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GlobalEconomic
Prospects
and the Developing Countries

2003gep_fm.qxd 12/5/02 4:16 PM Page ii© 2003 The International Bank for Reconstruction and Development /The World Bank
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ISBN 0-8213-5338-1
ISSN 1014-8906
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Contents

Forewordix

Acknowledgments
Summaryxi

xiii

Abbreviations and Data Notes

xxi

Chapter 1 The International Economy and Prospects for Developing Countries
A recovery constrained by major risks
4
Investment cycles in developing countries
23
Growth and poverty to 2015: coming changes in savings andinvestment patterns
28
Notes
41
References
42
Chapter 2 Changes in Global Business Organization
The surge in trade and FDI
46
The rise in service sector FDI
52
Global production networks
55
Good policies attract FDI
66
Notes
69
References
71

1

45

Chapter 3 Domestic Policies to Unlock Global Opportunities
77
Investment climate and investment policies
78
Promoting efficient private investment: harnessing competition
Public investment in infrastructure and human capital
103
Policies to promote competition
107
Notes
109
References
110

85

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Chapter 4 International Agreements to Improve Investment and117
Competition for Development
International efforts to promote investment
119
International agreements to promote competition and competition policy
Conclusions
145
Notes
146
References
147
Appendix 1 Regional Economic Prospects

151

Appendix 2 Global Commodity Price Prospects
Appendix 3 Global Economic Indicators

133

175

199

Figures
1.1
The recovery was initiated in a typical fashion
6
1.2
A brief rebound in industrial countries was underway
6
1.3
Rebound in industrial countries boosted production in East Asia6
1.4
Non-oil commodities are recovering but stand well below previous peaks
7
1.5
Private sector creditors have cut debt exposures so far in 2002
9
1.6
FDI flows to emerging Asia are proving to be quite resilient10
1.7
Investment recovery is still uncertain
10
1.8
World trade rebounds along with GDP, 1998–2004
13
1.9
2002 marks the start of a moderate recovery
15
1.10
LAC and MENA are not experiencing the recovery
15
1.11
Low case: world trade and other indicators will be much lower thanthe baseline20
1.12
G-7 investment falls sharply
21
1.13
Investment growth and net capital flows into Latin America arestrongly correlated22
1.14
Oil prices spike
23
1.15
Investment is more volatile than GDP in East Asia
23
1.16
Investment is more volatile than GDP in Latin America
23
1.17
Central Europe and Turkey experience greater volatility ininvestment than in GDP
24
1.18
Investment volatility declines with income24
1.19
A better investment climate reduces volatility of investment cycles
25
1.20
Impact of policy climate on investment volatility after correcting forincome remains strong25
1.21
Growth of working-age population decelerates
33
1.22
Productivity has not been the dominant source of growth in regions35
1.23
Productivity is expected to be more significant in the longer term
35
1.24
Major structural shifts in investment and savings behavior have occurred
37
1.25
Youth dependency ratio will fall everywhere except Japan39
1.26
Elderly dependency ratios will rise in some regions
39
2.1
Exports-to-GDP ratios have increased since the 1970s
47
2.2
All regions have benefited from rising FDI flows
47
2.3
FDI is concentrated in large countries, but many small countries receive large amounts
relative to GDP
48

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2.4
2.5
2.6
2.7
2.8
2.9
2.10
2.11
2.12
2.13
2.14
2.15
2.16
2.17
2.18
2.19
3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.8
3.9
3.10
3.11
3.12
3.13
3.14
3.15
3.16
3.17
4.1
4.2
4.3
4.4
4.5
4.6
4.7

The service sector dominated the 1990s mergers and acquisitions boom
49
Cross-border mergers and acquisitions are small compared withstock market capitalization
49
U.S. aggregate concentration has held steady50
Global concentration has not increased significantly
51
Share of FDI in the service sector increased in major industrial countries
52
U.S. cars are produced in many countries
55
Cross-border networks capture increasing shares of production and trade56
The role of production networks continued to increase throughmost of the 1990s
56
Tariff rates fell in the last two decades
57
Reforming countries boosted exports through production networks
58
Parts and components exports grew rapidly, 1981–2000
61
Developing countries’ share of global parts and component exportsrose between 1981 and 2000
61
Developing countries’ parts and component exports are highly
concentrated, 2000
62
Strong rule of law attracts foreign investors
66
Foreign investors have been shifting away from weaker investment
climate locations
67
Private infrastructure investment surged in the 1990s
68
Domestic capital is the largest source of investment in developing countries
78
Incentives for FDI are varied and numerous
80
Competition and ease of entry are associated with higher growth86
Competition from imports checks markups in concentrated markets
87
High tariffs are correlated with lower productivity
88
High entry costs inhibit FDI inflows
90
Barriers to entry can become barriers to exit
92
Barriers to entry and exit allow inefficient firms to stay in the market
94
Difficulties in obtaining licenses and permits discourage FDI
94
Inefficient customs hurt Indian exports
95
Inefficient ports raise India’s transport costs far above competitors’transport costs
95
Privatization revenues soared in the 1990s
96
Granting monopoly rights brings in revenues
98
More competition means more phones
98
Better infrastructure means higher growth105
Greater literacy is associated with higher growth106
Education raises the productivity of FDI, which leads to higher growth
107
Countries are increasingly liberalizing their investment regimes
123
South-South FDI is rising
123
Share of South-South FDI in total FDI is rising
124
Revealed preferences: governments shield services more often thanmanufacturing from the winds of investment competition
126
FDI is growing faster than exports and output
128
OECD countries spent $230 billion in 2001 to support agricultural producers
135
Imports affected by cartels rose from 1981 to 2000 for both rich andpoor countries
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Tables1.1
Global conditions affecting growth in developing countries andworld GDP growth3
1.2
External environment for developing countries, 1991–2004
14
1.3
Global effects in a low-case scenario, 2003–04
20
1.4
Low case: contributions to global effects in 2003
21
1.5
Relative volatility of investment is high in developing countries
24
1.6
Upturns can be financed abroad and domestically26
1.7
Capital inflows lead investment in middle-income countries: correlation
between investment ratios and (past or future) capital flows
26
1.8
Long-term prospects are projected to be stronger for most regions29
1.9
Large poverty reductions in EAP and SAR partially offset bypoverty increases in SSA
30
1.10
Savings fall in high-income countries, but increase in most other regions38
2.1
FDI inward stocks in services and manufacturing, 1988–99
52
2.2
Growth of exports of parts and components, 1981–2000
55
2.3
Export activity for product groups with the fastest growth inworld exports, 1980–98
62
2.4
Rapid growth and structural change experienced by
network participants
65
3.1
Profitability on equity, concentration, and market share (percent):
Brazil, 1971–78
99
3.2
Cartel enforcement in selected developing countries
101
4.1
Many antidumping investigations were initiated during the 1995–2001
period136
4.2International cartels can be expensive: estimates of sales and overcharge
138
4.3
National exemptions to competition law for exporters
141
4.4
Breaking up floating cartels could help developing countries
142
Boxes
1.1
1.2
1.3
1.4
1.5
1.6
2.1
3.1
3.2
3.3

vi

Is Latin America going against the rising tide?
8
Integration pays off where policies are supportive
12
The terrorist attacks of September 11, 2001 had an economic impact
16
Consumption in low- and middle-income countries is smoothed overthe business cycle
27
Is the World Bank overestimating global poverty?
31Technological progress is an important determinant of growth34
Intra-firm trade increases worldwide
59
Trade restrictions shield MNCs from competitive forces at enormous cost:
the case of Argentina
89
Competition policy and competition law share similar objectives
across countries
102
Does public investment “crowd out” or “crowd in”
private investment?
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4.1
4.2
4.3
4.4
4.5
4.6
4.7

What is a BIT?
120
The Multilateral Agreement on Investment (MAI)
122
South-South flows: who invests and who receives?
125
Do BITs increase investment flows? Only a bit
129
Disciplines on corporations can also improve the investment climate
The lysine cartel, 1995–2001
139
International cooperation aids competition policy
144

132

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ForewordP

roductivity increases and efficient investment are essential conditions for rapid growth andpoverty reduction. The key to accelerating technological improvement and increasing investment is improving the “investment climate.” In the broadest sense, this term encompasses the policy and institutional environment that fosters entrepreneurship, learning, and productive investment.
In this report, we argue that the investment climate for developing countries has both a global
dimension and a national dimension. The global investment climate, although less amenable topolicy initiatives of developing countries, nonetheless presents opportunities, risks, and at times
obstacles for developing countries. In this report, we focus on two aspects of the global investment climate: the current state of the world economy as it affects developing countries’ financial
outlook, exports, and growth prospects (chapter 1) and the organization of global business,notably the proliferation of multinational companies and associated production networks (chapter 2). In previous reports we have studied other aspects of the global investment climate, including the world trading system (Global Economic Prospects 2002) and aspects of the global
financial system (Global Development Finance 2002).
The national dimension of the investment climate for developing countries is discussed inchapter 3. This dimension is composed of the policy and institutional environment that fosters
entrepreneurship—and that strongly influences the pace of productivity growth and the rate ofinvestment. Differences in national policies help explain why some countries grow rapidly andothers do not, even though all operate within the same international investment climate. In short,policymakers have considerable scope for choosing policies that influence the amount and productivity of investment.
For the purposes of this report, we focus on two types of national policies that affect how
countries use globalization to grow. The first type is investment policies—for example, tax incentives, tariffs, subsidies, and policies to channel investment into particular activities, as well as
public investment. The second type is policies that promote or limit competition—for example,
tariffs, entry restrictions, and state monopolies as well as conventionally defined competition
policy.
We chose these policy areas for three reasons. First, these policy areas directly link the domestic policy dimensions of the investment climate with the global economy. Second—in contrast
to macroeconomic policies, property rights, and other institutional features that primarily affect
the quantity of investment—policies fostering investment and competition work instead throughmicroeconomic incentives to influence the quality of investment (as measured by its productivity).
Finally, these policies are at the center of global debate, figuring prominently in discussions of theixgep_fm.qxd 12/5/02 4:17 PM Page x

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Doha Development Agenda launched at the World Trade Organization (WTO) Ministerial Meeting in November 2001.
To inform that debate, the final chapter of this report asks how the international community
can support developing countries in their quest for better investment climates, both global andnational. The chapter focuses on synergies that can emerge from developing countries’ participation in international agreements on investment and competition policies, topics that are not only
central to the WTO Doha Development Agenda but that also figure prominently in many
regional trade negotiations around the world.
Nicholas Stern
Chief Economist and Senior Vice President
The World Bankx

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AcknowledgmentsT

his report was prepared by the Development Prospects Group in the World Bank, drawing on resources throughout the Development Economics Vice Presidency and the WorldBank’s operational units. Richard Newfarmer was the lead author and manager of thereport, under the direction of Uri Dadush. The principal chapter authors were Hans Timmer(chapter 1), William Shaw (chapter 2), Jeffrey Lewis and Scott Wallsten (chapter 3), and Richard
Newfarmer and Pierre Sauvé (chapter 4). We are grateful for the ideas and insights of Bernard
Hoekman, Michael Klein, and Theodore Moran (Georgetown University). The report was prepared under the general guidance of Nicholas Stern.
Many staff from inside and outside the World Bank contributed to the report. In chapter 1,
Caroline Farah, Himmat Kalsi, Robert Keyfitz, Annette I. De Kleine, Robert Lynn, Fernando
Martel Garcia, Mick Riordan, and Bert Wolfe contributed to the global trends; Dominique Van
der Mensbrugghe provided the long-term analysis; and Shaohua Chen and Martin Ravallion
contributed to the poverty analysis; Kathleen Rollins was the staff assistant. Chapter 2 benefited
from background papers and other inputs from Gary Gereffi, Mary Hallward-Driemeier, Shafiq
Islam, Frances Ng, Matthew Slaughter, Lawrence White, and Yong Zhang. Similarly, in chapter 3,
Claudio Frischtak, Rughvir Khemani, Kamal Saggi, Luis Villela, and Alberto Barreix as wellas Mary Hallward-Driemeier provided background papers that became building blocks for thesections on incentives, investment, competition, and foreign investment, and Denis Medvedev
provided valuable written inputs and research assistance. Chapter 4 was based on background
papers by Simon Evenett and Benno Ferrarini (competition), Bijit Bora (performance requirements), and Mary Hallward-Driemeier (bilateral investment treaties and investor protections) as
well as inputs from Aaditya Mattoo and Shweta Bagai (various). Beata Smarzynska and JacquesMorisset provided helpful guidance and comments on various aspects of the report. The regional
appendixes benefited from the written inputs of the Regional Chief Economists around the Bankand their staff. John Baffes, Betty Dow, Donald Mitchell, and Shane Streifel prepared the commodity appendix. The staff assistant for the report was Awatif Abuzeid. Mark Feige provided editorial assistance. Yinne Yu and Yong Zhang as well as Jonathan Koh provided valuable research
assistance at various stages of the report’s preparation. Dorota Nowak coordinated publicationand dissemination activities.
Several experts provided written comments that immeasurably improved the quality of the report at various stages: Pierre-Richard Agenor, Robert Anderson, Milan Brahmbhatt, Jean-Jacques
Dethier, Simeon Djankov, Richard Eglin, Antonio Estache, Shahrokh Fardoust, Alan Gelb,
Coralie Gevers, Ian Goldin, Rughvir Khemani, Aart Kraay, Ernesto May, Mustapha Nabli, Annexi

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McGuirk, Ashoka Mody, Ijaz Nabi, John Panzer, Guillermo Perry, Guy Pfeffermann, Karl
Sauvant, Todd Schneider, Mark Sundberg, and Roberto Zagha.
We are also grateful for the many substantive comments we received from governments
around the world through their Executive Directors on the World Bank’s Board.
Melissa Edeburn, Susan Graham, and Ilma Kramer managed the production for the WorldBank’s Office of the Publisher.

xii

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Summary

The global recovery is fragile, because
investment spending is insufficient tounderpin continuing growth—
Strong cyclical dynamics, together with aneasing of macroeconomic policies in the
United States and elsewhere, have boosted
large parts of the global economy into the initial phase of a recovery in 2002. The driving
forces behind the initial phase of the recovery
were strong, but they have proved short-lived
because inventory and high-tech cycles areshort and appear to have peaked. Thoughconsumption spending has held firm, this isprecisely the time when investment demandshould pick up and boost recovery onto ahigher trajectory. So far it has not. Financial
imbalances, evident in different forms
throughout the world economy, seem to beweighing down growth. Wide-ranging uncertainty in financial markets may jeopardize theneeded rebound in fixed investment and may
thus diminish prospects for projecting the
global recovery into the future. Falling andvolatile stock markets, accounting scandals,
accumulated debts (domestic and foreign, private and public), and reassessments of longrun profitability keep investors cautious, if
not jittery, throughout the world. For thesereasons, growth in 2003 seems certain to be
weaker for almost all developing regions than
we anticipated as recently as six months ago.
Analysis of long-term trends indicates thatthe investment cycle as a determinant of overall cyclical behavior is as important in low-

and middle-income countries as it is in highincome countries. But the volatility of investment is greater in developing countries than inrich countries. Countries with sound investment climates experience far less volatility
than countries with deficient policies andinstitutions.
Capital flows to developing countries have
proved to be procyclical. But the direction of
causality between investment and capital inflow appears to differ significantly between
rich and poor countries. In rich countries, aboom in domestic fixed investment tends toattract foreign capital, while in middle-income
countries it is the acceleration of capital
inflows that typically stimulates domestic
investment. Similarly, a fall in rich countries’
investment tends to reduce net capital inflows,
while for middle-income countries reduced net
capital inflows (or increased capital outflows)
are the driving forces behind contractions indomestic investment. This dependence on capital flows makes the middle-income countries
especially vulnerable to tensions in global financial markets. Low-income countries, withgreater reliance on official aid and with limited access to private capital markets, do notexhibit either of these patterns.

—but long-term prospects remain
promisingOver the long run, new opportunities fortechnological advances (often driven by
globalization), together with more stablexiii

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macroeconomic policies and an improved
business climate, have the potential to accelerate growth and to increase investment ratios
in developing countries that currently lag
behind. The outlook for reductions in global
poverty, while generally positive and of thesame order of magnitude as in our previous
report, is marginally dimmer because of theabsence of a robust recovery today.
At the same time, demographics are likely
to alter existing savings and investment patterns and will tend to push countries to become more interdependent through capital
flows. Major demographically driven shifts incurrent account balances—particularly inJapan, which is moving toward reduced surplus, and in middle-income countries, which
are moving toward increased surplus—arelikely to accelerate financial integration.
Underneath large swings in net flows are evenlarger movements of gross capital flows, as
foreign direct investment (FDI) expands into
growing markets in developing countries andas financial agents in developing countries
seek to diversify their portfolios in rich countries. However, because international financial
flows have at times fluctuated widely, they
have sometimes proved damaging to growthand poverty reduction. The international community and developing countries have tosearch for mechanisms to provide greater stability in integration. Developing countries cando much on their own. Improving the domestic investment climate, particularly throughsound macroeconomic policies and governance, can reduce the volatility of capital
flows and attract less-volatile FDI.

Global competition is creating newopportunities for developing countries
Cross-border trade and direct investment have
expanded rapidly over the past three decades.
Global exports of goods and services increased from 14 percent of output in the early
1970s to 23 percent by the late 1990s, while
global FDI flows have more than doubled relative to the gross domestic product (GDP).
The surge in FDI flows accelerated in the latexiv

1990s, rising from $331 billion in 1995 to$1.3 trillion in 2000, before falling off to an
estimated $725 billion in 2001. Most of theseflows are destined to rich countries.
FDI flows to developing countries areabout $160 billion. This amount is still relatively small compared with all domestic investment in developing countries, now about$1 trillion. Nonetheless, in virtually every region, FDI is a driving force of globalizationand has risen relative to total capital expenditures during the 1990s. It has doubled in
middle-income countries and has tripled in
low-income countries. However, recently FDI
flows have fallen. They peaked in 1999 at$184 billion and are experiencing their mostsustained fall since the global recession of
1981–83.
These trends over the past decade have increased competition in most markets aroundthe world. Despite a sharp increase in mergers
and acquisitions, the share of global economic
activity accounted for by the largest companies does not appear to have risen over the
1990s. The profits of the top 50 companies accounted for 0.8 percent of world GDP in
2001. Although their share of aggregate profits amounted to 3.3 percent of global savingsin 2000, up from 1.8 percent in 1994, this increase is likely to be the result of the boom in
the United States and the overstatement of
earnings of some large U.S. corporations.
These factors point to a pattern of stability
rather than a trend of increases. Similar patterns exist for the largest 500 companies.
Four changes in the organization of business are particularly important for developing
countries. First, the rise of foreign investment
in services is creating a new source of competition—and potential productivity gains—indeveloping countries, where staid state companies have often monopolized production for
decades. Recent efforts to privatize these companies and to open industries to competition
have allowed some developing countries toharness this competition for gains. In many
developing countries, restrictions on services
still remain high, because some countries have

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S U M M A R Y

privatized only slowly and others have privatized badly, creating private monopolies still
insulated from competition.
Second, production networks that span the
globe, once barely a dot on the horizon of international business, have now become a central feature. That so many large firms havechosen to outsource production of parts andequipment or to otherwise locate production
facilities offshore offers new opportunities
for developing countries. Firms choosing to“deverticalize” production through outsourcing create new opportunities for suppliers andcreate a foundation for a steady increase intrade for participating developing countries.
The downside is that this production and theassociated high rates of export growth arehighly concentrated geographically, and so
this door into a greater share of the global
economy has, to date, opened only for relatively few countries. Taking advantage of
networks requires a strong policy environment that fosters private investment and provides complementary public investments (seebelow).
Third, with growing concerns about risk,
investors are becoming increasingly sensitive
to investment climates in developing countries, and the result is that money is moving to
the countries with large, rapidly growing, andrelatively stable economic environments.
Countries such as China, the Republic ofKorea, and Mexico benefited from the largest
inflows in 2000. As a share of domestic investment, however, small-market countries areproving they can keep pace—provided thatthey protect property rights, have stable
macroeconomic environments, and have good
institutions. Poor countries that fall short on
policies and institutions compound the disadvantages they already experience from having
small markets. Hence, they may be virtually
shut out from foreign investment flows in any
sector other than natural resources.
Finally, long-term private investment financing for infrastructure has fallen off tolevels that may prove persistent. This retrenchment has two origins. First, the post-1997 risein global risk premiums has reduced investors’
appetite for risk and for projects with long gestations. Adversity to such projects is reflected
not only in the average spreads over U.S. Treasury interest rates that developing countries
must pay to their bondholders in the Emerging
Market Bond Index (even excluding country“outliers” in crisis) but also more generally in
spreads of high-risk corporate bonds in the
United States. Both have more than doubled
from under 500 basis points to more than
1,000. The recent collapse of the telecommunications sector, as well as difficulties experienced by major power companies associatedwith the Enron scandal, has diminished thenumber of players and enthusiasm among
potential long-term financiers. Second, many
projects have suffered payment problems
because of the inability of contracts to weather
sharp contractions in demands. From
Argentina to Indonesia, the string of defaults
associated with infrastructure projects and restructurings has left in its wake a severe retrenchment. Thus, governments throughout
the developing world will have to do more tooffset this risk—principally through better
policies, and perhaps through a slowing of theretreat from government financing of infrastructure that has occurred under the bannerof privatization.

Harnessing globalization requires
reducing barriers to competition—
To raise the productivity of both foreign anddomestic investment, developing countries
have to harness the full force of competition
inherent in globalization. Too often they havenot done so. In many countries, policy barriers to competition—whether they are impediments to trade, restrictions on incoming
foreign investment, administrative barriers tocompetition, or monopolies granted to state
enterprises—have channeled domestic as well
as foreign investment into less-productive
activities that dampen productivity improvement and hobble growth. Import competition,for example, can limit what would otherwise
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2 0 0 3producers. In a wide sample of developing
countries, decreasing imports in concentrated
industries from 25 percent of domestic sales tozero is associated with increases of 8 percent
in oligopolistic markups on sales.
Competition-impeding regulations in recently privatized industries have undermined
potential benefits from privatization and haveinsulated new owners—frequently foreigncompanies—from efficiency-improving competition; the result has been slow growth andresource misallocation. In Africa, for example,
telephone services in countries with privatemonopolies have expanded growth only onethird as fast as telephone services in countries
with competitive networks.
Over time, firms in countries with lower
barriers to trade and to investment competition tend, as a general rule, to enjoy significantly higher productivity of investment, bothforeign and domestic, and with it more rapid
growth. This fact does not imply a single prescription for all countries irrespective of theirstage of development. As the experience ofChina—among others—has shown, reforms
have to be tailored to country circumstances
and integrated into sustainable development
strategies. The analysis does imply, however,that countries wishing to increase their opportunities from globalization would do well tolook first at the incentive features of theirinvestment climate, with special attention tobarriers that impede competition.

—and using targeted interventions
with care—
Governments may hope to make up for an
unfriendly investment environment through incentive mechanisms. But while there are clearlyexamples in which targeted interventions—such as fiscal incentives, export processing
zones (EPZs), or support for economic clusters—may indeed lead to higher investment
levels (and the jobs and related spillovers thatgo along with them), there is, unfortunately,
little evidence that such initiatives can besystematically successful. Instead, they tend towork best when they work in support ofxvi

broader reform packages, either to catalyze
support for emerging opportunities (such as
clusters) or to create transitional mechanisms
and initial constituencies for reform that canbe progressively expanded (such as EPZs). But
more broadly, investment incentives will generally not make up for serious deficiencies
in the investment environment or generate
sustained growth. To encourage productive
investment and benefit from globalization,
governments must tackle the challenges ofpromoting competition and entrepreneurshipand of undertaking complementarily productive public investment in areas such as
education.

—and therefore sound public investments
are essential
Public investment also plays a crucial role inenhancing growth. Some countries get boththe levels and the composition of investmentright, and their growth rates are high. Other
countries invest too much through the public
sector and crowd out private investment.
Because these effects are also associated withinvestments in state enterprises that enjoy monopoly positions protected from competition,
the composition effects of public investment
are negative. Other countries invest too little
through the public sector. This problem is usually manifested in poor education, poor infrastructure, and poor public institutions
generally—all of which reduce profitable investment opportunities for both domestic andforeign companies. Investing in effective public institutions has an especially high return.

International agreements on investment
and competition policies can provide
benefits through reciprocity—
Countries get most of the positive growth
stimulus from domestic unilateral reforms
tailored to local strategy and conditions, andthese reforms should not be held hostage tointernational agreements. Nonetheless, reforming governments may be able to obtain
additional benefits from international agreements. Benefits can take several forms. Forgep_fm.qxd 12/5/02 4:17 PM Page xvii

S U M M A R Y

investment policies, participating in international agreements that are linked to greater
market access may elicit more investment bysignaling to investors that changes are permanent. Also, participating in international negotiations may strengthen the hand of domestic
reformers by holding out the prospect of market access abroad in exchange for new domestic policies; simultaneously, negotiations canprompt reciprocal reforms among partners
that would not otherwise occur. For competition policy, international agreements may leadto the removal of restraints that inhibit competition, thereby unleashing new price competition that benefits all countries.

—but agreements on investment policy arelikely to have strong development effects
only if they deal with the big issues facing
developing countries—
The purposes of coordinating investment
policy are to expand the flow of investment
around the world, to minimize policy externalities that hurt neighbors, and to help
improve economic performance. Agreements
might contribute to achieving these goals
through three main channels: protecting
investors’ rights, which increases incentives toinvest; liberalizing investment flows, which
permits enhanced access and competition; andcurbing policies that may distort investment
flows and trade at the expense of neighbors.
International agreements that focus on establishing protections for investors cannot be
expected to expand markedly the flow of investment to new signatory countries. This isbecause many protections are already contained in bilateral investment treaties (BITs).
Even the relatively strong protections in BITs
do not seem to have increased flows of investment to signatory developing countries.
These facts suggest that expectations for newflows associated with protections emerging
from any multilateral agreement should be
kept low.
International agreements that allow countries to negotiate reciprocal market liberalization and to promote nondiscrimination canreinforce sound domestic policies and cancontribute to better performance. Since mostof the remaining restrictions are on services,
governments around the world can increase
market access by using the existing multilateral framework rather than creating a newone. The General Agreement on Trade in Services (GATS) provides an as-yet-underutilized
arrangement to negotiate reciprocal market
access in services. To date, the coverage ofcommitments for a large number of countries
is limited. About two-thirds of the World
Trade Organization membership has scheduled 60 or fewer sectors (of the 160 or so specified in the GATS list). Moreover, in manycases, commitments do not reflect the actual
degree of openness. Finally, in some countries,
the commitments that have been made serve
only to protect the privileged position of incumbents rather than enhance the contestability of markets. To remedy these problems,
governments must take greater advantage ofthe opportunity offered by the GATS to lend
credibility to reform programs by committing
to maintain current levels of openness or byprecommitting to greater levels of future
openness. To advance the process of services
reforms beyond levels undertaken independently and to lead to more balanced outcomesfrom the developing-country point of view,countries could better harness the power ofreciprocity by devising negotiating formulasthat widen the scope for tradeoffs across sectors (both in goods and in services) and acrossmodes of delivery, particularly the temporary
movement of workers. While difficult, such efforts may prove easier than designing a whole
new international investment arrangement.
Similarly, curbing policy externalities that“beggar thy neighbor” can benefit developing
countries, especially if the countries focus
on two critical issues. The first is to reduceinvestment-distorting trade barriers. By depriving developing countries of market accessand by discouraging their exports, many tradebarriers also lessen the attractiveness of opportunities to invest in developing countries’ export industries for both foreign and domestic

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investors. In Canada, the European Union(EU), Japan, and the United States, average advalorem–equivalent tariffs for manufactures
are roughly twice as high for developing countries as they are for members of the Organisation for Economic Co-operation and Development. The ad valorem–equivalent tariffs on
agriculture (to say nothing of subsidies) in
those countries are also more than three times
higher than such tariffs on manufactures. Reducing trade barriers among developing countries themselves is as important as reducing
trade barriers in rich countries. Developing
countries import from each other at average advalorem–equivalent rates comparable to EU
rates for imports from developing countries.
This level of protection dampens investment—
both domestic and foreign—in affected exportindustries, and removal of these barriers
would have significant development effects.
The second critical issue is to curb the
emerging competition among countries to lureforeign investment through investment incentives. Unfortunately, information on the extent of investment incentives is inadequate toassess their effects, and so a high priority forinternational collaboration is to systematicallycompile this information.
Finally, participation in international agreements on investment may also have benefits
over and above unilateral reforms if the agreements include reciprocal market access inareas of importance to developing countries.
These benefits can become clear only in thecourse of negotiation.

