countries.
While China and India are unlikely to threaten
Western dominance of “big idea” innovation,
Puga and Trefler (2005) suggest that the great
capacity of these countries for lower-level
incremental innovations may have important
implications for middle-income developing
countries. The presence of many well-trained
scientists and engineers in China and India
means that Western firms looking to invest willtend to be attracted to these countries—for theirgreater capacity to assist the firm in incremental
innovation—rather than to other countries,
such as Thailand and Mexico. Puga andTrefler refer to the rapidly increasing number

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of U.S.-owned patents with at least one inventor
who is a resident of China or India. Thailand
and Mexico have not witnessed such growth.
But Cravino, Lederman, and Olarreaga(2006) find no evidence that FDI by Western
firms in China and India is displacing FDI
in Latin America. In a detailed econometric
exercise, Bravo-Ortega and Lederman (2006)
find no statistical evidence that current patenting activity by China and India has had an
impact on the number of patents of Latin
American countries. They do find some evidence, however, that the stock of patents towhich China and India have contributed
is feeding the innovation process in Latin
America. In other words, innovators in Latin
America can learn from innovations undertaken in China and India.
Thus both economic theory and the available evidence suggest that while the sheer sizeof new entrants into the global economy poses

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Box 4.5 Does globalization lead to a race to thebottom on labor standards?

Looking at the relationship between core labor
standards (freedom of association and collective
bargaining; and elimination of forced labor, childlabor, and discrimination in employment) and trade,
the OECD (1996) finds no empirical support for
the view that low-standards countries will enjoy
gains in export-market shares to the detriment ofhigh-standards countries. There is also no evidence
that low core labor standards are associated with
low unit labor costs: real wages actually grew fasterthan productivity growth in a number of lowstandards countries from the mid-1980s to themid-1990s. While core labor standards will notnecessarily affect comparative advantage negatively
and indeed may have a positive affect, noncore or
economic standards such as working time and minimum wages may affect trade performance negatively(OECD 2000a).a However, the picture is not clear;
Dehejia and Samy (2002) find no clear link between
labor standards and a country’s competitiveness.
Rodrik (1996) finds that labor standards are a significant determinant of labor costs when one controls
for productivity, but not of comparative advantage,
which is mostly determined by factor endowments.
Evidence on FDI also suggests that firms are
attracted to countries with higher, not lower, labor
standards (OECD 2000b; Aggarwal 1995; Rodrik
1996; Brown, Deardorff, and Stern 2002).b Multinationals invest principally in the largest, richest, andmost dynamic markets; with the significant exceptionof China, countries where core labor standards are notrespected receive a very small share of global flows.
Even in China, the average foreign affiliate pays wages
30 percent higher than the average in state-owned enterprises and has higher occupational safety andhealth standards than Chinese-owned firms (Lardy
2004). Overall, multinational firms provide incentives
to improve, rather than worsen working conditions;pay higher wages than alternative employment; andtend to promote, rather than repress worker rights(Brown, Deardorff, and Stern 2002).
In some countries, labor regulations do not apply
and a range of labor standards issues still arise inexport processing zones (EPZs), which now employ

around 50 million persons worldwide. That said, themajority of EPZs are covered by national labor laws,
and physical conditions and wages tend to be better
than in the rest of the economy (ILO 1998). EPZs
with poor working conditions do not attract long term
investment—“smart” EPZs have introduced measures
to continuously upgrade labor (OECD 2000b).

Why not a race to the top?
Globalization may be forcing a race to the top, as itplaces a new emphasis on speed, efficiency, and quality as well as cost, shifting the focus from cheap
labor to productive labor (ILO 1998; Aggarwal
1995). Countries can gain an advantage by improving labor standards. Strengthened core labor standards can increase economic growth and efficiency
by raising skill levels, thereby creating an environment that encourages innovation and higher productivity (Stiglitz 2000; OECD 2000a). At the sametime, in the sectors with a reputation for poor labor
standards (clothing, footwear, and sporting goods)
consumers are increasingly demanding products produced under acceptable working conditions, with
monitoring and certification, often by trusted nongovernmental organizations.
Indeed, efforts to promote labor standards at a
global level have been increasing: examples include
the 1998 International Labour Organization (ILO)
Declaration on Fundamental Principles and Rights at
Work (under which monitoring and reporting oncore labor standards is extended to all members) anddevelopment cooperation programs to reduce childlabor. More controversially, trade agreements havebeen used to promote compliance with labor standards. The United States suspends access under the
Generalized System of Preferences (GSP) in the eventof noncompliance, while the European Union grants
additional access for compliance. Labor provisions
or side agreements figure in U.S. free trade agreements. Links to the World Trade Organization(WTO) have faced strong resistance from developing
countries.c Other market-based mechanisms, such aslabeling schemes or codes of conduct for firms (atthe OECD, ILO, and firm level) have expanded, with(continued)

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(continued)

most U.S. Fortune 500 companies now embracingsuch codes (see OECD 2000a; Stern 2003).d
Labor standards rise with income (Stern 2003;
OECD 2000a), and the path to higher growth fordeveloping countries lies in seizing the opportunities
of global production networks in goods and services.
But this in turn requires efforts to raise productivity
and create a stable and attractive environment for
FDI. And the evidence suggests that improving corelabor standards and creating frameworks for soundand stable labor relations can contribute to both ofthese goals, with the potential to create a virtuous
circle of rising wages and standards for workers indeveloping countries.
aBates (2000) distinguishes between core labor standards,
which are viewed as fundamental human rights and can create
the framework conditions for the economy to operate
efficiently, and developmental or economic labor standards(for example, minimum wages), which will vary dependingon the level of income in a given society.
bData on freedom of association rights in 75 countries that
represent virtually all of world trade and all inward and outward FDI show no significant deterioration in these rights inany of the 75 countries between 1980 and 1999 (the period
during which competition for FDI heated up). Data show
significant improvement in those rights in 17 countries(OECD 2000b).
cMoran (2004) provides a persuasive analysis of thepractical problems of using dispute settlement under trade
agreements to enforce labor standards, given the lack of international agreement on exactly what core labor standards mean
and what is required for adequate implementation and thereliance on incomplete, nonrepresentative, noncomparable,and potentially biased sources of information.
dMore recently, attention has shifted beyond core labor
standards to the concept of decent work (work that is freely
chosen, provides an income sufficient to satisfy basic economic
and family needs, respect for rights and representation, basic
security through some form of social protection, and adequate
conditions) (ILO 2004).

a number of challenges to other countries, bothdeveloped and developing, there are enormous
opportunities. To grasp these opportunities requires that countries have in place a policy environment that allows competitive advantages
to be exploited and the key sources of growth
to flourish, while ensuring that those workers
adversely affected are assisted in adjusting by
moving to new sectors and/or by augmenting
their particular skill set. In other words, while
aggregate gains are available to all countries,
some industries, firms, and workers will incursome pain. Appropriate policy responses are
discussed further below.

New challenge II—global sourcingof services
Workers in previously sheltered services
face international competition
The global competition in goods that has been
under way for decades is now visible in services, as falling telecommunications costs andgreater openness to FDI enable different parts

120of the services value chain to be performed indifferent locations around the globe—a phenomenon that has come to be known as “outsourcing” or “offshoring,” but could perhaps
be most accurately termed “global sourcingof services.”19 Global sourcing has increased
competition in services markets for a wide variety of activities, from low-skilled functions
such as data entry, word processing, and callcenters to higher-skilled activities such as software development, consultancy, medical services, and R&D. A range of services previously
thought to be nontradable are now being provided electronically over large distances.
Global sourcing allows firms to benefit
from around-the-clock production (for just-intime delivery of both goods and services) andlower wage costs. Estimates of the total costsavings from global sourcing vary across awide range—for example, from 15–30 percent(Atkinson 2004) to 30–60 percent (industry
estimates cited in Kirkegaard 2005).
While absolute numbers to date are notlarge, growth rates have been high, and global
sourcing of services is expected to grow by

N E W

Figure 4.5 Developing-country exports ofbusiness services are growing rapidly
Growth in export of business services, 1994–2003
India
Estonia
Romania
China
IsraelBrazilArgentina
Mauritius
EU15
United States

CanadaBarbados
Dominicaa
Australia
Ghana
Japan
0

100 200 300 400 500 600 700
Percent

Source: Data from IMF Balance of Payment Statistics.
Note: “Business services” are defined as total services minustransportation, travel, and government services.
a. 1994–2002.

30 percent per year over 2003–08.20 While developed countries still dominate the trade, somedeveloping countries experienced fast growth inexports of business services between 1994 and2003: nearly 700 percent for India; more than
200 percent for China, Brazil, and Argentina;
and more than 100 percent for Mauritius,
Barbados, and Dominica (figure 4.5).
Sourcing locations expand and change overtime, and technology advances are likely toallow more services to be provided offshore. As
costs in Ireland rose, activities moved to India
and the Philippines. Now, as costs in India rise,other locations, including some in Eastern Europe, are becoming popular (Atkinson 2004).
Language patterns influence location decisions, but these are not immutable.21 Against
this backdrop, countries across all regions andlevels of development—from Senegal to Sri
Lanka, Argentina to Zambia—are now seeking
to become sites for services sourcing.

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The number of service jobs that migratefrom rich to poor countries could be large
Estimates to date of the scale of potential job
movements from global sourcing of services
vary widely according to the definitions andmethodology used. A great deal of attention
was initially given to a report by Forrester
Research (2002) that estimated that 3.3 million service jobs would move offshore from theUnited States by 2015. However, when put
into perspective—the U.S. economy creates
about 30 million jobs per year—that number isquite small. Even for the job categories deemed
to be vulnerable to outsourcing, including
management and computer operations, thepredicted impact amounts to just over 0.5 percent of existing employment (see Bhagwati,
Panagariya, and Srinivasan 2004).
Blinder (2006) asserts that a much broader
range of services will be liable to global sourcing (almost all of those activities that do not
require direct personal delivery) as communications costs decline further and technology
continues to advance. His rough estimate isthat between 28 and 42 million jobs in the
United States could move overseas as a resultof global sourcing. OECD (2005c) concludes
that close to 20 percent of total employment
could potentially be affected by informationand communications technology–enabled offshoring of services.
The potential size of the future market for
global sourcing of services remains a matter of
debate, reflecting uncertainties over how thedividing line between tradable and nontradable services will shift over time (see box 4.6).
Even if these higher predictions come tofruition they do not imply a corresponding
lower level of employment. The impact of
global sourcing of services on the overall levelof unemployment in rich countries may besmall, especially in countries that are effectivein generating new jobs.

Global sourcing will benefit bothdeveloped and developing countries
The shift in jobs resulting from global sourcing of services is unlikely to be a zero-sum

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Box 4.6 The number of services jobs liable to be
moved abroad: large or small?

To identify the tradability of industries and occupations, Jensen and Kletzer (2005) use indicatorsof regional concentration of production in the UnitedStates to group industries into three categories of
tradability, leaving a similar number of industries ineach category (the more the geographical concentration, the higher the degree of tradability). They thenuse this degree of tradability of the sector to estimate
the number of jobs that are prone to global sourcing.
Results are very sensitive to assumptions about
what is considered tradable. The first figure below
presents possible effects for the U.S. economy(excluding public administration), distinguishing
between the agriculture and manufacturing sector,
nonpersonal services, and personal services. For
each category, the first bar shows the number ofworkers currently employed, while the second barshows the number of jobs that may potentially be
globally sourced under three possible scenarios. The
lowest part considers only the highly concentrated
industries as tradable; here fewer than 4.5 million
jobs in the nonpersonal services sector could be
lost overseas. In contrast, the middle part of eachsecond bar adds those jobs that could potentially belost if all jobs in all tradable sectors (including thosewhere production is only relatively geographicallyconcentrated) could be sourced globally. Thischanges the picture dramatically; more than half thejobs in nonpersonal services could be affected by
globalization (about 30 million jobs).
In Jensen and Kletzer’s analysis there is a distinct
difference in the vulnerability to global sourcing between wholesale and retail activities, which are lessconcentrated and therefore deemed less prone toglobal sourcing (about 36 percent of jobs in these
sectors are at risk), and professional services (where
71 percent of jobs are at risk). However, technological change may make global sourcing more relevantto the wholesale and retail activities. The top part ofthe second columns shows that an additional 9.7 million jobs could be lost if the sensitivity to global
sourcing for professional sectors were equal to thatof the other nonpersonal services (the light gray partin the second column for nonpersonal services). The
second figure below shows the same analysis for theEuropean Union (EU15). The figure suggests that the

Jobs and potential for outsourcing, United States

Jobs and potential for outsourcing, EU15

Millions of jobs

Millions of jobs

70

70

60

62

57

55

57

60

50

50

40

40

36

9.7
30
20
10
0

10.3
30

23
25.2

13.5

20

3.6

Agriculture
andmanufacturing

4.3
Nonpersonal
services

24.4
2.4

0.8
6.8

21.8

10

0.3

10.1

4.4

0
Personal
services

Agriculture
andmanufacturing

Nonpersonal
services

Personal
services

Sources: Jensen and Kletzer 2005; World Bank staff calculations.
Note: The first, black bar for each sector represents the number of workers currently employed in that sector. The second bar indicates the numberof jobs potentially globally sourced. The black section represents only workers in highly geographically concentrated industries subject to global
sourcing; the other two sections represent workers in less geographically concentrated industries (see text).

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potential future adjustment for the EU15 is somewhat skewed toward the agricultural and manufacturing sectors, where currently a higher share of total
employment can be found than in the United States.
A further important caveat to these estimates isthat only certain elements of production in tradable
sectors can be sourced overseas. Equally, there could
be activities in the production process of largely nontradable services sectors that could be globally

game, owing to the presence of significant
offsetting factors. While workers whose jobs
are liable to offshoring will face lower labordemand and downward pressure on their relative wages, workers who are complementary to the offshored activities will see a risein their productivity and an increase in relative wages. In addition, global sourcing willaugment the productivity of firms that utilize
the opportunities presented by lower laborcosts overseas. These firms are more likely to
expand than other firms, increasing theirdemand for labor, some of which will be
for local tasks that can be fulfilled by thetype of worker affected by offshoring, thus
offsetting, to some extent, the impact ofoffshoring on wages (Grossman and RossiHansberg 2006).
Moreover, demand is not inelastic—lower
wages for software workers in developing
countries raise global demand for software,
benefiting all countries. Some OECD countries are experiencing a net inflow of service
jobs from outsourcing (Amiti and Wei
2004); investment by foreign companies in
the United States, for example, exceeded
investment by U.S. companies in foreign countries every year over 1996–2001 (Atkinson2004),22 and several OECD countries haveexperienced double-digit growth in exports ofbusiness services. For example, exports grewat 11 percent in both the United States andAustralia (OECD 2005a).23

sourced. For these reasons it is preferable to identify
tasks, rather than sectors, as tradable or nontradable(see box 4.7). Jensen and Kletzer make a crude attempt at this by repeating their exercise for broad
occupational groups. They find that 11 percent of total
employment is represented by tradable occupations inindustries that are classified as nontradable. Similarly,
about 22 percent of the total workforce is found in
nontradable occupations in tradable industries.

There is also little evidence to date that
tradable service activities have lower employment growth than other service activities,
or that net outward investment or imports ofbusiness services are associated with significant declines in the share of employment potentially affected by outsourcing (Jensen and
Kletzer 2005; OECD 2005a; Amiti and Wei
2004). However, growth is lower at the lower
end of the skill distribution—although thismay also indicate that these jobs are most
readily substituted by technology. Worker displacement rates are higher in tradable services, but affected workers have higher skills
and higher predisplacement earnings thandisplaced manufacturing workers (Jensen and
Kletzer 2005).
The key labor-market issues raised in richcountries by the global sourcing of services are
the nature of the new jobs that will replacethose transferred overseas, and the difficulties
that firms and workers may face in adjusting
to this new facet of globalization. Workers
previously sheltered from global competition
are facing greater job insecurity, downward
pressure on their wages, and potential costs ofadjustment in moving from one job to anotheror in upgrading their skills to obtain new
employment following displacement. Theseissues are explored in more detail below, following a brief discussion of an appropriate
framework in which to assess the nature andimpacts of global sourcing.

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Global sourcing of services offers
opportunities as well as challenges
Global sourcing of services is creating considerable opportunities for development in poor,
low-wage countries, through export possibilities and through access to cheaper service inputs that raise productivity when used in othersectors. Global sourcing is providing important new employment—in India, employment
in the information technology (IT) sector is
now three million, although this is concentrated in five or six urban centers (Yusuf,
Nabeshima, and Perkins 2006). Employment
creation is at a wide range of skill levels, reflecting the range of activities open to global
sourcing. In the relatively low-value segments
such as call centers, wage costs are important
determinants of location (along with language
skills), and competition is fierce among developing countries. At the high end, global sourcing of services may be reducing incentives
for skilled migration by creating new opportunities at home. A large number of those employed as a result of global sourcing are
women, offering a different route to development than those based on the growth of agriculture and manufacturing.
While India and China are likely to cometo dominate the market for global sourcingof services, comparative advantage will ensure that there are opportunities for many
developing countries. Small island economies
in the Caribbean, for example, have beenable to attract certain back office activities
from the United States, such as data entry.
The services revolution and global sourcing
are offering opportunities for new exports
and for attracting services-related foreign
investment for a range of poor countries. IT
and global sourcing offer new and alternative drivers of development that circumvent
some of the key constraints to growth driven
by the expansion of exports of agriculturaland manufactured goods.
This is most apparent for landlocked countries and small (often island) economies thatface very high transport costs. For example,
development in Rwanda has to confront an

124

extremely adverse location, one of the highest
population densities in the world, and a highpopulation growth rate. While increasing thequality and quantity of exports of traditional
agricultural exports (coffee) and minerals is
crucial to increases in incomes for the poor in
the short to medium term, the government of
Rwanda has identified the provision of ITintensive services, both locally and abroad, asa base for growth in the long run, to provide
for employment and turn the country’s large,
but very young, population into a driver ofdevelopment rather than a constraint.
The important new opportunities for developing countries are accompanied by considerable challenges related to the provision ofnecessary infrastructure, the design and implementation of appropriate regulation, better
education to increase the supply of humancapital, and the creation of strong marketing
profiles and reputations for reliability.24 Access to relatively cheap and reliable electricity,a critical problem for many poor countries,
will be necessary. High-quality telecommunications infrastructure must be accompanied
by a competitive framework for the provisionof telecommunications services. Liberalizationof the trade and investment regime, complemented by an appropriate and effective regulatory environment, can help ensure theefficient and competitive provision of thetelecommunications backbone services.
Many developing countries could assist theirnascent IT sectors by joining the Information
Technology Agreement (ITA) of the WTO.
The agreement covers the main categories
of IT products, computers, telecommunications equipment, semiconductors, semiconductor manufacturing equipment, software,and scientific instruments, and commits members to bind tariffs at zero on these items.
Joining the ITA can provide a strong signal toinvestors, both domestic and foreign, of acountry’s commitment to an open IT environment by ensuring access to necessary equipment at world prices. The ITA has 43 members (with the European Union treated asone), among them industrial countries andN E W

some large and small developing countries,
such as China, the Arab Republic of Egypt, El
Salvador, India, Mauritius, Moldova, andMorocco. As yet, however, none of the least
developed countries is a member.