—and thus competition agreements should
focus on restraints to competition thathurt developing countries
Greater competition is associated with more
rapid development, and lowering policy barriers to trade and foreign investment in developing countries, as shown in chapter 3, is a
powerful procompetitive force. Beyond unilateral actions, international agreements on competition policy might also bring benefits, provided they address the major restrictions thatadversely affect developing countries.

xviii

Restrictions on competition in the global
marketplace that most hurt development takethree forms. The first form consists of policy
barriers in markets abroad that limit competition among developing countries in thesemarkets. These barriers, like those discussed
above, discourage investment and create obstacles to competition. Particularly harmful
are the $311 billion in agricultural subsidies
and textile quotas, as well as the corresponding high border protection, tariff distortions(that is, tariff peaks and escalation), and protectionist use of antidumping. These practices
are only too common in all countries, rich andpoor alike. All of these trade restrictions limit
the ability of exporters in developing countries
to compete in international markets.
Second, private restraints on competition
can adversely affect prices for consumers andproducers in developing countries—much as
they can in industrial countries. For example,
cartel practices among companies based inhigh-income countries taxed consumers indeveloping countries by up to $7 billion in the
1990s. Actions that facilitate prosecution ofcartels should be high on the priority list. Suchactions can range from developing more systematic arrangements to exchange information among competition agencies, to granting
standing for developing countries to sue under
foreign antitrust laws when their trade is adversely affected. Indeed, both developing andindustrial countries would benefit from muchgreater efforts to identify and document restrictive business practices that adversely affect prices of their trade.
Third, many governments in high-income
countries officially sanction trade restraints
through antitrust exemptions for their companies in domestic law. For example, many governments permit their companies to cartelize
exports. Shrouded in the secrecy of government
registries, these national export cartels may
well raise prices to developing countries. Efforts should be made to make information on
national export cartels transparent. Everyone
would benefit from a decrease in cartels thathave damaging price effects. Similarly, antitrustgep_fm.qxd 12/5/02 4:17 PM Page xix

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exemptions for ocean transport have given riseto price-fixing arrangements that systematicallyhurt consumers everywhere, including those indeveloping countries. These restraints are estimated to cost developing countries more than
$2 billion per year and entail similar costs to
consumers in industrial economies.
Finally, competition policies in developing
countries themselves can in many cases be
improved through increased transparency,
nondiscrimination, and procedural fairness.
However, international cooperation in thiscomplex area of regulation has to recognizethat countries have different capacities andinstitutional settings, warranting caution inrecommending—much less in mandating—across-the-board policies. In this area, voluntary programs that facilitate the learning andadoption of best practices in developing countries can pay high dividends.
Unlocking global opportunities begins withthe efforts of developing countries to improvetheir investment climates. Deployed well, investment policies and policies to unleash competition can accelerate economic growth andreduce poverty. This report offers a generalframework and lessons, but each country has
to formulate its own development strategy.
Nonetheless, the international community,
working together, can help through development assistance, voluntary collaboration, andwell-conceived international agreements. For
these efforts to have greatest effect, they haveto tackle the most pressing investment andcompetition problems—and that is the challenge ahead.

xixgep_fm.qxd 12/5/02 4:17 PM Page xxi

Abbreviations
and Data Notes

ADB

Asian Development BankASCM

Agreement on Subsidies and Countervailing Measures

BITs

Bilateral Investment Treaties

EPZ

Export processing zone

EU

European Union

FDI

Foreign direct investment

FSAP

Financial Sector Assessment Program

GATS

General Agreement on Trade in Services

GPA

Government Procurement Agreement

HIV/AIDS

Human immunodeficiency virus/acquired immune deficiency syndrome

ICC

International Chamber of Commerce

ICN

International Competition Network

ICSID

International Center for Settlement of Investment Disputes

IMF

International Monetary Fund

ITO

International Trade Organization

LDC

Least developed countries

M&A

Mergers and acquisitions

MAI

Multilateral Agreement on Investment

MERCUSOR

Latin America Southern Cone trade bloc (Argentina, Brazil, Paraguay, andUruguay)

MFN

Most favored nation

MNCs

Multinational corporations

NAFTA

North American Free Trade Agreement

NGO

Nongovernmental organization

OAS

Organization of American States

OECD

Organisation for Economic Co-operation and Development

ROSC

Reports on the Observance of Standards and Codes

SOEs

State-owned enterprises

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TNCs

Transnational corporations

TRIMs

Trade-Related Investment Measures

TRIPS

Trade-Related Aspects of Intellectual Property Rights

U.S. BEA

U.S. Bureau of Economic Analysis

UNCITRAL

United Nations Commission on International Trade Law

UNCTAD

United Nations Conference for Trade and Development

UNDP

United Nations Development Programme

USAID

U.S. Agency for International Development

WTO

World Trade Organization

Data notes
The “classification of economies” tables atthe end of this volume classify economies byincome, region, export category, and indebtedness. Unless otherwise indicated, the termxxii

“developing countries” as used in this volume covers all low- and middle-income countries, including countries with transition
economies.

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1
The International Economy andProspects for Developing Countries

Developments in early 2002 showed acyclical rebound—
Macroeconomic stimulus, a rebound from arecord trough in the high-tech sectors anda bottoming-out of inventory cycles, broughtlarge parts of the global economy onto a recovery path at the end of 2001. Lower interest
rates helped keep consumers’ demand fordurable goods strong. Together with fiscal easing, that demand provided support for therebound in the United States and, to a lesser
extent, in some East Asian and European
countries. High-tech markets—in which technologies quickly become obsolete—returned
to strong growth by creating replacements forold products. Inventory selloffs ceased, thereby
contributing to an acceleration of gross domestic product (GDP) growth in early 2002.
The driving forces behind the initial phaseof the recovery were strong, but short-lived, asbusiness confidence remained weak. Inventory
and high-tech cycles typically are short, andboth appear to have peaked toward the middleof 2002. The effects of fiscal stimulus andmonetary easing can also, under current circumstances, dissipate quickly.

—but uncertainty in financial markets has
sapped momentum
In the second phase of a typical recovery, theupturn spreads to other sectors and otherregions, and the driving force shifts from inventory dynamics to accumulation of fixed
investment. In the current upswing, however,the second phase is in jeopardy because of tensions in financial markets, which reflect accumulated financial imbalances and significant
uncertainties. These pressures have made therecovery in 2002 less uniform, and they arelikely to moderate growth in 2003.
In Japan, deflation and high and rapidly
growing government debt have placed severe
limits on both monetary and fiscal stimuli.
Combined with the fragility of the banking
sector, which is burdened by bad loans anddiminishing capital caused by lower equity
values, financial uncertainty prevents the
spread of recovery from export sectors to
those that produce for the domestic market.
The accounting scandals in the United States
have undermined the trust in reporting systems. Investors, who have come to rely on
continuously rising equity prices, now find it
difficult to assess the profitability of firms.
That difficulty sharply pushed up risk premiums in equity markets. European financial institutions were forced to adjust their balance
sheets in the wake of large-scale defaults,
notably by Argentina and several major
U.S. firms, which probably played a role in
suppressing a nascent recovery in European
economies. In Europe and elsewhere, telecommunication sectors still suffer from overinvestment and high debt burdens, making a
speedy recovery of capital spending in those
sectors unlikely.
Uncertainty is keeping investors cautious,
if not skittish, throughout the world. While1gep_ch01.qxd 12/5/02 4:15 PM Page 2

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investors in high-income countries take theirlosses and replenish their reserves, they limit
their exposure to developing countries andconcentrate their assets in investment-grade
borrowing countries.1 Capital flows into large
parts of Latin America dropped sharply, reflecting the aftermath of Argentina’s default
and the vicious combination of global uncertainty, domestic problems in some large countries, and intra-regional contagion. The reversalof capital flows—with the accompanying risein spreads and depreciation of currencies—
when combined with vulnerable balancesheet characteristics triggered a dangerous
worsening of debt dynamics in some Latin
American countries. In such an environment,
average per capita income in Latin America
has fallen in 2002 for the second year insuccession.

The rebound in 2002 was less uniform
than anticipated—
Rapid recovery in the beginning of 2002,
driven in part by sharp increases in the U.S.
government’s expenditure in the aftermath ofterrorist attacks, has resulted in upward revisions of 2002 growth for the United States,
East Asia, and Japan, relative to forecasts
prepared in February (table 1.1). At the otherextreme, growth in Latin America has been
lowered by 1.6 percentage points for theyear. This decrease reflects not only the crisisin Argentina, but also the major contractions of GDP in Uruguay and the República
Bolivariana de Venezuela, plus slow growthin Brazil, Chile, and Mexico. Those events
made the 2001–02 period the worst for theregion since the debt crisis of the early 1980s.
Consistent with higher-than-anticipatedglobal growth, non-oil commodity prices in2002 have risen more than anticipated.
Nonetheless, the present rebound in commodity prices is modest from an historicalperspective, thus highlighting the continuing
downward pressures on prices tied to structural factors. Higher commodity prices havesupported modestly improved performance in
Sub-Saharan Africa.

2—and the outlook for 2003 is
for tepid growth
Reflecting financial uncertainty and the disappointing recovery of business confidence,
projected growth for 2003 has been marked
down for almost all developing regions, because a robust rebound in industrial country growth—driven by strong advances ininvestment—has become less likely. In linewith these revisions, inflation, interest rates,
and non-oil commodity prices are also likely
to be lower. The sole exception to this patternis the Middle East and North Africa region,
where oil exporters have benefited from highoil prices during 2002. Several of these countries are seeing increased government expenditure, financed by rapidly mounting surplusesof oil revenues.

Investment cycles in developing countries
are more volatile than in rich countries
With the sharp fall in global investment in2001 and the uncertainty surrounding a rebound in capital expenditure, investment
behavior has become a key element of theoutlook. A closer look at investment cycles indeveloping countries suggests the following
conclusions:• Investment behavior in low- and middleincome countries is a determinant ofoverall volatility that is even more
important than it is in high-income
countries.
• Those developing countries with astronger policy environment exhibit
lower volatility in investment.
• Although in rich countries domestic
fixed investment tends to drive foreign
capital inflows, in middle-income countries the opposite tends to occur (that is,capital inflows typically drive domestic
investment).
These conclusions imply that the middleincome countries are especially vulnerable tothe current jitters in financial markets. Suchcountries are exposed to sudden reversals ingep_ch01.qxd 12/5/02 4:15 PM Page 3

T H E

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

Table 1.1

E C O N O M Y

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

Global conditions affecting growth in developing countries and world GDP growth(percentage change from previous year, except interest rates and oil price)

Current estimate

Global Development
Finance 2002 forecasts

Current forecasts

2000

2001

2002

2003

2004

2002

2003

Global conditions
World trade (volume)

13.1

0.5

2.9

7.0

8.0

1.8

8.3

Inflation (consumer prices)
G-7 OECD countriesa,bUnited States

1.9
3.4

1.7
2.8

0.9
1.5

1.2
2.1

1.5
2.3

0.9
1.5

1.6
2.4

Commodity prices (nominal $)Commodity prices, except oil ($)
Oil price ($, weighted average), $/bbl
Oil price (% change)
Manufactures export unit value ($)c

1.3
28.2
56.2
2.1

9.1
24.4
13.7
1.4

5.0
25.0
2.7
0.5

5.8
23.0
8.0
3.0

4.4
20.0
13.0
2.2

1.3
20.0
17.9
0.5

7.3
21.0
5.0
3.6

Interest rates
LIBOR, 6 months (US$, percent)
EURIBOR, 6 months (euro, percent)

6.6
4.5

3.6
4.2

1.8
3.4

1.5
3.2

3.1
3.8

2.3
3.0

4.0
4.0

World
Memo item: World GDP (ppp)e

3.8
4.5

1.1
2.1

1.7
2.8

2.5
3.4

3.1
4.0

1.3
2.4

3.6
4.3

High-income countries
OECD countriesf
United States
Japan
Euro Area
Non-OECD countries

3.5
3.4
3.8
2.1
3.7
6.8

0.7
0.8
0.3
0.3
1.5
0.7

1.5
1.4
2.3
0.0
0.8
2.3

2.1
2.1
2.6
0.8
1.8
3.7

2.7
2.6
3.1
1.3
2.6
5.3

0.9
0.8
1.3
1.5
1.2
2.7

3.3
3.1
3.7
1.7
3.3
5.3

Developing countries
East Asia and Pacificf
Europe and Central Asia
Transition countries
Latin America and the Caribbean
Excluding Argentina
Middle East and North Africa
Oil exporters
Diversified economies
South Asia
Sub-Saharan Africa

5.2
7.0
6.6
6.4
3.7
4.5
4.2
3.6
3.7
4.8
3.2

2.9
5.5
2.3
4.6
0.4
1.2
3.2
2.4
4.3
4.4
2.9

2.8
6.3
3.6
3.5
1.1
0.7
2.5
2.4
2.2
4.6
2.5

3.9
6.1
3.4
3.3
1.8
1.9
3.5
3.7
2.7
5.4
3.2

4.7
6.4
3.6
3.5
3.7
3.6
3.7
3.6
3.6
5.8
3.8

3.1
5.6
3.2
3.4
0.5
2.1
2.7
2.2
3.1
4.9
2.6

4.9
7.1
4.3
4.0
3.8
4.3
3.3
2.8
4.4
5.3
3.6

5.0
4.6

2.6
1.7

2.7
1.5

4.0
2.8

4.9
3.8

3.1
2.0

5.1
4.1

GDP (growth)d

Memorandum items
Developing countries
Excluding the transition countries
Excluding China and India

Note: OECD  Organization for Economic Co-operation and Development, bbl  barrel, EURIBOR  European interbank offered rate, LIBOR  London
interbank offered rate, ppp  purchasing power parity.
a. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
b. In local currency, aggregated using 1995 GDP weights.
c. Unit value index of manufactures exports from the G-5 countries to developing countries, expressed in U.S. dollars.
d. GDP in 1995 constant dollars: 1995 prices and market exchange rates.
e. GDP measured at 1995 purchasing power parity (international dollar) weights.
f. Republic of Korea income classification changed from middle to high income (July 2002). Both forecasts were adjusted for this revision.
Source: World Bank, November 2002 and Global Development Finance 2002 projections of February 2002.

3

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capital flows, which can dampen investment
sharply and can undermine growth momentum. Countries with strong policy environments are more likely to avoid or smoothly
absorb potential external financial shocks.

In the long term, faster growth
can be achieved in mostdeveloping regions
Market reforms and trade liberalization during the 1990s have opened opportunities foraccelerating technological advances throughout the developing world for the next 15 years.
An exception is emerging East Asia, wheresome moderation of technological progressis anticipated, reflecting in part the extraordinarily rapid catching-up that occurred during the 1980s and 1990s. The acceleration of
growth in many of the other regions is likely
to coincide with increasing savings and investment rates. Demographic transitions are anticipated to boost saving rates in developing
countries, while reducing them in high-income
countries.
On balance, the declining availability ofsavings in the aging populations of high-income
countries and the increased savings in thedeveloping world—set against investment
patterns needed to accommodate potential
growth—imply that more and more developing countries will move toward surplus on thecurrent account and that the recent shift fromdebt accumulation to debt reduction is likely
to continue. As long as domestic credit markets continue to mature and public savings
do not deteriorate, domestic savings can be
expected to rise, and the required reduction in
debt levels will not conflict with the required
investment.

A recovery constrainedby major risks

During the summer of 2002, investor risk
perceptions increased and market sentiment deteriorated across large parts of theworld’s economy, thereby jeopardizing the
global recovery that had started in the fourth

4quarter of 2001. Accumulated financial imbalances that had built up during the 1990s
emerged as a critical factor that clouded theeconomic outlook. In the United States, thebursting of the equity bubble and cumulated
private sector debt kept investors cautious andresulted in a continuous flight to quality,
which moved the yield on government bonds
to a 40-year low while hampering the recovery
in private investment. In Japan, banking problems and the lack of scope for monetary easing and fiscal stimulus limited the spilloverfrom an export-driven recovery to a reboundin domestic investment. In Europe, weakness
was concentrated in the highly indebted
telecommunications sector and in financial
sectors that had to absorb sharp devaluationsof their assets.
Bankruptcies and reductions in investment
during the global downturn of 2001 and thesubsequent first phase of recovery in early
2002 had not reduced corporate debt nor restored profitability sufficiently. In a number ofcases, the downturn has generated new imbalances. Throughout the world, fiscal balances
deteriorated and balance sheets of financial
institutions weakened. Continued tension in
financial markets made the recovery less uniform in 2002—as well as probably less robustin 2003—than would have been the caseunder more normal circumstances. Vulnerability to adverse shocks has increased, and eventhe potential for a “double-dip” recession scenario in the industrial countries cannot—at
this juncture—be entirely ruled out.
Three distinct phases characterize recent
developments. The first phase portrays thedriving forces behind the initial phase of therecovery that started in late 2001, a recovery
that was more robust in the United States andEast Asia. These forces range from the end of
inventory adjustment, monetary easing, andfiscal stimulus to a technical rebound in thehigh-tech industrial sectors. This picture normally would be characterized as a favorable
environment for developing countries. That
environment includes low inflation and interest rates, plus a significant recovery in global

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E C O N O M Y

trade and commodity prices, albeit a recovery
from low levels. During the second phase, arecovery typically broadens to other regions
and other sectors. Therefore, a recovery of
profits and strong growth in fixed investment
becomes the driving force that sustains or evenaccelerates growth. In the absence of suchbroadening and deepening, driving forces that
underpin the initial phase would suddenly
appear to become short lived, which is thesituation today. Finally in the third phase—typically the shift from “recovery” to economic expansion—implications of the set of
opposing forces (cyclical rebound and financial turbulence) for the medium-term global
outlook (2003–04) are analyzed. The lack of
uniformity in growth performance during
2002, following an almost synchronized slowing of growth across regions in 2001, is particularly notable. The growth projections for2003 are more uniform across regions, but
are distinctly weaker than would have been
anticipated in a strong, synchronized global
recovery.

The first phase of the global
recovery was driven
by policy stimulus—
In the wake of the terrorist attacks in September 2001, forceful monetary easing in the
United States—and to a lesser extent inEurope—helped prevent a deepening of the
global downturn. U.S. consumers benefited
from historically low interest rates to boost
their purchases of durable goods. Combinedwith double-digit growth in government
spending—mainly driven by security, defense,
and reconstruction efforts—the stimulus was
sufficient to turn U.S. GDP growth positive, to
2.7 percent (annualized), in the fourth quarterof 2001. One quarter later, Japan, which suffered steep output declines for three quarters
in succession, and Europe, having experienced
only a modest fall in GDP, broke away fromnegative growth rates as well.
The importance of U.S. domestic demandin this recovery is striking. During the firsthalf of 2002, GDP advanced at a 3 percent

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

annual rate, despite a drag of nearly 1.5 percentage points stemming from a deteriorationof net exports. In contrast, output in Japan increased by 2.5 percent, of which foreign tradecontributed 1.8 percentage points, while in theEuro Area, GDP growth of 1.6 percent was
supported by almost 1 percentage point frompositive net exports contributions.

—inventory dynamics—
Inventory dynamics played a pivotal role in
the recovery, thus complementing macroeconomic stimulus efforts. The same reductionin the inventory stock that led to a negative
contribution of stock building to GDP growthin 2001 implied a positive contribution ofstock building to GDP growth in 2002. Oncethe lower level of desired inventories wasachieved, stock building shifted from sharply
negative to close to zero. The slowing of inventory liquidation significantly shifted the contribution to GDP growth from the second halfof 2001 to the first half of 2002: that shift
added 1.2 percentage points to the acceleration of GDP growth in both Japan and theEuro Area, and a full 2.2 percentage points in
the United States (figure 1.1).

—a high-tech rebound—
Recovery in global high-tech markets was anequally powerful stimulant. After demand forsemiconductors and related equipment plummeted during 2001, markets were anticipated
to rebound sharply, but the scope of recovery
exceeded expectations. There are several
natural limits to declines at rates of up to
50 percent. The nature of the product—thetechnology of which becomes obsolete
quickly—warrants a periodic return to highgrowth, as old products are replaced by newones and as the introduction of advanced
technologies generates new and growing markets. Defense- and security-related spending in
the United States also played a role in bolstering demand (U.S. manufacturing orders forcomputers and communications equipment
ratcheted to annual rates of 40 and 90 percent, respectively, in early 2002). As the5gep_ch01.qxd 12/5/02 4:15 PM Page 6

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2 0 0 3Figure 1.1 The recovery was initiated in a typical fashion(growth in percent)5
GDP growth

4

Japan

3
Stock contribution

2
1
0
1
2

United States

3Euro Area

4
5
6
Q3
2001

Q4
2001

Q1
2002

Q2
2002

Q3
2001

Q4
2001

Q1
2002

Q2
2002

Q3
2001

Q4
2001

Q1
2002

Q2
2002

Source: U.S. Department of Commerce; Japan Economic Statistics and Research Institute (ESRI) and Eurostat.

rebound intensified, a strong boost was given
to manufacturing output in industrial countries, and especially to production and exports
from East Asia (figures 1.2 and 1.3).
Macroeconomic stimuli, inventory dynamics, and a powerful turnaround in high-techmarkets in the industrial countries set the stage

Figure 1.2 A brief rebound in industrial
countries was underway
Manufacturing production

Figure 1.3 Rebound in industrial
countries boosted production in East
Asia
Semiconductor dollar sales and industrial
production*(percent change, 3m/3m saar)(percent change, 3m/3m saar)

50

125

20

Semiconductor sales(left axis)

100

15
Japan
EU-15

5

40
30

75

10

Industrial production(right axis)

50

20
10

0

25

5

0

0

10

25

10

United States

15
20
Jan. May Sep. Jan. May Sep. Jan. May Sep.
2000 2000 2000 2001 2001 2001 2002 2002 2002
Note: 3m/3m saar refers to 3-month/3-month seasonallyadjusted annualized rate.
Source: Datastream.

6

for a broader global recovery through thetraditional channels of international transmission. With world trade increasing, commodity
prices firming, and interest rates—fostered by
low inflation—standing at historically low

20

50
Jan.
2000

Jul.
2000

Jan.
2001

Jul.
2001

Jan.
2002

Jul.
2002

Note: Through July 2002. *Republic of Korea, Malaysia,
Singapore, and Taiwan, China.
Source: Semiconductor Industry Association (SIA) andnational sources through Datastream, World Bank staff
estimates.

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E C O N O M Ylevels, developing countries faced a broadly
favorable environment during the early part of
2002.

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

crisis, such as Argentina and Turkey, haveposted inflation peaks of just 20 to 40 percent.

—and a recovery of global trade

The second phase of the recovery
is on uncertain footing

World trade began to grow at near doubledigit annual rates, recovering from a fall tonegative territory during 2001. The WorldBank’s non-oil commodities price index
gained 19.2 percent between October 2001
and October 2002 (figure 1.4), while the relevant index for Sub-Saharan African (SSA)
countries rose further—by 30 percent. However, commodity prices are still one-third
below their peak levels, which occurred during
the summer of 1997, and several exporters,
notably those in Caribbean countries thatspecialize in coffee and sugar, did not benefit
from the rebound in average prices during thefirst half of 2002. Historically low inflation
characterized not only the high-income
economies, but also those in the majority ofdeveloping countries. The median inflation
rate in developing countries is presently onethird of that during the 1990s, despite relatively high oil prices and more widespread
adoption of flexible exchange rates. Indeed,
double-digit inflation rates have become an
exception, and countries experiencing recent

Notwithstanding the positive environment
taking shape in early 2002, it became apparent before the middle of the year that financial
strains were clouding the outlook. In thewake of large corporate bankruptcies andthe accounting scandals in the United States,
stock markets still seemed overvalued anddebt levels seemed underestimated. Falling
equity prices further eroded the capital baseof Japanese commercial banks and otherfinancial institutions. The growth outlook
for Latin America deteriorated noticeably.
Following Argentina’s default, Uruguay andParaguay were also hit hard through financial
and trade linkages. Political uncertainty in the
República Bolivariana de Venezuela triggered
capital flight, and in several other countries
debt dynamics worsened as a result of a combination of domestic problems and increased
risk aversion in international capital markets(box 1.1). In Europe, financial institutions
were hit hard by defaults in the United Statesand in Argentina, as well as by falling equity
prices and a weakening of the dollar. And the

Figure 1.4 Non-oil commodities are recovering but stand well below previous peaks(index, Sept./Oct. 2001  100)
190
Agriculture

180
170
160

Sub-Saharan Africancommodities

150
140
130
Metals/minerals

120
110
100
Jan.
1997

Jul.
1997

Jan.
1998

Jul.
1998

Jan.
1999

Jul.
1999

Jan.
2000

Jul.
2000

Jan.
2001

Jul.
2001

Jan.
2002

Jul. Oct.
2002 2002

Source: World Bank staff.

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2 0 0 3

Box 1.1 Is Latin America going against therising tide?

E

conomic activity in Latin America and the
Caribbean (LAC) has fallen behind production
trends in other developing countries (box figure).
The region’s per capita gross domestic product(GDP) is estimated to have dropped by 2.6 percent
in 2002, the only developing region where per capita
output contracted during the year. This decline was
the second consecutive year of contraction in percapita incomes—the worst performance since thebeginning of the debt crisis in the early 1980s. Why
is LAC going against the tide of rising global income
growth?
The crisis in Argentina and the spillover
effects on Southern Cone Common Market(MERCOSUR) countries (particularly Uruguay
and Paraguay) clearly contributed the most to thedecline in regional output during 2002. In Brazil,
the combination of rising public debt, of declining
export revenues tied to the collapse of demand in

Latin America falls behind(industrial production, index, 1995  100, 3-monthmoving average)
135
130
125

All developing
countries

120
115
Latin America
110
105
100
Feb.
1997

Feb.
1998

Feb.
1999

Feb.
2000

Feb.
2001

Feb.
2002

Argentina, and of expanding political uncertainties
in the run-up to the October elections all contributed to a weakening in financial market sentiment toward the country. The combination also resulted in a sharp reduction in private financing
flows, which, in turn, led to a deterioration of public
debt dynamics.
With financial markets increasingly averse to
taking risks through financial flows to the major
LAC countries over the course of the year, othercountries in the region were unable to obtain significant new financing from international capital
markets at reasonable terms. This lack of financing
limited growth in high-debt countries with significant
financing requirements. Political instability in
República Bolivariana de Venezuela—an aborted
coup in March that came on top of poor economic
management in previous years—led to a large
contraction in GDP of some 6 percent.
The crisis in Argentina and its fallout is a classic
example of a vicious circle of instability in international financial markets and domestic vulnerabilities:
high levels of debt; large financing requirements;
and, in some countries, fixed exchange rates, political uncertainties, and weak banking systems. Oncea crisis erupts, the vicious circle turns into a brutal
downward spiral in which a depreciation of thecurrency, debt burdens, a deterioration of dollar
returns, a rise in spreads, and a reversal of capital
flows reinforce each other. Argentina’s peso lost
more than two-thirds of its value in the year to
September. In a comparative perspective, stock
prices increased over the same period by 20–30 percent in several countries in East Asia and Central
Europe, currencies were stable and spreads did notincrease substantially.

Source: National statistics; World Bank staff.

Source: World Bank staff.

plight of European telecommunications sectors continued to deepen under the weight ofoverinvestment and mounting debt loads.
Bankruptcies and sharp reductions in investment expenditure, driven by the erosion ofequity values and a tightening of credit stan-

8

dards, have reduced some of the corporate
debt, but they have also led to a deteriorationof the balance sheets of financial institutions.
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so, they further fueled the fall in stock prices
and amplified new imbalances. Similarly,
the drop in capital flows has increased debt
problems in several vulnerable middle-income
countries.
Another example of new or deteriorating
imbalances is the public sector deficit acrossthe industrial countries. The U.S. general government deficit deteriorated from a surplus
position of 2.3 percent of GDP in calendar
year 2000 to a deficit of 2.5 percent in 2002,
with 2.5 percentage points of that shift attributed to structural deterioration. In turn, theUnited States has not taken advantage of therecession to narrow its deficit on current account. Despite increases in the household savings rate and declines in the private investment
rate, the current account deficit widened toa watershed mark of 5 percent of GDP as ofthe second quarter of 2002.
In the Euro Area as well, fiscal deficits havedeteriorated from a 0.9 percent surplus to a likelevel of deficit, though this deterioration reflects mainly the work of automatic stabilizers.
Unlike the U.S. fiscal deficit, it is not a structural deterioration. France, Germany, Italy,
and Portugal are now approaching the current
limits of a 3 percent of GDP deficit, limits
that were imposed by the European Monetary
Union Growth and Stability Pact. The originalplan to eliminate deficits by 2004 has beenabandoned and replaced by an agreement to
reduce structural deficits by at least 0.5 percentage points per annum over the coming
years. Japanese fiscal deficits remain extraordinarily high, at levels above 7 percent of
GDP. And East Asian emerging economies, on
average, continue to run relatively high deficit
levels—above 4 percent of GDP—contrasted
with a deficit of 1 percent before the 1997 crisis.
In other parts of the developing world, primary
surpluses are increasing, but improvement of
the overall deficit remains difficult to achieve,
given the burden of debt service.
Deteriorated government deficits, combined with low nominal interest rates, haveleft little room for further fiscal stimulus ormonetary easing, although some lowering of

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

interest rates seems still likely, especially in
the Euro Area. The limited scope for macroeconomic policy makes the risks surrounding
the recovery even more severe. Policy solutionsin the industrial world may best be focusedon eliminating bad debts and restoring investor’s sentiment by strengthening institutional oversight.

Capital flows to emerging markets
are declining
Also important for middle-income countries was a continued decline in international
market-based capital flows, despite low international interest rates and the initial phase ofrecovery in the industrial world. New grosscapital market flows fell from $228 billion in2000 to $175 billion in 2001, falling further
to near $140 billion during 2002 (figure 1.5),
with bank lending showing the steepest falloff.
The latter point highlights the cautious position that international banks have adopted
following financial crises in Turkey andArgentina and following defaults by several
large U.S. corporations. These capital flow figures suggest that total external debt in thedeveloping world continues to contract.
Net foreign direct investment (FDI) inflows
to developing countries also trended down-

Figure 1.5 Private sector creditors havecut debt exposures so far in 2002
(gross market-based monthly flows in billions of dollars)
25
20

2001 monthly average  $14.3
2002 monthly average  $12.1

15
10
5
0
J F M A M J J A S O N D J F M A M J J A
2001
2002
Source: Euromoney and World Bank staff estimates.

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2 0 0 3Figure 1.6 FDI flows to emerging Asia
are proving to be quite resilient
Net inflows of FDI by region(billions of dollars, half yearly rate)
50
45

Latin America

40
35
30
25
20
15

Emerging Asia
Emerging Europe

10
5
0
1st
2nd
half
half
1999

1st
2nd
half
half
2000

1st
2nd
half
half
2001

1st
half
2002

Source: World Bank staff estimates.

ward, from about $170 billion in both 2000
and 2001, to an estimated $145 billion during
2002 (figure 1.6). The decline can be almost
wholly attributed to reduced flows into Latin
America, as FDI into Central Europe and East
Asia retained a resilient tone. That resilience
underscored the importance of the course of
integration into global and neighboring markets that China [recently gaining membershipin the World Trade Organization (WTO)] andCentral European countries [anticipating
European Union (EU) accession] are following
at present.

Financial strains may inhibit
corporate investment—
During the fall months of 2002, investment
was still declining in both high-income anddeveloping countries, although the declines
were bottoming out, which indicated the beginning of a turnaround (figure 1.7). In a typical recovery, once investment growth returns
to positive territory, the recovery gets new
impetus, because a virtuous circle of adjustments in the capital stock and in expectedmarket growth may easily generate doubledigit advances in capital spending. However,10

financial strains currently battering corporate
sectors are likely to have a restraining effecton investment. Falling equity prices, concerns
about corporate debt, uncertainty about profitability, and cautious commercial bank lending in high-income countries tend to curtailfinancing for investment. Moreover, current
business uncertainty regarding future demand
growth serves as an additional restraining
force on capital spending. Reduced capital
flows to emerging markets place a damper
on investments in the developing world. If
one looks further ahead, large and increasing public sector deficits carry the potential
to “crowd out” private investment in highincome and developing countries alike, although low interest rates on government
bonds show that such crowding out is not yet
a problem.

—and driving forces for the initial phase
could be short-lived—
Without a solid upswing in investment anda concomitant broadening of recovery, theforces driving the first phase of the reboundFigure 1.7 Investment recovery is still
uncertain(4-quarter moving average, percentage change
q/q, saar)
15

Developing countries*

10
Industrial
countries
5

0
5
10
Q1
1997

Q1
1998

Q1
1999

Q1
2000

Q1
2001

Note: q/q refers to quarter over quarter.
*Argentina, Brazil, Chile, Mexico, Czech Republic,
Poland, Turkey, Indonesia, Rep. of Korea, Malaysia,
Philippines, Thailand, and South Africa (45% of
developing country total).
Source: Datastream and World Bank staff estimates.

Q1
2002

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could well become short-lived. Widening public sector shortfalls limit the range of options
for fiscal policy. As France, Germany, andItaly approach Maastricht limits; as the U.S.
deficit widens; and as Japan remains encumbered by continuing massive fiscal imbalance,
opportunities for further fiscal stimulus in theindustrial world have indeed become quite
scarce. Moreover, it appears that several otherdriving forces for the initial recovery could
quickly run out of momentum while theirstimulative properties dissipate. Official interest rates now standing at historically low
levels (particularly in Japan and the UnitedStates) leave little prominent role for further
monetary easing. And the inventory andhigh-tech cycles—typically of short duration—
probably reached peak levels by mid-2002.
Japanese output growth is now largely
grounded in export growth, although consumers have begun to spend at more rapid
rates—despite softening labor market conditions. Japan’s strong export performancestands at risk and could fade quickly should
foreign demand conditions worsen, should theyen resume its appreciation against the dollar,
or both. In the United States, considerable uncertainty is attached to the outlook for consumer spending. Following robust purchasesof durable goods during the third quarter—
particularly automotive sales that were induced by zero interest incentives—questions
arise concerning the tenor of growth into thefinal quarter of the year. Incentives cannot continue indefinitely, and massive equity-based
wealth losses of the past two years could playa larger role in households’ consumption decisions. Though low interest rates have spurredmortgage refinancings and “cash outs,” which
are anticipated to place some $100 billion to$200 billion of additional liquidity into thehands of consumers during 2002, this trend
could prove limited if the recovery falters seriously. U.S. business remains cautious in investing or rehiring, in part because of the clouded
outlook for growth in final demand. And in
the Euro Area, especially in Germany, domestic demand is lackluster, and near-term growth

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

appears to be dependent on (and exposed to)
global demand and financial conditions.
Growth was disappointing in the first half of2002, and expectations for only a sluggish
advance in output during the second half of theyear have now become more widespread.

—implying a much less supportive
external environment for developing
countries
Against this background—particularly thelack of a rebound in fixed investment acrossindustrial countries and the intensification offinancial uncertainties—the environment fordeveloping countries is much less favorable.
International interest rates may remain low,
but borrowing costs have risen in step with increases in interest rate spreads. Trade volumes
and commodity prices may be on the rise, butthey are still at low levels, and momentum isweakening. Metal prices started to decline
again in the middle of 2002, adding to the
doubts about the strength of the global recovery. The further rise in agricultural prices was
mainly due to specific supply disruptions—ascivil strife in Côte d’Ivoire jeopardized cocoa
production and as droughts in Australia,
Canada, and the United States boosted wheat
prices—and was not a sign of rising demand.
Inflation remains low, but the danger ofoutright deflation has emerged in parts ofdeveloping and industrial East Asia—China,
Hong Kong (China), Singapore, Taiwan(China), and Japan. Stable and low inflation isa prerequisite for solid growth and creates afavorable environment for effective monetary
policy. However, in several cases, a sharp drop
in inflation has increased real interest rates
and has worsened debt problems. Althoughdeflation limits the options for monetary policy, it tends to depress investment and demandfor durable goods.
With market emphasis on financial strains
and risk perceptions, it is important not tolose sight of several brighter spots in thedeveloping world. Market reforms, including
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2 0 0 3many countries during the 1990s, are noteworthy. These changes have contributed tofaster growth in trade and in welfare gains, andthe process continues across many countries.

China and several Central European countries
are examples of successful reforming economies that are preparing for even further integration into foreign markets. This integration

Box 1.2 Integration pays off where policies
are supportiveT

he recent global downturn has depressed export
growth across the developing world, leading toa contraction in aggregate volume from the third
quarter of 2001 through the first quarter of 2002.
However, several countries—notably China, theCzech Republic, Hungary, and Poland—have beenable to record impressive export volume growth(box figure). They have done so by increasing theirmarket share, which has allowed them to partially
offset the dampening effect of the global downturn.
This increase in market share, in turn, reflects acontinuing pattern of their intensifying integration
into the global economy and of attendant inflowsof FDI.
Greater integration with world markets has
been achieved by China, for example, through its
recently gained membership (December 2001) inthe WTO, after years of negotiations and efforts tocomply with WTO rules and standards. The three
Central European countries have raised their trade

Several developing countries
show solid export performance(volumes, 3-month moving average, percent y/y)
40

China

30

Eastern Europe

20
10
0
10

Other developing countries

Jan.
2000

Jul.
2000

Jan.
2001

World
Jul.
2001

Jan.
2002

Note: y/y refers to year over year.
Source: Datastream and World Bank staff estimates.

Jul.
2002

integration with global markets largely through the
EU accession process, association agreements, andlower trade barriers, which will culminate with full
membership in the EU, which appears now on trackfor 2004.
Reduction of trade barriers is but one factor
that has made these countries successful and able
to take advantage of trade opportunities. Macrostability, rapid institutional reforms toward liberalization of domestic markets, good or adequatelevels of education, and competitive wages (relative
to productivity growth) all contribute to thesuccess.
These four countries have benefited fromstrong and sustained inflows of FDI from Westerninvestors that have been building production
capacity and transferring management skills andtechnical know-how, in addition to financing, suchthat these countries can gain additional market
share as integration deepens. FDI inflows help expand production capacity and raise productivity(that is, they help to improve the recipient country’s
competitiveness). All four countries have posted
high FDI inflows according to various measures.
For example, using the ratio of the economy’s shareof world FDI inflows to the economy’s share ofworld GDP, China, the Czech Republic, Hungary,and Poland all posted ratios of above 1 (or the world
average) for 1998–2000—of 1.3, 2.7, 1.2, and 1.5,
respectively. As a share of gross fixed capital formation, FDI inflows to these countries have also beenhigh, particularly in China, where FDI inflows averaged 13 percent of gross fixed capital formation during 1990–99. In the Czech Republic, Hungary, andPoland, FDI inflows averaged 25, 19, and 16 percent, respectively, as a share of gross fixed capitalformation during 1997–99.
Source: World Bank staff.

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A N D

not only pays off in the long run, but also has
assisted these countries in absorbing or evenavoiding short-term shocks and fluctuations,by promoting business confidence and by facilitating export-oriented FDI. Perhaps more
important, through relatively large inflows of
FDI, these countries have become less vulnerable to turmoil in international financial markets (box 1.2).

• Global growth in 2002, the initial yearof the forecast, shows little resemblance
to the uniform recovery that one would
normally expect after an almost synchronous downturn in 2001. Instead, it displays quite diverse patterns of activity
across industrial as well as developing
countries.

F O R

D E V E L O P I N GC O U N T R I E S• Growth in 2003–04 is anticipated to bemoderate. World GDP reflects a combination of a more gradual recovery in
Latin America, an emergence of modest
growth in Japan, and a generally subdued rebound in other parts of the global
economy. The average outturn does notfollow the typically strong patterns ofrecovery and expansion that is concurrent
across regions and reinforced by accommodating macro policies.
• Downside risks to the baseline forecast
are substantial. The global recovery
appears vulnerable to additional shocks.
(These points are discussed after we
review the external environment andoutlook for developing countries.)

The medium-term outlook calls
for modest growth in the global
economy—third phase
The baseline forecast reflects the interactionof strong opposing forces: the stimulative
policies and the intrinsic recovery in stockbuilding and high-tech production that workto accelerate global growth on the one hand,
and the financial strains—high and rising debt
levels, falling equity prices, and uncertainty
about profitability—on the other hand. These
driving and restraining forces affect the outlook in three ways:

P R O S P E C T S

The external environment is mixed
The driving forces may be found in expectations for growth of global trade volumes:
2.9 percent in 2002 and an average of 7.5 percent in the following two years (figure 1.8 andtable 1.2). The restraining forces make a substantial rise in capital flows unlikely over the
medium term. The modestly firming trends in
non-oil commodities prices—5 percent in 2002
and averaging 5.1 percent in the following
years—reflect the subdued recovery. The 5 percent gains in commodity prices remain far
below historical patterns during booms. Increases in real commodity prices are expected

Figure 1.8 World trade rebounds along with GDP, 1998–2004(percentage change)
14
Forecast

12

World trade10
8World GDP

6
4
2
0
2
1998

1999

2000

2001

2002

2003

2004

Source: IMF, OECD, World Bank, and World Bank projections.

13

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2 0 0 3

Table 1.2

External environment for developing countries, 1991–2004(percentage change from previous year, except interest rates and oil price)
Current
estimate
Growth rates/ratios

Industrial country GDP growth
World trade growtha
Industrial country import demand
United States
Japan
Euro Area
Developing-country import demandMarket growth for developing countriesb
Non-oil commodity prices (nominal)
Agriculture
Metals and minerals
Real non-oil commodity pricesc
Oil price ($, weighted average), $/bbl
Manufactures unit value indexd
Developing-country terms of trade
Terms of trade/GDP (%)e
LIBOR (US$, 6 months)
EURIBOR (euro, 6 months)

Current forecasts

1991–2000

1999

2000

2001

2002

2003

2004

2002–04

2.4
7.2
6.9
9.4
5.6
6.6
8.2
10.7
1.4
1.3
1.8
1.1
19.1
0.3
0.1
0.1
5.6
5.4

2.9
5.6
8.5
12.4
6.6
6.4
1.3
5.3
11.2
13.9
–2.3
11.0
18.1
0.2
3.3
0.7
5.5
3.1

3.4
13.1
11.6
13.7
10.7
11.2
16.9
13.1
1.3
5.5
12.6
0.8
28.2
2.1
2.8
0.6
6.6
4.5

0.8
0.5
1.0
3.6
2.8
0.8
4.5
0.2
9.1
9.1
9.6
7.8
24.4
1.4
0.3
0.1
3.6
4.2

1.4
2.9
1.3
4.4
2.0
0.5
5.6
2.6
5.0
8.4
3.5
4.5
25.0
0.5
3.2
0.8
1.8
3.4

2.1
6.7
5.3
8.1
7.7
4.0
10.1
7.0
5.8
8.5
5.6
2.8
23.0
3.0
1.4
0.4
1.5
3.2

2.6
7.7
6.8
8.0
8.6
6.6
10.0
8.4
4.4
4.8
5.7
2.2
20.0
2.2
1.3
0.4
3.1
3.8

2.0
5.7
4.4
6.8
4.7
3.3
8.0
6.0
5.1
7.0
2.5
3.2
22.7
1.9
2.0
0.5
2.2
3.5

Note: bbl  barrel, LIBOR  London interbank offered rate, EURIBOR  European interbank offered rate.
a. Goods and nonfactor services.
b. Weighted average growth of import demand in export markets.
c. Deflated by manufactures unit value index.
d. Dollar-based export prices of manufactures in the G-5 countries.
e. Change in terms of trade, measured as a proportion to GDP (percent).
Source: World Bank, November 2002.

to be even more moderate, about 2.5 percent
per year. Most of the increase in commodity
prices in 2002 was due to a surge in agricultural prices, which bounced off cyclical lows:
the agricultural index had dropped 40 percent
below its peak, which was reached in 1997.
The recent surge is to a large extent inducedby supply factors: for example, droughts inAustralia and the United States have boosted
grain prices, and supply disruptions in Côte
d’Ivoire and Ghana did the same for cocoa
prices. Conversely, the rally in metal prices thatstarted in October 2001, which is normallystrongly correlated with the business cycle,
stalled in the second quarter of 2002. The forecast for metal prices is one of decline in 2002,
and of a return to 5–6 percent gains thereafter.
This trend is another indication that the tenorof global recovery is anticipated to be modest.
The base forecast assumes that the current
risk premium in the oil market gradually dis-14

sipates and that increased supply, both from
Organization of Petroleum Exporting Countries (OPEC) and non-OPEC sources, can easily meet moderate increases in demand. This
forecast would imply oil prices of around$20 per barrel by 2004. The lack of strength
in the recovery is also reflected in the interest
rate projections. The London interbank offered rate (LIBOR) and European interbank
offered rate (EURIBOR) are anticipated todrop modestly further during 2003, but to increase in step with firming economic activity
by 2004, at rates below 4 percent.
The recovery in global markets is shaped
primarily by developments in industrial countries. At 1.4 percent in 2002 and an average of
2.3 percent in the following years, growth remains at or below potential, which is a rare
phenomenon during a recovery (figure 1.9). In
this forecast, inflation will accelerate little, remaining below 2000 or 2001 levels.

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P R O S P E C T S

F O R

D E V E L O P I N G

2003

2004

C O U N T R I E S

Figure 1.9 2002 marks the start of a moderate recovery(GDP growth rate in percent)6
Developing countries
5

Forecast

Industrial countries

4
World GDP
3
2
1
0
1998

1999

2000

2001

2002

Source: World Bank data and projections.

An outlook for moderate growth acrossdeveloping regions—

12 percent, and growth in the region slowedfrom 1.2 percent in 2001 to 0.7 percent in2002). The region’s per capita income fell
2.6 percent after a drop of 1.2 percent in 2001,
which was the worst performance across two
years since the debt crisis in the early 1980s(figure 1.10). Oil exporters, particularly in
the Middle East and North Africa (MENA),

What does this environment imply for output
growth in the developing countries? In 2002,
a strong recovery in East Asia coincides with adisappointing performance in Latin America,
where GDP declined by 1.1 percent (excluding
Argentina, where GDP plummeted by nearly

Figure 1.10 LAC and MENA are not experiencing the recovery(developing countries GDP growth, percent change)
7
6
5
2004
4
3
2003
2
2001
1
0
1
2002
2
East Asia
and PacificSouth Asia

Latin
America andthe Caribbean

EasternEurope andCentral Asia

Middle Eastand North
AfricaSub-SaharanAfricaSource: World Bank projections.

15

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2 0 0 3follow an independent growth pattern, which,to some extent, is the same for developing
countries that are rapidly integrating into foreign markets (for example, Central European
countries, China, and Mexico), where exports
were recently able to outperform world trade
growth as a whole (see box 1.2).
Average growth in 2002 for developing
countries is anticipated to be 2.8 percent,
0.3 percentage points lower than was expectedin the February 2002 forecast and 0.8 percentage points lower than was projected in the
December 2001 forecast. Even with the bene-

fit of hindsight, it is quite difficult to disentangle the set of recent shocks and their effects ondeveloping countries. Yet the downward revisions do not contradict the assessment madein the fall of 2001 that adverse effects stemming from the terrorist attacks of September
2001 would not be limited to the UnitedStates, but would spread to developing countries as well (box 1.3).
Sharply different growth patterns are likely
to characterize economic activity across countries and regions in the short run, as jittery
financial markets affect the vulnerable andBox 1.3 The terrorist attacks of September 11, 2001
had an economic effectShortly after the terrorist attacks of September 11,
2001, the World Bank concluded that the economic effects would be most severe in the UnitedStates but would be significant in developing countries. The main transmission mechanisms were
thought to be:• Tourism revenues would decline, especially in SouthAsia, the Middle East, and the Caribbean.
• Increased risk perceptions in international markets
would make oil prices more volatile, foreign capitalless readily available, and transportation more costly.
• There would be delayed recovery in the United States,
where immediately after the attacks air traffic wasconstrained, equity prices had declined sharply, andconsumer confidence had plummeted. That delay
would also hamper the recovery in world trade, commodity prices, and financial flows.

Of the developing world, Latin America wasthought to be the hardest hit because of its proximity
to the United States, its dependence on tourism revenues and commodity prices, and its vulnerability
to financial shocks. Countries in Sub-Saharan Africa
were also vulnerable because they have limited
options to absorb adverse shocks.
Even with the hindsight of a year, it still remains
quite difficult to assess the independent effect of 9/11
on the global economic environment. Not only are
the counterfactuals unknown but new shocks, suchas the financial crisis in Argentina or the emergence16

of accounting scandals in the United States, complicate the picture.
The fiscal stimulus and rapid monetary easingin the United States probably prevented a serious
delay in the U.S. recovery and in world trade growth.
Non-oil commodity price increases have slightly outperformed forecasts made in the fall of 2001. However, the steep decline in tourism revenues and theincrease in risk perceptions did materialize, and theoutlook for developing countries has further deteriorated, especially for Latin America. This observationsuggests that 9/11 did exert strong influence in shaping ensuing economic trends in developing countries,
albeit reinforced by other factors.
Following continuous and robust growth overthe past decade, global tourism arrivals declined
by 0.6 percent in 2001, tied in large measure to theeffect of the terrorist attacks. The most-affecteddeveloping regions were South Asia (down 6 percent), Latin America (down 4 percent), and the Middle East (down 3 percent).
Business and consumer confidence across theindustrial centers fell abruptly in the aftermath of
the attacks. Although the losses evaporated within
2 months as the recovery took shape, the tenor of
business and financial market confidence has continued to be exceptionally fragile (box figure). This factor was one underlying the decline of capital market
flows to emerging market recipients in 2002, as wellas the rise in bond markets.

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Box 1.3

E C O N O M Y

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S(continued)

U.S. confidence plummets(ISM and Conference Board business and consumer sentiment indices)60

120
Consumer confidence

55

110

(right axis)
ISM index(left axis)

100

50
90
45

80

40

70
Jan.
2001

Apr.
2001

Jul.
2001

Oct.
2001

Jan.
2002

Apr.
2002

Jul.
2002

Oct.
2002

Source: Institute for Supply Management and Conference Board, through Datastream.

Developing countries’ GDP growth in 2002 hasbeen limited to 2.8 percent—about 0.8 percentage
point below that expected one year ago (notably,
figures that included an assessment of the 9/11 effects). Although not all barriers to stronger growth
are linked directly to the terrorist attacks, most ofhighly indebted developing countries more
severely than countries with lower debt ratios.
Though the forecasts for 2003—and especially for 2004—display acceleration of
growth that tends toward more uniformity
across regions, that acceleration is weaker
than one would expect in a strong, synchronized global recovery.2
The forecast for Latin America and the
Caribbean (LAC) assumes some rebound in
Argentina, where output has fallen some
20 percent below 1998 levels, but the reboundis insufficient to return to earlier prevailinglevels within the time horizon of this forecast.
Modest growth rates are anticipated for Brazil
and most other countries of the region. That
growth is grounded in a recovery in global
trade and an end to the freefall in Argentina,

these developments took form under the influence ofa global environment that was highly unsettled by
the destruction of the New York World Trade
Center.
Source: World Bank staff.

together with the pursuit of policies geared toward reducing financial strains. Mexico andsome Central American and Caribbean countries are in position to benefit most from theexpected upswing in the United States, andMexico’s growth in particular is anticipated to
exceed that of most Latin American countries.

—has the strongest growth evident inEast Asia—
Prospects for developing East Asia and Pacific(EAP) appear more buoyant than those forother regions, as growth is expected to reach
6.4 percent by 2004. Continued solid expansion in China and recovery in most othercountries—albeit with growth rates that remain below the robust performance of 2000—
underpin this view. Favorable prospects do

17

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2 0 0 3

not imply that risks are negligible, however.
East Asia remains vulnerable to oil pricespikes, to uncertain demand conditions in the
United States, and to the fragile state of theJapanese commercial banking system andgrowth prospects there. Moreover, the dynamics in high-tech markets remain volatile.
Options for domestic stimulus are more limited than in previous years because in mostcountries fiscal deficits have widened and interest rates stand at low levels.
In Europe and Central Asia (ECA), growthis expected to remain strong, but it will begrounded in a highly differentiated outlook
between the Central and Eastern European(CEE) group of countries and the hydrocarbon
exporters that dominate growth trends in the
Commonwealth of Independent States (CIS—
Russian Federation, Kazakhstan, and several
smaller states). For the former group, output
growth is projected to accelerate from 2.3 percent in 2002 to 3.1 percent and 4.3 percent
in 2003 and 2004, respectively. Activity is
expected to be driven by increased importdemand from the EU and by intensificationof the EU’s accession process. For Turkey(included in this group), assuming that there
is relative political stability and that the new
government continues to pursue the current reform path, recovery is expected to strengthen
in 2003. In contrast, growth is anticipated toease in the CIS subregion in the years through2004 (through fiscal and trade linkages to thehydrocarbon exporters in particular), assuming a significant medium-term decline in theoil price. CIS GDP is anticipated to deceleratefrom 4.4 percent in 2002 to 3.5 percent and3 percent in 2003 and 2004. These divergent
trends combine to shape the path of growth
for the broader region, from 3.6 percent in2002 to an average of 3.5 percent in the years
following.
Growth in the Middle East and North Africa(MENA) region is expected to revive in
2003–04 to average 3.6 percent, as hydrocarbon output increases in line with global energy
demand, and as accumulated oil-surplus funds
are progressively committed and expended on

18

infrastructure and other development activities,
especially in Algeria, the Islamic Republic of
Iran, and Saudi Arabia. Growth among the diversified exporters should increase to an average of 3.2 percent, as drought conditions easein Morocco and Tunisia and as fiscal deficits
are brought under tighter control and business
confidence returns in Egypt—as the government there sets an appropriate interest rate andpushes ahead with policies, such as privatization, that will increase international investor
confidence. Risks to this outlook are substantial, however, with political tensions mounting
during apparent preparations for military
action in Iraq. At this juncture, the baseline
does not explore these potential developments,
but rather focuses on the country-specific andregion-specific economic fundamentals, as well
as global factors that contribute to shape theoutlook.