But does the global sourcing of services
have different implications for labor indeveloped and developing markets?
Trade in services that use skilled labor intensively is not new. In the standard analysis
of multinational firms, parent companies indeveloped countries are seen as exporting a
range of services such as design, management
and engineering consultancy, marketing, andfinance to their overseas subsidiaries in poorer
countries. What is new is trade in the opposite
direction, as services both within multinationals and through arm’s-length trade flow fromlow-wage countries to richer markets.
An immediate implication of this new
development is that the standard factorendowments model of trade (countries export
goods and services that make intensive use offactors abundant in their country) cannot explain why skilled-labor-intensive services arebeing exported from countries with very
scarce skilled labor. A common explanation
involves the absence in developing countriesof the knowledge-based assets that are complementary to skilled labor. The lack of theseassets limits the use of skilled labor at homeand keeps such workers cheap even though
they are relatively more scarce than in richcountries. Globalization in the form of thetransfer of know-how to complement cheap
skilled labor in poor countries leads to tradein skilled-labor-intensive services.
There is much discussion of whether the
global sourcing of service activities to lowwage countries presents features and issues different from those associated with global tradein goods. Bhagwati, Panagariya, and Srinivasan (2004), for example, argue that global
sourcing of services has effects that are notqualitatively different from those emanatingfrom the sourcing of goods. In both cases, there
are gains from trade and national incomes

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rise, but displaced workers face some costs ofadjustment.
For Trefler (2005), by contrast, the fact thatskilled workers lose their jobs when services are
sourced from low-wage countries has important economic implications that do not arise
when low-skilled jobs disappear. The loss ofrelatively high-wage jobs and the pressure on
the wages of high-skilled workers may reduce
economic incentives to invest in and to acquire
skills. In addition, in knowledge-intensive service activities skilled workers are more likely tohave obtained some industry- and firm-specificknowledge that is lost when the job is lost. Thismay have a direct negative impact on productivity, especially if the knowledge is complementary to other skills or factors. In developing
countries the opposite will tend to occur. The
transfer of know-how, the increasing demand
for skilled workers, and the upward pressure
on skilled wages will tend to increase the incentives to acquire skills. This will increasedemands on the education system in developing countries, which in many cases is likely to
become a constraint on this process.
The rapid pace of change and flexibility demanded by competitive global markets, alongwith new trends such as global sourcing of services, will lead to potentially rising adjustment
costs falling on a wider range of—more highly
skilled—workers. These trends all argue forcountries to review their domestic policy andinstitutional frameworks to ensure that theiradvantages can be exploited and that affected
workers are supported when they incur adjustment costs.

Policies to confront the labormarket challenges of globalizationF

ocusing on factors that determine thegrowth of productivity will be key to confronting the challenges of globalization without neutralizing its opportunities. This will require a change of mindset by policy makers,
who must grasp and internalize the fundamental changes in the nature of international production and trade (see box 4.7).

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Box 4.7

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Trading goods and services or trading tasks?

n the classic conception, international trade is theexchange of complete goods and services acrossnational boundaries. Countries gain from specialization in particular sectors of the economy, such as
textiles and steel. Within firms, gains are had fromhigher productivity, that is, by allowing workers tospecialize in particular tasks. In the past, effective coordination of these efforts, and the combination oftasks to produce a product, required proximity.
Communication required physical presence and thetransportation of intermediate inputs was slow andcostly. Specialization led to geographic concentrationof production. International trade occurred if consumers lived in another country.
However, the nature of production has changed.
Revolutions in transport and communications technologies have led to enormous reductions in cost,allowing tasks to be separated in time and space, andweakening the link between specialization and geographic concentration. Instructions and information
can be effectively conveyed over long distances andintermediate inputs can be transported quickly andmuch more cheaply than before. Thus, increasingly it
is tasks in addition to final goods and services that areexchanged across national boundaries, resulting in
global production networks of activity in a wide
range of sectors. In this new global economy there are
additional gains from specialization, as firms takeadvantage of differences in the cost of labor and skills
across countries to allocate tasks internationally.
Some tasks can be offshored more easily than others. What matters is the extent to which a particular
task is contested globally (Leamer 2006). This is
more likely for standard, mundane tasks that can becoordinated through codifiable information and lesslikely for complex tasks that require tacit information. The latter often require relationships and areoften best performed in clusters of individuals. Yourneighbors matter. Even for some mundane tasks,
such as mowing the grass, physical presence isrequired.
In this new global environment, interventions thattarget particular sectors will be ineffective relative toinitiatives to provide an environment that supports
activities and tasks. This entails greater emphasis ona business environment that facilitates the entry andexit of firms across all sectors and policies and infrastructure and regulations that support the free flow
and low cost of imported inputs (whether physical orinformation) to which domestic workers can contribute their tasks. What matters is the quality ofroads, ports, telecommunications, and electricity together with relatively low tariffs on imported inputs
and effective regulation of key backbone services.
Finally, the increasing importance of trade intasks creates a challenge for the measurement ofinternational trade flows. Currently imports of goods
are recorded according to their invoice value as they
cross the border and the whole value of the import is
attributed to the country in which the last substantial
transformation occurred. There is no system bywhich the countries that contributed value added tothe product are identified. Thus, for example, thevalue of the iPod discussed in box 4.4, when imported into the United States, is attributed to China,
where it is assembled. Yet most of the value of theiPod is added by tasks undertaken in other countries.

Sources: Grossman and Rossi-Hansberg 2006; Leamer 2006.

In the new environment, productivity
growth requires openness to new ideas and theability to exploit new technologies and opportunities. Economies need to be sufficiently
flexible to enable resources to move from lowproductivity to high-productivity tasks andactivities, which policy makers cannot identify
beforehand. This places a premium on institutions and policies that encourage innovation,126

investments in human capital, and reductionsof barriers to the flow of knowledge, capital,and labor. This process is not without adjustment costs, and complementary policies areneeded to ensure that particular groups insociety do not bear a disproportionate shareof the pain.
The appropriate policy mix that provides aframework for productivity growth will vary

N E Wover time and according to country characteristics, such as level of development and size.
Nevertheless, key ingredients will be openness
to trade and FDI and an attractive climate forinvestment and for innovation, investing in education, and repositioning labor-market policies to focus on protecting workers, not jobs.
Rich countries have a particular responsibility
to maintain and, indeed, increase the opennessof their markets to goods and services produced in poor countries. A related issue is theimpact that globalization and openness may
have on a country’s capacity to raise tax revenues to fund infrastructure for trade or training for affected workers.

Supporting open access to markets,
innovation, and a strong business climate
Openness to trade in goods, services, andideas provides a critical stimulus to innovationand productivity growth, both for countries
at the global technology frontier and thosecatching up. But because trade and technology
can lead to lower relative wages and greater
employment volatility for some workers, policy makers are often tempted to meet the challenges of globalization by increasing tradeprotection. Doing so compromises a key
source of growth. As a former finance minister of a developing country that undertook
successful reforms stated, “Trade shocks are
better dealt with through more, rather thanless, trade.”25
Trade policies interact critically with otherelements of the business and investment
climate. Reaping the benefits of globalization
requires not only openness to trade and investment but also physical infrastructure
and a policy framework that enables actualand potential exporters to effectively exploit
their advantages. High costs of clearing
customs, poor port infrastructure, weak
telecommunications services, and poor regulation, for example, raise costs and hamper
competitiveness. These major challenges fordeveloping countries, particularly the least
developed, must be addressed if trade liberalization is to be effective in stimulating trade,

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investment, and growth. Domestic policy
reforms, underpinned where necessary by increased “aid for trade” from the international
community, will be essential in helping thepoorest countries benefit from the opportunities of new global markets.
In addition, policies that affect innovation
and access to technology are crucial. For the
least developed countries, moving up the technology ladder by acquiring technologicalknow-how from overseas through trade and
FDI will be a key driver of growth over the
next 20 to 30 years. Innovation and learning
will continue to play essential roles in raisingproductivity and sustaining growth in richcountries and increasingly in the middleincome countries, placing emphasis on theinstitutions that frame incentives to invest in
R&D and in the acquisition and applicationof knowledge.26 In the middle-income countries there will be opportunities to be had fromincremental innovations to processes that
improve the tasks undertaken for foreign
firms and to products that can be tailored for
growing domestic markets. In the richer countries it is innovation and learning creating new
goods, services, and new processes for producing them, that will be of greater importance. The key elements of a policy framework
to support innovation and learning will differ
between countries according to level of development as well as size but to varying degrees
will include the following:• Investing in human capital to overcome
shortages of skilled labor, including due
to migration. Learning-by-doing in firms
increases with its workers’ human capital.
• Supporting public research throughuniversities and research centers, andfacilitating interaction with private businesses to ensure dissemination of “basic”
knowledge that stimulates research forcommercially exploitable innovations.
• Defining—and enforcing—adequate intellectual property rights to encourage domestic investment in innovation and acquisition of technology through FDI.27

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• Promoting access to finance, especiallyfor new entrants and small and medium
enterprises (SMEs), which are more
likely to be innovative (Geroski 1990).
• Careful review of fiscal incentives tostimulate R&D and innovation, taking
into account that evidence of effectiveness is scarce (de Ferranti and others
2002) and that there could be crowdingout or in of private investment (Jaumotteand Pain 2005).

Providing more people with lifelong
learning
In all countries investment in education will
become an ever more critical determinant oflabor-market performance in the context ofgreater global competition and increasing
rewards to skills. Higher-skilled workers are
better at dealing with changes, including
adoption of new technologies, new workforce
organizations, and ongoing pressures for adjustment and shocks, and also support the creation of well-functioning institutions (WorldBank 2006; Hoekman and Javorcik 2006).28
Countries need to focus not only on enrollment in education but also on quality and relevance, a fact underlined by the prevalence ofyouth unemployment in both developed anddeveloping countries.
Education systems everywhere face newchallenges, however. In the face of rapidchanges in technology and business organization, these systems struggle to keep pace withdemand for new skills—a trend likely to be exacerbated by global sourcing of services. For
individual workers, this means rapid changes
in the value of their skills, demanding constantretraining and skill upgrading. But workers
facing more rapid obsolescence or devaluationof skills may have lower incentives for skill
acquisition. Moreover, firms already facedwith competitive cost pressures and concernsthat they will not benefit from their investment in training as their workers leave forother firms, will increasingly have access to a
global pool of workers with the desired skills
to substitute for the existing workforce. This128

could place greater pressure on the education
system to provide the industry-specific skills
previously provided by firm-level training;
while continuing volatility could also place apremium on providing workers with the general skills that enable continuous adaptation.
In sum, education systems will be expected
to provide more people with more opportunities to learn across a broader menu of educational and skill-development options at morestages of their lives than ever before. This will
require a new model of education and training, as well as ongoing reform of traditional
methods, providers, and financing of education (box 4.8).

Protecting workers, not jobs
While globalization offers new opportunities for workers, it can also entail greater
movement—for example, between jobs, sectors, or regions—and this brings with it additional risk. This calls for policies that shift theemphasis from measures designed to protect
those in employment—which, as discussed
earlier, can discourage job creation—to mechanisms aimed at ameliorating the potentiallynegative effects of greater labor movement
through targeted labor-market policies andsocial safety nets. While the precise combination of labor-market programs and income
support measures will need to be determinedat the national level—taking account of local
circumstances and involving all relevant stakeholders—and there can be important differences in the types of programs that are mosteffective in developing and developed countries, some general lessons can be drawn.
In all countries, income support programs
will remain the core of worker assistance. In
OECD countries, the redistributive impact of
the tax-transfer system increased in the late1980s and 1990s (Brenton 2006). In developing countries, the design of such programs
raises specific challenges.
• Unemployment benefits can ease adjustment and maintain public support forstructural change, but if set too high

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Box 4.8 Key challenges for education systems in the
new global economy

While some of the key challenges relate to problems that education systems have traditionally
faced, such as increasing access to and quality of education, others relate to revisiting the nature, type,
and purpose of educational offerings to equip a globally competitive workforce. In key respects, traditional educational methods are ill-suited to providing
the lifelong learning that is necessary in the new
global economy (World Bank 2003).
Increase access. In Sub-Saharan Africa and SouthAsia, more than 40 percent of those aged 25 and overin 2000 had not completed any formal education. In
developing countries, public funding—directed
through public educational institutions or to individuals (loans or vouchers)—can help expand access(World Bank 2005). Recent policies in Brazil that addressed supply-side constraints in the education systemby establishing a minimum spending level per student
have proven successful in increasing enrollment rates
substantially (de Mello and Hoppe 2005). While thecentral government transfers funds to the local governments in case these are unable to finance the prescribed
spending levels, demand for education is increased byusing school attendance as a requirement for certain
types of income transfers to low-income households.
Provide access at all ages. Preschool and earlychildhood programs establish a solid basis for subsequent learninga while primary and secondary education give workers the basic skills that enable them tolearn new skills required by technology-inducedchanges (OECD 1996).b Lifelong learning helps workers to adjust, but government support (for instance,
via a training levy) may be needed (World Bank 2005).
In many emerging economies, improving the access tosecondary and postsecondary education will be criticalin view of the rising skill premium.
Improve quality.c Efficient increased spending
should be combined with strengthened incentives toteach and learn, and with improved accountability(World Bank 2006). Quality assurance mechanisms(including regionally) and national qualifications
frameworks raise standards and facilitate international recognition.
Focus on learning to learn, equipping workers
to learn throughout their working lives, andcontinuously upgrade how they produce in whateversector they might be employed (de Ferranti and others 2002). This means moving away from a model inwhich the teacher is the source of knowledge to asystem where educators function as guides to multiple sources of knowledge.
Include a range of providers. Including private
sector as well as public sector providers can promote greater access to education and greater variety
in educational offerings. Additionally, foreign institutions can help upgrade standards, although soundregulation is needed to ensure quality and access,and to provide clear and nondiscriminatory conditions for investors. Here again, government measures to ensure broad access may be necessary.
Strengthen the links between education andwork. The mismatch between graduates’ skills
and labor-market needs in many developing
countries argues for greater links between theprivate and public sectors. In the Middle East andNorth Africa, skills geared toward public sector jobs
are ill-suited to the needs of industry, while the traditional focus on law, philosophy, and theology in
education in much of Latin America and the
Caribbean is argued to have slowed the developmentof natural resource sectors (de Ferranti and others
2002). Postsecondary education should be balanced
between academic and technical-vocational training(OECD 1996), with the latter assessed, certified,
and formally recognized.
aIn developing countries, early childhood and preschool programs show returns of $2–5 for every $1 invested (World Bank
2006).
bFor a full discussion of ensuring access and quality in education, see World Bank (2006). For a discussion of issues in thedelivery of basic education services, see World Development
Report 2004: Making Services Work for Poor People.
cChildren in Argentina, Chile, and Mexico perform about two
standard deviations below children in Greece, one of the poorestperforming countries in the OECD. In reading competence (basedon the OECD’s Programme for International Student Assessment[PISA] 2001), the average Indonesian student performed at thelevel of a French student at the seventh percentile (World Bank
2006). More than 20 percent of firms in many developing countries rate inadequate skills and education of workers as a major orsevere obstacle to their operations (World Bank 2005).

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2 0 0 7and given for too long, can slow down
adjustment. In developing countries, informality makes targeting of benefits
difficult as the unemployed may also
have jobs in the informal sector, and theregistered unemployed may be middlerather than low-income workers (Hoekman and Winters 2005).29 However,
unemployment insurance may also be analternative source of credit for selfemployment. Individual savings accounts or similar types of unemployment insurance may be a better solution
for developing countries, although there
is a risk that workers have insufficient
resources.
• Mandatory severance pay is the mostcommon income support program indeveloping countries, as compliance iscomplaint-driven and an expensive
bureaucracy is not required. However, if
overly large, severance pay may discourage hiring or reforms as costs become
unmanageable.
• One-off compensation programs havealso been used in both developing (public
sector downsizing) and developed (restructuring of declining industries) countries. While supporting relatively well-off
workers (the previous beneficiaries ofrents), they are often seen as politicallynecessary for reform—although experience suggests that they have often not succeeded in attaining their stated goals.30• Wage insurance gives workers a proportion of their former wage for a set periodof time, conditional upon their finding
new employment. This eases adjustment,
provides an incentive to take a new,albeit lower-paying, job and (in effect)
subsidizes on-the-job retraining—themost effective kind (Kletzer 2001).
Global competition and movement ofworkers argues for separating health care from
employment status. The possibility that in future more types of workers could experience

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periods of unemployment or more frequentjob change argues for new mechanisms to ensure that they are not left without access to essential health services. Moreover, health carebenefits provided by firms are a burden on
globally contestable jobs and make employers
wary of forming long-term relationships withprospective employees (Leamer 2006). In developing countries, extending universal basic
medical care not linked to other aspects of formality could help to reach the poorest, butrisks increasing incentives for informality(Arias and others 2005). One option is general
health provision, funded by tax revenue rather
than attached to employment; a more modest
alternative is the creation of a health insurance
subsidy for displaced workers, as proposed by
Kletzer (2001).31
Active labor-market programs can be effective in keeping workers in the labor market andupgrading their skills, but experience has been
mixed and programs need to be designed tosuit the conditions in developing countries.32
While there is considerable experience in theOECD countries,33 less is known about policies in developing countries.34 For the latter,the key issues are the size of the informal sector, limited administrative capacity, and the absence of broader social safety nets. Leakage
risks are higher, as the unemployed may also
have informal jobs and may not be lowincome. Policies need to improve conditions in
the informal sector, but avoid creating additional incentives for informality.
In both developed and developing countries
successful interventions are comprehensive,oriented to labor demand, linked to real workplaces, and carefully targeted (box 4.9). Interventions are also more effective when theeconomy is growing. But longer-term assessments are needed (most cover one to two
years) and a range of effects—deadweight (impact would have been achieved in the absenceof the program), substitution (participants
substitute for nonparticipants in the labormarket and the employment effect is zero),and displacement (firms with subsidized

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Box 4.9 Overview of the impact of active
labor-market programs
Employment services. Generally have a positive
impact on employment and earnings and are costeffective. But they are of limited use where structural unemployment is high and labor demand low.
May be less effective in developing countries
where informality is high and implementation
capacity limited.
Public works. Effective, including for informal
workers, as a short-term safety net in developing
countries but do not improve future labor-market
prospects, especially where a stigma is attached toparticipation. Wages need to be sufficiently low totarget those with low incomes and few job
prospects, and projects should also target poor
areas. Can be most redistributive, but require
government expenditure.
Training. Can result in higher employment rates,
if not earnings. Programs work best with active employer involvement (on-the-job training), and limited evidence from developing and transition
economies suggests better results for women thanmen. But firms are reluctant to train lower-skilledworkers; in the OECD countries the least qualified
are only a quarter to a third as likely as the highly
qualified to participate in job-related training. A
growing number of countries fund enterprise-based
training via compulsory levies (usually 1 percent of
payroll), with reimbursement based on training provided in some cases (examples include Singapore
and Mauritius).
Retraining after mass layoffs. No positive impact,
except with a comprehensive package of employment
services, and expensive. Workers are often geographically concentrated with industry-specific skills.
Best results have been achieved with longer programs
that include some worker contribution to costs.

workers displace those without)—need to betaken into account. Given their mixed record,
and the challenges of appropriate design, governments need to be realistic about what active labor-market policies can achieve.

Training for youth. Less successful than earlier investments in the education system. Some success in
Latin America with programs that integrate training
with remedial education, job search assistance, andsocial services. For example, the “Jovenes” programsof Argentina, Chile, Peru and Uruguay are targeted
at disadvantaged youth. They combine training andwork experience with other services, include the private sector, and are financed by tripartite levy-grantschemes or the government. They have substantial
and positive impacts on employment and earnings,
but can be small scale, may not be cost-effective, andparticipants can displace other workers.
Employment subsidies. Mostly for disadvantaged
groups, although some countries (Belgium, France, theNetherlands) provide for all low-paid work. A significant share of overall active labor-market program(ALMP) spending in several OECD countries. Most
do not have a positive impact and have substantial
deadweight (workers would have been employed
without the subsidy) and substitution (worker displaces a nonsubsidized worker) costs.
Microenterprise development and self-employment
assistance. Some evidence of positive impacts forolder and better-educated workers, but take-up is
low and business failure rate is high.

Sources: Betcherman, Olivas, and Dar 2004; World Bank 2005;
Rama 2003; Arias and others 2005; OECD 2005a, 2005d;
Heckman and Pagés 2000.
Note: Betcherman, Olivas, and Dar (2004) build on an earlier
World Bank study of 72 scientific (that is, using a control
group) evaluations of ALMPs by Dar and Tzannatos (1999) byadding 87 new studies, 39 of which cover programs in developing and transition economies. Similar conclusions on a numberof points have been made in OECD reviews (see Martin 2000).