—and South Asia
A forecast of consistent growth in the South
Asia region (SAR) of well above 5 percent
over 2003–04 comes after a significant cyclical downturn in 2001, when manufacturing
output in India and Pakistan stopped growing
and when GDP growth mainly reflected continued expansion in the service sectors. The
main challenge for the subcontinent remains
fiscal reforms to curb over-large government
deficits and to promote further trade liberalization. With almost-balanced current accounts and with substantial capital flows into
Pakistan, external financial tensions remain
limited at present. But, it is expected that theeffects of accumulated fiscal debt will, at somefuture point become an obstacle to achieving
the acceleration in growth required for substantial alleviation of poverty levels.
Growth in Sub-Saharan Africa (SSA) remains restrained by unfavorable domestic conditions, ranging from civil strife, to droughts,
to macroeconomic imbalances, and to the AIDS
epidemic. Elements of the external environment should, however, provide some support
for a modest acceleration of growth over the
next years. Despite a relatively sluggish pickupgep_ch01.qxd 12/5/02 4:15 PM Page 19

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in world GDP growth in 2003–04, a robust
recovery is anticipated for African trade volumes, ratcheting from growth of 3 percent in2001 toward 6 percent by 2004. That recovery should be accompanied by generally
firmer non-oil commodity prices (exceptions
are cocoa and gold, where prices have surged
to unsustainable levels). The resulting terms oftrade gains should support relatively buoyant
external performances by African non-oil exporters. For oil exporters of the region, theprice of crude is expected to weaken in themedium term. Even so, oil sectors will remain
profitable, and production and export volumes are anticipated to rise—from Nigeria
and other producers in the Gulf of Guinea, as
well as from Angola’s offshore sector.
In the domestic sphere, agricultural production will benefit from a return to morenormal weather patterns in southern Africa,
thus contributing to a recovery of domestic
output and expenditure. On balance, GDP
growth for the region is expected to rise from
2.5 percent in 2002 to 3.2 percent in 2003 and3.8 by 2004. The overall acceleration reflects
gains by non-oil exporters, which will morethan offset modest retrenchment by oil producers. The current projection for the region
represents a slight deterioration of prospects
compared with the spring 2002 forecast,which is consistent with the overall downgrading of expectations for world output andtrade growth. Nevertheless, though performance will continue to lag behind other developing regions, per capita incomes are set toresume positive growth following several yearsof stagnation.

Risks to the base case are substantial
The world recovery is clouded by substantial
uncertainties in the immediate to near term.
These uncertainties carry with them implications for medium-term developments in global
growth and financial flows. Among criticalfactors in the outlook are (a) continued financial turbulence in high-income countries that
could jeopardize a rebound in investment;(b) a reversal in capital flows to emerging

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

markets, thereby heightening tensions in several vulnerable middle-income countries; and(c) the risk of higher oil prices, which are associated with prospective developments in the
Middle East.
The base case presents a moderate but
steady recovery in investment; it effectively
rules out financial crises in middle-income
countries and foresees a gradual decline in oil
prices. If downside risks materialize, adverse
outturns in these domains could easily occur
at the same time or could, in sequence, reinforce cumulative effects on the economy. To
gauge the sensitivity of economic recovery tothese risks, we have traced the possible effects
on the economic outlook of these elements.
The results underscore the set of tensions embedded in the base-case forecast and can illuminate the magnitude of potential downsiderisk to the projections—with particular focus
on the implications for developing countries.3

Global recovery could be delayed
until 2004
Table 1.3 outlines the global effects of a lowcase scenario in which the risks highlighted
above occur essentially at the same time, buteach of the adverse shocks is fairly short lived.
The scenario reflects the joint effects of atemporary relapse to negative growth in theindustrial country’s investment cycle, of shortlived financial disruptions in several middleincome countries, and of a momentary spike
to $45 per barrel (bbl) in world oil prices. The
scenario suggests that, rather than an acceleration of global growth in 2003 to 2.5 percent
as in the base case, a continuation of sluggish
output advance in a range of 1.9 percent could
characterize the year. Contrasted with basecase forecasts, cumulative differences over
2003–04 in world trade growth, OECD inflation, and interest rates are fairly substantial.
The latter element reflects a strong monetary
policy response to the financial and real disturbances of the scenario. OECD output
growth is dampened by 1 percentage point,
and for developing countries, it is dampened
by 0.8 point over the period (figure 1.11).

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Table 1.3

2 0 0 3Global effects in a low-case scenario, 2003–04
2003

2004

2003–04

Scenario

Diff. (base)

Scenario

Diff. (base)

Cum. diff.

GDP growth (%)
World
Industrial countries (OECD)
Developing countries

1.9
1.5
3.0

0.6
0.6
0.9

2.7
2.2
4.8

0.4
0.4
0.1

1.0
1.0
0.8

Consumer price index inflation (%)
Industrial countries
Developing countries (median)

2.2
5.0

0.1
0.6

1.2
4.4

0.6
0.0

0.5
0.6

Short-term interest rates (%)
Industrial countries

2.9

0.3

3.3

0.8

1.1

Trade volumes (%)
OECD imports
Developing-country exports

5.5
9.3

1.3
1.0

7.5
9.2

0.4
0.3

1.7
1.3

Source: World Bank, November 2002.

Among industrial countries, growth profiles in the United States and Japan are more
adversely affected. This is linked to the relapseof fixed investment spending during 2003,
with less room for monetary easing than exists
in the Euro Area. Among developing regions,
Latin America will feel the initial brunt ofdiminished capital inflow during 2003 (growth

Figure 1.11 Low case: world trade andother indicators will be much lower thanthe baseline(cumulative differences, 2003–04; low-case scenario
versus base-case scenario, percent)

World
trade

Interest OECD
rates
inflationOECDgrowthDevelopingcountry
growth

0.0

0.5

0.5
0.8

1.0
1.1
1.5
1.7
2.0
Source: World Bank.

20

1.0

falling substantially below baseline), but it
will rebound with some vigor as conditions
equilibrate in 2004. East Asia—with strong
links to export markets in all three industrial
centers—will also suffer a sharp falloff ingrowth, but less so than Latin America.
Initially, inflation increases slightly in reaction to the rise in oil price. However, when oil
prices start falling again and the effect oflower growth becomes noticeable, inflation
will drop in high-income countries, thereby
triggering substantial monetary easing compared with the baseline. In developing countries, inflation will remain on average above
its base-case level, as higher oil prices are complemented by devaluation of several currencies in reaction to financial tensions.
Table 1.4 breaks out for 2003 the contributions of the individual risk scenarios (outlined below) to the overall low-case simulation. A relapse of investment in the industrial
countries carries the largest downside potential to the global outlook, which affects output
growth, world trade, and interest rates mostacutely. Developing-country growth is more
affected under the restraint of capital flow
scenario, but is equally diminished by developments under the G-7 investment scenario
and by higher oil prices. The latter scenariogep_ch01.qxd 12/5/02 4:16 PM Page 21

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Table 1.4

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

E C O N O M Y

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

Low case: contributions to global effects in 2003
Total

Diff. (base)

Investment

Capital flows

Oil prices

GDP growth
World
Industrial countries (OECD)
Developing countries

1.9
1.5
3.0

–0.6
–0.6
–0.9

–0.3
–0.3
–0.2

–0.1
–0.1
–0.5

–0.2
–0.2
–0.2

Consumer price index inflation (%)
Industrial countries
Developing countries (median)

2.2
5.0

0.1
0.6

–0.1
–0.1

0.0
0.1

0.2
0.6

Short-term interest rates

2.9

–0.3

–0.3

–0.1

0.1

World trade
OECD imports
Developing exports

5.8
5.5
9.3

–1.3
–1.3
–1.0

–0.9
–1.0
–0.6

–0.1
0.0
–0.2

–0.3
–0.3
–0.2

Source: World Bank, November 2002.

prospectively could hamper a fuller easing ofmonetary policy across the industrial centers,with growth suffering commensurately.

Figure 1.12 G-7 investment falls sharply(base-case scenario and low-case scenarios, volume
growth, percent saar)

Financial market turbulence in highincome countries could trigger a relapse
in the investment cycle—

5

Though investment growth momentum is now
building in selected sectors and countries, thepotential for relapse looms large as imbalances and uncertainties remain acute throughout the industrial world. The low-case scenario assumes that the growth of real business
investment in industrial countries drops tonegative territory (0.7 percent) during 2003,
which would be 3.5 percentage points ofgrowth below the baseline path. Spillovers
into 2004 carry cumulative growth differences
in capital spending to 6.5 percentage points(figure 1.12).
If one examines the scenario environment
among the industrial countries, cumulative
inflation over 2003–04 is reduced by 0.5 percent. At the same time, the profile of shortterm interest rates reflects reductions that are
more than the improvement in inflation performance, which represents a substantial
easing of monetary policy in the wake of developments. The rate of unemployment rises
by 0.4 percentage points in OECD countries.
Among prominent growth effects, industrial
country output gains are dampened by0Base-casescenario

5
Low-case
scenario10
Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q42000 2001 2001 2002 2002 2003 2003 2004 2004
Source: National statistics; World Bank projections.

0.4 percent in 2003 and by a further 0.3 percent during 2004, as multiplier effects placepressure on household consumption. With
the compression of imports, adverse growtheffects in the major industrial countries aretransmitted to smaller advanced economies,
while weakened demand for commodities
places downward pressure on nonenergy
prices, thus affecting developing countries’
terms of trade adversely. On balance, GDP
growth in developing countries will decline
by 0.3 percentage points relative to the basefigures during 2003–04.

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2 0 0 3—while financial tensions pose difficulties
for emerging markets—
Under a scenario of substantially lower inflows of private capital into countries withweak or declining credit ratings and with large
financing requirements, interest rates rise, exchange rates depreciate, or both, which raises
the cost of servicing debt and results in difficulties in meeting debt payments for both the
public and private sectors. To understand thepossible implications of such development, we
performed a simulation in which capital flows
to selected emerging market countries wereassumed to drop by 15 percent below thebaseline forecast in 2003, while spreads on international debt would increase substantially.
With these assumptions, the Latin America
region will suffer an average falloff in output
growth of 1.9 percentage points comparedwith the baseline in 2003. Rebound in response to eventual equilibration in exchange
and interest rates, as well as to falling risk
spreads, should be grounded in stronger exports, and output growth rises some 0.9 percentage point above the base in 2004. The
cumulative fall in regional growth amounts
to 1.1 percentage points during 2003–04. This
fall is a reflection of the strong dependenceof Latin America on capital inflows, whereas
reversals in capital flows tend to have farreaching consequences for domestic economies
in that region (figure 1.13). Central Europe isanother region that is affected by the reversal
in international capital flows, although thegreater diversity within the region makes theoverall effect smaller than for Latin America.

—and higher oil prices could temporarily(yet moderately) dampen recovery
Crude oil prices have risen to more than
$29/bbl because of expectations of a supply
disruption in Iraq and of increasingly tighter
market fundamental conditions. Crude oilstocks fell sharply in the third quarter of 2002,
particularly in the United States. The drop wasdue to high runs of refined products, a decline
in Iraqi crude exports, and continued restraint
by OPEC to limit exports in support of higher

22

Figure 1.13 Investment growth and net
capital flows* into Latin America arestrongly correlated(4-quarter moving
average, percent GDP)

(4-quarter moving
average, percent saar)

7

25
Investment

6

20
15

5

10

4

5
0

3

5

2
1

10
Net capital flows*as percent of GDP

0

15
20

Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1
1994 1995 1996 1997 1998 1999 2000 2001 2002
*Net capital flows defined as CAD—addition toreserves-IMF funds.
Source: Datastream and World Bank staff estimates.

prices. A so-called war premium on prices has
been estimated at up to $8–$9/bbl. The basecase assumes that the oil market normalizes
with further increases in non-OPEC supply,with a modest rise in OPEC quota, and witha dissipating of the war premium. These assumptions might turn out to be too optimistic.
With continued tensions in the Middle Eastand with the possibility that, for example,
some 2 million barrels per day (mb/d) of Iraqi
oil exports would be temporarily lost to themarket, oil prices might rise well above$30/bbl—partly because of low stocks andtight market conditions—and might peak at$45/bbl during the height of the disruption.
However, it is likely that any loss in supply
will eventually be replaced by other OPEC
producers. They currently have about 5 million barrels per day (mb/d) of spare capacity—of which Saudi Arabia alone has some 3mb/d.
Or supply will otherwise be replenished. Prices
could fall relatively quickly below $20/bbl by2004 before OPEC begins to restrain output asworld demand increases, as the organization
attempts to bring prices back into its target
price band of $22–$28/bbl (figure 1.14).

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Figure 1.14 Oil prices spike(base-case and low-case scenarios; oil price $/bbl)

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

Figure 1.15 Investment is more volatile
than GDP in East Asia
(4-month moving average, percentage change q/q, saar)

36.0

30
Investment

31.5
Base-casescenario

Low-case
scenario

20
10

27.0

GDP

0

22.5

10
18.0
Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q42000 2001 2001 2002 2002 2003 2003 2004 2004
Source: World Bank data; World Bank projections.

20
30
40
Q1
1997

On a cumulative basis, a $2.50/bbl increasein oil price above baseline levels (but with dynamics as outlined above) will yield a moderate fall in global growth of 0.1 percent during
2003–04. Effects during 2003 will be somewhat more pronounced, however: a drop inworld output of 0.2 percentage points. Inflation and interest rates in the industrial countries will be boosted modestly, by some
0.2 and 0.1 percentage points, respectively.

Q1
1998

Q1
1999

Q1
2000

Q1
2001

Q1
2002

Note: Indonesia, Rep. of Korea, Malaysia, Philippines,
and Thailand.
Source: Datastream and World Bank staff estimates.

Figure 1.16 Investment is more volatile
than GDP in Latin America(4-month moving average, percentage change q/q, saar)
20
15
Investment

10

Investment cycles in developing
countriesFor developing countries, the risk of an
untimely interruption to the recovery inglobal investment comes after a period of sharp
swings in investment in the past five years.
During the East Asian crisis, investment fell at
an annual rate of 30 percent, three times thefall in output (figure 1.15). Crises in Argentina
and Turkey dominated recent developments in
Latin America and Central Europe, respectively, with regional investment declining at
annual rates of 15–20 percent (figures 1.16 and1.17). The dynamics of investment are much
more forceful than that of output.4
This section looks at three importantpatterns:• The volatility of investment, relative tothe volatility of output, and compar-

GDP

5
0
5
10
15
Q1
1997

Q1
1998

Q1
1999

Q1
2000

Q1
2001

Q1
2002

Note: Argentina, Brazil, Chile, and Mexico.
Source: Datastream and World Bank staff estimates.

isons of developing with high-income
countries.
• The effects of improvements in the investment climate on the volatility ofinvestment and output.
• The role of capital flows that influence theinvestment cycle in developing countries.

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2 0 0 3Figure 1.17 Central Europe and Turkey
experience greater volatility ininvestment than in GDP(4-month moving average, percentage change q/q, saar)
45
30
Investment
GDP

15
0
15
30
Q1
1997

Q1
1998

Q1
1999

Q1
2000

Q1
2001

Q1
2002

Note: Czech Republic, Poland, and Turkey.
Source: Datastream and World Bank staff estimates.

Table 1.5 Relative volatility of investment
is high in developing countries

Low income
Middle income
High-income OECD

1971–80

1981–90

1991–2000

4.6
4.9
2.9

5.2
3.6
3.2

7.6
4.5
3.5

Note: This table presents unweighted averages of countryspecific standard deviations of investment growth as a ratio
to the unweighted average of standard deviations of GDP
growth.
Source: World Bank.

Investment cycles are more pronounced
in lower-income countries than in higherincome countries
The volatility of investment growth relative tothe volatility of output growth is twice as large
in low-income countries as in high-income
economies—and volatility has increased overtime (table 1.5). An understanding of the investment cycle is pivotal to the explanationof overall cyclical behavior in developing
countries.
A similar picture emerges if one examines adifferent measure of the cyclical component ofinvestment, namely the percentage deviationfrom trend.5 Figure 1.18 displays the meanand standard deviation of that measure24

for some 160 countries over the 1990–2000
period.6 The volatility of the cyclical components of investment declines steeply withhigher income per capita.
Explanations for the high volatility of investment in low- and middle-income countries
will vary from large external shocks relative tothe size of the country to a poor investment
climate. Properly functioning domestic financial institutions may smooth cycles by allowing additional savings to be channeled toinvestors during downturns.
Poor countries, on average, tend to be relatively small economies. Thus, the GDP of an
average low-income country during the 1990s
was $25.6 billion, barely 2.5 percent of theaverage high-income country. Baxter andCrucini (1993) and Crucini (1997) argue that,as a result, external shocks are relatively large
in proportion to GDP, which explains reasonably well the patterns observed in figure 1.18.
For example, international capital flows caneasily be much larger from the standpoint ofa small country, and reversals in capital flows
can have a relatively large effect. The decision
by a French multinational to invest $100 million in Senegal instead of at home would reduce France’s investment spending in 2000 by

Figure 1.18 Investment volatility declines
with income(mean and standard deviation of volatility of investment)
0.20Standard deviation
Mean

0.15

0.10

0.05

0
Low
incomeMiddleincomeHigh income High income
non-OECDOECD

Note: Investment volatility is defined as the standard
deviation of the deviation from (HP filtered) trend.
Source: World Bank staff estimates.

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just 0.04 percent, but it would raise Senegal’s
investment by 11.5 percent. The effects on
the two economies of such a decision would
be disproportionate. Similarly, idiosyncratic
shocks—economic, weather-related, or thereflection of civil strife—have a relatively large
effect on smaller countries. Low levels of development and small size will tend to imply
less diversification in the output and export
mix but stronger dependence on commodity
prices, so that poor countries’ terms of trade
will tend to be more volatile than those ofOECD countries.

Improvements in the investment climate
can reduce volatility
The quality of the investment climate, extensively discussed in the following chapters of
this report, appears to be highly correlated withinvestment volatility. If one examines theinvestment climate, several candidates areavailable to proxy for this environment, all ofwhich correlate highly with one another. Figure 1.19 is based on the quality of governanceindicators compiled by Kaufmann, Kraay,
and Zoido-Lobatón (2002), which have theadvantage of comprehensiveness. Six subindexes attempt to capture various dimensionsof policy and institutional quality. An unweighted average of all six is identified in
the figure as “All.” Meanwhile, two of thesubcomponents seem especially pertinent tomeasuring the investment climate: “regulatoryburden,” which reflects the incidence of market
friendly policies, and “rule of law,” which measures respect for society’s rules. “Regulation”
consists of the first of these, while “Regulationand Law” is an average of the two. All threeindexes show a similar pattern of declining
volatility as the policy environment improves,suggesting the finding is robust.
One concern about the evidence presented
in figure 1.19 is that all three indexes correlatevery highly with income.7 However, in regressions that explain volatility with both income
and governance as explanatory variables, thecoefficient for governance tends to be moresignificant than is the coefficient for income.

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

Figure 1.19 A better investment climate
reduces volatility of investment cycles(standard deviation of cyclical component of investment)
0.4
Regulation
0.3
All
0.2

Regulation and law

0.1
0.0
1st quartile 2nd quartile 3rd quartile 4th quartile
Bad

GovernanceGood

Source: World Bank staff estimates using governanceindicators developed by Kaufmann, Kraay, andZoido-Lobatón (2000).

Figure 1.20 Impact of policy climate on
investment volatility after correcting forincome remains strong(standard deviation of cyclical component of investment)
0.25
0.20
0.15
0.10
0.05
0.00
1st
quartileBad

2ndquartile

3rdquartile

4thquartile

GovernanceGood

Source: World Bank staff estimates using governanceindicators developed by Kaufmann, Kraay, andZoido-Lobatón (2000).

The independent effect of governance onvolatility can be shown in a different way.
Figure 1.20 repeats the analysis, but it corrects
for the possible influence of income by first regressing the governance index on income andthen examining the relationship between thevolatility of investment cycles and the residuals

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2 0 0 3from this regression (that is, in relation to thatpart of the governance indicator that is notcorrelated with income). Investment volatility continues to fall with a better investment
climate.

International net capital inflows are procyclical, both in developing and highincome countries—
Because investment cycles are more pronounced than output cycles, investment as ashare of GDP tends to rise during a boom andto decline during a downturn. For countries at
all income levels, financing of the increase in
the investment ratio during a boom comesfrom both domestic and foreign sources. During an upturn, domestic savings rates normallybuild, while current accounts deteriorate(table 1.6). In other words, foreign investors
turn away during downturns, while domestic
consumers reduce their savings and increase
their consumption as a share of income.
Clearly, procyclical capital flows do not prevent consumers from absorbing shocks bysmoothing consumption over time (box 1.4).
Table 1.6 Upturns can be financed abroadand domesticallyCorrelation of cyclicalinvestment components
with changes in …

Current account(as % of GDP)
Domestic savings(as % of GDP)

Low
incomeMiddleincomeHighincome
OECD

0.21

0.39

0.43

0.16

0.16

0.45

Note: The table shows unweighted averages of correlation
coefficients of variables in individual countries.
Source: World Bank.

—but capital flows tend to trigger
domestic cycles in middle-income
countries
Both “push” and “pull” factors are responsible for the procyclical nature of capital
inflows. In a downturn, demand for investment financing is reduced as firms postpone
investment plans and reduce capital stocks(the pull factor). At the same time, financial
investors look for less risky or risk-free investments and show little appetite to invest in
countries and sectors that suffer from declining growth and profit rates (the push factor).
For developing countries, the push factors
have often been emphasized as a major challenge. Sharp increases in external finance frequently preceded severe crises (such as in
Mexico, East Asia, and Turkey), which were
triggered by sudden reversals of these flows.
The dynamics of net capital inflows and thechanges of official reserves over the cycle doindeed indicate that the push factor is more
important for middle-income countries, while
the pull factor dominates in high-income
countries. Net foreign capital inflows actuallylead the domestic investment cycle in middleincome countries, while they lag the cycle inhigh-income countries. For example, one-yearlagged capital inflows are correlated with investment by 0.27 in middle-income countries,
compared with a correlation of only 0.08 forhigh-income countries. In middle-income
countries, one-year-lagged capital inflows are
as strongly correlated with the domestic investment cycle as they are with contemporaneous capital inflows (table 1.7). In highincome countries, a one-year lead in capital
inflows is, by contrast, as strongly correlated

Table 1.7 Capital inflows lead investment in middle-income countries: correlation between
investment ratios and (past or future) capital flows
2-year lag

1-year lag

No lag or lead

1-year lead

2-year lead

0.09
0.13
0.20

0.09
0.27
0.08

0.21
0.35
0.32

0.07
0.10
0.35

0.01
0.11
0.25

Net capital inflows
Low income
Middle income
High income (OECD)
Source: World Bank staff estimates.

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E C O N O M Y

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F O R

D E V E L O P I N GC O U N T R I E S

Box 1.4 Consumption in low- and middle-income
countries is smoothed over the business cycleIn all country groupings, the savings rate is positively (or the consumption rate is negatively) correlated with GDP growth in the short run (see box
figure). The correlation is relatively weak fordeveloping countries, but that weakness is mainly
because GDP is an inaccurate measure of income in
the presence of terms-of-trade shocks. Real growthof gross national income (GNI), which includes
terms-of-trade gains and losses, is much morevolatile than growth of real GDP in developing
countries. In industrial, high-income countries, theterms of trade have a much smaller effect (see box
table). The correlation between the savings rate andreal growth of GNI is decisively more similar acrosscountries.
The strong evidence of consumption smoothingin low- and middle-income countries is remarkable,
because the conditions in such countries for absorb-

Consumption smoothing is strongest in
high-income countries(correlation of change in average propensity to consume
and GDP growth)
LowincomeMiddleincomeHigh income High income
non-OECD
OECD

0
0.1
0.2
0.3
0.4
0.5
Income growth0.6

GDP growth

Relative and increasing vulnerability of
low-, middle-, and high-income countries toterms-of-trade shocks
1971–80

1981–90

1991–2000

2.1
1.9

2.2
1.8

2.8
2.2

2.8

1.5

1.5

1.4

1.3

1.3

Low income
Middle income
High income(non-OECD)High income(OECD)

Note: Standard deviation of national income growth/standard
deviation of GDP growth.
Source: World Bank data.

ing fluctuations in income are less favorable than in
high-income countries. First, domestic credit markets
tend to function less smoothly, and access to international capital markets is more difficult than in highincome countries. Second, as far as fluctuations inincome are caused by terms-of-trade shocks, thesmoothing of consumption over time is less attractive
than in the case of volume shocks, which prevail inhigh-income countries. If, for example, import prices
fall, the decline in price amounts to a rise in income,which could trigger an increase in the savings rate.
However, a temporary price fall implies a future
price rise, making future spending of current savings
less attractive. In the case of a temporary rise in thevolume of income, it is more appealing to save now
and spend later, when income is back at a lower
level.
Despite these impediments, developing countries’
consumption is being smoothed over the businesscycle, providing relief for consumers and supporting
domestic financing of procyclical investment ratios.

Source: World Bank staff estimates.

Source: World Bank staff.

with the domestic investment cycle as with
contemporaneous capital inflows.
The picture of capital inflows being a pushfactor for middle-income countries is strengthened when one considers the behavior of

official reserves. Some of the foreign capital
inflow that precedes a domestic investment
boom in middle-income countries is temporarily accumulated as foreign reserves, while capital outflows that precede a domestic bust are27

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2 0 0 3

temporarily absorbed by reductions in official
foreign exchange reserves.
In low-income countries, capital inflows
are also procyclical, but the correlation withthe domestic cycle is less significant. The
weaker correlation reflects the specific character of these flows—official aid and FDI are lesscyclical—and also the dependence of thosecountries on commodity prices. Part of the financing for investment booms comes not fromforeign borrowing, but from increased export
revenues as a result of terms-of-trade gains.
Similarly, investment busts are not necessarily
driven by a reversal of capital flows, but they
can originate from terms-of-trade losses.
On the basis of these relationships, it appears that cycles are still a prominent featureof macroeconomic developments, which iseven more important in developing countries
than in industrial countries, and cycles weremore pronounced during the 1990s than during earlier decades. Investment swings arefinanced both domestically and abroad, whichmakes current account deficits and capital
inflows strongly procyclical. A major difference between developing countries and highincome countries is that middle-income
countries are more exposed to independent
reversals in capital flows, while capital flows
are more accommodating in high-income
countries, and the cyclical dynamics in lowincome countries are to a significant extent
influenced by terms-of-trade shocks andidiosyncratic disturbances.

Growth and poverty to 2015:
coming changes in savings andinvestment patterns

A

fter an impressive wave of market reforms and increased openness in developing countries during the 1990s—both ofwhich prompted acceleration of technologicalprogress and brought about a more stable
macroeconomic environment—long-term economic growth prospects for developing countries are relatively optimistic. If the projections
come to pass, growth patterns could lead to a28

significant reduction of poverty. Thus, the millennium development goal of halving poverty
by 2015 could be reached on a global level,although growth will be insufficient to achieve
poverty targets in all regions. At the sametime, financial imbalances and volatility ininternational capital flows continue to jeopardize uninterrupted growth. Vulnerable countries will benefit from further debt reductionin their pursuit of sustained high growth.
The acceleration of growth in developing
countries is expected to coincide with increases in investment ratios. Saving rates arealso expected to increase, driven particularly
by a declining proportion of youths and by
the need for adults to save for retirement. Opposite movements are expected in industrial
countries, where aging is bound to reducesavings rates and where a sharp decline in
population growth will suppress investment
ratios.
The long-term forecast suggests that, on balance, net inward capital flows toward developing countries could well decline, though grossflows will continue to play an important role inenhancing growth potential. These changes in
global savings and investment behavior raisequestions about the critical role of financial
integration and the need for improvements ininternational financial intermediation.

Long-run per capita growth is expectedto accelerate—
Developing-country growth, on a per capita
basis, is projected to more than double during
the 10-year period from 2005 to 2015 whencompared with the performance of the 1990s(table 1.8). This projection reflects substantially improved growth prospects for Europe
and Central Asia—leaving behind sharp contractions that characterized the transition tomarket economies during the 1990s—and for
Sub-Saharan Africa. For Africa, the scenario ispredicated as a continuation of broad trends
toward better governance and economic policies, of progress toward resolving conflicts anddiversification away from agriculture, and ofexport dependence on primary commodities.

gep_ch01.qxd 12/5/02 4:16 PM Page 29

T H E

Table 1.8

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

E C O N O M Y

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E SLong-term prospects are projected to be stronger for most regions(real GDP per capita, annual average percentage change)
Forecast scenario
Medium termLong term

1980s

1990s

2001–05

2006–15

World total

1.3

1.2

1.1

2.1

High-income countries
OECD
United States
Japan
European Union
Non-OECD countries

2.5
2.5
2.2
3.5
2.1
3.3

1.8
1.8
2.2
1.2
1.7
3.6

1.5
1.5
1.6
0.4
1.9
1.7

2.4
2.4
2.4
2.0
2.4
3.3

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

0.7
5.6
0.7
–0.9
–0.6
3.4
–1.2

1.6
6.4
–1.9
1.6
1.0
3.3
–0.4

2.4
5.1
3.3
0.3
1.3
3.5
0.8

3.5
5.4
3.4
2.6
1.3
4.0
1.6

Note: Aggregations are moving averages, reweighted annually after calculations of growth in constant prices.
Source: World Bank.

At the same time, a lack of human capital,poor infrastructure, and the AIDS epidemic
remain pressing problems.
Per capita growth in Latin America is
expected to accelerate by 1 percentage point
under this scenario, but as a result of slowing
population growth, the acceleration of real
GDP growth is small. Latin American countries are expected to have benefited fromreform efforts during recent years and fromsustained improvements in macroeconomic
stability. The East Asia and Pacific Region
should witness a declining per capita growthrate from 6.4 percent in the 1990s to 5.4 percent in the longer term, as economies mature
and as options for rapid catching up becomeless abundant. Per capita growth in the rest of
the world, including South Asia, the Middle
East and North Africa, and high-income countries, is projected to accelerate moderately.

—leading toward significant poverty
reduction
As projected in previous Global Economic
Prospects (GEP), achieving the millennium

development goal of halving extreme poverty
by 2015 from the 1990 poverty level should beachieved on a global level, though with wide
regional disparities. The revised poverty projections indicate a poverty rate of some 13.3 percent in 2015 compared with 29.6 percent in1990. The actual number of poor would
decline to around 809 million from 1.3 billion
in 1990 and 1.1 billion in 1999. Asia should
readily achieve the target, but the MENA
and SSA regions will make little progress in
improving poverty incidence (table 1.9).
Though the central message remains thesame, the long-term outlook reflects rather
significant changes from last year’s forecasts.
These changes are a combination of threefactors:• The economic projections reflect recent
trends and a downgrading of the mediumterm forecast, as detailed earlier in thechapter, page 5. The long-term forecast
has remained relatively unchanged, but
lower growth—actual and forecast—between 2000 and 2005 has slightly29gep_ch01.qxd 12/5/02 4:16 PM Page 30

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2 0 0 3worsened the poverty forecast, all else
being equal.
• New surveys and methodology have significantly altered the 1999 estimate ofpoverty incidence. For developing countries, this change has led to a 1.6 percent
rise in the estimate of the number ofpoor living on less than $1 per day.
However, the revisions are not uniform
across regions. There is a significant risein East Asia and in Europe and Central
Asia, while the estimated number ofpoor has dropped in Latin America.8• The third factor is the change in therelation between economic growth andpoverty reduction. This relation has been
re-estimated using the new survey data.
Overall, the relationship has weakened(that is, for the same growth rate, therate of poverty reduction has declined).
The reader should bear in mind that thesenumbers are sensitive to the poverty line chosen and underlying assumptions and data (seebox 1.5).
The relation between growth and poverty
may not have changed in a fundamental way,
but the change may be a consequence of pasttrends at a more disaggregated level. Recent
studies9 of poverty trends in India indicatethat poverty has been successfully reduced ina number of states in which growth rates arehigh and in which the responsiveness ofpoverty reduction to growth is likewise higher.
Moreover, the evidence suggests that these regions had significantly better initial conditions

Table 1.9 Large poverty reductions in EAP and SAR partially offset by poverty
increases in SSA
Number of people living on less than $1 per day (millions)
GEP 2002

GEP 2003

Region

1990

1999

2015

1990

1999

2015

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

452
92
7
74
6
495
242

260
46
17
77
7
490
300

59
6
4
60
6
279
345

486
110
6
48
5
506
241

279
57
24
57
6
488
315

80
7
7
47
8
264
404

1,276
916

1,151
937

753
700

1,292
917

1,169
945

809
735

Total
Excluding China$1 per day headcount index (percent)
GEP 2002

GEP 2003

Region

1990

1999

2015

1990

1999

2015

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

27.6
18.5
1.6
16.8
2.4
44.0
47.7

14.2
7.9
3.6
15.1
2.3
36.9
46.7

2.8
0.9
0.8
9.7
1.5
16.7
39.3

30.5
24.2
1.4
11.0
2.1
45.0
47.4

15.6
10.6
5.1
11.1
2.2
36.6
49.0

3.9
1.1
1.4
7.5
2.1
15.7
46.0

Total
Excluding China

29.0
28.1

22.7
24.5

12.3
14.8

29.6
28.5

23.2
25.0

13.3
15.7

(continued on page 31)30

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E C O N O M Y

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E STable 1.9 (continued)
Number of people living on less than $2 per day (millions)
GEP 2002

GEP 2003

Region

1990

1999

2015

1990

1999

2015

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

1,084
285
44
167
59
976
388

849
236
91
168
87
1,098
484

284
93
42
146
65
1,098
597

1,114
295
31
121
50
1,010
386

897
269
97
132
68
1,128
480

339
120
45
117
62
1,139
618

Total
Excluding China

2,718
1,919

2,777
2,164

2,232
2,041

2,712
1,892

2,802
2,173

2,320
2,101

$2 per day headcount index (percent)
GEP 2002

GEP 2003

Region

1990

1999

2015

1990

1999

2015

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

66.1
57.3
9.6
38.1
24.8
86.8
76.4

46.2
40.4
19.3
33.1
29.9
82.6
75.3

13.5
13.3
8.7
23.4
16.7
65.5
68.0

69.7
64.9
6.8
27.6
21.0
89.8
76.0

50.1
50.2
20.3
26.0
23.3
84.8
74.7

16.6
18.4
9.3
18.9
16.0
68.0
70.4

Total
Excluding China

61.7
58.8

54.7
56.5

36.3
41.0

62.1
58.7

55.6
57.5

38.1
44.7

Note: The GEP 2002 figures include the Republic of Korea, which has been reclassified into the high-income group.
Source: World Bank staff estimates.

Box 1.5 Is the World Bank overestimating
global poverty?

A

recent study (Bhalla 2002) concludes that theWorld Bank has overestimated the number ofpoor in developing countries, and that the millennium development goal of halving extreme poverty
by 2015 (from its 1990 level) was already achievedin 2000. The study estimates that the percentage
of poor in developing countries in 2000 was only
13.1 percent and that the World Bank’s estimate is
10 percentage points higher (see table 1.9). Threedifferences between the Bhalla estimates and theWorld Bank’s explain Bhalla’s different conclusion.
These differences include the choice of the poverty

line, his use of secondary data sources rather than
primary surveys, and consumption adjustments.
These differences highlight the complexity in counting the number of poor and are described here. A
more complete critique of the Bhalla study can befound in a separate paper (Ravallion 2002).
The World Bank has chosen to use $1 per day
and $2 per day poverty lines for global estimations,roughly spanning the range of national poverty lines
in developing countries. Bhalla uses $1.50 per day.
Because the cost of purchasing 2,200 calories differsfrom country to country, each country estimates its

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Box 1.5

P R O S P E C T S

2 0 0 3

(continued)

own national poverty line. This approach also reflects the fact that the nature of poverty varies significantly across and within countries. Moreover,
poverty has many dimensions: inadequate consumption of essential commodities, as well as low life expectancy, high child mortality, and low school enrollment rates, among other attributes related to thequality of life. Poverty is also a relative and subjective concept. What is deemed a necessity in somecountries (for example, indoor plumbing in richcountries) may be a luxury in others. In Latin America, the regional estimate for the percentage of people living in extreme poverty is 17.8 percent in 1998
(Wodon and others 2002), compared with 11.1 percent in 1999 using the $1 per day poverty line. The
former is based on national poverty lines and is froma regional perspective. This higher number—arguably a more accurate reflection of the incidence ofpoverty from a social point of view—is more relevant in determining policies for reducing poverty.
However, for purposes of global comparisons, theWorld Bank has tried to select a level of real consumption that best measures the same level of consumption across countries so it can make aggregate
judgments independent of where the poor live.
Unlike the Bhalla study—which relies on aggregate secondary data sources—the World Bank’s
poverty estimates rely exclusively on primary datafrom comprehensive household surveys. Since the1980s, the World Bank and developing-country governments have been actively involved in undertaking
national household surveys to get an accurate pictureof the distribution of consumption across individuals. To date, more than 300 comprehensive surveys
have been collated and used to estimate the numberof poor. Currently, the surveys cover more than
90 countries, with surveys available for various years
for most counties. The surveys used all have national
coverage. They include consumption from ownproduction—a key feature in many developing

countries—and the calculations are properly
weighted to reflect survey design and differences inhousehold size. Consumption is deemed to be thepreferred measure to income, but income is used
when consumption is not available.
Finally, Bhalla’s study makes consumption
adjustments, which may not be warranted and could
lead to a biased poverty estimate. The headcountindex (that is, the percentage of the population living
at or below the poverty line) is calculated using an
estimate of the per capita consumption level relative
to the poverty line. There can be significant discrepancies between the survey-based mean consumption
and the mean consumption as measured by the national accounts. Part of this discrepancy is explainedby the way consumption is estimated in the national
accounts (which typically includes consumption of
non-household private agents such as nonprofit
organizations). Other discrepancies can arise frommeasurement error (for example, misreporting of
consumption in surveys). Adjustments for these discrepancies can lead to different estimates of poverty.
If, for example, the misreporting is biased toward
high incomes—that is, if only rich households underreport consumption in the surveys—and if an upward adjustment is applied to all households (including the poorest), then the number of poor will clearlybe underestimated (see Ravallion 2002). The WorldBank’s poverty estimates rely on the survey-based
consumption levels.
Transparency in the methodology and data used
to assess the level of poverty is critical in this debate
regarding how to count the number of poor. The
ability of different researchers to easily assess andcompare results will lead to improved estimates andto a better understanding of the nature of poverty
and policies that accelerate poverty reduction.

Source: World Bank staff.

than did states with lower growth rates. Thisevidence implies that progress in the future
will be harder to achieve with the same national growth rate. Poverty-reducing policies
will, therefore, have to focus on raising the32

initial conditions in the laggard states andshould not rely exclusively on raising the national growth rate.
The number of poor in last year’s report
was projected to be 753 million in 2015,

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F O R

D E V E L O P I N GC O U N T R I E S

Population growth will easein all regions—or a headcount rate of 12.3 percent. The current forecast shows the number of poor will
decline to only 809 million by 2015, or aheadcount rate of 13.3 percent. This change
represents a 7.4 percent increase when compared with last year’s figure. The percentage
increase can be decomposed into two factors.
The higher initial level of the number of poor
in 1999 would lead to an increase of 2.3 percent in the 2015 forecast, all else being equal.
The remaining 5.1 percent of the increase in
the forecast is attributed to a weakening of therelation between growth and poverty.

In virtually all countries, growth of theworking-age population is slated to decline
over the next 15-year period, thereby affecting labor supply and thus contributing less to
GDP growth in the long run (figure 1.21).
High-income countries and those in Europe
and Central Asia are likely to see an absolute
drop in the working-age population by 2015.
Developing regions will see a slower pace of
decline, although East Asia is expected to see
its growth rate halved to 0.7 percent per yearby the end of the period.10 A slower growthrate in the labor force means that achieving
the same rate of per capita growth will requirean acceleration of investment, a higher level ofproductivity, or a combination of both.

Population, savings, and investment
are factors underlying the long-term
forecast
Some developing regions will need to see areversal in performance of underlying growth
factors—particularly in productivity and insavings and investment—from the last decade.
That reversal should show either changes topolicies or persistence with ongoing reforms.
Assessing the factors underlying the longterm forecast—population and labor supply,
technological progress, and savings andinvestment—will elucidate some of the underlying dynamics in the long-term growth forecast and its policy implications.

—but technological progress should
accelerate
The role of total factor productivity (TFP)
growth in determining growth rates has been
the subject of significant research over the past
decade (see box 1.6), but there is a growing
consensus that technological advances andefficiency improvements are pivotal determinants of growth patterns. If one looks forward, many countries are expected to reap the

Figure 1.21 Growth of working-age population decelerates(annual growth of population for ages 15 to 65)
4.0

MNA

3.5
SSA

3.0

SAS
LAC

2.5
2.0
1.5

EAP

1.0

ECA

0.5
0.0
0.5

HIY

1.0
1998

2000

2002

2004

2006

2008

2010

2012

2014

Note: HIY refers to high-income countries; SSA refers to Sub-Saharan Africa; EAP refers to East Asia and Pacific; SAS refers toSouth Asia; ECA refers to Eastern Europe and Central Asia; MNA refers to Middle East and North Africa; LAC refers to Latin
America and the Caribbean.
Source: World Bank staff demographic projections.

33

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Box 1.6 Technological progress is an important
determinant of growth
growing consensus in the economic literature isthat TFP accounts for the bulk of cross-country
differences in the level of income and the rate of
GDP growth (Easterly and Levine 2001).11 Whether
TFP or capital and labor accounted for the bulk of
income differences among countries has been an
issue of dispute since seminal articles by Denison(1972) and Jorgenson and Griliches (1967, 1972).
The debate sharpened in the 1990s when a numberof comparative growth studies found that the successof the East Asian Tigers was driven mostly by increases in capital and labor rather than by increases
in TFP (Young 1992, 1995; Collins and Bosworth1996). Because capital is subject to diminishing returns, such studies implied that the high rates ofgrowth achieved in East Asia were not sustainable(Krugman 1994).
More recently, the weight of evidence appears
to be moving toward the conclusion that TFP is themain driver of growth. The East Asian studies havebeen criticized for not accounting for the role thattechnological progress plays in encouraging greater
capital accumulation (Hulten 2000; Barro and Sala-iMartin 1992).12 Nelson and Pack (1999) emphasizethat learning, technology absorption, and forceful entrepreneurship were critical to the success of large investments in physical and human capital. Klenow andRodríquez-Clare (1997) estimate that TFP made animportant contribution to growth in all of the East
Asian “miracle” economies, except Singapore. Easterly and Levine (2001) summarize studies that show
TFP accounts for more than 40 percent of output
growth in most of the industrial countries, 30 percent
or more in most Latin American countries, and awide range (from 5 percent to 30 percent) in East
Asia (box figure). Some writers attempt to refine estimates of the contribution of TFP to growth by incorporating some measurement of the quality of inputs—for example, adjusting data on labor input forthe degree of education or training (see Easterly andLevine 2001 and Parente and Prescott 2000 for recent
contributions). In general, efforts have not been successful in greatly reducing the amount of growth orincome differences that are accounted for by TFP.
The evidence that growth in TFP is the main
driver of economic growth is essentially an optimistic

34

sign for developing countries, because constraints on
domestic resources and access to external financing
severely limit a country’s ability to raise growth rates
by increasing the volume or improving the qualityof physical and human capital. To the extent thatdifferences in TFP growth will reflect differences intechnology, then developing countries (which are
well below the technological frontier) can potentiallyachieve high “catch-up” rates of growth by importing technology. Parente and Prescott (1994) see themain source of cross-country productivity differences
as stemming from policy-induced barriers to adopting advanced technology. TFP growth also reflects
other aspects of economic efficiency that are
amenable to change through improving policies. For
example, policies that increase competition may raise
TFP by improving the allocation of labor and capitaland by increasing the ability of the economy to respond to changes in the economic environment(Easterly and Levine 2001; Solow 2001; Hulten
2000).
Critiques of using this accounting approach
include the fact that it typically relies on various
restrictive assumptions (for example, constantreturns to scale and competitive markets) that may
not hold in reality (although models that incorporate
TFP is a major contributor to growth(percent )
60
50
40
30
20
10
0
10

Fra
Ge nce
rm
an
y
Ita
Un
ly
ite
J
a
d
pa
Un King n
ite domdS
Ar tates
ge
nti
na
Bra
zi
Ve
Ch l
ne
zu
Me ileela
Hox, R ico
ng
.B.
Ko
d
ng
(C e
S h
Ko inga ina)rep
Ta a, Re oreiwapn ( . of
Ch
ina
)

A

Source: Easterly and Levine (2001).

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Box 1.6

E C O N O M Y

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S(continued)

market imperfections also confront difficult econometric problems; see Brock and Durlauf 2001).
Often, key parameters, such as the share of capital in
output, are assumed to be based on limited empirical
work (Senhadji 2000). Solow (2001) notes that thegrowth-accounting framework assumes that theeconomy is moving along the potential output frontier. In developing countries, the volatility of thebusiness cycle means that actual output may be considerably different from potential at any point intime. Thus, growth-accounting estimates using timeseries data may be biased by differences between
potential and actual output levels at the beginningand end points, even if a considerable time period is

Figure 1.22 Productivity has not been
the dominant source of growth inregions(average percent per annum 1990–2000)
8
Productivity
6
4
Capitalcovered. Finally, growth accounting generally does
not reflect either improvements in the quality ofgoods or the introduction of new products, which
are also important for welfare (Hulten 2000). Those
criticisms underscore the substantial methodologicaland measurement difficulties involved in quantifying the contribution of inputs and productivity to
growth rates. Nevertheless, as Hulten (2000) stresses,
this approach has provided a simple and internallyconsistent intellectual framework that has been used
to gain vital insights into the process of economic
growth.
Source: World Bank staff.

changes in its service sectors, which will havelong-term payoffs. Both Europe and Japan,
although lagging somewhat behind the UnitedStates, have the opportunity to reap gains from
improved use of information technologies.
The East Asia region has been the leader
among developing regions in terms of accelerating productivity over the past two decades.
It has built on compositional shifts (fromagriculture to manufacturing and services),

20Figure 1.23 Productivity is expected tobe more significant in the longer term

Labor

2

(average percent per annum 2005–15)
4
HIY

EAP

ECA

LAC

MNA

SAS

SSA

HIY  high-income countries.
Source: World Bank staff estimates.

8

Productivity

6
Capital4benefit of reforms undertaken during the past
10 years. These benefits will likely show up as
an acceleration of technological progress (figures 1.22 and 1.23). Among industrial countries, those countries in Europe will see accelerating benefits from the single currency plus
greater capital and labor mobility. Japan,
though still burdened with significant problems in its financial sector, is witnessing

2
0
Labor

2
4
HIY

EAP

ECA

LAC

MNA

SAS

SSA

HIY  high-income countries.
Source: World Bank staff estimates.

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educational improvements, and productivityenhancing policies (for example, increasing
openness). The region will continue to benefit
from good policies and compositional shifts.
After all, the largest country in the region,
China, still has more than 60 percent of its
work force in agriculture. However, as the gap
with technologically more advanced countries
closes, the opportunities for extreme advancesin productivity diminish.
Europe and Central Asia is benefiting fromthe substantial reforms of the 1990s, accompanied by large FDI flows. Moreover, many of
the accession countries will accelerate the reform process in preparation for joining the EU
early in the forecast period.
In Latin America, progress has been visible
regionwide. As has been positively demonstrated by Chile and Mexico, openness andstability are key elements in providing sustainable growth. A recent study of Latin American
growth over the past three decades concludes
that structural reforms and stabilization policies accounted for a large contribution to theoverall acceleration in the rate of growth in
the 1990s compared with the “lost decade” ofthe 1980s.13 These trends are expected to continue in the next decade, with increasing investments in infrastructure and education andwith greater openness to trade underpinningsolid productivity growth. The key downsiderisk includes the vulnerability of the region toexternal shocks, particularly given its sizable
external debt burden, and the effects that thisdebt could have on the stability of the domestic financial sector.
Sub-Saharan Africa has benefited from similar policy reforms and stabilization. FDI has
been increasing, and the resolution of somelong-term civil conflicts should provide amore enabling environment for sustained
growth. South Asia and the Middle East andNorth Africa regions have maintained some ofthe highest trade barriers in the world. Thesebarriers will slowly be removed under the impetus of multilateral and regional trade agreements, with ensuing efficiency gains.

36

Figures 1.22 and 1.23 summarize the decomposition of the various sources of GDP
growth into three broad components: thelabor supply, capital accumulation and productivity for the historical period 1990–2000,
and the long-term projection for 2005–15.
The decomposition profiles projected for theperiod 2005–15 are rather similar to the
1990–2000 period, with the significant exception of the contribution from technologicalprogress. As argued on page 38, we have projected that most regions will see an acceleration of technological progress, which will
drive the improvements in GDP growth. That
progress will trigger further capital accumulation to accommodate and to further enhance
growth prospects—hence the need for providing an enabling investment environment.
Capital accumulation implies an investment
profile—discussed in more detail below—
linked, of course, to behavioral assumptions
regarding savings during the coming decade.

Convergence of investment ratios is likely
to continue
After a distinct divergence of investment ratios
across regions during the past decades, someconvergence is expected during coming
decades, though disparities will remain significant. Investment rates in the developing East
Asia and the Pacific region gradually increased
from 15 percent of GDP during the 1960s to
almost 30 percent during the 1980s (figure 1.24a). This increase coincided with rapid
growth of the economies in the region, major
sectoral shifts as a result of diversification,and regional and global integration, which all
required expansion or replacement of capitalstocks. During the first half of the 1990s, theaverage investment rate jumped further to
35 percent, of which a substantial part wasused for real estate development when foreign
capital streamed in. In 1997, investors realizedthat their collective behavior was based on
overly optimistic expectations. The resulting
financial crisis sharply lowered investment
rates back to levels near 25 percent.

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The investment rate in South Asia was extremely low until the mid-1970s, but then it
started to rise. To a large extent, that rise is areflection of the green revolution and industrialization programs in India. Although not asstrong by far as in East Asia, the average ratecontinued to increase during the 1980s and1990s, and the current level is now close to
OECD levels of around 22–23 percent. Thatlevel is well above rates in Latin America and
Sub-Saharan Africa.
Structural developments in the latter two
regions (LAC and SSA) were quite different
from the Asian experience. A gradual rise ininvestment rates during the 1970s, which waspartly financed abroad, suddenly turned intoa sharp decline when the debt crisis hit in theearly 1980s. Investment rates dropped around
5 percentage points. Macroeconomic imbalances and hyperinflation in Latin America, as
well as sharp terms-of-trade losses in Africa,
led to extremely low growth during the 1980s.
In this environment, investment rates continued to fluctuate around historical lows. During the 1990s, investment rates showed onlya slight recovery, although the composition
shifted significantly away from public to private investment, following major structural

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E Schanges and privatization programs. One reason for the lack of a strong rebound in investment was the continued low domestic savings
rate in both regions (figure 1.24b). Even with
low investment rates, the current accountshowed large deficits during the 1990s.
Future investment trends will be influenced
by expected GDP growth, by real domestic
interest rates, and by expected domestic rates
of return to capital compared with the average
global rate of return. If one assumes a stablerisk environment, the last effect should tend
to benefit developing countries, where rates
of return are higher than in rich counties.
Table 1.10 summarizes the changes in investment behavior between the average of the
1997–2001 period and the final year (2015)of the baseline scenario. On average, the highincome countries will see a drop in the investment rate of about 2.9 percentage points (relative to GDP). This figure is derived largely
from lower projected GDP growth rates andthus changes in the optimal capital to output
ratio. The average investment rate in developing countries increases slightly by 0.2 percentage points, with higher investment rates inmany regions offset by lower investment inEast Asia. The latter region is still suffering

Figure 1.24 Major structural shifts in investment and savings behavior have occurreda. Investment-to-GDP ratio

b. Savings-to-GDP ratio(current dollar-weighted average)(current dollar-weighted average)

35

35

1980s

30
25

1970s

30
1990s

1960s

25

20

20

15

15

10

10

5

5

0

1960s

1970s 1980s
1990s

0
South
Asia

Latin
Sub-Saharan East Asia
America andAfricaand Pacific
the Caribbean

South
Asia

Sub-Saharan East Asia
Latin
AfricaAmerica andand Pacific
the Caribbean

Source: World Bank staff estimates.

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Table 1.10

P R O S P E C T S

2 0 0 3

Savings fall in high-income countries, but increase in most other regions(as a percentage of GDP)
1997–2001

Total
High income
Low and middle income
European UnionJapan
United States
Rest of high income
East Asia and PacificSouth Asia
Middle East and North Africa
Sub-Saharan Africa
Europe and Central Asia
Latin America and the Caribbean

2015

Savings(S)

Investment(I)

Capitalinflows(KA)

Savings(S)

Investment(I)

Capitalinflows
(KA)

22.4
22.0
24.2
20.8
29.8
17.5
30.8
36.9
21.3
26.2
13.9
21.9
17.9

22.5
21.9
24.7
20.4
27.5
19.5
26.1
33.9
22.2
21.4
17.6
22.6
21.7

0.1
0.1
0.5
0.4
2.2
2.0
4.7
3.0
0.9
4.8
3.7
0.7
3.7

20.5
18.6
26.0
17.5
26.0
14.5
24.9
35.0
23.7
23.1
19.0
22.0
20.5

20.5
19.0
24.9
17.4
25.4
16.3
23.2
29.3
23.5
22.2
20.1
27.1
20.6

0.0
0.4
1.1
0.1
0.6
1.9
1.7
5.8
0.2
0.9
1.1
5.1
0.0

Note: The columns (S), (I), and (KA) represent, respectively, the national saving rate, the national investment rate, and the capital
account, all as a share of GDP. The values for 2015 are simulated values from the global general equilibrium model (maintainedby the Development Economics Prospects Group). The values for the 1997–2001 period represent the average observed values
from the World Bank’s statistical databases. For the high-income countries, these values are the 1997–99 or 1997–2000 averages,
depending on data availability. For the totals, the averages cover only the years 1997–99.
Source: World Bank model simulations.

from past overinvestment, particularly insome sectors, and will adjust its investment
needs to a slight deceleration in growth. Mostof the other developing regions will see acceleration in investment in anticipation of higher
growth. Investment in those regions will also
provide relatively higher returns than in the
more mature economies.
Future changes in investment rates do notnecessarily lead to corresponding changes incurrent accounts. Despite capital mobility,
investment rates tend not to correlate withcurrent account deficits in the long run, theso-called Feldstein-Horioka puzzle (1980).
Also in the coming 15-year period, the savings
rate is expected to increase in those countries
that are anticipated to enjoy an acceleration of
growth, partly because of rapidly changing
demographics.

Changing demographics will raisesavings in developing countries
and will lower savings in industrial
countries
Global population dynamics are evolving
fairly rapidly at the beginning of the new mil-38

lennium. Rich countries are seeing an extension of life spans and a rapid decline inbirthrates, leading to a sharply aging population. Developing countries are witnessing a
relatively sharp drop in the percentage ofyouths as well as modest increases in thenumber of elderly. Recent economic evidence
suggests that these trends could have significant implications on national saving rates—
lowering them in rich countries because of
aging, but raising them in developing countries as workers save for future retirement.
Lower birthrates also lead to a reduction inresource demand for the young.
The demographic transition with respect tothe proportion of youths is largely over in thehigh-income countries (figure 1.25). The overall average was 27.4 youths per 100 workers14
in 2000 and is expected to drop to 24.4 by
2015. Developing regions are likely to witness
much greater changes. First of all, the proportion of youths is starting from a significantly
higher base, with the dependency ratio averaging 51.0, which is nearly double the highincome average. The ratio is expected to drop
to 40.7 by 2015, twice the percentage of thegep_ch01.qxd 12/5/02 4:16 PM Page 39

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F O R

D E V E L O P I N G

Figure 1.25 Youth dependency ratio will
fall everywhere except Japan

Figure 1.26 Elderly dependency ratios
will rise in some regions(number of youths, age 15 and under, per 100
working-age population)(number of elderly, age over 60, per 100 working-age
population)

90

2000

2000

C O U N T R I E S

50

80
2015

70

2015

2015

40

60
30

50

2000
2015

40

20

2000

30
20

10

10
0

HI
Y
LM
Y

TO
T

U
JP
N
US
A
RH
Y
EA
P
SA
R
MN
A
SS
A
EC
A
LA
C

E_

HI
Y
LM
Y

TO
T

E_

U
JP
N
US
A
RH
Y
EA
P
SA
R
MN
A
SS
A
EC
A
LA
C

0

RHY  rest of high income; TOT  global average;
HIY  high-income average; LMY  low- and middleincome average.
Note: Working-age population is defined as those people
between the ages of 15 to 65.
Source: World Bank staff.