Globalization may undermine funding
for programs to support labor
While integrating into the world economy
requires that import taxes be kept low andrelatively uniform, for the least developed131

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Figure 4.6 Low-income countries depend
heavily on import duties for tax revenues
Percent of GDP
7

VAT, sales, or
turnover taxes
Importduties

6
5
4
3
2
1

e
m
co
in
hig
H

r-m
in idd
co le
m e

pp
e
U

er
w
Lo

Lo

w

-in

co

m

-m
in idd
co le
m e

e

0

Source: World Bank staff calculations.

countries they are a key source of revenue relative to value-added tax (VAT) and sales taxes(figure 4.6). High-income countries are able torecover revenues lost from trade liberalizationfrom other sources: on average, middleincome countries recover 45–60 percent of lost
tariff revenues while least developed countries
recover less than 30 percent (Baunsgaard andKeen 2005).
But many countries collect far less in tariff
revenue than the applied tax rates would suggest, owing to the widespread (discretionary)
granting of exemptions. Exemptions make thetax regime opaque and difficult to administerand can lead to a distorted incentive structurethat discriminates against small firms with lessinfluence. Further, there is little evidence thatexemptions have a significant impact on investment, their primary justification. Many
countries could substantially reduce applied
tariffs while maintaining or even increasing
revenue if exemptions were removed and collection improved. However, it is still necessary
to address the development challenge highlighted in figure 4.6 of moving from easyto-collect trade taxes to harder-to-collectconsumption and income taxes.35 Simply
implementing a VAT is not sufficient; a highdegree of collection efficiency (the ratio of
actual to potential revenues) is needed.36

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While feelings of greater economic insecurity among workers may lead to greater demands for social insurance, it has been argued
that globalization is limiting the capacity of
governments to fund such protection—and tosupport the productivity-enhancing measures
discussed above. The fear is that globalizationand greater mobility of capital and wealthy
workers will undermine the tax base, as thesefactors move to the lowest tax locations, compromising social welfare programs for thosebearing the burden of adjustment. There is little
evidence of this process in developed countries(OECD 2000b), however, and the preferencesof wealthy individuals for education, health,
law and order, and social welfare suggest thatfears of large numbers of skilled workers emigrating to low tax havens are unlikely to be justified. Moreover, much of the knowledge ofthese workers is gained and creates value frominteractions and synergies with clusters of othersimilar workers. As Leamer (2006) says, itmatters who your neighbors are.

The international community—working
together—can help realize the potentialof globalization
The rise of China, India, and other emerging
economies amounts to a huge increase in the
supply of unskilled labor on a global scale.
This could heighten the existing—and growing—inequality between skilled and unskilledworkers in both developed and developing
countries that has resulted from a mix of technology and trade effects. There are fears that
there will be no space for other countries, particularly developing countries, to compete in
low-wage exports or in attracting global capital flows. In addition, because China andIndia are rapidly upgrading the skills of theirworkforce, and services activities along thevalue chain are being globally sourced, skilledworkers everywhere are increasingly facing
competitive pressure. There are mitigating
forces, however; China and India offer hugemarkets for the exports of other countries,
their own wages are bound to grow rapidly,
and developing the full range of institutions

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needed to underpin a modern, dynamic market economy will take time.
This new global climate poses challenges—
but also offers considerable opportunities—for
all countries. The countries best placed to address the challenges will be those best able toseize the opportunities and generate the newsources of growth and wealth needed to finance additional investments in social safety
nets and education. In many developing countries, domestic reforms to reduce rigidities in
the labor market and improve the climate forbusiness and innovation will be critical. All
countries will need better mechanisms to cushion adjustment costs and distribute the benefitsof growth to offset the tendencies toward inequality and volatility. But collective action by
the international community will also beneeded in two important respects. First, as thepressures of globalization increase the calls for
beggar-thy-neighbor protectionism, the international community will need to band together
to preserve and extend the open markets thathave underpinned recent advances in growthand poverty reduction. In the absence of open
global markets, many of the new opportunities
from the coming globalization will disappear.
Second, the international community needs toprovide the financial and technical support—
the “aid for trade”—to enable the poorest
countries to overcome the infrastructure andcapacity constraints that limit their ability totake advantage of new trade opportunities.

Notes
1. Trade among developing countries is also growing significantly; South-South trade now constitutes
one-quarter of developing-country exports, and thistrade is growing 50 percent faster than world trade.
2. A recent U.S. study (Brofenbrenner and Luce
2004) concludes that the Bureau of Labor Statistics(BLS) grossly underestimates the total number of jobs
lost to global production shifts. While the BLS reported 4,633 private sector workers in establishmentswith 50 or more employees who lost their jobs because of global outsourcing from January to March
2004, the authors, drawing on media reports, findevidence of a minimum of 25,000 jobs lost over that
period. Moves were often to several destinations

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simultaneously and most were in manufacturing, although there was a significant increase in shifts ofwhite-collar-services jobs to India.
3. Ghose (2003) identifies a group of manufacturingexporting developing countries that have shown impressive growth in employment in the sector, fromabout 50.9 million in 1980 to 82.8 million in 1997 (orfrom 79 to 88.7 percent of total employment over thesame period). In this group are China, the Arab
Republic of Egypt, India, Indonesia, Israel, theRepublic of Korea, Malaysia, Mauritius, Morocco, thePhilippines, Singapore, Sri Lanka, Taiwan (China),
Thailand, and Turkey. However, other manufacturingexporting countries have witnessed declines of 13.5 to
10.6 million (21 to 11.3 percent) over the same period—
this group consists of Argentina, Brazil, Hong Kong
(China), Malta, Mexico, Pakistan, and South Africa.
Note that Mexico’s figures do not include themaquiladora; if they did, the country would haveappeared in the first group.
4. A further question is the distribution of gains between labor and capital. However, this issue has
proven difficult to analyze and beyond the immediate
scope of this chapter, which focuses on the distribution
within labor markets between skilled and unskilledworkers.
5. Whether the impacts of greater openness operate
more or less through wages as opposed to employment
depends on labor-market institutions, the efficiency of
capital markets, and social policies. Hence in the UnitedStates, the more flexible labor market and more efficient financial sector mean that wages bear a greater
share of shocks than in the European Union. In developing countries, it also appears that wage responses are
greater than employment impacts, suggestive both oflabor-market rigidities and industry rents engenderedby trade policy (Hoekman and Winters 2005).
6. For full-time workers in the United States between 1979 and 1995, real wages of those with 12 yearsof education fell by 13.4 percent, and real wages of thosewith less than 12 years of education fell by 20.2 percent.
During the same period, real wages of workers with 16
or more years of education rose by 3.4 percent so thatthe wage gap between these groups grew significantly(Feenstra and Hanson 2003).
7. Some of the overall increases in the skill premium could also be related to the artificially low prices
for skilled labor prior to opening. Modest increases arealso found in China and Vietnam (World Bank 2002).
8. Economic literature has mainly focused on theimpact of globalization on labor demand elasticities. Authors such as Rodrik (1997) argue that globalization
has led to an increase in the labor demand elasticity, withthe result that changes in product prices now havemagnified impacts on wages and employment. The

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empirical support for this link is mixed, although estimating elasticities is prone to difficulties. Rodrik (1997)
finds that the interaction between trade openness andvariation in a country’s terms of trade is positively linked
with volatility of growth and government expenditures.
The latter, Rodrik argues, reflects the increasing demand
for social protection as globalization increases insecurity. On the other hand, Iversen and Cusack (2000)
argue that what is required is to show that volatility
from international markets is greater than that in domestic markets; they find that in developed countries
there is no correlation between trade openness and output, earnings, or employment volatility. Others have
tried to link trade liberalization to changes in labor demand elasticities. Slaughter (2001) finds that labour demand elasticities for low-skilled workers in the UnitedStates have increased over time but with no clear link totrade variables. Fajnzylber and Maloney (2005), for aset of Latin American countries, and Krishna, Mitra,
and Chinoy (2001) for Turkey do not find strong support for this link. On the other hand, Hasan, Mitra, andRamaswamy (2003) find a strong link between trade reform and wage and employment volatility in India.
Nevertheless, even though a positive link between globalization and observed measures of volatility has notbeen found, globalization may still have contributed togreater risks and to heightened economic insecurity(Scheve and Slaughter 2002).
9. Data for 19 developed and developing
economies suggest that flexible hiring and firing rules
are positively associated with higher rates of entry of
new firms, which are often better at harnessing newtechnologies (World Bank 2005).
10. Alternatively, of course, it could be argued thatstrict employment protection is a response to thehigher level of anxiety of workers in these countries. If
that is the case, however, one would also have toconclude that protection has not been very effective in
reducing that anxiety.
11. Skilled workers are considered to be those withsome secondary education, plus those with secondary
education or above. This selection does not take into
account the quality of the education received orcomparability among countries.
12. This is notwithstanding the fact that trade liberalization in India and especially China has advanced
greatly over the last 15 years, in China driven in partby World Trade Organization (WTO) accession and in
India by unilateral reforms.
13. It should be noted that Hong Kong (China) is
the world’s third-largest outward investor, with flows
of about $40 billion in 2004 (UNCTAD 2005).
14. There is controversy around the exact numberof graduates from Chinese and Indian institutions. For
example, a recent study by Duke University indicated134that engineering graduates from Chinese universities
numbered only 351,000 per year as opposed to previous estimates of over 600,000. Note that the new number is still two and a half times as many graduates as in
the United States; however, China’s population is fourtimes as large.
15. It is interesting to note that the Soviet Union
overtook the United States in the number of research
workers (Nolting and Feshbach 1980) but did not succeed in achieving strong and sustained innovationdriven growth.
16. Migration of skilled workers can be positive forthe country of origin when those workers come back. In
Morocco, high-skilled labor has started to return,bringing substantial know-how and technologicalknowledge into the country, increasing productivity andboosting innovation in terms of improved businesspractices.
17. The value of a relationship-specific investment
is significantly higher within a buyer-seller relationshipthan outside it. An example is where suppliers or subcontractors to a car producer make investments in design modifications that improve the fit or ease of assembly with other parts but which are not relevant to
the production process of other car makers. Suchinvestments tend to be associated with longer-term
contractual commitments between producers andtheir suppliers and less repeated bargaining (Joskow(1987)). Spencer and Qui (2001) find that such relationships in the Japanese car industry tend to limit therange of imports to less important parts and that it ispossible that no parts are imported despite lower
production costs overseas.
18. Looking at U.S. imports from 10 major developing countries (which together accounted for 26.5
percent of U.S. imports at the time of the cited study),
Aggarwal (1995) noted that sectors with egregious
labor conditions were not a primary share of thesecountries’ exports; that standards were often lower inless export-oriented or nontraded sectors; and that,within the export-oriented sector, labor conditions infirms more involved in exporting were either similar toor better than those in other firms. Raynauld and Vidal(1998) showed that, since 1980, countries with low
standards had not increased their share of global exports and two-thirds of 39 countries with low labor
standards had seen their international competitiveness(as measured by unit labor costs) stagnate or decline(decline reflects either a decline in labor productivity
relative to the nominal cost of labor or a rise in thenominal cost of labor relative to its productivity) while
14 of the 18 high-standards countries had increased
their international competitiveness.
19. “Outsourcing”
or“offshoring”
haveboth been used to refer to the global sourcing of

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services—technically “outsourcing” refers to the sourcing of an activity outside a company (such as the contracting out of billing services), which can also take place
within the domestic market, while “offshoring” is the
movement of production of a service outside a country.
For firms, offshoring need not be outsourcing when theactivity stays within a foreign affiliate; from the perspective of national labor markets, it is the movement of
production to another territory that is the focus of interest. Strictly speaking, not all FDI is offshoring, as in cases
where a foreign affiliate is built to service the local
market in the host country (Kirkegaard 2005).
20. Note that balance of payments (BOP) statistics
imperfectly measure the full extent of global sourcingof services because of classification and data limitations; figures should be taken as an underestimate.
21. Atkinson (2004) notes that a concerted effort
by the Chinese government to expand acquisition ofEnglish could see China moving beyond non-languagebased services to other business services.
22. Care needs to be taken with comparisons between outsourcing and inward FDI, as the foreign establishment may be created primarily to serve the domestic market (see note 19). That said, the comparison
may be more relevant in terms of the contribution offoreign companies to job creation within the UnitedStates, to offset the movement of jobs overseas.
23. For every $1 of call-center work offshored by
U.S. firms, an estimated $1.43 is reinvested in the U.S.
economy; the amounts are $1.33 and $1.42 for information technology services and high-end knowledge
services (such as equity research, tax preparation, andrisk management), respectively. The net benefit to the
U.S. economy of shifting $1 previously spent in the
United States to India could be as high as 12–14 cents
per dollar (McKinsey Quarterly, October 2003).
24. The absence of international standards formany service sector activities reinforces the importanceof reputation in attracting new clients.
25. Nicolás Eyzaguirre, former Minister of Financefrom Chile, comparing the experiences of Chile andArgentina, in a presentation to the Mauritius HighLevel seminar in September 2006.
26. Rates of return can also be influenced by thelack of competition. If incumbents are able to extract
large rents that are not endangered, the incentive toinnovate is severely restrained because the returns
will replace some of the rents they are actually
collecting, reducing the net value of innovation. Evidence indicates that monopolies are not particularly
innovative and that small firms stimulate innovation(Geroski 1990). Opening markets by reducing external barriers and creating better regulatory frameworks for natural monopolies is hence likely to raise
rates of innovation.

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27. However, IPR protection must be balanced
against the need to avoid stifling competition.
28. Education can also promote access to technology and development of new sectors: in 21 countries in
Latin America and the Caribbean, an increase of five
years in the average level of education in those above
15 was associated with an increase in FDI of 3 percent
of GDP (de Ferranti and others 2002).
29. While the informal sector can also be a way ofmanaging risk, there are limits to its role as a safety
net, as it often generates most of the flows into unemployment (about 60 percent in Argentina, Brazil, andMexico) and is ineffective in cases of multiple/covariate
shocks (Arias and others 2005).
30. In the United States, the structure of the political system (including, for example, passage of Trade
Promotion Authority in Congress) and nature of pressures have led to the development of trade-specificadjustment measures (Brenton 2006). Under the U.S.
Trade Adjustment Assistance (TAA) program, qualified
workers can receive an additional 52 weeks of unemployment insurance provided they are enrolled in an approved training program; a similar program was created
for the North American Free Trade Agreement(NAFTA) in 1993. TAA and NAFTA payments areabout $300 million annually (Kletzer 2001). The European Union is also now considering a Globalization
Fund of half a billion euros to help retrain and relocate
35,000–50,000 workers a year whose jobs are lost to
global sourcing and trade. Money would be available inthe case of layoffs of at least 1,000 people in regionswith a population of at least 800,000 where the unemployment rate was already higher than the European or
national average; or where several companies in a sector
laid off at least 1,000 workers over six months in regionswith a population of up to three million and where thejob losses added up to 1 percent of total employees inthat sector. While the fund will cover a relatively small
number of workers, it is seen as important in resistinggrowing calls for protection (Kanter 2006). It is notclear, however, that there is an equity argument for distinguishing between trade-affected and other workers,
such as those affected by technological change. In somecircumstances—such as mass layoffs—trade-specific assistance may be more cost-effective. However, it should
be used sparingly, aimed at orderly adjustment, be timelimited, and include both services and manufacturing
workers as well as workers who have lost their jobs fromboth import and export competition (OECD 2005d).
31. Under Kletzer’s proposal for the United States,
all full-time displaced workers would be eligible to receive a health insurance subsidy for up to six months,
or until they found a new job, whichever is earlier.
32. ALMPs include employment services, training,
public works (which offer short-term employment on

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community projects in sectors such as construction,
rural development, and community services), wage andemployment subsidies, and self-employment assistance.
33. Over 1990–2002, average national expenditure on ALMPs in OECD countries remained relatively
constant at about 0.75 percent of gross domestic product (GDP). This average masks wide differences, however, with some European countries spending over
1 percent of GDP while the United States, Japan,
Korea, and the United Kingdom spent under 0.4 percent. Training accounted for the bulk of spending(36 percent), followed by public employment services(24.5 percent) and job subsidies (19.5 percent). Transition economies show similar (but lower) patterns ofspending (Betcherman, Olivas, and Dar 2004).
34. There is some evidence that Latin Americancountries have been investing significantly in youth
training and public works programs, but in Africa
there is very little active programming on any significant scale (Betcherman, Olivas, and Dar 2004).
35. For many resource-rich developing countries
facing rising demand from China and India andhigher world prices, a crucial opportunity that has tobe addressed is translating higher revenues into investments in social and educational programs that enhance competitiveness and support diversification. For
these countries, the priority for domestic reform must
be to address governance and corruption issues associated with distributing the revenues from resources.
This must be supported by the global community
through increased efforts to discipline the activities offirms and governments in countries demanding theseresources.
36. Countries with smaller agricultural and larger
urban sectors, with strong political institutions, withhigher per capita incomes, and that are more open to
trade tend to have higher collection efficiencies for
VAT (Aizenman and Jinjarak 2006).

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5Managing the Environmental Risks
to Growth

The gains from growth and globalization
could be undermined by their environmentalside effects. Because increases in production
magnify cross-border pollution, while improvements in technology make it possible toexpand or intensify the exploitation of scarce
global resources, decisions at the national
level are having a growing impact on othercountries. International institutions will thus
be required to play a larger role in a wide
spectrum of issues—all involving global
public goods—where exclusive reliance on thedecisions of individual governments or theprivate market can lead to adverse outcomes.
Such goods include maintaining global security, keeping the trading system open andnondiscriminatory, and ensuring global financial stability. As developing countries enlarge
their role on the global stage, their integration
as full partners in multilateral solutions to
global problems will be essential.
Mitigating climate change, containing
infectious diseases, and preserving marine
fisheries are three additional global public
goods that demonstrate the need for—and
benefits of—international policy cooperation.
Rising industrial output means increasing
concentrations of greenhouse gases in the atmosphere, which will have detrimental effects
on future productivity and—more generally—on human welfare around the globe. Even in
the next decade or two, scientists underscorethe (unlikely) possibility that global warming
could cause natural disruptions severe enoughto depress growth rates below the low-growthscenario presented here. It is more likely that
decades will pass before the most severe effects
of climate change begin to be felt. Even so, thecollective response of today’s global leaders isalmost certain to have far-reaching implications for the welfare of future generations.
Technological progress and rising demand
have increased efforts to harvest fish from theopen seas, degrading ocean environments anddriving some valuable species to nearextinction. Longstanding efforts to limit
marine catches to sustainable levels have
met with only a few successes. Why? Because
institutional weaknesses, technical difficulties, and fishing subsidies impede sustainable
management.
The growing interaction of national
economies through trade and movementsof people, while broadly beneficial, has
increased the risk of spreading contagious
diseases. HIV/AIDS (human immunodeficiency virus/acquired immune deficiency syndrome) is one example. The severe acute respiratory syndrome (SARS) is another. The
most prominent current threat is the avian
influenza virus.
These examples of the side effects ofglobalization—one long-term, one mediumterm, and one immediate—pose risks to theprogressive expansion of the global economy,
and to developing countries in particular. Someof the more catastrophic climate-change
scenarios, if they materialize, could undermine141

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2 0 0 7the development prospects of whole countries
and even regions through their effects on agriculture, water, and ecosystems. Similarly, failure
to contain an epidemic could bring global commerce to a sudden halt, isolate some populations, and impose huge losses on affected developing countries. Unrestrained marine fishing,while less potentially calamitous than climatechange or a flu pandemic, could permanently
exhaust a critical global food source and destroy
irreplaceable deep-sea habitats and biodiversity.
Effective multilateral collaboration isneeded to ensure that economic growth andpoverty reduction will proceed without causing
irreparable harm to future generations. Developing countries are central to the managementof these risks. Although these countries are relatively small contributors to global warming
today, the projections in chapter 2 imply thatthey will soon enough become large contributors to global warming. And if no action istaken, the standard of living that they could
otherwise expect may well be put at risk.
Given the limited supply of medical facilities
and nursing care in the developing world, a flu
pandemic could have horrific consequences.
In many developing countries, people dependon fish for an important share of their diet,and the poor would suffer if the price of fish,
as well as substitutes, were to skyrocket as
supplies dwindled.
The degree of international coordination
required varies greatly from issue to issue,
depending on the nature of the issue and thegeographical spread of its causes and effects(table 5.1). The need for international coordination falls with the degree to which an individual country can benefit from its own efforts
to provide the good (or mitigate the evil),and rises with the number of countries involved (Barrett 2004). For example, the U.S.Canadian agreement on reducing acid rain
was facilitated in part because only two countries had to agree and because each country
gained an important benefit from its own
efforts to reduce pollution. By contrast—as
shown below—negotiations over climatechange are intractable in part because even142though every country will be affected, there islittle systematic relationship between the sizeof most countries’ efforts to reduce carbon
emissions and the damage these countries
experience from climate change.
Ensuring that developing countries reap the
benefits from global public goods is particularly difficult. Developing countries typicallyaccount for a small share of internationaltransactions, so they often lack the clout toensure that decisions made in international
fora adequately reflect their interests. Many
developing countries lack the financial andtechnical resources to participate effectively ininternational negotiations on many issues. For
example, the simultaneous negotiations on avariety of critical environmental issues forces
governments with inadequate resources tolimit their participation (Esty and Ivanova
2002). Developing countries also lack theresources required to effectively address many
common problems. For example, malaria kills
millions in developing countries, but researchon pertinent vaccines is limited, althoughsome efforts are now under way.
While the three cases spotlighted here differ
in the agreement on the extent of risks, there
is a sufficient scientific consensus to move
forward on all of them. The needs and themethods to protect against the spread of(selected) contagious diseases are well known,
although the efficacy of particular strategies(quarantine, stockpiling of available vaccinations) in limiting the spread of avian flu is indispute. The overexploitation of marine fishstocks is well understood, although disagreement remains on the amount of resources tocommit, the limits on fishing to impose, andhow to allocate access to fisheries. There is aninternational consensus that human activity iscontributing to climate change, but the precise
implications of different levels of greenhousegas concentrations for climate change remain
uncertain. While disagreements over the factsof each case have affected efforts at international cooperation, they have not been the
major impediment to progress. In reviewing thestate of knowledge in each area, this chapter

M A N A G I N G

T H E

E N V I R O N M E N T A L

R I S K S

T O

G R O W T H

Table 5.1 Progress in providing many global public goods is limited
Examples of global public goods
Good

Role of developing countries

Progress of international efforts

Limited current contributors, but major
future source, of carbon emissions;potentially disastrous impact on many
countries

Current mitigation efforts insufficient tostabilize global temperature

Biodiversity and ecosystems

Main reservoir of many species

Rate of species extinction rising; tropicalforest cover declining

Water resources

Over 600 million people face acutefreshwater shortage

Little international effort beyond
increasing awareness; 2–3 billion people
may face severe freshwater shortage by
2020

Fisheries

Many countries dependent on ocean
fisheries for exports and domestic
consumption

75 percent of commercial fish stocks
exploited at or above sustainable levels

Developing countries could suffer severe
losses in a global flu pandemic; alreadysuffer millions of deaths from tropicaldiseasesFlu pandemic avoided (for now); limited
progress in containing malaria, measles,
AIDS in developing countries

Peacekeeping

Millions killed in civil wars andintercountry conflicts

Some interventions successful (Kosovo in
the Republic of Serbia); others less so(Sierra Leone)

Poverty

1 billion people living on less than
$1 a day

Asia expected to see continuing decline inpeople living in extreme poverty; Africa
likely to see rise

Developing countries account for
27 percent of global merchandise exports;
goods and services exports represent
33 percent of developing countries’ grossdomestic product

Trade rules effective, but limited progress
on removing trade barriers critical todeveloping countries

Total fiscal costs of systemic crises indeveloping countries since 1975 exceeds$1 trillion

Crisis interventions have mixed success;little change in global rules that would
dampen volatility

Global commons
Climate change

Human issues
Infectious diseases

Regulatory framework
Trade

Financial architecture

Sources: Rischard 2002; World Bank, World Development Indicators; Honohan and Laeven 2005.

discusses some of the key economic issues that
constrain or support effective action to protect
the environment and sustain growth.

The immediate risk of epidemics

G

lobalization has increased the volume andspeed of cross-border transactions, thusincreasing the potential for the transmission ofcontagious diseases. The international transmission of disease is nothing new.1 But air
travel and international contacts have greatly
accelerated its potential speed. Over the next

quarter-century the global economy will continue to be at risk of sharp downturns from
disruptions caused by contagious diseases. For
example, a human flu pandemic similar to the1918 Spanish flu could reduce global GDP
by 3 percent over a one-year period, with themore severe effects (in percentage terms) felt indeveloping countries (World Bank 2006).
The potential for a devastating global outbreak of contagious disease underscores theimportance of international cooperation. Individuals benefit directly from access to vaccination, and individual countries benefit from143

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controlling disease within their borders—both
benefits reduce the role that international
institutions must play. Nevertheless, other countries do have a critical interest in containing disease, as containment reduces the probability offurther transmission. Measures by individual
countries to contain infectious disease may be insufficient from a global perspective, in part because individual countries may lack the resources
to take all measures that the international community might consider prudent. And the supply
of informational goods—for example, researchon vaccines and knowledge of treatment andquarantine procedures—is likely to be impairedin the absence of effective international cooperation. This section discusses these issues in thecontext of the recent SARS epidemic and thepotential for an avian flu pandemic.

countries—whether they had reported SARS
cases or not—designated special treatment
centers (“SARS hospitals”) and put in place
quarantine procedures. In some of the places
most severely hit, the measures were very
strict. Hong Kong (China) imposed restrictions on peoples’ movement between city districts, and Singapore used TV surveillance andradio bracelets to monitor and control the
movements of persons who had come in contact with SARS patients and of patients discharged from SARS hospitals. The World
Health Organization (WHO) collected anddisseminated up-to-date information on thedevelopment of the disease and how to respond, and coordinated scientific efforts tocontrol and identify the virus causing the
sickness. Given the crucial role of air traffic in
the spread of SARS between countries andcontinents, WHO issued the first emergency
travel advisory in its history. Travel bans were
imposed for major affected areas in April
2003 (Bell and Lewis 2004).
The combined efforts by local, national,
and international authorities to contain thethreatening pandemic were successful: newly
reported cases, which increased rapidly inMarch and April of 2003, peaked in early
May and thereafter declined rapidly (figure 5.1). Although no cure has yet been found

SARS was a case study in virus
proliferation and containment
Five months after initial reports from East
Asia (in February 2003) of an atypical respiratory disease, more than 8,000 cases had
been reported in close to 30 countries.2 The
disease, labeled SARS, was highly contagious
and life threatening: almost 10 percent of reported cases ended with the patient dying.
The global response to the rapidly spreading disease was swift and determined. Many

Figure 5.1 The SARS epidemic was contained in a matter of months
Number of cases
9,000
8,000
7,000
6,000
5,000

Cumulative
recoveries

Cumulative cases

4,000

Active cases

3,000
Cumulative deaths

2,000
1,000
0
0

7

14

21

28

35

42

49

56

Days into outbreak
Source: http://www.adrianboyko.com/SARS (WHO data).

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63

70

77

84

91

98

105

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for the disease, it was successfully containedby late 2004, and no new cases have beenreported since 2005. The containment of
SARS was facilitated by the fact that the disease is less transmissible than some influenzas
experienced in the past. The SARS experiencehighlights the role of the technological developments and rapid communications that promote globalization both in speeding the
spread of contagious diseases and in providing
the tools to combat them.

Has the risk of avian flu been contained?
The virus causing avian flu (H5N1) affects
primarily birds, although cases of human infection, recorded since 1997, have increased
significantly since 2003, while remaining low.
An outbreak of avian flu through human-tohuman transmission could have catastrophic
implications for welfare, particularly in developing countries where public health systems
are weak, and could result in a sharp, shortterm interruption in global growth.
Possible pandemic. The avian flu is a subjectof great concern principally because more thanhalf of all infected persons have died from thedisease, and flu viruses have the potential tomutate into a form that is easily transmitted
between humans (the “Spanish flu” pandemicof 1918–19 killed up to 50 million people). The
rapid expansion of the poultry population, andin particular the close proximity between
humans and animals in East Asia, has increased
the likelihood that such a mutation may occur.3
And if it does, the greatly increased speed andscope of human travel would facilitate a rapid
spread of the disease worldwide. WHO
projections reckon that the mutation of theavian flu virus permitting human-to-humantransmission would, under best-case scenarios,
entail the spread of the disease among humans
across all continents (WHO 2005). Other
estimates that assume a more virulent virus
involve much higher numbers of deaths.
Prevention and countermeasures. Alternative
measures of preventing or responding to an

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outbreak have been discussed widely at boththe national and international level (WHO2006; CDC 2004; Osterholm 2005; SturmRamirez 2006). A large number of actions toaddress a potential avian flu pandemic can beenvisaged:• Reducing the incidence of avian flu inbirds would reduce the probability ofhuman infection. Effective systems tomonitor flocks is required, coupled withcompensation for damage if birds haveto be slaughtered, and punishment for
failure to report, as otherwise breeders
are likely to conceal incidences of thedisease in their flock. There also is a needto regulate bird breeding and marketing
methods that facilitate the occurrence or
spread of the disease.
• Developing a vaccine that is certain to beeffective is impossible, given present
knowledge, because the form of the future
mutation of the virus is unknown. Thereis hope among researchers that it may bepossible to develop flu vaccines that will
be effective against whole classes of flu
viruses, including future mutations. Manyexperts argue that the likely success ratefrom the use of existing vaccines is sufficiently high to make stockpiling vaccines
a key ingredient in a comprehensive response strategy.
• An effective surveillance system will beessential to detect and report cases—evensuspected cases—before they have achance to spread. The SARS episodeshowed how important early detection
can be for an effective containment
strategy.
• Steps to treat victims and contain the
disease may range from administering
appropriate medicines to implementing
quarantine procedures for contagious
patients. It is uncertain whether current
antiviral drugs would be effective against
a future mutation of the avian flu virus.
Even so, many experts argue that existing antiviral drugs are sufficiently likely

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2 0 0 7to be effective to justify stockpiling themas part of any response strategy.
• Should both prevention and containment
in the early stage of the disease fail, trade
and travel restrictions, quarantine procedures, the transformation of existingbuildings into emergency hospitals, andgeneral efforts to deal with the multitudeof disruptions accompanying any suchcatastrophe would be required.
Avian flu threat receding. At this writing there
are encouraging reports that the avian influenza
is indeed in retreat. New cases are rarely
reported, and the countries where the mosthuman infections have occurred (Vietnam,
Thailand, and China) report that cases
observed in both poultry and humans havedeclined steeply.4 Officials of WHO and theWorld Organisation for Animal Health (OIE)
credit countries’ aggressive countermeasures
for the apparent success in getting the disease
under control. Global communications andcooperation clarified the risks, publicizedadvanced methods to contain it, and induced
valuable international cooperation at various
levels. Virtual unanimity among national
administrations on the need to act rapidly
enabled WHO and OIE to implement
appropriate supranational measures without
delay. Nevertheless, these efforts have failed
to prevent the disease from becoming fully
endemic in several countries, and reducing thescope of the disease remains a high priority tolimit the risk of another flu pandemic.

Global cooperation may
prevent contagion
The success of international efforts to containinfectious disease is in part rooted in thenature of the problem. The threat of a global
pandemic is immediate, well understood, andpotentially catastrophic for the industrial
countries that have the resources to act. In
addition, while international cooperation has
played a critical role in reacting to SARS andavian flu, individuals and individual governments have been willing to make major,

146

independent efforts because they benefited
directly, thus reducing the burden on international cooperation. Contrast this (so far)success story with the failure to eradicate
other endemic diseases.5 The burden of infectious diseases is greatest for developing countries, which often lack the resources to effectively distribute vaccines and treatments.
Would these diseases still be so prevalent if
industrial countries continued to be vulnerable
to them?

The medium-term risks
to marine fisheriesMarine fishing, on the high seas andwithin many nations’ 200-nautical-mile
exclusive economic zone (EEZ), is reaching
its limits. Increased demand and technological improvements have led to increasing pressures on marine fish, as well as on the fragile
ecosystems in which they live.6 Excluding
data from China, the accuracy of which has
been questioned, production has declined
since about 1990 (FAO 2004 and figure 5.2).
The acceleration of global growth envisioned
in chapter 2 is likely to increase pressures on
marine fisheries over the medium term. Without efforts at conservation, the global economy is likely to confront dwindling supplies
of commercially exploited marine fish, coupled with rising demand for fish with growing incomes.

Marine fish are under increasing pressure
A significant number of the world’s most valuable fish stocks have been depleted throughoverfishing, habitat degradation, pollution,or other causes (Bolton 2005). Fully 75 percent of the world’s marine fish stocks are being
exploited either at or above their maximum
sustainable level (FAO 2004). While reductions in fish stocks from fishing are not new,they have accelerated over the past few
decades owing to technological advancesthat have enabled large-scale commercial
fishing fleets to increase their exploitation of
traditional waters and expand to new areas

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Figure 5.2 Total marine fish catch has leveled off
Total catch, millions of tons
100
90

China, including Hong Kong and Macao

80
70
60
50
40

World, excluding China

30
20
10

04
20

01
20

98
19

95
19

92
19

89
19

86
19

83
19

80
19

77
19

74
19

71
19

68

65

19

19

62
19

59
19

56
19

53
19

19

50

0

Source: FAO 2004.

in the Indian Ocean and the seas around
Antarctica.7 And improvements in fishing gearand onboard storage technology have madenew species commercially viable (Kura andothers 2005). Natural phenomena, for example the impact of El Niño on Chilean andPeruvian fisheries and of warmer water in the
North Atlantic on North Sea cod, have contributed to the reduction in fish stocks(Schmidt 2002). Climate change (discussed
below) will increase the acidity of the ocean asincreasing amounts of carbon dioxide dissolve
in sea water, with potentially serious implications for ocean environments and the sustainability of some fish species (U.K. Government
2006). And some deep-sea fish are particularly
vulnerable to overfishing owing to their long
lives and few offspring (Shotton 2006). Subsidies, estimated globally at between $12 and$20 billion a year, have also contributed tooverexploitation of fish resources (Milazzo
1998; APEC 2000; WWF 2001).8

Managing high-seas fisheries is not easy
The UN Convention on the Law of the Seas
(effective in 1994) helped define property
rights by enabling coastal states to establish
EEZs of up to 200 miles.9 The UN Agreement
for the Conservation and Management ofStraddling Fish Stocks and Highly Migratory
Fish Stocks, called the UN Fish Stock Agreement (effective in 2001), established basic
standards for fisheries management for highly
migratory species, such as tuna, and for socalled straddling stocks—species that range
between EEZs and the high seas
(Lodge 2005). But high-seas bottom-dwelling
species are in a jurisdictional vacuum. Few of
the regional fisheries management organizations are mandated to manage bottom fishingon the high seas (Gianni 2004), and most ofthese fisheries should be considered unregulated (FAO 2004). Even when a mandate
exists, the regional fisheries management organizations established for this purpose often
suffer from inadequate resources or insufficient political support, and face several
important obstacles:• Data on catch volume and area, the number and size of fish, the number of juveniles
that develop to maturity, interactions withother species, and the impact of environmental factors are often inadequate todefine sustainable catches (Kura andothers 2005). Overall, estimates of fishstocks may be off by as much as 30 percent(Berrill 1997), and single-species stock147

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assessments have failed to predict rapid
stock declines in a number of cases (Paulyand others 2002).
• It can be difficult to set limits on fish catchthat impose the right incentives. The
allocation of licenses, the most common
system for controlling fish effort(Cunningham and Greboval 2001), canbe thwarted by expanding the capacity of
individual boats or improving technology.
Limits on the total catch (at which point a
fishery is closed) can result in the harvest
being caught more rapidly and using
more resources than would be the case if
quotas were allocated to individual fishers (difficult for regional fisheries management organizations, though it is donein areas controlled by single countries),and may encourage more dangerous fishing, such as during inclement weather(Kura and others 2005).10• Monitoring and enforcing limits on fishing can be problematic, because fishers
understandably are reluctant to provide
information that can affect their competitiveness (Shotton 2006). Some fishers
report data to national authorities underconfidentiality agreements that prohibit
release to international authorities.
• Fishers can attempt to evade enforcement of conservation measures by registering under a flag of convenience (withcountries that exercise little control overtheir ships); at least 2,800 large fishingvessels either have a flag of convenienceor no registry at all (WWF 2001).

Developing countries are
particularly vulnerable
Developing countries, important participantsin large-scale commercial fishing, confront
particular weaknesses in managing fisheryresources. In 2001, 6 of the top 10 marine
fishing nations were from the developingworld, with China and Peru (numbers 1 and 2)
alone accounting for more than a quarter of
total marine capture in metric tons. Developing countries also account for the vast majority

148of the increased trade in highly migratory
species since the late 1970s (Webster 2006).11
About 250 million people in developing countries depend directly on the fishing sector(including inland fishing) for food andincome, and fish provide nearly 20 percent ofanimal protein consumed by people in developing countries (World Bank 2004).
Many developing countries lack the resources to police their own coastal waters andeconomic zone, much less establish effective regional institutions to manage nearby marine
fisheries. The expansion of distant-water fishing fleets to new, mostly unregulated areas has
spawned conflicts with traditional fishers in thepoorer developing countries, while largely uncontrolled fishing has led to the depletionof valuable fishery resources in the southern
seas—for example, the sharp decline in orange
roughy and in Patagonian toothfish (Chilean
sea bass), as worldwide demand for themincreased. While some developing countries
earn significant foreign exchange by sellingfishing rights in their waters (several West
African nations without significant industrial
fleets have done so), this practice has intensified competition for small-scale fishers(Kura and others 2005).12 Fish resources in theshallow waters off the west coast of Africa may
have declined by half from 1985–90 because of
distant-water fleets.

International cooperation aims to ensuresustainable fishing
There is a global consensus, expressed at theWorld Summit on Sustainable Development
in Johannesburg in 2002, that depleted fishstocks should be restored to levels that can
produce their maximum sustainable yieldby 2015. Progress has been considerable insetting the institutional framework for conserving the ocean’s fish, both through defining
ownership rights (setting an EEZ of 200 miles)
and in setting up multilateral institutions(regional fisheries management organizations). Effective management plans have been
implemented for a few highly migratory fishstocks, for example the North Atlantic

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swordfish and Atlantic bigeye tuna (Webster
2006). Still, most commercially exploited
marine fish species face increasing pressures.
Regional management is clearly inadequate inmany fisheries. And further uncontrolled exploitation could lead to the irretrievable lossof valuable sources of the world’s food. A further strengthening of domestic and multilateral institutions, particularly the regional fisheries management organizations, is a highpriority for international action.

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consequences for growth. Moreover, the approach adopted to reducing carbon emissions
could entail costs to growth, particularly if political constraints prevent the adoption of efficient policies. Developing countries, at the center of this issue, are likely to suffer the worst
consequences of climate change and have theleast ability to adapt. They also are the largest
future source of additions to carbon emissions,and thus will have an important role in negotiations to limit emissions.

Global temperatures are rising

The long-term riskof climate change

The burning of fossil fuels produces gases that
trap incoming solar radiation, leading to arise in global average surface temperature.13
Measurements show that the average world
temperature has increased since the start of
the Industrial Revolution (figure 5.3). Modelsof the determinants of temperature changethat take into account the addition of greenhouse gases (GHGs) into the atmosphere fromhuman activities (second panel of figure 5.4)
provide much more accurate explanations ofhistorical trends in temperature than models

Climate change induced by carbon emissions already has had significant impacts
on the global environment, and continuingemissions at current levels are likely to havesevere implications for human welfare over thelong term. The threat of climate change is inextricably linked with the scenario for global
growth over the next 25 years, because there
is a risk that climate change could accelerate,entailing greater-than-expected near-term

Figure 5.3 Temperatures have increased rapidly since the Industrial Revolution
Departure in temperature ( ⬚C) from the 1961–90 average, Northern Hemisphere

Data from thermometers
0.5

0.5

0

0

⫺0.5

⫺0.5
Data from tree rings, corals, ice cores,
and historical records

⫺1.0
1000

1100

1200

1300

1400

1500

1600

1700

1800

1900

⫺1.0
2000

Year
Source: Intergovernmental Panel on Climate Change (IPCC) 2001.