RHY  rest of high income; TOT  global average;
HIY  high-income average; LMY  low- and middleincome average.
Note: Working-age population is defined as those people
between the ages of 15 to 65.
Source: World Bank staff.

fall expected in industrial countries. This anticipated decline is the consequence of two factors: a boom in births over the past two
decades, leading to a rapid rise in the workingage population, and, more recently, declining
birthrates, which are caused by a combinationof economic growth and family-planning
programs.
The elderly dependency ratio, defined as
number of members of the population who
are older than 65 per 100 workers, is rising inalmost every region (figure 1.26). The transition is occurring rapidly in industrial countries
as the Baby Boom generation ages and aslife expectancy improves, but there will only
be modest changes in developing countries
through 2015 because relatively more recent
improvements in health and life expectancy
will affect elderly demographics only further
in the future.15 The elderly dependency ratio
average in 2000 for industrial countries was
21.2 per 100 workers. It is expected to rise to
26.9 by 2015, surpassing the youth dependency ratio. Japan will witness the most dramatic increase, from 25.1 to 39.8. This change

alone could have major macroeconomic implications for Japan and have consequences forthe rest of the world, because Japan has long
had large excess savings that have been recycled abroad. Outside the industrial countries,
the average elderly dependency ratio is notexpected to change significantly. The average
was 8.9 in 2000, increasing to only 9.6 in2015.
Several recent studies of private savings
behavior have linked the private savings rate
to a number of different factors: demographics, income levels and growth, interest and inflation rates, and degree of financial intermediation.16 The results discussed next focus on
only three channels affecting savings: the rateof per capita GDP growth, the youth dependency ratio, and the elderly dependency ratio.
Other channels may prove to be equally important, however, such as improved financial
intermediation and a stable macroeconomic
environment. Combining these three effects
suggests that global savings may decline byaround 1 percentage point over the longer
term, a figure that takes into account a39gep_ch01.qxd 12/5/02 4:16 PM Page 40

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2 0 0 32.7 percentage point decline in high-income
countries and a 3.7 percentage point rise indeveloping countries.
With relatively large swings in domestic
savings rates, the scenario suggests a rather
significant change in net capital flows. In
1997, the base year of model simulations,industrial countries were exporting around$67 billion in net investment to low- andmiddle-income countries, some 1.1 percent oflow- and middle-income countries’ GDP. East
Asia was the only developing region that was
a net exporter of capital in the base year.17 By
2015, under these savings and investment assumptions, low- and middle-income countries
would be significant net exporters (some1.1 percent of their GDP), while industrial
countries would be net importers. Among industrial countries, Europe would be in approximate investment-to-savings balance, but
the United States could continue to be a significant net importer of capital. The UnitedStates would actually see little change in its
capital account surplus from the base year (asa share of GDP), though it would experiencea reversal from its present high level. Japan’s
capital account deficit would diminish sharply
with a rapidly increasing elderly population
leading to a decrease in savings.18
The actual magnitude of these changes
in savings and investment rates remains
speculative—even though they are grounded inempirically validated economic theory withina consistent accounting framework—becausesome of the underlying behavioral relations
could change the savings rates, the investment
rates, or both to some extent and could havea noticeable effect on the balance (that is, thecapital account). Nevertheless, there is little
doubt regarding the broad changes in thepattern in these projections. A clear trend
emerges of further reduction in developing
countries’ foreign debt. East Asia could continue to show significant surpluses on the current account, while Latin America could converge toward a balanced current account. The
latter would be the result of, and represent arise in, the savings rate and a relatively stable40

investment ratio. Those figures would reflect
no change in overall growth compared withthe 1990s because declining population
growth will counteract the acceleration in percapita growth.19 These trends in savings andinvestment rates will require adjustments torelieve the strains on budget and other variables. Open capital and goods markets would
facilitate the potential strains from demographic transition.

Major policy challenges are likely
to emerge
While there is evidence in support of the economic growth projection in this long-run scenario, the degree of uncertainty regarding the
projections is high. There is recognition thatthese trends will require good policies, because many developing countries are still subject to major shocks.
These scenarios raise important long-term
policy issues. First, the changing savings andinvestment patterns will have consequences
for net capital flows. Several developing countries that in past decades have relied on net
capital inflows will find it harder to do so inthe coming 15 years. Indeed, the recent shift
from debt accumulation to debt reduction in
many of these countries is likely to herald
a new long-term trend of further declines
in debt. If the expected increase in private
domestic savings is accompanied by further
maturing of domestic credit markets and is
not thwarted by deterioration of public savings, then debt reduction will not conflict with
the investment patterns needed to underpin
growth.
Underlying large swings in net capital flows
are even larger movements of gross capital
flows, because FDI expands into growing
markets in developing countries and because
financial agents in developing countries seek
to diversify their portfolios in rich countries.
These capital movements will require further
international financial integration. Because
the history of financial integration has notbeen entirely felicitous—and at times has beendamaging to growth and poverty reduction—

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the international community and developing
countries have had to search for mechanisms
to provide for greater stability in integration.
Developing countries can further facilitate
potential growth by improving their investment climates. A sound policy environment
will trigger investment flows and, more important, will ensure that these flows go into
internationally competitive activities. A soundinvestment climate in developing countries
can also attract FDI, which is a form of lessvolatile capital inflow.

Notes
1. Examples of investment-grade borrowing countries are Chile, China, the Republic of Korea,
Malaysia, Mexico, Thailand, and several Central
European countries.
2. See Appendix 1, “Regional Economic Prospects,”
for detail on recent developments, policy, and prospects
for developing regions.
3. Simulation used the world model by Oxford
Economic Forecasting Inc.
4. Investment is the most cyclical component of
GDP and is the key driving force underlying the emergence of turning points in the economy. The flow ofinvestment expenditures is volatile because investment,
unlike consumption, represents the desired change ofa stock. As the capital stock tends to move with income
and consumption, the change in the stock shows
sharper fluctuations than the change in income. Furthermore, a downturn in investment is inherently temporary and bears the seeds of subsequent recovery.
Once the lower desired capital stock has been achieved,
the flow of investment stops falling and starts increasing again to keep the capital stock stable at the newlevel.
5. The trends are computed with Hendrick-Prescottfilters.
6. To reduce the potential risk of bad data contaminating the results, we have excluded outliers (investment volatility more than three standard deviations
above the mean).
7. The correlation coefficient exceeds 0.75.
8. The large drop in the poverty incidence in Latin
America comes from new surveys and from revisions to
consumption levels. The surveys predate the recent turmoil in the region, particularly in Argentina, where theincidence of poverty has increased substantially after
three years of recession. The large recent rise in poverty
in Argentina reflects the national poverty line. The riseusing the World Bank’s $1 per day or $2 per day may

A N D

P R O S P E C T S

F O R

D E V E L O P I N GC O U N T R I E S

have a lower magnitude because average per capita income in Argentina ($12,100 in purchasing power parity terms in 2001, and $7,750 in 1995 terms) is muchhigher than the $2 per day level.
9. See, for example Datt and Ravallion (2002).
10. The growth rates are weighted by labor value
added, which may bias the regional estimates downward if high-wage countries have slower growth rates.
Among other things, this method would affect a world
total because industrial countries have significantly
higher wages than developing countries.
11. TFP is not the same as technical progress, butinstead includes all contributions to growth that are
not captured by data on capital and labor. However,
the integration of more efficient technologies into production can raise the level of TFP.
12. Technically, only the fraction of capital accumulation that arises from the underlying propensity toinvest at a constant rate of TFP growth should beviewed as capital’s independent contribution to output
growth. Hulten (2000) found that correcting for the
induced capital accumulation caused by higher TFP
almost doubled estimates of the contribution of TFP
to growth for the United States.
13. See Loayza, Fajnzylber, and Calderón (2002).
14. We will use the term “workers” as shorthandfor the working population between ages 15 and 65.
15. With the significant exception of SSA, where
AIDS has dramatically reversed life expectancy, and toa lesser extent ECA, where health systems deteriorated
during the transition toward market economies.
16. See, for example, Loayza, Fajnzylber, andCalderón (2002) and Masson, Bayoumi, and Samiei(1998).
17. Model simulations start in the base year 1997,
and net capital flows for that year are derived from the
Global Trade Analysis Project (GTAP), release 5.0,
database. Note that the GTAP data, though based on
official statistics, are adjusted to ensure global accounting consistency (that is, the sum of the capital
account across all regions is identically equal to zero).
The world capital account has had a significant andincreasing residual over the past few years. The values
in the first three columns of table 1.10 (that is, theaverage savings to investment ratios for the period
1997–2001) are largely consistent with the initial 1997
base levels from the GTAP dataset. The only region
where the sign of the capital account balance differs between 1997 and the 1997–2001 average is the MENA,
which is subject to considerable volatility because of
the price of oil, the region’s main export.
For all other regions, the sign of the observed early
period capital account balance is consistent with the1997 base year, though the magnitude may differ. The
difference in magnitude is easily magnified because the41gep_ch01.qxd 12/5/02 4:16 PM Page 42

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capital account balance is a residual item. Thus, even
if there is little volatility in the savings and investment
components individually, there could be significantly
more variation in the capital account balance.
Finally, as already highlighted in the table note, thecapital account imbalance at the global level has been
large of late—and is increasing. In the model simulations, the base data are adjusted to remove theglobal imbalance, and the model itself ensures global
accounting consistency in each year of any simulation.
(The model could track perfectly the observed saving
and investment ratios for each country except one. Or
there would have to be a residual country in the modelthat would absorb any adjustments to ensure global
accounting consistency.) Even if the global capital
account imbalance is small as a share of global GDP,squeezing out the $100 billion to 200 billion residual
error is bound to have significant effects on the capital
account of individual countries, even a large one suchas the United States. If the U.S. imbalance is $400 billion and the entire adjustment is forced on it, the U.S.
capital account imbalance could change by as much as
50 percent.
18. Note that this concept is flow based. All industrial countries have significant assets in other industrial
countries as well as in developing countries. One
would anticipate, as in the case of Japan, that as the
population ages, the retired elderly will draw down
their accumulated savings, including those funds invested abroad.
19. Table 1.10 compares the observed investment
ratios over the 1997–2001 period with the end-ofperiod investment ratio generated by the model. The
starting point of the model, 1997, has an investment
ratio of 20.5 for Latin America. Thus, the scenario is
forecasting virtually no change in the ratio.

References
Barro, Robert, and Xavier Sala-i-Martin. 1992. “Convergence.” Journal of Political Economy 100(2):223–51.
Baxter, Marianne, and Mario J. Crucini. 1993.
“Explaining Saving—Investment Correlations.”
American Economic Review 83(3): 416–36.
Bhalla, Surjit. 2002. Imagine There’s No Country:
Poverty, Inequality, and Growth in the Era of
Globalization. Washington, D.C.: Institute forInternational Economics.
Brock, William A., and Steven N. Durlauf. 2001.
“Growth Empirics and Reality.” The World Bank
Economic Review 15(2): 229–72.
Collins, Susan M., and Barry P. Bosworth. 1996. “Economic Growth in East Asia: Accumulation versus

42

Assimilation.” Brookings Papers on Economic
Activity 2: 135–91.
Crucini, Mario J. 1997. “Country Size and Economic
Fluctuations.” Review of International Economics 5(2): 204–20.
Datt, Gaurav, and Martin Ravallion. 2002. “Is India’s
Economic Growth Leaving the Poor Behind?”
Journal of Economic Perspectives 16(3): 89–108.
Denison, Edward F. 1972. “Some Major Issues in
Productivity Analysis: An Examination of theEstimates by Jorgenson and Griliches.” Survey ofCurrent Business 49(5, part II): 1–27.
Easterly, William, and Ross Levine. 2001. “It’s Not
Factor Accumulation: Stylized Facts and Growth
Models.” The World Bank Economic Review 15:
177–219.
Feldstein, Martin, and Charles Horioka. 1980.
“Domestic Savings and International Capital
Flows.” Economic Journal 90(358): 314–29.
Hulten, Charles R. 2000. “Total Factor Productivity: A
Short Biography.” National Bureau of Economic
Research (NBER) Working Paper no. 7471. Boston.
Jorgenson, Dale W., and Zvi Griliches. 1967. “TheExplanation of Productivity Change.” Review of
Economic Studies 34(3): 249–83.
———. 1972. “Issues in Growth Accounting: A Reply
to Edward F. Denison.” Survey of Current Business 52(5, part II): 65–94.
Kaufmann, Daniel, Aart Kraay, and Pablo Zoido–
Lobatón. 2002. “Governance Matters II: Updated Indicators for 2000–01.” Working Paper no.
2772. World Bank, Washington, D.C. February.
Klenow, Peter, and Andrés Rodríguez-Clare. 1997.
“Economic Growth: A Review Essay.” Journal of
Monetary Economics 40(3): 597–617.
Krugman, Paul. 1994 “The Myth of Asia’s Miracle.”
Foreign Affairs 73(6): 62–77 (November/
December).
Loayza, Norman, Pablo Fajnzylber, and César
Calderón. 2002. “Economic Growth in Latin
America and the Caribbean: Stylized Facts,
Explanations, and Forecasts.” World Bank,
Washington, D.C. June. Processed.
Masson, Paul R., Tamim Bayoumi, and Hossein
Samiei. 1998. “International Evidence on the
Determinants of Private Saving.” World Bank
Economic Review 12(3): 483–501.
Nelson, Richard R., and Howard Pack. 1999. “TheAsian Miracle and Modern Growth Theory.”
Economic Journal 109(July): 416–36.
Parente, Stephen L., and Edward C. Prescott. 1994.
“Barriers to Technology Adoption, Learning-byDoing, and Economic Growth.” Journal of Political Economy 102(2): 298–321.

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E C O N O M Y———. 2000. Barriers to Riches. Cambridge, Mass.:
MIT Press.
Ravallion, Martin. 2002. “Have We Already Met theMillennium Development Goal for Poverty?”
World Bank, Washington, D.C. Processed.
Senhadji, Abdelhak. 2000. “Sources of Economic
Growth: An Extensive Growth Accounting
Exercise.” International Monetary Fund Staff
Papers 47, no. 1. Washington, D.C.
Solow, Robert. 2001. “Applying Growth Theory
across Countries.” The World Bank Economic
Review 15(2): 283–88.
Wodon, Quentin, Rodrigo Castro-Fernandez, Kihoon
Lee, Gladys Lopez-Acevedo, Corinne Siaens,

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Carlos Sobrado, and Jean-Philippe Tre. 2002.
“Poverty in Latin America: Trends (1986–1998)
and Determinants.” World Bank, Washington,
D.C. February. Processed.
Young, Alwyn. 1992. “A Tale of Two Cities: Factor
Accumulation and Technical Change in Hong
Kong and Singapore.” In O. J. Blanchard and
S. Fisher, eds., NBER Macroeconomics Annual
1992. Cambridge, Mass.: MIT Press, pp. 13–53.
———. 1995. “The Tyranny of Numbers: Confronting
the Statistical Realities of the East Asian Experience.” Quarterly Journal of Economics 110(3):641–80.

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12Changes in Global Business
OrganizationThe organization of global business is
rapidly changing in ways that affectthe competitive opportunities open todeveloping countries. A principal feature ofbusiness organization is the steady expansionof multinational corporations and their relatedtrade and investment activities. Multinational
companies, including many based in otherdeveloping countries, are altering the competitive landscape by providing for developing
countries a new source of entry into markets.
Moreover, by taking advantage of falling communication and transport costs, multinationals have learned to manage different stagesof production in multiple, distant locations,
thereby creating opportunities for developing
countries to produce during those stages of
production—often labor-intensive stages—that correspond to their comparative advantage. But tapping into this potential sourceof competition is not automatic, and not all
countries have benefited. Moreover, someobservers have openly worried that the recent surge in global mergers among leading
multinationals might be dampening competition and creating obstacles for developing
countries.
This chapter reviews four recent trends inthe organization of global business that affectdeveloping countries’ ability to harness foreign investment for greater competition:changes in global business concentration, therise in service sector foreign direct investment(FDI), the growth of global production

networks, and the growing importance ofstrong investment climates for the allocationof foreign investment.

Developing countries have benefited
from the boom in global trade andinvestment—
Cross-border trade and direct investment have
expanded rapidly over the past three decades.
Global exports of goods and services increased
from 14 percent of output in the early 1970s to
23 percent by the late 1990s, while global FDI
flows have more than doubled relative to grossdomestic product (GDP). The surge in FDI
flows, with a large boost from cross-bordermergers and acquisitions (M&A), accelerated
in the late 1990s. FDI rose from $331 billion
in 1995 to $1.3 trillion in 2000 before fallingto an estimated $725 billion in 2001. Despite
the sharp increase in M&A, the share of global
economic activity accounted for by the top
50 companies does not appear to have risen
significantly during the 1990s. The top 50 companies accounted for 0.8 percent of worldGDP, and their aggregate profits amounted to
3.3 percent of global savings in 2000.

—the rise in service sector FDI—
A second change in global business organization creates an opportunity for developing
countries to expand productivity-enhancing
competition. Foreign investment in services—financial, wholesaling and retailing, realestate, and business services—is accelerating.

45

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Today, services account for more than halfof the FDI stock in most major industrial
countries. The rise in service sector FDI helps
developing countries to introduce new technology, to boost competition in services, andto increase the availability and quality of services. Because many services are essential inputs to production, with multiple linkages tovirtually every dynamic part of the economy,increasing their efficiency directly boosts
economy-wide productivity. However, many
countries still maintain impediments to thisnew source of competition and technology
and, as a result, are at risk of being left
behind.

—and the growth of cross-borderproduction networks—
Technological progress in transport, communications, and data processing—coupled with
policy reforms—has fueled the growth ofcross-border production networks, in which
multinational corporations break down the
production of final goods into stages thatvary in the intensity of capital, skilled labor,
unskilled labor, and other requirements, andmultinationals produce each stage where it
can be done at lower cost. In part, production
through networks is accomplished by greater
outsourcing of production, as multinationals
become less vertically integrated. In part,
networks are established through foreignsubsidiaries.
Developing countries’ increased participation in production networks is seen in the
rapid growth in their exports of parts andcomponents, as well as in their increasing
importance in intra-firm trade by multinationals. Participation in networks has generated
substantial gains for developing countries
through improving access to technology, thusincreasing the demand and supply of skilledlabor, as well as providing the opportunity formoving up the value chain to produce moresophisticated products. However, production
for networks is highly concentrated in countries with strong policy regimes, skilled workforces, and adequate infrastructure.

46—but a strong investment climate is
criticalThe policy and institutional framework is an
important determinant of whether countries
have participated in the rise in FDI. During
the 1990s, countries with strong investment
climates captured an increasing share of rapidly
expanding global FDI flows. The removal ofrestrictions on private investment in services(particularly infrastructure services) has increased private investment and has improved
the quality of services available to firms in developing countries. The lowering of trade barriers and reduction in restrictions on FDI has
facilitated developing countries’ participationin cross-border production networks. External
factors also play a role in determining access to
FDI. For example, the recent deterioration of
the global business environment has led to a
reduction in investment in high-risk projects,
and foreign investment in infrastructure has
dropped all over the world. Still, those countries with macroeconomic stability, sound governance, and healthy institutions will attract anincreasing share of available funds.

The surge in trade and FDI
Trade and FDI have grown rapidly sincethe 1970s—
Cross-border trade and direct investment have
expanded rapidly over the past few decades.
Global exports of goods and services increased
by 5.5 percent per year in real terms from1978 to 2001, rising from just over 14 percent
of output in the 1970s to almost 25 percent
of output in 2001. High-income countries
account for the bulk of world trade and hence
the largest increment to trade flows. Developing countries’ exports rose by just under 6 percent per year in real terms from 1978 to 2001,
and their aggregate exports-to-GDP ratio increased by more than half over this period(figure 2.1).
Global FDI flows have also expanded
rapidly. The surge in FDI flows accelerated
in the late 1990s, rising from $331 billion ingep_ch02.qxd 12/5/02 2:53 PM Page 47

C H A N G E S

Figure 2.1 Exports-to-GDP ratios haveincreased since the 1970s(percent)
35
30
25
High-income countries
20
15
Developing countries
10
5

19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00

0

Source: World Bank data.

1995 to $1.3 trillion in 2000 before falling toan estimated $725 billion in 2001 (UNCTAD
2002a). All income groups experienced a

I N

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O R G A N I Z A T I O N

sharp rise in the average ratio of FDI to investment during the 1990s (figure 2.2), with thelargest increase in the industrial countries during the last years of the decade. Low-income
countries have seen a five-fold rise in FDI relative to investment, to almost the same ratio as
in lower-middle-income countries. FDI flows
to developing countries equal about $160 billion, while domestic investment in developing
countries equals about $1.5 trillion.
The rise in trade and FDI has played an
important role in boosting the productivity offirms in developing countries. In part, developing countries may become more productive
because trade improves the allocation of resources and because multinational subsidiaries
may be more productive than domestic firms.
In addition, domestic firms may increase theirproductivity through participation in tradeand contacts with local subsidiaries of foreign
firms, although the extent and channels are amatter of considerable debate in the economic

Figure 2.2 All regions have benefited from rising FDI flows(FDI-to-investment ratios, 1990–2000, in percent)
40
35
30
25
20
15
10
5
0
Top 10 developing
country recipients

Low-income
countries

Lower-middle-income
countries

Upper-middle-income
countries

High-income
countries

Note: Each set of bars represents the period 1990–2000; each bar represents one year during that period. The data on FDI include
both greenfield and M&A transactions, whereas national income account data on investment represent only new investments. “Top10 developing country recipients” refers to the 10 developing countries that received the largest inflows of FDI.
Source: World Bank data.

47

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2 0 0 3literature. Much empirical work has focusedon the potential for technological spillovers
through importing, exporting, and FDI (seechapter 3 for a full discussion). On balance,
the evidence for technological spillovers
through imports is strong, while the evidence
that exporting promotes technology diffusion
is less robust. Evidence for the existence oftechnology spillovers from FDI is mixed.
Many industry-level studies (for example,
Blomström 1986) have documented a positive
correlation between FDI inflows and productivity, although the causal direction is unclear.
Some firm-level studies have failed to find evidence of technological spillovers in developing
countries. The effect of FDI will depend, inpart, on the form that FDI takes. FDI directed
to heavily protected industries or attracted byvery costly incentives may have a low, or evennegative, effect on growth and productivity.
But FDI used to integrate domestic subsidiaries in production networks could havesubstantial spillover effects (Moran 2001).

—but not all countries have participatedequally in the rise in FDI
Among industrial countries, the top five recipients of net FDI flows accounted for 74 percent of total FDI. However, a few of thesmaller countries (for example, Ireland andDenmark) have the highest ratio of FDI toGDP. The same pattern can be seen in developing countries, where the top 12 recipients
captured 80 percent of total FDI flows, butsome smaller countries had FDI-to-GDP ratiosthat were several times the average ratio. Figure 2.3 compares each developing country’s
share of total FDI with its ratio of FDI to
GDP (the countries are ordered by the shareof total FDI). Almost half of the 12 largest
recipients of FDI (at the far right of the distribution in figure 2.3) have FDI-to-GDP ratiosthat are lower than the average. According toa more comprehensive measure developed by
the United Nations Conference on Trade andDevelopment (UNCTAD), FDI to developing
countries is mildly concentrated: only 30 out of

Figure 2.3 FDI is concentrated in large countries, but many small countries receive large
amounts relative to GDP(percent share of total FDI)

(FDI as a share of GDP)
45

25

40
20

35
Top 10 receive almost
80% of total FDI
flows (left axis)

15

Some countries with a small share of total
FDI have high FDI-to-GDP ratios (right axis)

30
25
20

10

15
10

5

5
0

rea

Ch

Ko

Ar

ge

ina
nti
na
,R
ep
.o
Po f
lan
Ve
d
Th
ne
ail
zu
an
ela
d
,R
.B.
de
Ind
Ka
ia
za
kh
sta
Vie n
tna
Tri
m
nid
Bo
ad
li
an
d T via
ob
ag
Az
erb o
aij
Cô
an
te
d’l
v
Nic oire
ara
gu
a
Ho
nd
ura
s
Le
so
tho
Ca
Eq
mb
ua
od
tor
ia
ial
Gu
ine
Sw
a
az
ila
nd
La
oP
St Sey DR
the . Vin chel
Gr cent lesenad and
ine
Be s
lize
Er
itre
a
Ta
jiki
sta
n
Do
Co
mi
nic
ng
a
o,
Re
p.
of

0

Most FDI
Note: Countries sorted by share of total FDI, 1999.
Source: World Bank data.

48

Least FDI

gep_ch02.qxd 12/5/02 2:53 PM Page 49

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Figure 2.4 The service sector dominated the 1990s mergers and acquisitions boom
Services dominated the mergers and acquisitions
boom from 1987 to 2000

(billions of dollars)(billions of dollars)

1200

900
800
700
600
500
400
300
200
100
0

19

19

99

97

95
19

93

99
19

97
19

95
19

93
19

91
19

89
19

19

87

0

19

200

Primary
Manufacturing

19

High-income countries

89

Developing countries

400

Services

19

600

87

800

19

1000

91

Mergers and acquisitions boomed in the 1990s

Source: UNCTAD (2001).

Global concentration of ownership
does not appear to be increasing
Contrary to popular perceptions, the boom incross-border M&A does not appear to have
had a major effect on the global concentration of ownership. Cross-border M&A transactions in the late 1990s represented only asmall fraction of industrial countries’ stock
market capitalization. The dollar value ofcross-border M&A transactions equaled lessthan 3 percent of stock markets in most of
the top seven industrial countries (figure 2.5).4

Figure 2.5 Cross-border mergers andacquisitions are small compared withstock market capitalization(average value 1997–99, in percent)

an
Ja
p

ly
Ita

Un
Sta ited
tes

rm
an
y
Ge

ce
Fra
n

Ca

na
da

4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
Kin Unite
gd dom

102 developing countries had shares of FDI
that equaled or exceeded their average shares ofworld GDP, employment, and exports (see box
2.2 in World Bank 2002b). Obviously, manyfactors other than market size, particularly thepolicy and institutional framework, are important in determining a country’s attractivenessto FDI.1
The takeoff in M&A transactions amongindustrial countries—driven in part by extraordinarily rapid increases in the stock prices
of some major corporations and in part by
expectations (during the boom) that continuing productivity increases would fuel continued rises in stock prices—was a driving force
behind greater FDI (see figure 2.4). Global
M&A rose more than five-fold between 1995
and 2000 (after increasing by only 24 percent
in the first half of the 1990s) to a peak of$1.1 trillion in 2000, before dropping by some
45 percent in 2001 with the decline in stock
markets and the global economic slowdown.2
This experience was not unprecedented:
through the 1980s and 1990s, the global economy experienced major waves of corporate
mergers.3 The bulk of the cross-border M&A
transactions was in service sectors (more thanhalf in finance, transport, storage, and communications alone), which accelerated rapidly
beginning in 1998 (see also the discussion of
FDI in service sectors, page 10).

Source: Evenett (2002).