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Figure 5.4 Temperatures and greenhouse gas emissions have risen
Natural forcing only

Natural ⴙ anthropogenic forcing

Temperature anomaly in ⬚C

Temperature anomaly in ⬚C

1.0

1.0

1.0

1.0

Observations

Observations

0.5

0.5

0.5

0.5

0

0

0

0

⫺0.5

⫺0.5

⫺0.5

Model results

Model results
⫺1.0
1850

1900

1950

⫺1.0
2000

Year

⫺1.0
1850

1900

1950

⫺0.5

⫺1.0
2000

Year

Source: IPCC 2001.

that ignore this addition (first panel of figure 5.4). There is general agreement thathuman activity has contributed to the rise in
GHG concentrations and climate change
since the start of the Industrial Revolution.
Climate change, while generally viewed
as a long-term problem, has already had
significant effects. Ice coverage has declined at
the two poles (box 5.1), mountain glaciers are
retreating worldwide, ocean temperatures
are rising, the sea level is rising, the permafrost is thawing, growing seasons in mid- tohigh-latitude areas are lengthening, and theranges of some animal and plant species are
moving toward the poles and higher altitudes(IPCC 2001). Controversy remains about the
precise quantitative impact of anthropogenic
GHG emissions on the climate. Neverthelessthere is widespread concern that a continuation of the rapid economic growth experienced since the beginning of the Industrial
Revolution (and as a second industrial revolution unfolds in China and other major
rapidly growing developing countries), supported by the continuing exploitation of fossil
fuels, will induce significant changes in global
and regional climates.14

150

Temperatures will continue to rise
The extent of climate change will depend on
future GHG emissions (which will be determined largely by growth, technological developments, and policies that determine incentives
for carbon efficiency) and on the ultimate effectof those emissions on climate. The Intergovernmental Panel on Climate Change (IPCC) has
developed scenarios that relate forecasts of
output, population, and technological developments to future CO2 (the most important
GHG) concentrations in the atmosphere, andthus to climate change. While the scope forlimiting future GHG concentrations and theassociated climate change remains great, pastand current GHG emissions will continue toinfluence the global climate for some time.
Even if emissions peak in the 21st century andthen decline below current levels, global surface
temperature will continue to rise for centuries,and sea levels will rise for several millennia(figure 5.5).
The IPCC scenarios cover a wide range of
growth paths, with the four principal scenarios
ranging from 1 percent to 3 percent growthin per capita income during 2000–30.
Although these scenarios were developed in theM A N A G I N G

Box 5.1

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The vanishing polar iceOne effect of the rise in global temperatures has
been the drastic reduction in large bodies of ice
in the Arctic and in Antarctica, which appears tohave accelerated recently. Average temperatures in
the Arctic region are rising twice as fast as elsewherein the world. Arctic ice is thinning, melting, andrupturing. The largest single block of ice in the
Arctic, the Ward Hunt Ice Shelf, had been aroundfor 3,000 years before it started cracking in 2000.
Within two years it had split all the way throughand is now breaking further into smaller pieces.
The polar ice cap as a whole is shrinking.
Images from National Aeronautics and Space
Administration (NASA) satellites show that the areaof permanent ice cover is contracting at a rate of
9 percent each decade. If this trend continues,

The summer arctic ice field is shrinking

summers in the Arctic could become near ice-free by
the end of the century.
Consecutive satellite images also have revealed thecollapse of the Larsen B ice shelf on the Antarctic
Peninsula during the 2002 Antarctic summer, fulfilling predictions made by British Antarctic Survey(BAS) scientists. The collapse of the 3,250 km2 ice
shelf is part of the ongoing developments in a regionof Antarctica that has experienced unprecedented
warming over the last 50 years.
Continued melting of polar ice could induce
significant rises in sea levels, with potentiallycatastrophic implications for many coastal areas,
and raise the possibility of interrupting the Gulf
Stream, which could drastically reduce European
temperatures.

The Larsen B ice shelf collapsed

North Pole

March 5, 2002
February 17, 2002
January 31, 2002

Summer Arctic Sea
ice boundary, 1979late 1990s, a recent review finds that they areroughly consistent with projections undertaken
since then (Van Vuuren and O’Neill 2006). The
scenario outlined in chapter 2 envisions global
per capita growth of 2.2 percent. Thus, the pathof carbon emissions implicit in this scenario isroughly similar to that envisioned in many of the
IPCC scenarios. As discussed in chapter 2, this
scenario assumes a steady improvement in thetechnical efficiency of energy use but no major
policy initiatives that would raise the price offossil fuels. Thus, the forecasts in this bookwould imply considerable potential for reining
in carbon emissions over the medium term,
given strong international efforts to slow climate change. While achieving reductions inemissions (as envisioned in figure 5.5) by improving efficiency holds considerable promise,the near-term prospects for reducing carbon
emissions through alternative energy sources arelimited (box 5.2). The world is not yet on a path
toward the emissions reductions that will beessential even to stabilize global temperatures(at significantly higher levels than at present).

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Figure 5.5 Greenhouse gas emissions have long-term effects
Magnitude of response
Time to reach equilibrium
Sea-level rise due to ice melting:several millennia

CO2 emissions peak
0–100 years

Sea-level rise due to thermal
expansion:
centuries to millennia
Temperature stabilization:a few centuries
CO2 stabilization:
100–300 years
CO2 emissions
Today ⫹100 years⫹1,000 years

Source: IPCC 2001.

Box 5.2 Can efficiency and renewables
be the answer?

S

ignificant reductions in GHG emissions can beachieved through improvements in energy
efficiency and increased use of renewable energy
sources. Nevertheless, the share of renewables inenergy use is not expected to increase much within
the forecast period, and the demand for hydrocarbons
is set to rise by more than 50 percent (IEA 2004,
2005). This underlines the need for policies to encourage energy savings and improve the profitabilityof alternative energy sources.
Developing countries have much greater potential
than industrial countries for reducing emissions,in great part because they are moving toward thetechnological frontier in existing industry andinfrastructure. For example, China could use some
20 percent less coal if its plants were as efficient as
the average plant in Japan, and the potential for
adopting proven energy savings in cement and pulp
and paper is significant. Moreover, rapidly growing
developing economies can invest directly in energyefficient technologies, thereby leapfrogging earlier,inferior processes. For example, expansion of
low-power, white-light-emitting diodes that run onbatteries charged by solar panels could enable therural poor in some countries to bypass the need forcentralized electrical grids. Developing countries

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have the opportunity now to adopt more efficientchoices for infrastructure and technology that could
drastically reduce GHG emissions for decades to come.
Energy efficiency is often the most cost-effective
and low-risk approach to reducing the need for energy,
and can also generate significant environmental
benefits. Considerable potential exists for adopting
more efficient technologies in transport, industry,buildings, and power generation.
• In transport, new materials, compact engines, andadvanced fuel systems can lead to lighter and more
fuel-efficient vehicles, while hybrid vehicles canprovide substantial fuel savings. If all technicalmeans were implemented, the International Energy
Agency estimates that a 40 percent improvementin fuel economy of gasoline engines is achievablein the coming decades. The prospects for hydrogenand fuel cell vehicles are less promising over theforecast period because they require significant
cost reductions, performance improvements, anddevelopment of fuel cell vehicle markets andhydrogen infrastructure.
• Many new buildings could be 70 percent moreenergy efficient than the existing stock throughthe use of new technologies in windows,

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Box 5.2

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Renewable energy sources. Renewable energy
now accounts for 14 percent of world energy demand, and while the authors of this chapter anticipate that its use may rise by 50 percent by 2030, its
share of total energy is not expected to change
greatly unless vigorous policies encourage switchingfrom nonrenewable energy sources.

to accelerated expansion is competition with otherdemands for biomass, particularly for use as food.
• Wind generation is expected to rise, buoyed bysharp declines in the cost from economies of scalewith the use of larger turbines. Nevertheless, wind
still has problems of intermittency, low reliability,
problems connecting to the grid, and (morerecently) difficulties in siting land-based turbines.
• Generation from geothermal sources is concentrated in a few countries. While geothermal is avery competitive and reliable source of power,
and its potential is enormous, it is a site-specificresource that can only be accessed in certain
parts of the world.
• Solar power is expected to account for less than
0.5 percent of total power supplies by 2030, as its
investment and generating costs are the highestof all commercially deployed renewable energy
sources, although the range of costs varies widely
depending on the amount of sunshine available.
There will also be some rise in solar thermal
power, whose generation costs are typicallydouble those of conventional energy sources.
• Tide and wave generation is still in its infancy.
Projects need to be large-scale if they are towithstand offshore conditions, and these are very
costly and carry high risks. Site-specific environmental effects also need careful assessment.

• Renewable electricity generation is dominated byhydropower, which accounts for 16 percent of
global electricity production. Hydropower is thecheapest source of power in many areas. There isconsiderable potential for expansion, particularlyin the form of small hydro plants, althoughconcerns over undesirable environmental andsocial impact have been important barriers.
• Biomass generation can be highly economic,
particularly for co-firing other hydrocarbonbased plants. New technologies are expected
to reduce costs further, but the largest barrier

Biofuels may provide a significant alternative fueloption for transportation over the forecast period, withethanol from sugarcane (from Brazil, for example) offering the best chance of commercial viability. Other
feedstocks, such as corn, have much higher costs owing
to lower yields and are unlikely to be financially viablewithout government support. If ethanol can be produced from cellulose using biomass as the fuel for theconversions process, net GHG emissions from well towheel basis (that is, through the complete chain of fuelproduction and use) could be reduced to zero, according to the International Energy Agency.

insulation, furnaces, air conditioners, appliances, lighting, and standby power.
• In industry there is a large potential to improvethe efficiency of motors, boilers, pumps, andheating and cooling systems. In addition, large
amounts of energy can be saved through newprocesses in individual sectors, such as direct
casting in iron and steel, and biofeedstocks inthe production of petrochemicals.
• In the electric power sector, switching from coal
to natural gas would reduce emissions, bothbecause natural gas emits only about half as
much CO2 as coal per kilowatt hour and because the latest combined-cycle gas plants attainefficiencies of 60 percent, compared to 46–49 percent for the best available coal-fired plants.
Nuclear energy offers emission-free technology
but faces high capital costs, problems of waste
storage, risks of accident, public opposition, andpossible proliferation of nuclear weapons.

Climate change could have a catastrophic
impact on some countries
The effects of climate change on human welfare are uncertain, depending as they do on
the magnitude and timing of increased

temperatures, the precise climate changes involved, and the links between climate change
and human activity. Available calculations
indicate that the aggregate global economic
impact of a small rise in temperatures would

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2 0 0 7be significant, but not enormous. Tol (2002)
finds that the impact of a rise in the global
mean surface air temperature of 1 degree Celsius (the temperature rise anticipated over the
first half of the 21st century) could range anywhere from an annual increase of world GDP
by 2.3 percent to a decrease of 2.7 percent, depending on assumptions made about the valueof nonmarket goods and services. Examples
include how to value human lives lost andgained, and the damage to ecosystems andbiodiversity—a quarter of the world’s known
animals or plants, or more than a million
species, are likely to die out because of theforecast warming over the next 50 years(Grubb 2006b).15 A more recent analysis estimates that failing to address climate change
could reduce welfare by an amount equal to a
5–20 percent fall in per capita consumption(box 5.3).
These estimates also do not capture lowprobability risks that could imply severe
consequences for the global economy over a
relatively short timeframe. For example, if the
Gulf Stream stalls as melting ice introduces
more fresh water into the northern Atlantic,
European temperatures could plummet. And
there is potential for a rapid, almost selfperpetuating acceleration of climate change if
the large methane deposits in arctic tundra arereleased as climate change proceeds.
Estimates of the aggregate economic impact
of climate change mask extreme variations incosts and benefits for different countries. The
brunt of the damage from climate change will
be felt by low-latitude developing countries,
with the extent of harm critically dependent
on how much temperatures increase (so thatdamages are likely to rise as time goes on).
Many developing countries are more vulnerable to climate change because they are alreadywarmer than developed countries and sufferfrom high rainfall variability, they are heavily
dependent on agriculture (the sector mostvulnerable to climate change), poor public services increase the potential welfare loss, andlow incomes impede adaptation (U.K. Government 2006). Countries near the poles could154

benefit from a modest rise in temperatures,
while mid-latitude countries, many of themhigh-income, are likely to face small net effects
from climate change through this century (therise in the sea level may inundate some coastal
areas and increasing severity of hurricanes andcyclones could increase coastal damages,
while agricultural yields in other areas could
improve). Over the long term, and in the absence of successful mitigation efforts, climatechange is likely to be disastrous for all countries. Examples of the possible damage include
the following:• A rise of 1 degree Celsius could lead toan 80 percent loss of coral reefs; further
increases in extreme precipitation causing drought and landslides; a 20 to
35 million ton loss in cereal production
and an approximately 10 percent decline
in yields of various African crops (suchas barley and rice).
• A rise of 2 degrees Celsius could lead tolarge-scale displacement of people in the
Mahgreb as rainfall declines by at least
40 percent; the total loss of summer
Arctic sea ice; the likely extinction of thepolar bear and walrus; millions more
people at risk to malaria, particularly in
Africa and Asia; and a 50 percent loss of
the Chinese boreal forest.
• A rise of 3 degrees Celsius could lead tomassive changes in habitats, such as thecollapse of the Amazon rainforest and
the Great Lakes wetland systems; the inundation of the Ganges delta region, undermining the agricultural system that
feeds a quarter of a billion people; thespread of desert-like conditions in Africa
as the Kalahari dunes become mobile;
additional millions of people at risk ofhunger; two to three hundred million
more exposed to malaria; hundreds ofmillions more exposed to dengue; several
tens of millions displaced from coastal
areas because of rising sea levels; andbillions more subject to increased water
stress (Warren 2006).

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Box 5.3 Stern Review: The Economicsof Climate ChangeT

he government of the United Kingdom recently
issued a report on the economics of climatechange prepared by Sir Nicholas Stern at Treasury.
The report underlines the very serious global risks
posed by climate change, and the urgency of steps toreduce carbon emissions. The principal finding isthat the benefits of strong, early action on climatechange exceed the costs involved, reflecting two
insights.
First, the continued growth of carbon emissions
at current rates raises the risk of serious, irreversible damage to global welfare. Absent changes
in policies, carbon emissions could rise by the middle of this century to a level that would eventuallycommit the world to a rise in average temperaturesof more than 5 degrees Celsius above preindustrial
revolution levels, equal to the amount of global
warming that occurred between the last ice age andtoday. The total cost of the climate change resulting
from “business as usual” emissions over the next
two centuries is estimated to equal a minimum reduction in global per capita consumption of 5 percent. Taking into account the nonmarket impacts (onthe environment and human health) of these emissions, the potential for feedbacks that would amplify
climate change, and an increase in the weight accorded to the poorer regions, and “business as usual”
climate change results in a reduction of about 20 percent in global per capita consumption.
Second, atmospheric greenhouse gas concentrations could be stabilized at levels that greatly reduce
the risk of climate change damages, at relatively low
cost. Carbon emissions can be cut by reducing the demand for emissions-intensive goods and services, increasing energy efficiency, switching to low-carbon
technologies, and reducing non–fossil fuel emissions(from deforestation and in agriculture). A series ofmodel-generated estimates of the annual cost of cutting emissions to a level consistent with stabilizing atmospheric greenhouse gas concentrations at 550 parts
per million average 1 percent of global GDP by 2050.ª
Reducing emissions efficiently requires pricing
carbon to reflect fully the risks of climate change.
This can be done through setting a tax on emissions

or through establishing tradable quotas, although
regulation may also be used where market-based
mechanisms are ineffective. However, setting an appropriate price for carbon may not lower emissions
sufficiently, due to uncertainty on future pricing
policies, barriers to technology development in key
sectors related to climate change, and external benefits to technology development (for example, inspiring ideas for new technologies) that are not captured
by investors. Thus, the public sector also should
promote low-carbon and high-efficiency technologies through increasing support for research and development, demonstration projects, and early-stage
commercialization investments in some sectors. Governments also should focus on removing barriers to
behavioral change—such as transaction costs, organizational inertia, and a lack of reliable information—
through regulation (for example, minimum standards for buildings and appliances), labeling, andsharing best practices, and financing the upfront
costs of efficiency improvements.
Adaptation also will be essential to limiting thenegative impact of inevitable climate change. Whileindividuals will undertake adaptation in reaction tomarket or environmental changes, governments canprovide policy guidelines as well as economic andinstitutional support.
The Stern report emphasizes the importance of international collective action to respond to climatechange. Cooperation should cover all aspects ofemissions reductions policies. It is necessary to createa broadly similar carbon price signal around theworld, and to promote carbon finance to accelerateaction in developing countries. An equitable distribution of effort that takes into account income, historic
responsibility, and per capita emissions would haveindustrial countries undertaking emissions reductionsof 60 to 80 percent (from 1990 levels) by 2050.

aAnything higher than 550 parts per million would
substantially increase the risk of harmful impacts on global
welfare while reducing the expected costs of mitigation bycomparatively little.

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These measurements generally consider thewelfare impacts of a particular level of global
average temperatures, and thus may exclude
some significant risks. Climate change may
increase the uncertainty surrounding, andvariability of, weather, which could increase
costs. For example, a higher mean sea level
could make storm surges more devastating;and higher average temperatures may have asmaller impact on agricultural productivity
than increases in long, hot, dry spells (Weyant
2000). The speed of climate change is also
important, as many species may have trouble
adapting to rapid increases in temperatures.

What can be done to reduce
GHG emissions?
In the absence of intervention, global CO2
emissions could reach between two and fourtimes current levels by 2100, resulting inmuch greater GHG concentrations than envisioned in most models of climate change(Grubb 2006b). Thankfully, there is a wide
variety of possible methods to reduce GHG
emissions, for example improving energy
efficiency and relying more on renewableenergy sources (see box 5.2), switching tofuels with lower GHG emissions (from coal
to natural gas, for example), capturing andstoring carbon emissions, sequestering carbon through reforestation, changing lifestyles
to reduce demand for energy, reducing
growth in output, and geoengineering (tochange the reflectivity of the atmosphere,
oceans, and land).16 Some measures, suchas reducing subsidies that support high levelsof energy intensity, may have low or evennegative costs, while others involve very
expensive regulatory intervention.
The costs of measures to achieve a given
level of emissions reductions, and thus theconsistency of mitigation efforts with an acceleration of global growth, will depend criticallyon technological developments and the policies adopted. Technological developments are
uncertain, although the dangers posed byclimate change encourage attention to subsidizing research. Policies that would induce

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polluters to seek the least costly method of
reducing the risk of climate change are• Setting a uniform price for the emissionof GHG (a uniform global carbon tax,
for example), and an equivalent subsidy
for measures reducing atmospheric GHG
concentrations and other conditions thatcan cause climate change.17• Setting a global emissions target and establishing a market for emission permits.
Industries and nations with high (or low)abatement costs would buy (sell) suchpermits, up to the point where abatement
costs were equalized across industries andnational economies, resulting in a uniform price of emissions permits.18
Location is important in determining costs
because the marginal cost of combating climate change differs widely between countries
and economic sectors. For example, the costof a 100-million-ton reduction in carbon emissions by 2010 was estimated to be less than
$5 per ton of carbon (in 1985 dollars) for theUnited States, about $40 for the European
Union, and almost $400 for Japan (Ellerman,
Jacoby, and Decaux 1998). Costs tend to beeven lower for developing countries. The timespan over which emissions are required to fallalso affects the cost of abatement: longer timespans reduce costs because existing plants andequipment need not be retired before the endof their useful life, while shorter time spans
improve the credibility of compliance targets.
The future path of global growth may well beaffected by efforts at mitigation, depending on
their severity and the attention paid to ensuring that mitigation is achieved at least cost.
In addition to reducing carbon emissions,
efforts to adapt to climate change will also be
required. Even if the world succeeds inmarkedly reducing carbon emissions in thenear future, the GHGs already in the atmosphere imply increases in global temperaturesand rises in sea level for many years to come(see figure 5.5). The welfare impact of climatechange on developing countries is likely toM A N A G I N G

be all the more devastating because developing countries bear the brunt of the anticipateddamages and have less ability than industrial
countries to adapt, and because the welfare
impacts of income declines are greatest forthe poor.
Given the critical nature of this issue fordeveloping countries, the World Bank Groupis rapidly expanding its activities to achievea low-carbon economy. The Bank currently
manages nine funds devoted to developing thecarbon market, with a total investment of$2 billion. The Global Environment Facility is
the largest source of multilateral grant financing for low-carbon technologies, with a total
investment of $1 billion. The Bank is on track
to meet its 2004 commitment to a 20 percent
average annual growth in new renewableenergy and energy-efficiency commitments
between fiscal year 2005 and fiscal year 2009
(Sierra 2006).

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between the locations where GHG emissions
originate and where major damages induced byclimate change are likely to occur, most countries gain very little direct benefit from theirown mitigation efforts. Individual countries
thus face a strong incentive not to make efforts
to reduce emissions, and to minimize their own
commitments to international efforts. The
problem is exacerbated because likely damages
are distributed unevenly around the globe.
While the very existence of some island states
may be threatened by rising ocean levels, countries with large Arctic areas may actually benefit from (modest) climate change.19
Developing countries can be major players
in global efforts to reduce global climatechange—they certainly will be greatly affectedby success or failure. As discussed, developing
countries are likely to bear the worst costs ofclimate change. At the same time, they bear
little responsibility for the current stock of
GHGs in the atmosphere and are understandably loath to impede their own growth toresolve a problem that is largely the creationof industrial countries. Still, future increases in
GHG emissions will occur mainly in developing countries (figure 5.6), so that any policy
strategy that excludes these major future emitters is unlikely to be effective. Moreover,

Agreeing on policy is difficult
Model-based analyses suggest that the global
net benefits of a coordinated international
policy regime to reduce GHG emissions far
exceed the benefits of individual countries acting on their own (Nordhaus and Yang 1996).
However, as there is no systematic relationship

Figure 5.6 Carbon emissions from developing countries are set to rise
Annual carbon emissions, billions of tons
18

18

16

16
14
12

Major
emitters

14

Annex 1

10

12

World

10
8

8

6

6
4

4
Industrial
countries

2
0
1990

2000

2010

2020

2030

2040

2
0
2050

Source: OECD Green Model simulations.
Note: Annex 1 includes the industrial countries plus some countries in Eastern Europe and the former Soviet Union. Major emitters
include Annex 1 countries plus large developing countries: China, India, Indonesia, Mexico, and South Africa.