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Of course, the M&A boom coincided with the
sharp rise in stock market valuations in thelate 1990s, particularly in the United States.
Thus it is useful to keep in mind that both thenumerator and the denominator in figure 2.5
are rising rapidly.
A related concern is whether the concentration of global economic activity, either in individual sectors or in total, has increased forreasons other than cross-border M&A. For
social and political reasons, high concentration in an economy may be a matter of concern. For example, 5.5 million corporations
are in the United States, with the largest 100
companies accounting for about 11 percent
of employment and payroll.5 The fabric of
the U.S. economic (and socio-political) landscape would surely be different if there were
no small enterprises, no start-ups, and noalternative places (beyond a few mammoth
corporations) where someone with a new entrepreneurial idea might go to obtain financial
support and institutional encouragement.
Similar concerns would hold for a high level ofconcentration in the global economy. Theremay be an extra element of concern for developing countries in this regard. Few of thelargest companies in the global economy areheadquartered in and identified with a developing economy.6 A global economy that is
dominated by a relative handful of giant companies (if that were the case), which are headquartered in a relatively few industrial countries, may raise even greater socio-politicalconcerns in developing countries that feel thatthey can exert little effective control over theseenterprises.
Although the measurement issues involved
are enormous, it does not appear that global
concentration is high or has been rising significantly during the 1990s.7 White (2001, 2002)
reports declining or stable aggregate concentration in the U.S. economy from the 1980s
through the late 1990s, depending on whether
employment, payroll, or profit data are used(figure 2.6).8 Note that this measure of aggregate concentration does not provide an indicator of market power in individual markets,

50

Figure 2.6 U.S. aggregate concentration
has held steady
Share of top 500 companies of U.S. private sector(percent)
80
70

Profits

60
50
40
30

Employment

Payroll

20
10
0
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00

G L O B A L

Source: White (2001).

because each firm may participate in multiple
markets.9
Concentration at the global level appears
to remain low, although one confronts enormous data problems and difficult tradeoffs inmaking such estimates. In 2001, total employment by the largest 50 global companies (asidentified by Forbes) accounted for 0.3 percentof the world labor force, or 1.6 percent of
employment in Organisation for Economic
Co-operation and Development (OECD)
countries. Those companies’ profits amounted
to 0.8 percent of world GDP and 3.3 percent
of world gross domestic savings.10 Although it
is difficult to say what level of concentration
should be viewed as a cause for concern, atleast these aggregate data do not reflect a domination of the global or OECD economies by asmall number of firms.
Global concentration does not appear tohave risen significantly during the 1990s. The
share of the top 50 companies (as measured by
Forbes) in the world labor force and in OECD
employment has fallen slightly since 1994 (figure 2.7).11 The declining share of the large
companies’ employment levels is consistent
with the trend for the United States reported
by White (2001, 2002). Despite the merger
wave of the 1990s, very large companies have

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Figure 2.7 Global concentration has not increased significantly
Employment of the top 50 global companies, 1994–2001

Profits of the top 50 global companies, 1994–2001(percent)(percent)

1.8

Share of OECD employment

1.6

6
Share of OECD savings5

1.4

Share of world savings
4

1.2
1.0

3

0.8

Share of world labor force
2

0.6
0.4

1

0.2

0

0
1994 1995 1996 1997 1998 1999 2000 2001

1994 1995 1996 1997 1998 1999 2000 2001

Source: White 2002b.

not experienced a significant expansion of
employment relative to other companies. Thishas been partly due to internal rationalizations and cost-cutting by those companies andpartly due to significant numbers of spinoffs
and divestitures.
The share of the top 50 companies’ profits
in global savings and OECD savings has risen
since the mid-1990s (figure 2.7). The rise inprofits among the largest companies is also
consistent with the U.S. trend reported by
White (2001, 2002a). However, in the UnitedStates, economy-wide profits were rising
rapidly during the late 1990s; thus the ratio of
the largest companies’ profits to total profits
was relatively constant. Unfortunately, time series data on global profits, or even OECD profits, are not available. Nevertheless, it is likelythat OECD profits were rising more rapidly
than nominal GDP or savings; hence the shareof the top companies’ profits may not have increased as much as indicated by the ratios given
in figure 2.7. Moreover, the recent accounting
scandals affecting telecommunications, energy,
and other high-tech companies indicate a significant overstatement of profits in many of thelargest companies during the late 1990s. Thus
the rise in profits of the top 50 companies relative to global savings may be overstated.

A different approach to the calculation of
global concentration is reported by DeGrauwe
and Camerman (2002), with similar conclusions. They find that sales of the top 50 industrial corporations from the Fortune 500
list have grown slightly less rapidly than world
GDP from 1980 to 2000. Thus the 2000 salesof the 50 largest industrial corporations wereslightly smaller in relation to world GDP than
was true for the 50 largest corporations in
1980.12
These indicators of global concentration
reveal nothing about the concentration ofmarket power in individual sectors. Risingconcentration at the sectoral level may reduce
competition, thereby increasing prices facedby consumers and suppliers and shifting
wealth from consumers and suppliers incompetitive industries to producers in moreconcentrated industries. Unfortunately, comprehensive data do not exist on global sectoral
concentration.
Sectoral data are available for some majorcountries, and they do indicate a rise in concentration ratios. The average concentrationof industries at the Standard Industrial Classification (SIC) 4 level increased from 1947 to1992 in the United States, while concentration
declined slightly from 1983 to 1992 in Japan51

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before increasing sharply in 1992–98.13
However, sectoral concentration ratios at thecountry level provide little information on thecompetitiveness of markets, because most of
those companies face competition from imports. Indeed, the rapid rise in world tradeover the past two decades, coupled with the
emergence of developing-country exporters,
indicates that competitive pressures may haveincreased in many industries.14
Despite the difficulties in measuring global
sectoral concentration ratios and in determining the implications for competition, anticompetitive practices have clearly affected someindustries. The 1990s saw the uncovering of alarge number of international cartels, in whichfirms from more than one country madeexplicit agreements to fix prices, divide up markets, or rig bids for contracts (see chapter 4).

Table 2.1 FDI inward stocks in services
and manufacturing, 1988–99(growth rate and shares in dollars)
Growth rate,
1988–99(percent change
per year)

Share,
1999(percent)

World:
Total FDI
Manufacturing
Services

12.3
12.2
13.8

41.6
50.3

Industrial countries:
Total FDI
Manufacturing
Services

9.9
9.1
11.6

36.4
55.5

Developing countries:
Total FDI
Manufacturing
Services

21.5
19.6
28.2

54.5
37.3

Note: Second column data for France are from 1998, andsecond column data for Japan are from 1994.
Source: UNCTAD (2001).

The rise in service sector FDI
FDI flows into services have overtaken
those in manufacturing—Service sector FDI has grown rapidly over the
past few decades, and services are now thedominant sector for foreign investment.15
The stock of FDI in services was only about
one-fifth of the total in the 1950s (United
Nations 1989), but by the mid-1970s theshare of services in the stock of outward FDIof major industrial countries ranged mostly
between 30 and 40 percent.16 By 1990, thisshare rose to between 45 and 60 percent, andover the past decade, FDI in services has continued to rise more rapidly than FDI in manufacturing in both developing and industrial
countries (table 2.1). By the end of the 1990s,
services accounted for more than half of thestock of inward FDI in most major industrial
countries (figure 2.8). Despite the rapid
increase in service sector FDI, the global ratioof FDI to value added in services remains lessthan half the ratio of FDI to value added in
manufacturing, thus indicating the potential
for further increases in service sector FDI.
The dominance of service sector FDI under-

52

lines the importance of an effective regulatory
regime, because designing and enforcing anappropriate regulatory framework is moredifficult in many service sectors (such as
natural monopolies in infrastructure) than in
manufacturing.

Figure 2.8 Share of FDI in the service
sector increased in major industrial
countries(percent)
90
80

1988

70

1999

60
50
40
30
20
10
0
France Germany Italy

Japan

United United
Kingdom States

Source: OECD (2001) and OECD online database.

gep_ch02.qxd 12/5/02 2:53 PM Page 53

C H A N G E S—reflecting the rising role of services in
the global economy—
FDI in services has increased relative to manufacturing, in part because of the growing
importance of the service sector in economic
activity. By the late 1990s, the service sector
had increased from half of global output in theearly 1970s to 64 percent. Income growth has
been the driving force behind the rise in services: cross-country comparisons show thatthe richest countries have the greatest shareof services. Services account for 70 percent of
output in industrial countries, 55 percent
in middle-income countries, and 44 percent in
low-income countries. The correlation coefficient between income level and the share ofservices is 0.6. The relationship between
higher income and a greater share of services
in part reflects consumer demand, because
luxuries such as travel and entertainment
often have a large services component. Also,
higher incomes permit an allocation of moreresources toward protecting assets (insurance
and legal services), richer and complex societies require more resources devoted to education and advisory services, and technologicaladvances associated with higher income widen
the scope for the protection of health. Finally,
the higher labor intensity of services and rising
real wages have increased the nominal valueof services relative to manufacturing.

—technological changes that haveincreased the demand and supplyof services—
Technological progress has tended to increase
the demand for services connected with the
production of goods and to facilitate the separation of goods production from services production.17 The larger scale of production, thegreater technological sophistication of goods,
and the increased trade in goods and management of enterprises across large distances haveall contributed to the greater demand for services. The importance of management, marketing, distribution, and after-sale maintenancehas risen relative to the value of manufactured
products. Many information-and-knowledge-

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O R G A N I Z A T I O N

intensive services—research and development(R&D), engineering, design, computing anddata processing, inventory management, quality control, design, accounting, legal services,personnel services, and so on—have become acritical part of the production process in the
manufacturing sector. With modern manufacturing production and distribution becoming
increasingly dependent on the processing anddissemination of information, the demand for
those producer services is rising rapidly.
Moreover, the growing sophistication andvariety of services, coupled with specialization
emerging from economies of scale, have led
manufacturing firms to rely more on outsourcing than on in-house departments toprovide the services necessary for production.
The immediate consequence is a statisticaleffect: the size of the service sector rises whenservices that were previously classified as
manufacturing output are suddenly counted
as services. Typical examples of these types ofservices are accounting, computer services(data processing and software), warehousing,public relations, information technology, andmanagement information systems.
Technological progress has greatly reduced
the cost of some services, thus increasing thescope of services that are feasible to supply(for example, mobile telephones, complex
financial transactions such as derivatives, anda host of other services facilitated throughadvanced data processing). Technologicalprogress has also generated new means ofdelivering services (for example, the dissemination of research over the Internet). This
process is similar to what occurred during theindustrial revolution, when technologicalprogress and income growth greatly increased
the importance of manufactures when compared with the primary sector.
Both the reduced cost of some services andthe increased scope of services have increased
the tradability of services, a trend that has,in part, been exploited through increased FDI.
For example, software can be produced in
low-cost locations such as India and solddirectly to firms and consumers in the United53gep_ch02.qxd 12/5/02 2:53 PM Page 54

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2 0 0 3

States over the Internet. Many multinationals
have established centers in developing countries, where wages are low, to handle contacts
with consumers in industrial countries. For
example, call centers in the Caribbean manage
phone calls to multinationals from U.S. clients(this is an example of participation of service
firms in production networks; see page 13 foran elaboration of this concept in manufacturing). In some cases, the rising tradability ofservices may have reduced FDI by enablingfirms to provide services at a distance rather
than establishing a subsidiary. However, ingeneral, increased tradability has created newopportunities for multinationals’ subsidiaries
to export services to home markets and, insome cases, to operate as international hubs
to supply services to firms in other countries.
Because industrial countries are the lead consumers of tradable services, developing countries have benefited from the establishmentof subsidiaries to service the richer markets.
Technological advances that increase services
tradability have also imparted an advantage
in service delivery to multinationals relative todomestic firms, thus enabling the former toovercome the natural advantages of proximityand knowledge of the market (Sauvant andMallampally 1996).
Income growth and technological progress
have boosted the provision of services throughvarious forms of cross-border relationships
in several sectors: (a) management and franchise contracts in hotels, restaurants, and car
rentals (in which performance requirements
can often be adequately codified, local managerial input is desirable, and the synergistic
advantages of global reservations and referral
systems can be obtained without the risks andcosts involved in an equity stake); (b) joint
ventures in some business services, in recreational activities, in some accounting and legal
services, and in civil engineering in turnkey
projects (in which individual customizationand specialized knowledge of local practices
are required); and (c) services in which a local
partner is required for marketing and distribution (Dunning 1981). Firms that tend to54

provide services through subsidiaries, rather
than other kinds of relationships, include(a) financial institutions, in which much ofproprietary knowledge is tacit, is expensive to
produce, and is complex and idiosyncratic;(b) firms that require control over production
to maximize efficiency and to protect thequality of the end product (and thus customer
goodwill) for trademarks (for example, in
advertising, market research, construction,business consulting, consumer-oriented services, and goods-related personal services suchas motor vehicle maintenance and repair); and(c) trade-related service affiliates set up by
non-service multinationals to obtain inputs
for domestic activities or to supply markets.

—and policy changes that encourage
the private provision of services
The removal of restrictions on FDI and regulatory reforms that have improved competition
in service sectors have contributed to the rise inservice sector FDI. Until recently, many countries (including many industrial countries) prohibited foreign investment in sectors such astransport, communications, banking, finance,
utilities, and media. Since the mid-1980s,
governments in both industrial and developing countries have been gradually opening up
those service sectors to foreign investment.18
Multinationals can enhance the efficiencyof services industries in developing countries
by providing services that developing-country
suppliers cannot provide, as well as by intensifying competition. In particular, providing
producer services (for example, managerial
services, engineering, finance, and marketing)that are often subject to economies of scale andthat have a much higher cost from a distancecan generate important benefits to developingcountry firms. Availability of producer services
may be an important reason to form industrial
complexes and may explain a significant shareof the differences in economic performance
among regions. Producer services are likely tobe provided through FDI (rather, for example,
than through training unaffiliated firms)
because they involve knowledge-based assetsgep_ch02.qxd 12/5/02 2:53 PM Page 55

C H A N G E Sthat are easily copied if firms lose control
over the knowledge (Markusen, Rutherford,
and Tarr 2000). FDI has surged in developing
countries’ banking sectors, in many cases reducing the costs of financial intermediation,
increasing the scope of financial services available to local firms, and transferring skills toworkers in developing countries.19

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Figure 2.9 U.S. cars are produced inmany countries(percent share in value added)
40

30

The globalization of production has
helped fuel the growth in global trade

0
ep
.o
a,
R
Ko
re

Rapid growth in trade and in FDI flows has
reflected, in part, the expansion of production
networks.20 The production of many final
goods, which formerly took place in one location, has been broken down into discrete steps,
with each step moved to locations where it
can be performed at the lowest cost (Venables
1999; Kimura 2001). Thus a significant portion of international trade and FDI has shiftedfrom the exchange and production of final
consumer goods to the exchange and production of parts and components. This globalization of producing individual goods has
progressed to the point that it can become difficult to identify the nationality of some products. For example, the World Trade Organization (WTO [1998]) gives figures for the shareof value added in producing a U.S. automobile,with countries grouped by category of production. The United States accounts for only
37 percent of value added (figure 2.9).
There is considerable evidence that theshare of global trade accounted for by networks is increasing, although the results
vary among countries and studies. Baldone,
Sdogati, and Tajoli (2002) estimate that theshare of intermediate products in total trade
within the European Union (EU) rose only
slightly in the 1990s, from 17 percent in 1990
to 19 percent in 1999.21 One measure of international outsourcing—the ratio of imported tototal intermediate inputs in manufacturing—doubled in the United States from 1974 to1993 and increased in Canada and the

Ge
rm
an
Ta
y
iwa
an
n
d S (C
ing hinap a)ore
Kin Unite
gd d
om
Ire
lan
Ba d arba nddosUn
Sta ited
tes

10

f

Global production networks

Ja
pa
n

20

Source: WTO (1998).

United Kingdom, although it fell in Japan(figure 2.10). Using input-output tables,
Hummels, Rappaport, and Yi (1997) calculatethat the fraction of the total value of tradeaccounted for by inputs that are both
imported and then embodied in exports rose
in France, the United Kingdom, and theUnited States from 1970 to 1990, while dropping slightly in Japan.22 Data from the U.N.
Comtrade database show that exports ofparts and components—a proxy for participation in global networks—increased by almost
2 percentage points faster than exports of
total manufactured goods from 1981 to 2000
(table 2.2).23
The rise in the share of trade accounted forby global networks in part reflects the increasing importance in global production of goods
Table 2.2 Growth of exports of parts andcomponents, 1981–2000(average annual percentage change in dollars)

Manufactured exports
Parts and components exports
Memo item: Share of partsand components

1981–90

1990–2000

10.6
12.1

7.2
9.6

13.2

18.5

Source: U.N. Comtrade database.

55

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2 0 0 3Figure 2.10 Cross-border networks capture increasing shares of production and trade
Imports of intermediate inputs increased, 1974–93

Production through networks increased, 1974–93(ratio of imported to total intermediate inputs in
manufacturing, in percent)(percent share of trade accounted for by imported inputs
that are embodied in exports)

25

20
18
16
14
12
10
8
6
4
2
0

20
15
1993

1974
10
5
0
CanadaJapan

UnitedKingdom

1993

1974

UnitedStatesFranceJapan

UnitedKingdom

UnitedStates

Source: Feenstra (1998); Campa and Goldberg (1997); Hummels, Rappaport, and Yi (1997).

such as electronics, chemicals, and transport
equipment and machinery, where trade incomponents is most important. The share ofthose sectors in world trade rose from 27 percent in 1986 to 43 percent in 1997 (Schive andChyn 2001). However, the increase also
reflects a rise in components trade within the

product classes. Hanson, Mataloni, andSlaughter (2001) report that the share of U.S.
multinational affiliates’ imports of intermediate inputs in their total sales rose significantly
from 1982 to 1994 in electronics, transportation equipment, and industrial machinery andequipment (figure 2.11).

Figure 2.11 The role of production networks continued to increase through most of
the 1990s
Use of intermediate inputs rose, 1982–94

Exports by MNCs abroad rose, 1982–98(percent of U.S. affiliates’ imports of intermediate inputs asa share of sales)(percent of U.S. affiliates’ exports as a share of total affiliate
sales)

25

70

1998

60

20

1994

1982

1982

50

15

40

10

30
20

5

10

Source: U.S. Bureau of Economic Analysis, as reported in Hanson, Mataloni, and Slaughter (2001).

56

sp
eq orta
uip tio
me n
nt

Tra
n

Ele
c
a troneq nd ot ics
uip heme rnt

ch Induins
eq ery trial
uip an
me d
nt

ma

ing
tur
fac
nu
Ma

sp
eq orta
uip tio
me n
nt

Tra
n

Ele
c
an troneq d ot ics
uip he
me r
nt

ma

tur
fac
nu
Ma

ch Induins
eq ery trial
uip an
me d
nt

0
ing

0

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C H A N G E S

The establishment of global networks has
been facilitated by technology—
Technological progress in transport, communications, and data processing has fueled
increased FDI flows and the establishmentof cross-border production networks. A nearly
70 percent decline in sea freight unit costs
between the early 1980s and the mid-1990s(in part caused by a rise in the share of cargo
carried in containers; see World Bank 1997)24
and an increased reliance on air shipments,
plus the growth of express services (such as
overnight and two-day delivery)25 have facilitated the shipment of components for processing in different locations. The low cost of
long-distance telephone rates, the development of fax machines, and, most recently, theadvent of the Internet have made it easier for
multinationals to closely coordinate production at dispersed locations. Those changes
have also greatly reduced the costs of finding
and evaluating potential suppliers for more
arm’s-length transactions (Grossman andHelpman 2002). Finally, an increased ability
to process and analyze vast amounts of data
has facilitated the management of global
networks. Electronic data interchange (EDI)I N

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B U S I N E S S

O R G A N I Z A T I O N

systems greatly reduce the costs of procurement and improve the coordination of production across dispersed factories by automating the processing of routine transactions(Chen 1996).

—policy improvements—
Improvements in economic policies, notably
the decline in barriers to trade, have also contributed to forming cross-border production
networks. Successive rounds of multilateralnegotiations reduced average tariffs on manufactured products in industrial countries from
10 percent in 1980 to 5 percent by 1998. The
average tariff rate in developing countries fell
from between 25 and 30 percent in the early
1980s to 13 percent by 1998 (figure 2.12).
Even relatively low tariff rates can have asignificant role in deterring the formationof cross-border networks, because goods oftenpass through borders several times in thecourse of production (Navaretti, Haaland,
and Venables 2000), and the gross margins
of manufacturing companies are often lower
than 5 percent.26 Hanson, Mataloni, andSlaughter (2002) find that tariffs are an important determinant of the size of intermediate

Figure 2.12 Tariff rates fell in the last two decades
Industrial countries’ tariffs on parts and components,
1988–2001

Average tariff rates, 1980–98(average tariff on imports from industrial countries,
in percent)(percent)

635
Developing countries
30

5

25

4

20
3
15
Industrial countries

2

10

1

5

0

0
1980

1984

1988

1990

1992

1994

1996

1998

1988–90

1991–93

1995–97

1998–2001

Note: Unweighted average of ad valorem, applied, or MFN rates, whichever data are available for a longer period.
Source: U.N. Comtrade database.

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2 0 0 3

inputs from parent companies relative to thetotal sales of U.S. affiliates (a direct measureof activity within production networks).
Higher tariffs are significantly correlated withless production sharing, with estimated elasticities in the range of 2 to 4. Multinationals
may even lobby for reduced tariffs on their inputs so they can reduce the costs of networks.
The average tariff rate that industrial countries impose on imports of parts and components declined during the 1990s and was well
below the overall average tariff rate by the endof the decade.
Steps toward greater integration between
geographically close neighbors with significantly different wage rates have had a particularly important role in stimulating the growthof regional production networks. Before 1990,
the export of processed goods from Eastern
Europe to the EU was minimal. By 1996, suchexports were almost 20 percent of Poland’s
exports to the EU, 40 percent of Romania’s,
and well over 10 percent in most other Eastern
European countries (Baldone, Sdogati, andTajoli 2002). Kaminski and Ng (2001) reportthat the value of Central Europe’s total tradein parts grew almost three-fold from 1993
to 1997. The maquiladora industry in Mexico
has grown spectacularly since introduction of
the North American Free Trade Agreement(NAFTA).
Networks have been boosted by special
arrangements. U.S. and European tariff provisions encourage production by the subsidiaries
of multinationals, because the tariff on a subsidiaries’ import is imposed only on the value
added in the assembly country, not on the total
value of the good (Ng and Yeats 2001).
Reduced restrictions on FDI in developing
countries have increased the participation ininternational production networks. Of thenumerous regulatory and policy changes thathave affected FDI and that were introduced
by developing-country governments during the
1990s, 95 percent were aimed at creating amore open environment for FDI (UNCTAD
2001). Many developing countries have eliminated broad restrictions on FDI and have58

shifted to negative lists (that is, lists specifying
a limited number of sectors from which foreign investors are excluded or are subject to aceiling on the share of the firm that foreigners
may own).27 Often, reforms in trade, FDI,
and other areas work together to encourage
greater participation in global networks. The
export-to-sales ratio of U.S. multinational
affiliates rose dramatically from 1982 to 1998
in Mexico (following trade and investment
reforms in the mid-1980s), in China (afterreforms in the early 1990s), and in Canada(after investment reforms of the mid-1980s
and the coming into effect of U.S.-Canada free
trade agreement in 1989) (figure 2.13).

—and incentives
Countries may affect their attractiveness to
global production networks by specific requirements or incentives affecting foreign firms.
Moran (2001) examines case studies on theindustries cited above as being most heavily
involved in global production networks (electronics, machinery, and transportation). He
finds that affiliates in countries that impose
relatively stringent or widespread performancestandards on multinationals (for example,
limits on foreign ownership, domestic-content
requirements, and various technology-sharing

Figure 2.13 Reforming countries
boosted exports through production
networks(exports of U.S. affiliates as a share of total sales,in percent)
45
40
35
30
25
20
15
10
5
0

1998

1982

All countries Canada

MexicoChina

Other Asia

Note: Exports from U.S. affiliates in all countries show
no rise in the share of sales due to declines in the export
shares in primary production.
Source: Hanson, Mataloni, and Slaughter (2001).

gep_ch02.qxd 12/5/02 2:53 PM Page 59

C H A N G E S

mandates) are much less productive, use older
technology, and take longer to introduce newprocesses and products than affiliates in countries that do not impose such requirements.
Thus, FDI to countries with strict requirements is more likely to be directed at local
markets, because participation in networks
often requires the latest technology.

Global networks can be structured
in many ways
Global networks are achieved through a rangeof ownership structures, from conducting
arm’s-length transactions (for example, tradein standardized parts sold in organized markets) to establishing a subsidiary for producing components that are custom-made forBox 2.1

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O R G A N I Z A T I O N

particular products (Arndt 2001). A spectrumof choices exists, and each involves someform of relationship between supplier andpurchaser.28 The major advantage that multinationals have over local firms is typically technology, and protecting that advantage is a key
consideration in determining the structure of a
global network (Ethier and Markusen 1996).29
Because it can be difficult to maintain control
over technology in arm’s-length arrangements,
FDI is often the preferred choice (Hoon and
Ho 2001).30 This preference is reflected in therise in the share of intra-firm trade in multinationals’ exports, at least as far as developing
countries are concerned (box 2.1).
There are disadvantages, however, to establishing a network through FDI. Securing

Intra-firm trade increases worldwideT

he boom in FDI flows during the 1990s was
associated with only a small rise in the share of
intra-firm trade in U.S. exports during the 1990s (seebox figure 1).31 By contrast, the share of intra-firm
exports in Japanese trade almost doubled during thisperiod. The failure of U.S. outward FDI flows (thestock of which nearly tripled in the 1990s) to resultin a sharper increase in the share of intra-firm tradeprobably reflects the dominance of M&A trans-

Intra-firm trade has increased(percent share of intra-firm exports in total exports)
40

1999

35
30
25

1990

20
15
10
5
0
United States
Source: OECD (2001).

Japan

actions rather than greenfield investments. The
transfers of ownership involved in such transactions
would not necessarily have a significant effect on
trade flows. If one looks at longer time series, there
is some evidence that intra-firm trade has become
more important for U.S. multinationals, particularly
in services (box figure 2).

Intra-firm trade in services is becoming
more important(percent share of intra-firm exports in total U.S. MNCexports)
50
45
40
35
30
25
20
15
10
5
0

Services

Manufactures

1977

1983

1993

1999

Source: OECD (2001).

59

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Box 2.1

P R O S P E C T S

2 0 0 3

(continued)

Intra-firm trade includes production that isshared among locations in global networks, as wellas trade in finished products for marketing and distribution in foreign countries. There is some evidence
that production through networks has become more
important over time. The share of exports of intermediate goods to overseas manufacturing affiliates intotal Japanese exports rose from 20 percent in 1994
to 29 percent in 1999. Products intended for further
processing increased from 57 percent of U.S. multinationals’ exports to foreign-owned affiliates in 1989
to 68 percent in 1999 (Mataloni and Yorgason 2002).
Trade among foreign affiliates of U.S. multinationals
has also expanded, which probably indicates that networks have become more complex over time. The
share of intra-firm exports of foreign subsidiaries
accounted for by exports to other subsidiaries (rather
than to the parent company) rose from 53 percent in1983 to 66 percent in 1999 (box figure 3). This riseis almost totally due to an increase in foreign affiliate
trade among developing countries, from 30 percent
of U.S. multinationals’ intra-firm trade in 1983 to51 percent in 1999. Production networks appear tobe less important in intra-firm trade among industrial
countries, given their more similar labor costs. For
example, 90 percent of intra-firm exports fromforeign multinationals to U.S. affiliates are finishedgoods for direct distribution to the U.S. market. The
picture that emerges is that total intra-firm exports

by U.S. multinationals have increased only slightly
more rapidly than have total U.S. exports. However,a growing share of this trade is devoted to production
networks, which increasingly involve developing
countries.

intermediate inputs through contracts withlocal firms often entails lower administrative
costs than establishing a subsidiary. The multinational is free to specialize in providing technology, marketing, and distribution services,while a local partner may be better situatedto handle the personnel and regulatory issues
involved in establishing a company. Moreover,some multinationals outsource a substantial
share of manufacturing, because contract
manufacturers may be better placed thanmultinationals to absorb the risk from rapid
product obsolescence (Ernst 2002). Contract
manufacturers that produce components forwell-known multinationals grew rapidly dur-60

Trade among U.S. affiliates is rising in
the developing world(percent share of intra-firm exports in total U.S. MNCexports)
70
60

1999

50

1993

40

1983

30
20
10
0
All
countries

Industrial
countries

Developing
countries

Source: OECD (2001).

ing the 1990s and now account for 20–30 percent of total electronics production.