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2 0 0 7agreements with limited geographic coverage
may lead to the migration of key polluting industries to nonparticipating countries, thereby
undermining success.20
Other aspects of climate change impedeinternational agreement. With a few highly hypothetical exceptions, the most severe impactsof climate change are not expected for several
decades, which raises uncertainty, leads to disagreement on how costs should be distributed
over time and across generations, and discourages action by political leaders concernedwith short time horizons (the next election).
And as elaborated above, considerable uncertainty remains over the costs of mitigation andthe precise impact of different levels of GHG
concentrations on human welfare.

What has been done to reduce
GHG emissions?
Despite the difficulties involved in reachinginternational agreements and the incentives
for free riding, some progress has been madein reducing GHG emissions, both throughinternational agreements and by individual
countries and regions.
Kyoto Protocol. The Kyoto Protocol, whichcame into force in February 2005, committed
most industrial countries and some of thetransition economies (together referred to as the“Annex B countries”) to targets that implied
reductions by 2008–12 of some 5 percent of the
GHG emissions recorded in these countries
in 1990. Countries may either reduce actual
GHG emissions or enhance the amount ofcarbon captured in “carbon sinks” (bysequestering GHG from the atmosphere), forexample, through reforestation programs.
The protocol also allows countries to achieve
their emission-reduction obligations together,to buy emission rights from other Annex B
countries whose emissions are below the limits,and to receive emission reduction credits forsponsoring GHG mitigation or sequestration
projects in other Annex B countries (Joint
Implementation Framework) or in developing countries (the Clean Development

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Mechanism). The provisions for carbon
trading and the Clean Development
Mechanism have provided useful practicalexperience on how to manage such mechanisms, which are likely to be part of futureagreements on climate change.
The Kyoto Protocol represents a major
attempt by the international community tocome to grips with climate change, and by
signaling future policy actions to reduce GHG
emissions, it may encourage investors to adopt
more efficient technologies. But it has been
subject to many criticisms. The sharp cuts inemissions required of some participating
countries restrained some countries from signing, particularly as no constraints were imposed on other countries where emissions will
be growing fastest in the foreseeable future.
The transaction costs involved in the Clean
Development Mechanism and the Joint Implementation Framework make it difficult for
countries to meet their obligations at the lowest
global cost. It is too early to judge compliance(emission curtailment obligations are legallybinding only for the 2008–2012 period). But
emissions from transition economies are well
below their Kyoto targets owing to the majordecline in economic activity after 1990, whileemissions from most industrial country signatories exceed their targets.21 The penalties fornoncompliance are not likely to change behavior. Countries that fail to meet their targets
during 2008–12 must make up for this shortfall in the subsequent commitment period,
plus a 30 percent penalty. A country liable forthe penalty could fail to ratify the extension,or insist on raising its emissions limit as a condition of participation. Unlike the World
Trade Organization (WTO) agreement, othercountries are not provided with the means ofenforcing compliance (Aldy, Barrett, andStavins 2003).
Country and local efforts. Individual countries, as well as some local governments,
have taken steps to limit carbon emissions.
While these have not yet had a major impact
on the size of total emissions, they do help toM A N A G I N G

encourage similar initiatives, provide somemomentum to efforts to limit climate change,and provide useful information on thefeasibility of different approaches. Finland,
the Netherlands, Norway, and Sweden
adopted a carbon tax in the 1990s, and theUnited Kingdom has imposed a “climatechange tax” on electricity generated by using
fossil fuels since 2001.
In the United States, the California legislature recently passed a law that would cut
carbon gas emissions 25 percent by 2020;
Oregon has mandated cuts of 75 percent by
2050; 279 cities have signed a commitment tocomply with the Kyoto targets; northeast states
have set up the Regional Greenhouse Gas Initiative to control emissions; and 22 states haveadopted so-called renewable portfolio standards to encourage renewable energy sources(Rabe 2006). Of course, a host of policies affect emissions, including many not designed tocontain climate change. For example, hightaxes on gasoline can help to reduce gasoline
consumption and thus reduce emissions.
Carbon trading. The Kyoto Protocol andregional initiatives have created a carbon
market that trades reductions in GHG
emissions, supported by efforts from thegovernment of the Netherlands and the WorldBank (notably through the Prototype Carbon
Fund, which began operations in April 2000).
The overall market rose from about 13 million
tons of CO2-equivalent in 2001 to 704 million
tons in 2005 (figure 5.7), when its value
totaled $11 billion. The value of the market
continues to rise—it was $7.5 billion in thefirst quarter of 2006 alone. The vast majorityof transactions are aimed at complying with
the Kyoto Protocol, and the market isdominated by the European Union’s Emissions
Trading Scheme. Developing countries
accounted for almost half of global
transactions in 2005 through the Clean
Development Mechanism. Given the huge
uncertainties about the post-2012 climate
policy regime, the volume of project-basedtransactions may decline, as the window of

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Figure 5.7 Global trading in carbon
emissions has mushroomed
Millions of tons of CO2 equivalent
800
700
600
500
400
300
200
100
0
2001

2002

2003

2004

2005

Total emissions traded
Emissions traded to comply with Kyoto Protocol
Other emissions transactions
Source: Capoor and Ambrosi 2006.

opportunity to develop projects and validate
their reduction credits under the Kyoto
Protocol will soon start to close.

The way forward
Because the establishment of institutions toaddress climate change requires considerable
lead time, it would be desirable to startbuilding such institutions immediately. And
because lack of agreement on international
cost distribution remains an important impediment to policy implementation, reaching acompromise on this question is a high priority.
Progress in international negotiations concerning optimal climate policies would
strengthen private incentives for energy
efficiency and government incentives forappropriate policies. Progress would be encouraged by an agreement that the results ofsuch efforts will be recognized in any futurerevisions of contractual obligations.
Proposals for a new agreement to succeed
the Kyoto Protocol should be evaluatedaccording to several criteria (Aldy, Barrett,and Stavins 2003). The emissions targets
should reduce climate change to an acceptable

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2 0 0 7level. Participation should be as broad as possible. The policies should be efficient, either
by maximizing the net benefits to society
compared with alternatives, or at a minimum,by representing the least costly means ofachieving an agreed-upon goal. The obligations and results of the policies should beviewed as equitable, both across countries
and, given the long-term issues surrounding
climate change, across generations. (A conflictcurrently exists between different notions ofequity: the industrial countries are most responsible for climate change and have thegreatest ability to pay, while developing countries are likely to be most affected.) Policies
should be flexible enough to take account of
new information; this is critical given the timescale involved and the potential impact oftechnological developments on emissions,mitigation efforts, and countries’ ability toadapt. Finally, the design of the rules and theinstitutions established must effectively address the substantial difficulties involved inmonitoring performance and ensuring compliance with treaty provisions.
Obviously there are important trade-offs
among these goals. Targets that achieve large
reductions in GHG emissions may not attract
sufficient participation, and flexible arrangements may not reflect sufficient commitment
to environmental targets. And the criteria for
judging some targets are subjective. Individuals and governments may have different viewsof what level of climate change is acceptable,or how much future generations should pay
for mitigation. So, designing an optimal agreement to limit climate change is ultimately apolitical, rather than a technical, exercise.
Negotiations for a successor to the Kyoto
Protocol have already started within the framework of the United Nations Framework Convention on Climate Change. Failure to seize
this opportunity to come up with an effective
treaty curtailing the risk of climate change may
seriously endanger not only the benefits ofachieving the Millennium Development Goals,
but also the welfare of entire future generationsin industrial and developing countries alike.

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Conclusions and policy
recommendations

A

vian flu, the depletion of marine fisheries,
and climate change are very different issues
representing different threats to global welfare.
But in some respects, they are similar. All could
involve substantial economic and human costs.
In all cases, the risks posed have been intensified by globalization and the related acceleration in growth and technological progress. And
in all cases, the necessary solutions will requirea high degree of international policy coordination. No one country can, by itself, stem the riseof GHGs sufficiently to avoid a continued increase in global temperatures and potentiallycatastrophic effects. Similarly, cooperation by
all countries is required to contain a potential
flu pandemic that could result in millions of fatalities. And ensuring the sustainability of marine fisheries requires cooperation on sustainable management and observance by many
countries of agreed-on fishing limits.

Institutional effectiveness varies
from case to case
The effectiveness of the current institutionalframeworks for addressing these issues varies.
International efforts to contain the shortterm threats of the SARS epidemic and avian
flu virus have been swift and effective, although avian flu remains endemic in several
countries and thus a continuing threat. The
generally adequate legal framework governing
the management of marine fish stocks is often
rendered ineffective by inadequate enforcement and inappropriate incentive systems.
The international institutions required toconfront the longer-term threat posed by climate change have been generally ineffective.
The Kyoto Protocol represents an initial effort
to limit GHG emissions, and it has provided
valuable experience in the implementation ofcontrols. However, it lacks the participationof major current and future GHG emitters,
enforcement of its provisions is problematic,
and, in its present form, it is neither an
effective nor an efficient response to theM A N A G I N G

climate change problem. There is at present nointernational institution able to coordinate aneffective response to climate change.
Achieving strong international coordination to address threats to global welfare is easiest where there is a general consensus on thenature of the problem and what to do, where
the threat is immediate, where individuals andcountries have strong private incentives to address the problem in ways that have externalbenefits, and where the number of countries
that must be involved in negotiations islimited (table 5.2).
The greatest difficulties in achieving effective international cooperation are presented
by climate change. Although scientific understanding of the relationship between GHG
emissions and global warming is sufficient tojustify action, the implications for welfare ofboth problems and solutions are difficult toforecast. The most severe damages from climate change will likely take several decades tooccur, leading to disagreements on the appropriate discount rate to apply to welfare calculations and the equitable division of costs
among generations. No one country gains
much relief from the threat of climate change
through its own efforts to control emissions.
And an effective response requires gaining
agreement from all major polluters. It is no
surprise that international institutions havemade little headway, despite the potentiallycatastrophic costs of failure. By contrast, there
is general agreement on the short-term threat
posed by a flu pandemic, and individuals andindividual countries gain substantial private

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benefits from prevention efforts, so international efforts to contain (some) infectious diseases have been relatively effective. The threat
to the sustainability of marine fisheries occupies an intermediate position: there is little
disagreement over the dangers of overexploitation of marine fish stocks, while the extent towhich individual government efforts to manage
fisheries generate private benefits varies depending on the species involved—and particularly on whether fish tend to migrate to the highseas or between exclusive economic zones.

Some policy priorities are clear
Climate change. Understanding how thelack of effective international institutions
impedes an effective response to climatechange focuses attention on policy priorities.
Discussions are already under way under theaegis of the UN Framework Convention on
Climate Change to replace the Kyoto
Protocol, which expires in 2012, with a morecomprehensive and ambitious agreement.
Meanwhile, it may be useful for the global
community to start putting in place thepertinent institutions, such as a global system
for trading emission permits, as well as
improved means of monitoring emissions(particularly in developing countries), which
will allow a rapid implementation of effective
policies once these are agreed upon.
Negotiations over the next agreement musttake into account the position of developing
countries. Since industrial countries are themajor source of the current stock of GHGs
in the atmosphere, there is a compelling

Table 5.2 Uncertainty and incentives affect international institutions
Time scaleof threat

Degree ofscientificconsensus

Benefit of country’s
own mitigation efforts

Number of countries
involved in solution

Effectiveness ofinstitutions

Flu pandemic

Short-term

High

High

Many

High

Marine fisheries

Medium-term

HighHigh/moderate

Many or limited(depends on species)

Moderate

Climate change

Medium- tolong-term

Moderate

LimitedMany

Low

ThreatSource: Authors.

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argument that they should assume the lion’sshare of the costs. Nevertheless, future growthin emissions will occur mainly in developing
countries. Industrial countries taking on alarger burden can be reconciled with achieving
universal participation through a system ofappropriate transfers, for example throughthe allocation of emission permits.
While international agreement is critical tolimiting GHG emissions, individual countries
need not delay action. A large number of measures could be adopted to limit atmospheric
GHG concentrations while simultaneously
raising current welfare. For example, eliminating subsidies on fossil fuels could reduce the energy intensity of production and thus unnecessarily high GHG emissions. These efforts could
also have a substantial role in improving healthby reducing local pollution. For industrial
countries, the health benefits from reduced pollution may offset a large share of mitigation
costs (see Burtraw and others 2003; Proost andRegemorter 2003; Aunan and others 2004;
McKinley and others 2005). Choosing energyefficient technology for the tens of trillions ofdollars in global infrastructure investment will
have irreversible impacts on GHG emission
paths throughout the century (Grubb 2006a).
The focus on international coordination isessential, given the nature of the problem. Butinternational negotiations typically proceed at
the slow pace required to achieve consensus,
while there is an urgent need for action now
to slow the accumulation of GHGs. Further
delays in addressing climate change would
increase the costs of future, necessary mitigation efforts and greatly increase the risks ofsevere damage to global welfare. The scientificconsensus is sufficient to demonstrate thatprudence lies on the side of addressing climatechange. Achieving policy consensus is moredifficult, but it is now urgent.
Avian flu. Research remains a priority in
combating future pandemics, particularly
efforts to speed the development of vaccines in
response to the next mutation of the flu virus,
or—even better—to develop vaccines with162

broader application against groups of viruses.
Because uncertainty concerning use, the large
sunk costs involved, and lack of effective
demand from many potential consumers indeveloping countries limit private investment
in vaccines, this is an urgent area for public
investment by the industrial countries.
Individual governments should focus on
the distribution of vaccines, arrangements forquarantine, financial incentives for reporting
disease, and sanctions for failure to report
within their own jurisdictions. Industrial
countries might consider it in their interest to
subsidize such activities in developing countries, which may lack financial resources
adequate to the task. And international
discussions could be useful to provide for appropriate burden-sharing among the countries
able to assume a portion of such costs.
Marine fisheries. Strengthening the system ofregional fisheries management organizations,and establishing them where none exist, may
merit further contributions by industrial
countries. The UN General Assembly fund toaid developing countries in implementing the
Fish Stocks Agreement appears to have gotten
off to a slow start, with some developing
countries calling for increased contributions
and others noting that the fund is underusedowing to a lack of knowledge by manypotential recipients (Fiji UN Mission 2006). A
reduction in fish subsidies, a redirection ofsubsidies toward assisting with exit from theindustry, and the financing of general support
to fishing through taxation of the fishingindustry would help limit overcapacity andoverfishing. Limits on the exploitation of
the environment at the bottom of the sea
are sensible until more knowledge has
accumulated on how fishing and otheractivities
affectthatenvironment.
Sustainability would be enhanced by implementing an ecosystem-based approach tofisheries management, which focuses onsustainable exploitation while safeguarding
the ecosystem’s structure, function, andproductivity. The uncertainties involved inM A N A G I N G

determining sustainable levels of fish stocks
argue for allowing a safe margin of error whensetting management regimes and catch limits.

The need for international
cooperation will growThe scenario presented in chapter 2 envisions
some acceleration in global growth and tradeover the next quarter century. A deepeningof globalization will lead to faster poverty reduction and a general improvement in global
welfare. But continuing globalization will
also increase the risks that countries face.
This chapter has highlighted the short-termrisks from infectious disease, the mediumterm risk of depletion of marine fish resources, and the medium- to long-term risk
posed by climate change. Of these, only
climate change appears capable of seriously
derailing global growth over the next quarter
century. The strength of global institutions
designed to meet these problems will haveimportant implications for the likelihood ofachieving this growth path.
Many other problems will, to differing
degrees, require a global solution—among
them preserving biodiversity, achieving an
intellectual property regime that encourages
innovation while limiting excessive monopoly
rents, and reducing the transmission ofmacroeconomic instability. The countries involved in each case, the importance of therisks and benefits, and the scope for international action will vary considerably. But theinterrelated phenomena of growth, technological progress, and globalization will intensify
the need to find cooperative international
solutions to all of these problems, while
diminishing the ability of any single country
to resolve critical issues on its own.

Notes
1. The Antonine Plague, either smallpox or measles,
is estimated to have killed 5 million people in thesecond century A.D., and major episodes of bubonic
plague occurred in the 6th and 14th centuries, thelatter killing a quarter of Europe’s population.

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2. Subsequent investigations established that thedisease originated in Guangdong province in China inlate 2002, but news of the early cases of the sickness
had not been made public by the Chinese government.
3. In China alone over the last 40 years the humanpopulation has increased by two-thirds, while the poultry population has expanded more than 10-fold. Similar
increases in both human and animal populations haveoccurred in other Asian countries (Osterholm 2005).
Additional concerns arise from the presence of the
H5N1 virus in migratory birds (without showing clinicalsymptoms), which can lead to the transmission of thedisease between continents, and the virus’s ability toadapt to other species (including various mammals).
4. The disease outbreaks have been found to bestrongly linked to the cold season, and the behavior ofthe disease over the coming months will be critical.
5. The one successful case of global eradication was
smallpox, which succeeded in part because of the natureof the disease: no nonhuman host, potential for effective
diagnosis and surveillance, ability to interrupt personto-person transmission, and vaccination (Barrett 2004).
6. Bottom trawling, where the trawling rig isdragged along the sea floor, can damage vulnerable
ecosystems on the sea bottom. Studies in Australiaindicate that the sea floor ecosystem had not recoveredfrom bottom trawling 15 years after an area is closed
to fishing (FAO 2004). The use of explosives has damaged coral reefs, and poisons have killed nontarget
species (Whole Systems 2006). The FAO estimates thatmarine fish discards (fish caught other than the target
fish and thrown away) total about 10 million metrictons per year (Kura and others 2005), although discards declined since the early 1990s (FAO 2004).
7. For example, improved ships and freezer facilities enable ships to stay at sea for long periods. Sonar,satellite navigation systems, depth sensors, and air surveillance, combined with detailed maps of the ocean
floor, help locate fish and improve the accuracy of net
casting (Parsell 2002).
8. All subsidies do not threaten the sustainabilityof fish stocks, and few studies have attempted to linkthe value of subsidies quantitatively to their effect onfish stocks (FAO 2000). For example, subsidies to artisanal fishing may not raise catch levels enough to endanger sustainability, and some subsidies already aredesigned to facilitate exit from the industry. Quantitative modeling is extremely difficult owing to the lackof adequate data on subsidies and the multiple causesof changes in fisheries stocks (Tallontire 2004). The
impact of subsidies will also depend on the effectiveness of management of fish stocks.
9. The Convention also provides that the freedom
to fish on the high seas is subject to the general duty
to cooperate in conservation and management and to163

G L O B A L

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P R O S P E C T S

2 0 0 7maintain or restore populations so as to obtain the
maximum yield.
10. Examples of other approaches, rarely used inregional fisheries management organizations, are atotal ban on fishing for several years to allow replenishment of fish stocks, restrictions on the capture offemales or immature fish (to allow them reproduce),and closure of the fishery during spawning season.
11. Note that these data include China, which
many believe has overstated fish captures (FAO 2004).
12. When industrial fishing fleets move close to
shore they can damage the sea-bottom habitat, damage
local fish nets, and drastically reduce fish species on
which local craft fishers depend.
13. Climate change refers to the incremental effectof anthropogenic GHG emissions on the average global
surface temperature and related changes in weather patterns. The natural greenhouse effect, caused by the
pre–Industrial Revolution contents of GHGs in the atmosphere, is estimated to raise average global surface
temperature by some 32 degrees Celsius from what it
would be without natural radiative forcing, allowing
human life to exist. So far anthropogenic emissionsof CO2, the most important GHG, have raised atmospheric concentration of CO2 from 280 parts per million(ppm) at the start of the Industrial Revolution to
380 ppm, coinciding with an increase of average global
surface temperature by about 0.6 degrees Celsius.
14. Given existing stocks of fossil fuels relative
to current and projected economic growth, the pastclose link between output and fossil-fuel use could continue for a sufficiently long period to lead to a multiple
increase in the atmospheric GHG concentrations thatprevailed before the Industrial Revolution. The carbon
contents of estimated fossil-fuel reserves are approximately five times the current atmospheric carbon
content (in the form of CO2) and more than 600 times
current annual anthropogenic carbon emissions.
15. These estimates are clearly subject to multiple
uncertainties (Grubb 2006b). In addition to the usual
caveats for forecasts of growth and population, theeconomic and welfare impact of climate change is difficult to measure. Many market effects are not included
owing to lack of data. The valuation of nonmarket
effects is problematic and can raise ethical issues (life istypically valued in terms of the willingness to pay topreserve it, thus leading to high valuations in richcountries and low valuations in poor countries). Transition costs are typically not included, and the sensitivity of existing systems to transitional rises in temperature is largely unknown.
16. These may include, among other ideas, windscrubbers to filter carbon dioxide from the air, “fertilization” of oceans with iron to encourage growth ofplankton, petrification of carbon dioxide, and deflection

164

of sunlight from the Earth through the use of a giant
space mirror (Hall 2005). While considered of little
practical relevance only a decade ago, geoengineering is
gaining more serious consideration today (Broad 2006).
17. The existence of various GHGs requires thatthey be taxed in proportion to their contributions toclimate change. Similarly, subsidies for alternative
activities that reduce climate change potential (such asreforestation) should be proportional to their effect.
While easy to formulate, the implementation of thisprinciple is not a trivial task.
18. In a world without uncertainty, setting a pricefor emissions is equivalent to setting a quota. If the costof reducing emissions is uncertain, the welfare effectsof either setting prices or quantities of emission may
differ (Weitzman 1974).
19. The present value of benefits from a coordinatedsolution may be negative for some countries (including
the United States), thus further undermining incentives
for participation (Nordhaus and Yang 1996). While side
payments might be envisioned to encourage participation by those who suffer from a coordinated solution, the fairness involved in paying the world’s largest
GHG emitter to restrain emissions is problematic.
20. While the problem of carbon leakage is generally recognized, there remains disagreement concerning
its quantitative importance: alternative model simulations come to different results as to the amount ofcarbon leakage likely to occur in response to a given
policy for a given subregion (Burniaux and Oliveira
Martins 2000).
21. Emissions from the European Union (EU15)
countries are estimated at 0.8 percent below 1990
levels, compared with a target of ⫺8 percent. Japan’semissions are estimated to be 7.4 percent, and Canada’s
29 percent, above 1990 levels, compared to a target of⫺6 percent (UNFCCC 2006).

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Appendix
Regional Economic Prospects

Table A.1 East Asia and the Pacific forecast summary
Annual percent change (unless otherwise indicated)
Estimate

GDP at market prices (2000 US$)b
GDP per capita (units in US$)PPP GDPc
Private consumption
Public consumption
Fixed investment
Exports, GNFSd
Imports, GNFSd
Net exports, contribution to growth
Current account balance/GDP (%)
GDP deflator (median, LCU)
Fiscal balance/GDP (%)

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

8.3
6.9
7.3
7.3
9.7
12.4
12.0
1.2
0.4
6.6
⫺0.8

8.8
7.8
8.9
6.1
5.3
17.0
17.8
17.0
5.3
3.5
3.4
⫺2.5

9.0
8.1
9.2
7.3
6.3
11.8
22.4
19.4
7.0
3.4
4.2
⫺1.8

9.0
8.1
9.2
7.7
5.9
9.6
17.7
12.5
9.6
5.8
3.0
⫺1.3

9.2
8.3
9.3
6.0
4.0
8.9
16.1
13.1
11.4
7.0
2.7
⫺1.1

8.7
7.8
8.8
6.5
6.3
11.7
12.7
14.0
11.3
6.4
4.7
⫺1.1

8.1
7.2
8.2
7.3
6.4
9.0
11.9
12.8
11.2
5.9
3.4
⫺1.0

5.9
9.5
3.3
3.6

5.5
10.0
4.9
7.0

6.1
10.1
5.1
6.2

5.4
10.2
5.6
4.5

5.4
10.4
5.5
4.5

5.7
9.6
6.2
4.6

5.9
8.7
6.5
5.0

Memo items: GDP
East Asia, excluding China
China
Indonesia
ThailandSource: World Bank.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.
c. GDP is measured at PPP exchange rates.
d. Exports and imports of goods and nonfactor services.

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Table A.2 East Asia and the Pacific country forecasts
Annual percent change (unless otherwise indicated)
Estimate
1991–2000a

Cambodia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

Forecast

2003

2004

2005

2006

2007

2008

7.0
⫺3.6

10.0
⫺3.9

13.4
⫺6.4

8.9
⫺13.7

6.5
⫺10.7

7.0
⫺7.7

China
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

9.5
1.5

10.0
2.8

10.1
3.6

10.2
7.1

10.4
8.5

9.6
7.5

8.7
7.0

Fiji
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.1
⫺3.1

3.0
⫺8.3

5.3
⫺17.0

0.7
⫺17.1

3.1
⫺10.3

2.2
⫺6.1

2.5
⫺1.9

Indonesia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.3
⫺0.4

4.9
3.5

5.1
0.6

5.6
0.3

5.5
0.8

6.2
0.2

6.5
⫺0.5

6.1
⫺8.2

6.4
⫺14.3

7.0
⫺19.9

7.3
⫺14.6

6.6
⫺24.9

6.9
⫺23.6

5.4
12.9

7.2
12.9

5.2
15.6

5.5
14.8

5.5
14.8

5.5
15.2

Lao PDR
GDP at market prices (2000 US$)b
Current account balance/GDP (%)
Malaysia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)
Papua New Guinea
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.9
2.3

2.7
11.2

2.9
2.2

3.0
13.5

3.8
8.0

4.0
7.0

4.0
4.9

Philippines
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.1
⫺0.2

3.6
4.4

6.2
1.9

5.0
2.5

5.5
2.6

5.7
1.8

6.0
1.5

Samoa
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.7
⫺8.4

⫺1.0
5.0

3.1
⫺4.5

3.0
⫺7.3

3.0
0.1

3.5
0.2

3.5
0.0

Thailand
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.6
⫺1.2

7.0
5.5

6.2
2.9

4.5
⫺1.5

4.5
0.2

4.6
2.2

5.0
2.5

7.0

7.3
⫺4.9

7.8
⫺2.0

8.4
⫺0.4

8.0
2.4

7.5
0.1

7.5
⫺1.7

Vietnam
GDP at market prices (2000 US$)b
Current account balance/GDP (%)
Source: World Bank.

Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained inother Bank documents. Kiribati, Dem. Rep. of Korea, N. Mariana Islands, Marshall Islands, the Federated States of Micronesia,
Mongolia, Myanmar, Palau, American Samoa, Solomon Islands, Timor-Leste, and Tonga are not forecast owing to data limitations.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.

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Table A.3 Europe and Central Asia forecast summary
Annual percent change (unless otherwise indicated)
Estimate

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

⫺0.2
⫺0.4
⫺0.4
1.2
0.5
⫺4.6
3.8
2.8
0.5

5.9
5.9
6.2
6.0
2.9
10.4
12.7
15.7
2.2
⫺1.0
4.3
⫺2.6

7.2
7.2
7.4
8.1
2.3
12.7
13.4
17.7
0.5
0.3
6.2
⫺0.6

6.0
6.0
5.9
7.9
2.9
11.7
7.3
10.5
⫺1.1
0.9
4.0
1.4

6.4
6.3
6.5
7.8
3.1
10.9
10.0
12.8
⫺2.5
0.8
6.0
1.9

5.7
5.6
5.8
6.3
3.0
8.9
9.5
10.6
⫺3.2
⫺0.6
5.1
2.2

5.5
5.5
5.6
5.8
2.9
7.9
9.9
10.2
⫺3.5
⫺1.4
5.0
1.5

4.8
4.3
7.7
3.8
7.3
5.8

6.7
5.5
8.0
5.3
7.2
8.9

5.5
4.6
6.7
3.4
6.4
7.4

5.8
5.7
7.3
5.4
6.8
6.0

5.2
5.3
6.4
5.1
6.0
5.0

5.2
5.3
6.0
5.2
5.5
5.0

GDP at market prices (2000 US$)b
GDP per capita (units in US$)PPP GDPc
Private consumption
Public consumption
Fixed investment
Exports, GNFSd
Imports, GNFSd
Net exports, contribution to growth
Current account balance/GDP (%)
GDP deflator (median, LCU)
Fiscal balance/GDP (%)

104.7

Memo items: GDP
Transition countries
Central and Eastern Europe
Commonwealth of Independent States
PolandRussiaTurkey

2.6
2.2
⫺3.7
4.5
⫺3.4
3.5

Source: World Bank.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.
c. GDP is measured at PPP exchange rates.
d. Exports and imports of goods and nonfactor services.

Table A.4 Europe and Central Asia country forecasts
Annual percent change (unless otherwise indicated)
Estimate

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

4.7
⫺5.6

6.0
⫺8.1

5.9
⫺5.5

5.5
⫺7.8

5.0
⫺8.1

6.0
⫺7.1

5.8
⫺6.5

Armenia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺2.6

13.9
⫺6.8

10.5
⫺4.5

14.0
⫺3.9

9.5
⫺4.7

8.5
⫺4.6

7.5
⫺4.5

Azerbaijan
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺5.1

11.2
⫺27.8

10.2
⫺30.0

26.2
1.1

22.7
15.1

25.7
25.6

19.9
34.1

BelarusGDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺1.1

7.0
⫺2.2

11.0
⫺5.2

9.2
1.5

9.3
⫺0.2

4.5
⫺3.2

3.3
⫺3.9

⫺0.9
⫺2.3

4.5
⫺5.5

5.7
⫺5.8

5.6
⫺11.3

5.6
⫺12.5

5.6
⫺12.0

5.6
⫺11.3

Croatia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

0.8

5.3
⫺7.2

3.8
⫺5.4

4.3
⫺6.6

4.5
⫺6.7

4.0
⫺5.1

4.0
⫺5.0

Czech Republic
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.5

3.2
⫺6.4

4.2
⫺6.2

6.1
⫺2.1

6.8
⫺3.0

6.0
⫺3.1

6.3
⫺3.0

Albania
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

Bulgaria
GDP at market prices (2000 US$)b
Current account balance/GDP (%)(continued)169

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Table A.4 (continued )Annual percent change (unless otherwise indicated)
Estimate

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

Estonia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

0.0

6.7
⫺12.1

7.8
⫺13.0

9.8
⫺11.0

9.2
⫺11.8

8.0
⫺11.2

6.8
⫺10.5

Georgia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺7.2

11.1
⫺7.2

6.2
⫺8.3

8.5
⫺8.4

7.5
⫺9.9

6.5
⫺11.5

6.0
⫺11.0

2.1
⫺5.4

3.4
⫺8.7

5.2
⫺8.6

4.1
⫺7.4

3.8
⫺8.0

2.5
⫺6.7

3.2
⫺6.0

Kazakhstan
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺2.5

9.3
⫺0.9

9.6
1.1

9.4
⫺0.9

9.0
7.0

9.0
2.4

8.9
⫺1.9

Kyrgyz Republic
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺3.2

7.0
⫺5.2

7.1
⫺3.4

⫺0.6
⫺8.3

4.3
⫺11.0

5.5
⫺9.8

4.8
⫺7.7

LatviaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺1.6

7.2
⫺8.2

8.5
⫺12.9

10.2
⫺12.4

9.8
⫺13.5

7.5
⫺12.0

6.0
⫺11.5

Lithuania
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺2.8

9.7
⫺7.0

7.0
⫺7.7

7.5
⫺7.0

7.0
⫺8.5

6.5
⫺8.4

6.0
⫺8.0

Macedonia, FYR
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺0.3

2.8
⫺3.3

4.1
⫺7.7

4.0
⫺1.4

4.0
⫺3.1

4.0
⫺3.9

4.5
⫺3.9

Moldova
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺8.2

6.6
⫺7.1

7.4
⫺2.0

7.1
⫺9.8

3.0
⫺21.2

3.0
⫺17.6

5.0
⫺9.8

PolandGDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.5
⫺3.5

3.8
⫺2.1

5.3
⫺4.2

3.4
⫺1.4

5.4
⫺1.5

5.1
⫺1.9

5.2
⫺2.4

Romania
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺0.3
⫺6.7

5.2
⫺5.8

8.3
⫺8.2

4.1
⫺8.7

5.8
⫺11.4

6.2
⫺12.9

6.3
⫺13.6

Russian Federation
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺3.4

7.3
8.2

7.2
10.2

6.4
10.9

6.8
9.7

6.0
5.2

5.5
2.9

Slovak Republic
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.9

4.5
⫺0.9

5.4
⫺3.1

6.1
⫺8.5

6.7
⫺7.2

7.1
⫺4.2

5.7
⫺3.5

3.5
⫺1.1

5.8
⫺3.4

8.9
⫺5.2

7.4
⫺6.4

6.0
⫺8.0

5.0
⫺7.5

5.0
⫺6.4

UkraineGDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺7.2

9.4
5.8

12.1
10.5

2.6
3.1

6.0
⫺1.0

4.5
⫺3.4

5.5
⫺4.1

Uzbekistan
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺0.2

4.2
8.7

7.7
9.9

7.0
14.3

6.0
17.0

4.0
17.2

4.0
14.8

Hungary
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

TurkeyGDP at market prices (2000 US$)b
Current account balance/GDP (%)

Source: World Bank.
Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained inother Bank documents. Bosnia and Herzegovina, the Republic of Montenegro, the Republic of Serbia, Tajikistan, andTurkmenistan are not forecast owing to data limitations.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.

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Table A.5 Latin America and the Caribbean forecast summary
Annual percent change (unless otherwise indicated)
Estimate

GDP at market prices (2000 US$)b
GDP per capita (units in US$)PPP GDPc
Private consumption
Public consumption
Fixed investment
Exports, GNFSd
Imports, GNFSd
Net exports, contribution to growth
Current account balance/GDP (%)
GDP deflator (median, LCU)
Fiscal balance/GDP (%)

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

2.9
1.4
3.5
2.5
1.5
5.2
7.4
8.9
⫺0.6
⫺2.8
10.1

2.0
0.5
2.1
2.5
5.9
⫺3.2
2.7
2.0
1.6
0.5
7.2
⫺0.1

6.0
4.5
5.6
5.3
0.9
14.6
12.4
14.4
1.3
1.0
8.3
0.2

4.5
3.1
4.3
4.7
3.4
7.7
7.8
11.3
0.6
1.6
9.1
0.2

5.0
3.7
4.9
5.0
3.3
9.0
6.2
9.0
⫺0.1
1.9
7.3
0.7

4.2
2.8
4.1
3.8
1.9
8.1
5.7
7.6
⫺0.6
1.4
6.1
0.1

4.0
2.7
4.0
3.6
1.1
6.9
6.8
7.2
⫺0.7
1.0
6.1
⫺0.4

2.8
3.1
3.1
3.3
2.6
3.0

1.0
3.2
1.6
8.8
0.5
1.4

5.5
2.5
4.3
9.0
4.9
4.4

3.8
6.5
3.2
9.2
2.3
3.0

4.6
7.6
4.5
7.7
3.5
4.5

3.9
5.0
3.6
5.6
3.4
3.5

4.0
4.8
3.6
4.0
3.8
3.5

Memo items: GDP
Latin Amer. & the Carib., excluding
Argentina
Caribbean
Central America
Argentina
BrazilMexicoSource: World Bank.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.
c. GDP is measured at PPP exchange rates.
d. Exports and imports of goods and nonfactor services.

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Table A.6 Latin America and the Caribbean country forecasts
Annual percent change (unless otherwise indicated)
Estimate

172

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

Antigua and Barbuda
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.1
⫺5.3

4.9
⫺10.1

5.2
⫺18.7

5.0
⫺15.9

7.1
⫺20.4

3.9
⫺18.4

4.1
⫺16.7

Argentina
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.3
⫺3.1

8.8
6.2

9.0
1.9

9.2
2.7

7.7
2.2

5.6
1.4

4.0
0.9

BelizeGDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.8
⫺7.2

9.4
⫺20.3

4.6
⫺17.6

3.1
⫺18.5

2.6
⫺18.8

2.6
⫺24.9

3.3
⫺24.9

Bolivia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.2
⫺6.1

2.8
0.8

3.6
3.5

4.1
5.2

3.1
5.3

3.1
4.0

3.2
3.9

Brazil
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.6
⫺2.1

0.5
0.8

4.9
2.0

2.3
1.9

3.5
1.4

3.4
1.1

3.8
0.8

Chile
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

5.6
⫺2.8

3.7
⫺1.5

6.1
1.7

6.3
0.6

5.0
3.5

5.3
2.7

5.3
2.0

Colombia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.3
⫺1.9

4.1
⫺1.2

4.8
⫺1.0

5.1
⫺1.9

4.7
⫺2.3

4.2
⫺3.0

4.0
⫺3.7

Costa Rica
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

5.0
⫺3.6

6.5
⫺5.3

4.1
⫺4.6

5.9
⫺4.9

5.0
⫺5.7

4.6
⫺4.1

4.1
⫺4.4

Dominica
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.8
⫺16.3

0.0
⫺19.5

3.6
⫺23.0

2.4
⫺23.2

3.0
⫺24.2

3.0
⫺24.5

3.0
⫺24.0

Dominican Republic
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

5.9
⫺3.2

⫺0.4
6.3

2.0
5.3

9.3
⫺0.4

8.5
⫺3.2

5.5
⫺4.1

5.0
⫺3.6

EcuadorGDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.3
⫺2.3

2.7
⫺1.7

7.9
⫺0.9

4.7
⫺0.3

3.5
0.7

3.0
⫺1.1

3.0
⫺2.7

El Salvador
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.2
⫺2.0

1.8
⫺5.1

1.5
⫺3.9

2.8
⫺4.4

3.2
⫺5.7

3.1
⫺4.7

3.1
⫺4.3

GuatemalaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.7
⫺4.6

2.1
⫺4.2

2.7
⫺4.3

3.2
⫺4.4

4.1
⫺4.1

4.0
⫺4.0

4.0
⫺3.4

GuyanaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.3
⫺19.9

⫺0.6
⫺6.3

1.6
⫺8.9

⫺3.0
⫺19.9

3.5
⫺26.1

3.3
⫺22.3

3.6
⫺15.4

Honduras
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.0
⫺7.7

3.5
⫺4.6

4.6
⫺5.3

4.2
⫺0.5

4.5
⫺1.5

4.5
⫺1.3

4.0
⫺1.2

Haiti
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺1.7
⫺1.6

0.4
⫺0.4

⫺3.8
0.4

1.5
0.7

2.5
⫺1.2

2.7
⫺1.4

3.0
⫺1.5

Jamaica
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

0.7
⫺2.7

2.3
⫺9.4

0.9
⫺5.8

2.0
⫺8.8

3.0
⫺10.4

3.5
⫺8.4

3.0
⫺5.0

R E G I O N A L

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Estimate

Forecast

P R O S P E C T S

Table A.6 (continued)
Annual percent change (unless otherwise indicated)

1991–2000a

2003

2004

2005

2006

2007

2008

Mexico
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.0
⫺3.7

1.4
⫺1.4

4.4
⫺1.0

3.0
⫺0.6

4.5
0.1

3.5
⫺0.2

3.5
0.4

Nicaragua
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.4
⫺28.6

2.3
⫺18.1

5.1
⫺18.7

4.0
⫺18.8

3.7
⫺18.1

4.2
⫺19.4

4.6
⫺19.9

PanamaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.1
⫺4.8

4.3
⫺3.9

7.6
⫺7.8

6.4
⫺5.2

6.3
⫺4.6

5.7
⫺5.0

5.5
⫺6.2

Peru
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.7
⫺5.5

4.0
⫺1.5

4.8
0.0

6.7
1.4

6.6
1.1

5.5
0.5

5.0
⫺0.4

Paraguay
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.7
⫺2.0

2.6
2.2

4.1
0.3

3.0
⫺0.2

3.2
⫺0.3

3.0
⫺0.4

3.1
⫺0.3

St. Kitts and Nevis
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.1
⫺18.8

2.1
⫺51.8

6.4
⫺24.4

4.9
⫺21.6

3.7
⫺21.0

4.0
⫺20.0

4.1
⫺20.0

St. Lucia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.4
⫺11.3

3.0
⫺18.6

4.0
⫺13.0

5.4
⫺25.2

5.5
⫺15.3

3.4
⫺10.0

3.3
⫺10.0

St. Vincent and the Grenadines
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.0
⫺19.0

4.5
⫺15.5

4.3
⫺19.4

4.9
⫺23.6

4.3
⫺24.3

4.1
⫺25.0

4.2
⫺25.8

Trinidad and Tobago
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.9
0.2

13.2
9.4

6.5
15.4

7.0
18.9

12.0
23.2

6.2
17.2

6.5
17.3

Uruguay
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.7
⫺1.5

2.5
⫺0.5

12.3
0.3

6.6
⫺0.5

5.5
⫺1.7

4.4
⫺2.2

3.8
⫺2.5

Venezuela, R. B. de
GDP at market prices (2000 US$)b
Current account bal/GDP (%)

1.1
2.6

⫺7.7
13.7

17.9
12.6

9.3
18.1

8.5
17.1

6.0
12.6

5.5
7.6

Source: World Bank.
Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained inother Bank documents. Barbados, Cuba, Grenada, and Suriname are not forecast owing to data limitations.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.

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Table A.7 Middle East and North Africa forecast summary
Annual percent change (unless otherwise indicated)
Estimate

GDP at market prices (2000 US$)b
GDP per capita (units in US$)PPP GDPc
Private consumption
Public consumption
Fixed investment
Exports, GNFSd
Imports, GNFSd
Net exports, contribution to growth
Current account balance/GDP (%)
GDP deflator (median, LCU)
Fiscal balance/GDP (%)

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

3.8
1.9
3.9
3.5
3.6
3.2
3.8
⫺0.9
⫺4.1
⫺0.5
7.7
⫺4.3

4.4
2.7
4.6
3.7
3.1
5.9
3.8
3.8
0.0
0.0
4.4
⫺0.9

4.8
3.0
4.8
6.3
2.8
10.0
6.2
12.9
⫺1.9
2.5
6.9
⫺2.4

4.4
2.6
4.4
4.8
6.2
5.4
4.8
7.2
⫺2.6
6.6
14.5
⫺1.2

4.9
3.1
5.2
5.0
9.2
10.1
6.6
12.5
⫺4.4
6.8
8.7
⫺0.4

4.9
3.0
4.9
5.0
5.3
9.5
4.7
8.7
⫺5.7
3.6
4.1
0.1

4.8
3.1
4.9
6.5
5.2
3.7
5.2
7.2
⫺6.4
2.3
4.8
0.1

3.1
4.8
2.8
2.3
1.8
4.4
2.9

5.7
4.0
5.1
7.4
6.8
3.1
5.0

5.0
4.8
4.9
5.3
5.2
4.2
5.1

5.3
4.0
4.7
6.7
5.3
4.9
4.4

5.5
5.0
4.7
6.5
3.0
5.8
5.8

5.2
5.1
4.6
5.7
4.5
5.6
5.0

5.0
5.3
4.4
5.2
4.3
5.8
4.7

Memo items: GDP
MENA Geographic Regione
Resource poor-labor abundantf
Resource rich-labor abundantg
Resource rich-labor importingh
AlgeriaEgypt, Arab Rep. of
Iran, Islamic Rep. of

Source: World Bank.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.
c. GDP is measured at PPP exchange rates.
d. Exports and imports of goods and nonfactor services.
e. Geographic region includes high-income countries: Bahrain, Kuwait, and Saudi Arabia.
f. Egypt, Jordan, Lebanon, Morocco, and Tunisia.
g. Algeria, Iran, the Syrian Arab Republic, and the Republic of Yemen.
h. Bahrain, Kuwait, Oman, and Saudi Arabia.

174

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Estimate

Forecast

P R O S P E C T S

Table A.8 Middle East and North Africa country forecasts
Annual percent change (unless otherwise indicated)

1991–2000a

2003

2004

2005

2006

2007

2008

Algeria
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.8
3.3

6.8
13.0

5.2
13.1

5.3
21.2

3.0
24.2

4.5
17.5

4.3
15.8

Egypt, Arab Rep. of
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.4
0.9

3.1
4.5

4.2
4.3

4.9
3.3

5.8
1.7

5.6
1.5

5.8
⫺0.7

Iran, Islamic Rep. of
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.9
1.2

5.0
⫺7.8

5.1
0.9

4.4
7.5

5.8
5.6

5.0
2.2

4.7
2.0

JordanGDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.9
⫺4.3

4.1
11.6

8.4
⫺0.2

7.3
⫺18.2

6.3
⫺21.6

5.0
⫺20.3

5.0
⫺16.2

4.9
⫺27.5

6.3
⫺23.7

1.0
⫺21.7

⫺5.5
⫺21.5

4.5
⫺23.1

2.9
⫺23.5

LebanonGDP at market prices (2000 US$)b
Current account balance/GDP (%)
Morocco
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.6
⫺1.4

5.5
3.5

4.2
1.9

1.7
2.4

7.0
1.2

3.5
0.7

4.5
0.9

Oman
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.0
⫺3.7

1.3
4.0

3.1
2.2

4.8
14.6

6.5
25.2

5.5
19.1

5.0
14.4

Syrian Arab Republic
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.1
1.0

1.1
3.4

3.9
1.1

5.1
⫺4.0

4.0
⫺2.5

3.7
⫺4.9

3.5
⫺6.7

Tunisia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.3
⫺4.3

5.6
⫺2.9

6.0
⫺1.7

4.2
⫺1.1

5.3
⫺1.2

5.6
⫺1.4

6.0
⫺1.2

Yemen, Republic of
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

5.3
⫺4.3

3.1
1.4

2.6
2.0

3.8
5.0

3.9
⫺4.9

2.5
⫺8.4

3.0
⫺11.5

Source: World Bank.
Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained inother Bank documents. Djibouti, Iraq, Libya, and the West Bank and Gaza are not forecast owing to data limitations.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.

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Table A.9 South Asia forecast summary
Annual percent change (unless otherwise indicated)
Estimate

GDP at market prices (2000 US$)b
GDP per capita (units in US$)PPP GDPc
Private consumption
Public consumption
Fixed investment
Exports, GNFSd
Imports, GNFSd
Net exports, contribution to growth
Current account balance/GDP (%)
GDP deflator (median, LCU)
Fiscal balance/GDP (%)

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

5.0
3.2
5.6
3.8
5.1
5.8
9.4
10.2
⫺2.4
⫺1.6
8.1
⫺7.6

7.8
6.1
8.0
6.7
4.6
11.5
11.5
11.3
0.4
1.4
4.5
⫺7.8

8.0
6.3
8.1
6.3
8.4
8.2
12.9
21.9
⫺1.1
⫺0.8
7.6
⫺7.2

8.1
6.4
8.2
8.2
4.4
10.9
19.0
19.6
⫺1.3
⫺1.4
6.3
⫺7.1

8.2
6.7
8.3
7.8
5.3
12.6
22.3
23.6
⫺1.7
⫺2.2
8.1
⫺7.1

7.5
5.9
7.5
7.0
4.2
12.1
15.5
16.9
⫺2.2
⫺2.5
7.4
⫺6.7

7.0
5.6
7.1
6.3
4.2
10.3
13.8
13.3
⫺2.2
⫺2.5
6.5
⫺6.1

3.9
4.5
5.4
3.4

5.1
5.3
8.6
5.0

6.1
6.3
8.5
6.4

6.9
6.2
8.5
7.8

6.5
6.7
8.7
6.6

6.6
6.2
7.7
7.0

6.4
6.5
7.2
6.5

Memo items: GDP
South Asia, excluding India
Bangladesh
India
Pakistan
Source: World Bank.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.
c. GDP is measured at PPP exchange rates.
d. Exports and imports of goods and nonfactor services.

Table A.10 South Asia country forecasts
Annual percent change (unless otherwise indicated)
Estimate

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

Bangladesh
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.5
⫺0.4

5.3
0.3

6.3
⫺0.4

6.2
⫺0.9

6.7
0.9

6.2
0.4

6.5
⫺0.6

India
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

5.4
⫺1.2

8.6
1.1

8.5
⫺0.8

8.5
⫺1.3

8.7
⫺2.2

7.7
⫺2.5

7.2
⫺2.4

Nepal
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.4
⫺6.3

3.1
2.1

3.8
2.9

2.7
2.2

1.9
2.4

3.7
3.9

4.5
2.9

Pakistan
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.4
⫺3.7

5.0
4.3

6.4
⫺0.8

7.8
⫺3.1

6.6
⫺3.9

7.0
⫺4.4

6.5
⫺5.3

Sri Lanka
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.7
⫺4.6

6.0
⫺0.6

5.4
⫺3.2

6.0
⫺2.8

7.0
⫺4.9

6.5
⫺4.1

6.0
⫺3.5

Source: World Bank.
Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained inother Bank documents. Afghanistan, Bhutan, and the Maldives are not forecast owing to data limitations.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.

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Table A.11 Sub-Saharan Africa forecast summary
Annual percent change (unless otherwise indicated)
Estimate

GDP at market prices (2000 US$)b
GDP per capita (units in US$)PPP GDPc
Private consumption
Public consumption
Fixed investment
Exports, GNFSd
Imports, GNFSd
Net exports, contribution to growth
Current account balance/GDP (%)
GDP deflator (median, LCU)
Fiscal balance/GDP (%)

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

2.3
0.0
3.2
1.9
2.9
3.8
4.3
4.3
0.7
⫺2.1
10.0
⫺4.4

4.2
1.9
3.8
0.6
7.2
7.7
7.5
7.3
⫺1.7
⫺1.0
5.7
⫺2.6

5.2
3.0
5.4
5.6
5.7
13.6
6.0
9.5
⫺3.0
⫺0.2
6.4
⫺2.4

5.5
3.2
5.7
5.8
5.7
9.0
6.8
9.2
⫺3.9
0.8
6.7
⫺1.3

5.3
3.3
5.6
5.3
5.0
13.6
5.7
10.3
⫺5.6
0.3
5.8
⫺1.0

5.3
3.3
5.7
4.5
5.9
8.7
7.2
7.7
⫺5.9
⫺0.2
4.6
⫺1.2

5.4
3.5
5.7
4.6
5.9
8.7
7.1
7.7
⫺6.3
⫺0.9
5.0
⫺0.9

2.6
2.4
2.5
1.7
2.2
1.9

5.0
6.7
3.5
3.0
10.7
3.0

5.7
6.6
5.0
4.9
6.5
4.5

5.9
7.0
4.3
5.8
6.2
4.9

5.8
6.9
4.1
4.9
4.8
4.6

6.2
7.5
3.6
5.1
5.1
3.9

6.1
7.2
4.4
4.9
5.4
4.3

Memo items: GDP
Sub-Saharan Africa, excluding South Africa
Oil exporters
CFA countries
Kenya
NigeriaSouth Africa
Source: World Bank.
a. Growth rates over intervals are compound averages; growth contributions, ratios and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.
c. GDP is measured at PPP exchange rates.
d. Exports and imports of goods and nonfactor services.

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Table A.12 Sub-Saharan Africa country forecasts
Annual percent change (unless otherwise indicated)
Estimate
2003

2004

2005

2006

2007

AngolaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

0.9
⫺6.0

3.4
⫺5.0

11.1
3.5

18.7
8.7

16.9
11.9

22.3
15.3

15.7
13.1

Benin
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.3
⫺6.8

3.9
⫺9.8

3.1
⫺7.9

3.5
⫺7.3

4.3
⫺7.4

4.2
⫺7.4

4.1
⫺7.4

Botswana
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.4
8.4

6.7
6.0

4.9
9.9

4.0
14.0

5.2
14.0

4.3
12.1

4.1
9.5

Burkina Faso
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.2
⫺5.6

8.0
⫺12.2

4.6
⫺13.2

7.1
⫺12.2

6.5
⫺6.9

4.9
⫺6.5

5.2
⫺5.0

BurundiGDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺2.2
⫺3.4

⫺1.2
⫺4.8

4.8
⫺8.1

0.9
⫺10.5

5.3
⫺15.6

5.7
⫺14.3

5.4
⫺13.7

Cameroon
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.8
⫺3.6

4.2
⫺6.3

3.6
⫺3.1

2.4
⫺2.0

4.1
0.5

3.9
0.2

4.1
0.2

Cape Verde
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

5.6
⫺8.3

5.0
⫺11.1

4.4
⫺14.6

5.9
⫺4.5

5.8
⫺9.0

5.9
⫺8.6

5.6
⫺8.2

Central African Republic
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.7
⫺4.3

⫺4.6
⫺2.2

1.8
⫺4.5

2.8
⫺2.8

3.6
⫺3.1

3.9
⫺2.9

4.3
⫺3.0

Chad
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.2
⫺5.5

14.3
⫺43.9

33.2
⫺3.8

8.4
4.1

3.9
8.7

2.8
7.0

2.7
4.8

Comoros
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.8
⫺6.7

2.1
⫺4.1

⫺0.2
⫺4.1

4.2
⫺4.6

1.3
⫺4.7

2.1
⫺4.2

2.7
⫺3.7

Congo, Rep. of
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.3
⫺16.5

0.8
14.1

3.6
20.7

7.7
19.6

6.8
25.5

1.1
25.4

6.5
25.6

Côte d’Ivoire
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.3
⫺4.0

⫺1.5
2.0

1.5
1.6

1.8
⫺0.1

1.7
1.7

2.2
2.5

2.7
2.3

Equatorial Guinea
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

18.5
⫺33.0

14.0
⫺147.6

29.4
⫺23.8

8.1
⫺13.4

8.2
⫺7.0

8.3
⫺8.4

12.3
⫺8.6

3.0
11.0

2.8
5.9

4.5
⫺0.6

1.7
⫺1.1

1.9
⫺1.7

2.4
⫺1.9

Eritrea
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

178

Forecast

1991–2000a

2008

Ethiopia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.8
⫺0.9

⫺3.9
⫺2.6

12.3
⫺4.4

8.7
⫺7.6

5.8
⫺7.7

5.6
⫺5.5

5.5
⫺4.9

Gabon
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.8
5.6

2.2
9.5

1.4
10.9

2.9
15.9

2.7
21.3

1.9
19.7

2.7
17.2

Gambia, The
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.0
4.5

6.9
⫺5.7

5.1
⫺11.8

5.0
⫺12.7

4.4
⫺9.1

3.8
⫺6.9

3.6
⫺5.9

R E G I O N A L

E C O N O M I C

Estimate

Forecast

P R O S P E C T S

Table A.12 (continued )Annual percent change (unless otherwise indicated)

1991–2000a

2003

2004

2005

2006

2007

2008

Ghana
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.8
⫺6.5

5.2
1.9

5.8
⫺2.7

5.4
⫺7.6

5.6
⫺7.6

5.7
⫺7.1

5.8
⫺6.9

GuineaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.8
⫺5.7

1.2
⫺2.9

2.6
⫺5.2

3.1
⫺2.9

4.1
⫺4.0

4.7
⫺3.2

3.9
⫺3.1

Guinea-Bissau
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.0
⫺24.0

0.6
⫺10.9

1.6
3.1

2.4
⫺7.1

3.8
⫺5.2

2.9
⫺7.8

3.1
⫺7.0

Kenya
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.7
⫺1.6

3.0
0.4

4.9
⫺2.7

5.8
⫺2.2

4.9
⫺3.5

5.1
⫺5.5

4.9
⫺4.7

Lesotho
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.0
⫺13.3

3.3
⫺10.7

2.7
⫺2.3

1.3
13.4

1.7
16.3

1.8
17.9

2.1
19.6

Madagascar
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.4
⫺7.8

9.8
⫺8.0

5.2
⫺9.3

4.6
⫺11.2

4.9
⫺10.6

5.3
⫺9.6

5.5
⫺8.3

MalawiGDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.6
⫺8.5

3.9
⫺7.9

5.1
⫺9.7

2.1
⫺8.1

8.1
⫺4.7

4.7
⫺6.3

5.1
⫺5.8

Mali
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.9
⫺5.7

7.6
⫺13.0

2.3
⫺6.1

6.8
⫺7.9

5.7
⫺6.6

5.0
⫺5.8

4.8
⫺5.4

Mauritania
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.5
⫺0.6

6.4
⫺9.4

5.2
⫺19.2

5.4
⫺40.0

17.9
4.7

9.8
⫺1.5

14.7
3.7

Mauritius
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.6
⫺1.6

4.4
1.7

4.7
⫺1.6

2.5
⫺3.9

3.8
⫺4.8

2.9
⫺6.2

2.7
⫺6.4

Mozambique
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

5.1
⫺17.2

7.8
⫺14.1

7.5
⫺8.6

6.6
⫺10.8

6.9
⫺12.3

6.5
⫺13.9

6.7
⫺13.7

Namibia
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.4
4.1

3.5
5.4

6.0
8.6

3.3
8.8

3.5
9.0

3.9
5.9

4.1
2.3

Niger
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.5
⫺6.9

3.8
⫺12.2

⫺0.6
⫺12.2

7.1
⫺10.8

4.1
⫺7.7

4.0
⫺7.4

4.0
⫺6.6

Nigeria
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.2
0.7

10.7
16.3

6.5
17.7

6.2
23.1

4.8
18.5

5.1
17.6

5.4
15.2

RwandaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

0.4
⫺3.5

0.9
⫺7.5

4.0
⫺2.7

6.5
⫺3.6

5.1
⫺9.3

6.1
⫺10.2

5.7
⫺9.7

SenegalGDP at market prices (2000 US$)b
Current account balance/GDP (%)

3.0
⫺6.0

6.5
⫺7.6

5.6
⫺7.1

5.5
⫺9.9

3.8
⫺9.9

5.1
⫺8.9

5.2
⫺8.0

Seychelles
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.3
⫺7.4

⫺6.3
⫺2.3

⫺2.0
⫺4.2

⫺2.3
⫺13.1

⫺1.8
⫺4.1

0.4
⫺3.9

0.9
⫺3.7
(continued)179

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Table A.12 (continued )Annual percent change (unless otherwise indicated)
Estimate

Forecast

1991–2000a

2003

2004

2005

2006

2007

2008

Sierra Leone
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

⫺5.6
⫺9.0

9.3
⫺7.1

7.4
⫺4.3

7.2
⫺8.4

6.9
⫺6.9

6.1
⫺6.0

6.2
⫺5.6

South Africa
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

1.9
⫺0.2

3.0
⫺1.4

4.5
⫺3.5

4.9
⫺4.2

4.6
⫺5.9

3.9
⫺5.7

4.3
⫺5.3

Sudan
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

4.9
⫺6.8

6.0
⫺5.4

5.2
⫺3.4

7.9
⫺11.0

11.8
⫺5.1

10.1
⫺3.7

9.2
⫺3.5

Swaziland
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.8
⫺2.6

2.4
1.7

2.1
1.4

1.8
⫺1.9

1.2
⫺2.5

1.1
⫺3.1

0.9
⫺4.0

Tanzania
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.7
⫺12.5

5.7
⫺0.6

6.7
⫺3.0

6.9
⫺4.7

5.5
⫺7.3

7.1
⫺7.2

6.8
⫺7.6

Togo
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

2.3
⫺8.5

⫺1.3
⫺9.9

4.6
⫺7.6

1.5
⫺11.0

2.8
⫺9.0

2.7
⫺7.2

3.1
⫺7.0

UgandaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

6.2
⫺7.0

6.5
⫺5.1

5.5
⫺1.7

6.3
⫺2.8

5.1
⫺6.5

5.7
⫺7.4

5.8
⫺7.0

ZambiaGDP at market prices (2000 US$)b
Current account balance/GDP (%)

0.7
⫺10.5

5.1
⫺8.1

5.4
⫺10.3

4.8
⫺7.8

5.1
⫺6.1

4.9
⫺6.9

4.6
⫺7.3

Zimbabwe
GDP at market prices (2000 US$)b
Current account balance/GDP (%)

0.4
⫺7.5

⫺10.4
⫺6.1

⫺3.8
⫺19.4

⫺6.5
⫺20.6

⫺3.3
⫺7.6

⫺2.9
⫺8.7

⫺2.1
⫺9.4

Source: World Bank.
Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained inother Bank documents. The Democratic Republic of Congo, Liberia, Mayotte, São Tome and Principe, and Somalia are notforecast owing to data limitations.
a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages.
b. GDP is measured in constant 2000 U.S. dollars.

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