Developing countries have increased
their participation in global
networks
Developing countries have been increasingly
involved in the international networks thatmanage the production and trade of intermediate goods. Differences in wage levels have led
firms to locate in developing countries thoseportions of the production chain that are intensive in manual labor, while locating at home
the technically skilled labor (such as that involved in R&D, management, and marketing)gep_ch02.qxd 12/5/02 2:53 PM Page 61

C H A N G E S(Hanson, Mataloni, and Slaughter 2001;
Filipe, Fontoura, and Saucier 2002). Multinationals operating in developing countries are
more likely to be part of a network (as opposed
to supplying the host market) than are multinationals in industrial countries. The share of
U.S. affiliate production that is sold back to
the United States is more than twice as highfor developing countries as it is for industrial
countries (Shatz and Venables 2000).
Data on parts and components exports,
which are a proxy for participation in networks, confirm the growing participation ofdeveloping countries.32 Their exports of partsand components increased by almost 18 percent per year in the 1980s and by 22.5 percent
in the 1990s (in U.S. dollar terms), almost
three times more rapidly than such exportsof high-income countries in the latter period(figure 2.14). As a result, the share of developing countries in global parts and components
exports increased from 4 percent in 1981 to
21 percent in 2000 (figure 2.15). By contrast,
the share of developing countries in exportsof world manufactures rose much more
slowly, from 16 percent in 1981 to 22 percent
in 2000, while developing countries’ share of
total trade fell slightly (largely caused by thefall in commodity prices).

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O R G A N I Z A T I O N

Figure 2.14 Parts and components
exports grew rapidly, 1981–2000(percent per annum)
25
20
15

1981–90
1990–2000

10
50High-income countries

Developing countries

Source: U.N. Comtrade and World Bank.

Access to networks among developing
countries is highly concentrated
Developing countries’ participation in global
networks is highly concentrated, particularly
in East Asia. The top five developing-country
exporters of parts and components (China,
Mexico, Republic of Korea, Malaysia, andThailand) accounted for 78 percent of developing countries’ exports of parts and components, and the next five largest developing
countries accounted for about 14 percent (figure 2.16). Developing countries outside the top
10 made up only about 8 percent. By contrast,

Figure 2.15 Developing countries’ share of global parts and component exports rose
between 1981 and 2000
Percent share of parts and components trade, 1981
Other developing
countries
1

Developing East Asia
3

High-income countries
96

Percent share of parts and components trade, 2000
Other developing
countries
14

Developing East Asia
7

High-income countries
79

Source: U.N. Comtrade and World Bank.

61

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2 0 0 3Figure 2.16 Developing countries’ partsand component exports are highly
concentrated, 2000
(percent share of total)
30
25
20
15
10
5

ve
rd
ev
elo
co
un ping
trie
s

nd

Ot

he

ex
t fi

ila

l, n
To
ta

Th
a

Ma
lay
sia

f

Ko
re

a,

Re
p.
o

a
Ch
in

Me
xic
o

0

Source: U.N. Comtrade and World Bank.

the top 10 countries accounted for 63 percent
of developing countries’ total exports and75 percent of their manufactured exports.
Thus trade of parts and components is much
more concentrated than total or manufactures trade. All top 10 countries (except Brazil)
either are from East Asia or are participatingin regional arrangements—with the UnitedStates or the EU—that provide for low tradebarriers and long-term arrangements to increase trade integration. By contrast, countries
that have limited ties to major industrial country markets, that lack adequate infrastructure(particularly transport facilities) or a sufficiently educated work force, that are subject
to high risks as a result of poor governance or
weak institutions, or that have pursued policies that erode incentives for private sector
investment have minimal participation in
global networks. South Asia, Sub-SaharanAfrica, and the Middle East and North Africa
together account for only 2 percent of developing countries’ parts and components
exports (and two-thirds of that amount isfrom South Africa and India), compared with
11 percent of developing countries’ total manufactured exports.

62

Networks help improve the allocationof resources
Global production networks break the production of a given final good into a set of constituent activities that vary in the intensity ofcapital, skilled labor, unskilled labor, andother production requirements. Instead ofmaking entire products, developing countries
can be involved in just those stages of products(for example, labor-intensive stages) that best
suit their mix of endowments. This approachenables developing countries to shift moreresources to activities in which they have acomparative advantage, particularly the fastgrowing segments that require large labor
inputs in one or more stages of the manufacturing chain. Developing countries’ participation in global networks has enabled thosecountries to increase their share of the world’s
fastest-growing export products (transistors
and semiconductors, computers, and computerand office machine parts) from 2.4 percent in1980 (about the same as the share of those
products in global exports) to 16.3 percent by
1998 (almost 7 percentage points higher than
the share of such products in global exports)(table 2.3).
Participating in networks may help dampen
the effect of adverse shocks. Multinationals
may have an interest in maintaining the operations of firms with which they have close ties,
either in the form of investment or long-term
contracting relationships. Some authors haveargued that intra-firm trade is less responsive to changes in relative prices than is trade
between firms, because multinationals will beconcerned with the effect of their production
Table 2.3 Export activity for productgroups with the fastest growth in world
exports, 1980–98(percent)

Share in world exports
Share in developing-country
exports
Source: UNCTAD (2002).

1980

1998

2.6

9.7

2.4

16.3

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decisions on the survival of foreign affiliates(Cho 1990; Helleiner 1978).33 Thus multinationals may lend funds to subsidiaries suffering temporary shocks or may provide thebacking necessary for them to access credit
markets.
Long-term contracts that have been enteredthrough networks may help firms survive
severe shocks. For example, exports from thePhilippines maintained double-digit growth
rates in 1998, while other countries in theregion saw outright declines in exports because of the crisis. This performance was principally due to the high growth in electronics
exports (while exports of consumer goods
languished), and almost all of the Philippines’
electronic exports come from affiliates ofmultinationals. The arrangements in placemeant that a substantial share of thePhilippines’ production was booked well inadvance (typically one year), which helped thecountry maintain output growth during thedownturn in demand (World Bank 1999).

Networks may boost access totechnology—
Participating in global networks may improve
developing countries’ access to technology.
Multinationals typically possess knowledge
assets such as patents, proprietary technology,
trademarks, and so forth that can be deployedin plants outside the parent country (seeDunning 1981). Blomström and Kokko (1998)
describe how multinationals typically haveproprietary technology that enables them tocompete against local firms, which presumably
have superior knowledge of local markets andbusiness practices. Approximately 90 percentof the world’s R&D is carried out in five countries (the United States, the United Kingdom,France, Germany, and Japan) that are among
the largest source countries for world FDI
flows (Keller 2001).

—which may be an important source ofgrowth potential
Access to technology is particularly importantfor developing countries, which tend to importI N

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O R G A N I Z A T I O Na large share of technical advances. Using international patent data, Eaton and Kortum(1999) find that even the major industrial
countries (the United States, Japan, Germany,
the United Kingdom, and France) generally
adopt from one-half to three-fourths of theirinnovations from abroad, and that the UnitedStates is the only country that derives most ofits growth from its own innovations (see also
Keller 2001). Because developing countries
spend a lot less than industrial countries onbasic research, they are even more dependent
on foreign sources of technology. Thus thepotential for increasing access to technology
as a result of participation in trade and FDI
may be great (Keller 2002).
In part, benefits from the transfer of technology are directly captured by the local firmor subsidiary participating in a network.
Technology is transferred from the parent toa subsidiary, or a local exporter may purchasetechnology as a condition of participating
in a network. One piece of microeconomic
evidence consistent with rising intra-firmknowledge transfer is the rising share ofmultinationals’ R&D performed by foreign
affiliates. The U.S. Bureau of Economic
Analysis (BEA) reports that, in 1982, affiliatesof U.S. multinationals performed 6.4 percent
of worldwide R&D for these firms. By 1994,
that share had nearly doubled, to 11.5 percent. This form of technology transfer may
increase domestic productivity, but the benefit
is fully reflected in market prices: the local
subsidiary or independent firm pays for thetechnology through profit repatriation or
expenditures on technology. In addition, local
firms may absorb technology from networks
in ways that are not entirely reflected inmarket transactions (referred to as spillovers;
see discussion in chapter 3). Rodriguez-Clare(1996) illustrates how multinational spillovers
from participation in global production networks may work: affiliates increase a hostcountry’s access to specialized varieties ofintermediate inputs, the improved knowledgeof which raises the productivity of domestic
producers.

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Networks may help increase the supply
and demand for skilled labor
Networks help improve access to technology,
which tends to stimulate demand for moreskilled workers relative to less-skilled workers.
Increased capital available through FDI may
also increase the demand for skilled workers(see the survey in Hamermesh 1993). Feenstra
and Hanson (1996) show that the transfer oftechnology and capital accumulation associated with global networks can raise thedemand for more-skilled labor in both industrial and developing countries, and Feenstra
and Hanson (1997) estimate that FDI into
Mexico’s maquiladoras has contributed to rising demand for skilled labor. Slaughter (2002)
finds a robust and positive correlation between skill upgrading and the presence of U.S.
foreign affiliates. This correlation is more than
twice as large for the subsample of developing
countries when compared with the subsample
of industrial countries.
Participation in global production networks may raise the supply of skilled laborin developing countries. One channel can be
the short-term activities by which individual
firms interact with host-country labor markets
through on-the-job training or support for
local educational institutions. Multinationals
might directly affect labor supplies, because
their transferred knowledge might boost theskills of their employees (and, with labormobility, the skills of the employees of domestic firms as well). They might indirectly affectlabor supplies (for example, by influencing the
educational infrastructure of host countries interms of curriculum choices and vocational
training). As Hanson (2001) reports, Intel
recently chose to establish a large assembly
and testing facility in Costa Rica, in part
thanks to Costa Rica’s agreement to expand
high school training in electronics and English(see also Moran 2001). Also, to the extent that
FDI inflows and trade increase the supply of
attractive employment opportunities, they
may inhibit the emigration of more-educatedworkers to industrial countries. For example,
the 1990s boom in Ireland, caused in large part64

by inward FDI, resulted in a surge in labor
supply driven largely by the reverse migrationof young Irish people back to Ireland.
If the presence of multinationals raises thedemand for skilled labor more than the supply,
then wage rates for skilled labor may increase
relative to those for unskilled labor. Thischange implies a widening of income inequality in countries with a large pool of unskilledlabor. However, multinationals’ demand forlabor is likely to raise the level of income of all
workers, regardless of the effect on relative
wages. Several studies have found that multinationals pay higher wages than do domestically owned establishments, even when controlling for a wide range of observable worker
or plant characteristics such as industry,
region, and overall size. The magnitudes involved are significant. Doms and Jensen(1998) document that for U.S. manufacturing
plants in 1987, wages in foreign affiliates exceeded wages in domestically owned firms bya range of 5 to 15 percent, with larger differentials being enjoyed by production workers
than by nonproduction workers.34 The premium could be accounted for by higher
worker productivity as a result of multinationals’ superior technology or capital. It could
also be a result of other factors, such as higher
worker productivity caused by unobservable worker qualities, or of multinationals
being more profitable and therefore more able
to share more rents with workers. Whatever
the case, the bottom line is that global production networks are likely to present highwage opportunities for both more-skilled andless-skilled workers.

The benefits from networks can contributeto growth and structural transformation
Improved allocation of resources, access totechnology, and increases in skilled labor can,in principle, make important contributions
to raising productivity and to facilitating thetransition from primary commodities to producing products with higher value added andgreater potential for growth. However, the extent of benefits from participation in networks

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is an empirical question. Local firms may not
capture the benefit from the transfer of technology and increased productivity throughnetworks if multinationals have a wide choiceof production locations and a monopsonist
position in the purchase of supplies. In thissituation, competition among suppliers may
drive prices down, and the benefits of local
firms’ productivity improvements will accrue
to the multinational.35
Some observers have argued that the benefits from network participation have been limited for most countries, with the important
exception of a few of the most successful East
Asian countries (see UNCTAD 2002b). Rising
manufactured exports through networks may
not be accompanied by increased value added
in manufactures, and network participation
may simply mean the continued use of unskilled labor in low value added activities
rather than the development of the manufacturing sector. For the 20 developing countries
with the largest exports of parts and components (a proxy for network participation), theaverage share of GDP devoted to manufactures has shown no increase over the past
20 years (table 2.4).36 However, average manufacturing value added (at constant prices)
has increased by more than 5 percent per year
in these countries, a very respectable performance over a 20-year period, and 2.5 percentage points more rapidly than the averageof developing countries with limited or no

Table 2.4 Rapid growth and structuralchange experienced by network
participants

Share of manufacturing value
added in GDP
Share of agriculture value
added in GDP
Memo item: average annual
growth rate of manufacturing
value added, 1980–2000

1980

2000

22.8

23.2

17.3

10.3

5.3

Note: Data represent the 20 developing economies (including
Taiwan [China]) with largest exports of parts and components.
Source: World Bank staff.

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participation in networks.37 The failure ofmanufacturing value added to rise as a shareof GDP reflects the rapid rise in services as income rises, particularly in these fast-growing
economies. That network participants didachieve significant structural change is indicated by the rapid fall in the share of agricultural value added in GDP, from 17 percent in1980 to 10 percent in 2000. These data do notdemonstrate that network participation was amajor cause of growth and structural change
in these economies, but they do indicate thatparticipation in networks has been consistent
with such progress.
Sectoral studies indicate that networks haveenabled countries to move from low-value torelatively high-value activities. For example,
the global apparel industry contains many examples of industrial upgrading by developing
countries.38 Several countries have shiftedfrom assembling apparel from imported inputs (which requires only low-wage labor) tofilling orders from global buyers. This latterrole requires the ability to make samples; topurchase or manufacture the needed inputs forgarments; to meet international standards interms of price, quality, and delivery; and to assume responsibility for packing and shipping
the finished items. A few East Asian countries
made this transition in the 1970s, then began
to set up their own international production
networks in the 1980s using low-wagecountries in Asia and elsewhere. Since then,several countries (for example, India, Mexico,
Romania, Turkey, and Vietnam) have developed expertise in managing apparel production chains. Their role is likely to expand
greatly as the apparel quotas under the Multifibre Arrangement are phased out in 2005.
Global production networks have been acentral feature in the development and upgrading of Asia’s large, dynamic electronics sector. While the East Asian newly industrializing
economies—Hong Kong (China), Korea,
Singapore, and Taiwan (China)—were the firstparticipants, the major Southeast Asian countries of Indonesia, Malaysia, the Philippines,
and Thailand have taken places directly below

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2 0 0 3them in the production chain, including working in design and setting up their own production networks. More recently, China has been
evolving from a provider of low-wage, assembly operations to the leading producer of electronics across a wide range of industries(Borrus, Ernst, and Haggard 2000). Finally,
exporters of fresh vegetables in Kenya andZimbabwe have benefited from their relationship with U.K. supermarkets, first throughassistance in meeting production standards,
and more recently in taking on higher value
added activities within the production chain.
These activities have included packaging andapplying barcodes; investing in state-of-the-art
methods for cold storage; adopting just-intime management techniques (including information technology) to reduce the time between
harvesting, packing, and delivery; and expanding to joint ventures with freight forwarders togain more control over the distribution process(Dolan and Humphrey 2000).
Of course, participating in networks has
not always been accompanied by progress tohigher value added activities. Survey evidence
indicates that East Asian firms participatingin networks have experienced an increased
propensity to innovate as they draw on foreign expertise (as well as increased export
growth), compared with firms in the same sectors that did not participate in networks(World Bank 2002a). However, networked
firms did not show faster growth in employment or value added, on average, than nonnetworked firms. The World Bank (2002a)
also found that few East Asian firms were able
to move up the value chain through participation in networks. However, these observations
are consistent with countries benefiting fromnetwork participation through spillovers andproduction by multinational subsidiaries.

Good policies attract FDIT

he quality of the policy regime is an
important determinant of the allocationof FDI flows among developing countries.
Macroeconomic stability, corruption, rule of66

Figure 2.17 Strong rule of law attracts
foreign investors
(FDI)
3
2
1
0
⫺1
y ⫽ 0.3996x ⫹ 0.0117(t ⫽ 1.90)

⫺2
⫺3
⫺1.5

⫺1

⫺0.5

0

0.5

1

1.5

Rule of law
Note: Partial correlation for developing countries
controlling for size, income, openness, inflation, education.
Source: World Bank staff.

law, and effectiveness of the regulatory regime
have been shown to be significant determinantsof the location of foreign investment, after controlling for other variables (Stein and Daude
2002). For example, figure 2.17 shows that aranking of countries according to the rule oflaw (see Kaufman, Kraay, and Zoido-Lobaton
2000) is significantly related to the level of FDI
inflows, after controlling for size, income,
openness to trade, inflation, and educational
attainment. By this measure, increasing the ruleof law by one standard deviation (for example,
from the level of Bangladesh to that of Turkey,
or from the level of Turkey to that of Chile)would raise FDI inflows by 40 percent.
Time series analysis underlines the importance of governance and institutional quality
for the allocation of FDI. Countries with better
investment climates—as indicated by the levelof corruption, voice (political openness), ruleof law, quality of the regulatory regime, government effectiveness, and political stability—
tended to receive an increasing share of total
FDI over the 1990s (figure 2.18).39 The importance of each dimension of the investment
climate used in figure 2.18 varies considerably.
Countries that have strong rankings for regulatory quality, government effectiveness, or
political instability consistently received morethan half of all the FDI to developing countries, with little change in their share of FDI

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Figure 2.18 Foreign investors have been shifting away from weaker investment climate
locations

Weakest

00
20

95

00
20

95
19

20

00
19
90

Above average

20
00

19

95

Above average

00
19
90

20

19
95

Below average

19

00
19
90

20

95
95
19

00
00
20

19

19

19

20

20

19

19

19

Above average

Below average

90

0
95

0

90

25

20
00

25

95

50

90

50

00

75

19
95

75

00
19
90

100

95

100

90

Political stability

Below average

20

WeakestGovernment effectivenessWeakest

19

19

90
19

20

19

20

19

20

19

19

19

19

Above average

95

0
00

0
95

25

90

25

00

50

95

50

90

75

00

75

95

Regulatory quality
100

90

Rule of law

Below average

1900

Below average

90

Weakest100

Weakest

90

90
19

20

Above average

19

Below average

19

19

20

19

20

19

19

19

Weakest

20

0
19

0

19

25

00

25

95

50

00

50

90

75

95

75

00

100

90

100

95

Voice

90

Anticorruption95(percent annual shares of total FDI to developing countries)

Above average

Source: World Bank staff.

by the late 1990s when compared with earlier
in the decade. In contrast, the extent of political openness has not been strongly associatedwith the share of FDI received. And althoughcountries with relatively poor rankings for ruleof law and anticorruption received substantial

shares of FDI, the shares tended to decline in
the latter half of the 1990s. For example, countries with below average anticorruption efforts
received 70 percent of developing-country FDI
in 1994, but only 50 percent in 2000, while
those with above-average ratings doubled their67

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share from 20 percent to just over 40 percent.
If one holds other determinants of FDI allocation (including market size, openness, inflation,and education) constant, corruption is significantly related to the share of FDI in the late
1990s, but not in the early 1990s.
Why should the share of FDI going tocountries with better investment climates haveincreased during the 1990s? Remember that
total FDI flows to developing countries increased very rapidly during this period. One
possibility is that countries with high levelsof corruption or weak rule of law had otherattractions (such as high tariff barriers or incentives programs) that made them desirable
locations for investment in particular sectors,
while they remained relatively undesirable
locations for FDI in general. Countries thatoffered such attractions for FDI were unlikely
to share equally in the FDI boom during the
1990s, which generally responded to the liberalization of economic policies and improvements in macroeconomic stability in several
countries. That is, countries with poor governance may have attracted a substantial
amount of FDI during the 1990s because of
costly incentives. However, they would be
unlikely to attract increasing amounts of FDI
unless they were able to continually raise in-centives. Another hypothesis is that investors
became more concerned about risk in reaction
to the crises of the late 1990s, and that countries with weak governance were viewed as
relatively risky. Indeed, risk premiums on junkbonds and on emerging market debt jumped
sharply toward the end of 1998, indicatinga shift toward increasing risk in the global
environment.
The boom in private infrastructure investment during the 1990s highlights the importance of a policy for attracting foreign investment. Private infrastructure investment indeveloping countries surged during the 1990s,
rising from $14 billion in 1990 to a peak of$117 billion in 1997, before easing to $89 billion by the end of the decade (figure 2.19).40
Foreign investors were involved in some
80 percent of recorded private infrastructuretransactions from 1990 to 1998, althoughforeigners accounted for only about 30 percent of the dollar value of total private infrastructure financing (Sader 2000). The boomin private infrastructure investment responded
to improvements in the investment climate inseveral of the largest developing countries.
Privatization programs opened infrastructure
sectors to private investment, and total privatization proceeds in infrastructure jumped

Figure 2.19 Private infrastructure investment surged in the 1990s
By region

By sector(billions of dollars)(billions of dollars)

140

140

120
100
80
60
40

120
LAC
EAP
ECA
SAS
SSA
MENA

100
80
60

Telecoms
Gas & electricTransport
Water

40

20

20

0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

01990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Note: MENA is Middle East and North Africa, ECA is Europe and Central Asia, SSA is Sub-Saharan Africa, EAP is East Asia andPacific, SAS is South Asia, and LAC is Latin America and the Caribbean.
Source: World Bank staff.

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C H A N G E Sfrom $10 billion in 1990 to $40 billion in
1998, before falling off sharply to $12 billion
in 1999 (World Bank 2001). More generally,
efforts in several countries to open theireconomies to trade and investment and toestablish more stable macroeconomic environments encouraged the surge in infrastructure
investment.
The decrease in foreign investment in infrastructure projects among developing countries
since 1997 largely reflects a reduced demandfor infrastructure services, owing to the crises
in East Asia, Russia, Brazil, and Argentina.
For example, in East Asia and the Pacific, private infrastructure investment collapsed froma peak of $38 billion in 1997 to an average ofless than $15 billion per year from 1998 to
2000. In Latin America, private infrastructure
investment in 1999–2000 was halved fromthe 1998 peak of $71 billion. The drop-off
affected all sectors, with peak-to-trough declines of 63 percent in gas and electricity,
57 percent in transport, and 24 percent intelecommunications.
Although comprehensive data are unavailable, foreign investment in developing-country
infrastructure projects has likely continued
to decline in the past two years. The overall
deterioration in the international economic
environment has driven a sharp decline in commercial bank lending to developing countries(net long-term lending from the banks fell toa negative $32 billion in 2001), and funds for
project finance have dried up. Also, the key investors in infrastructure sectors, utilities (in theEurope and United States), equipment manufacturers, and specialized venture capitalists
have seen their profits collapse, and in somecases the firms have gone bankrupt. Most of
those firms are under pressure to recapitalize
and are reluctant to devote their limited resources to high-risk ventures in developing
countries. Finally, the scandals involving energy deregulation and the spectacular losses ofprivatized telecommunications firms may have
reduced support for the deregulation of service
sectors, a key step toward providing infrastructure services by the private sector.

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Notes
1. A country’s location may have an important rolein attracting FDI flows. For example, Caribbean countries benefit from their proximity to the United States.
2. Data are from UNCTAD 2001. The data on
cross-border M&A already introduced are not comparable to the data on FDI. For example, M&A is reported on a transactions basis, while actual paymentsthat are reported as FDI may be spread over several
years. Also, the local financing share will be reported aspart of an M&A transaction but will not be reported
as FDI. Thus it is not useful to compare the magnitude
of M&A flows with FDI.
3. Documentation and discussion of those merger
waves can be found in Golbe and White (1988, 1993),
Black (2000), Holmström and Kaplan (2001), White(2001), and Pryor (2001a).
4. Analysis based on Evenett (2002).
5. These data are from White (2001, 2002). The
number of corporations refers to 2000. The share of
the top 100 refers to 1999.
6. In the Fortune list of the largest 500 global companies in 2000 (as measured by revenues), 12 were
headquartered in China (including Hong Kong); 11 in
Korea; 3 in Brazil; 2 each in Mexico, Russia, and South
Africa; and 1 each in India, Malaysia, and the República
Bolivariana de Venezuela. The remaining companies
were headquartered in Japan, North America, orWestern Europe.
7. Choosing the appropriate indicator of concentration is difficult. Value added is clearly the superior
all-around measure of aggregate concentration, but it
is not regularly reported by companies in their publicfinancial statements or in government data. Accounting profits will depend on depreciation and amortization rates that vary across firms, and on corporate
income tax rules that vary by country. Data on sales
will significantly distort the relative importance of retail firms (with large ratios of sales to value added) versus manufacturing firms. Measuring concentration interms of assets would imply double counting for financial intermediaries. Moreover, reported asset values
would depend on alternative accounting treatments for
M&A; changes over time in accounting and tax treatment of asset depreciation, amortization, and writeoffs; and changes in the treatment of expensing versus
write-off for various categories of costs. To avoid theseinconsistencies and definitional problems, we use employment data to analyze global concentration, but wealso look at indicators that are based on profits.
8. White (2001) also reports a rise in aggregate
concentration in manufacturing alone from the 1940s
to the 1980s, and then a decline in the 1990s, basedon value added measures; a decline in economy-wide
aggregate concentration in the 1970s, as shown by69

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employment and profit data; and a decline in aggregate
concentration from the 1950s through the 1980s,
based on assets. Somewhat similar conclusions arereached by Pryor (2001b).
9. The only antitrust concern that might be raised
would be that of multimarket contacts among thelargest companies. For discussions of the potential andactual influence of multimarket contacts, see Feinberg(1985), Rhoades and Heggestad (1985), Bernheim andWhinston (1990), and Evans and Kessides (1994).
10. The Forbes “Super 50” list is based on a composite calculation of sales, profits, employment, andmarket value.
11. The time series analysis is based on the Forbes
list, which provides comparable data from 1994 to
2001. The Fortune 500 list was not used because it
included several government-owned businesses. In particular, it extended in the latter years to a few stateowned Chinese companies, thereby distorting thecomparison with the mid-1990s.
12. As stated above, calculations of aggregate concentration should not be based on sales data because of
the wide range of ratios of sales to value added foundin different corporations. But this calculation is basedon changes over time, and presumably differences in
the growth rates of sales and value added are not as
disparate as the levels.
13. World Bank computations are based on datafrom the U.S. Bureau of Census and the Japan Ministryof International Trade and Industry.
14. Even if data were available, global trends in thenumber of companies in major oligopolistic industries
would provide only limited information concerningchanges in the degree of competition. On the one hand,declining numbers of firms may be consistent with rising competition, as lower transportation and communication costs enable formerly regional firms to enter
global markets. On the other hand, little change in thenumber of firms may be consistent with reduced competition (for example, resulting from strategic allianceswith the goal of coordinating prices or sharing out
markets) (OECD 2001).
15. Services are products that are to a large extent
intangible, nonstorable, and nontransportable. Intangibility implies that the quality of services is uncertain
because of their high and variable human content and“one-off” nature of production. Therefore, services
generally require proximity and close interaction
between the producer and the consumer to ensure asatisfactory level of quality. Nonstorability and nontransportability imply that services must be produced
and consumed at the same time and at the same location. However, some services can be embodied in goods
or stored and transmitted through electronic means.
Services include such economic activities as wholesale70

and retail trade; travel; transportation; storage andwarehousing; telecommunications; banking, finance,
and insurance; entertainment; real estate; accounting
and auditing; data processing; research and development; law; health; education; public relations; personal
assistance (such as auto and house repair, haircutting,and laundry); and public administration.
16. See UNCTAD (1992), table I.3, p. 18. For
Germany and Japan, the initial year is 1976.
17. Services are becoming increasingly interlinked
with goods, especially in high-tech products in which
the use of hardware requires various software andmaintenance service contracts.
18. Williamson and Mahar (1998) detail moves
toward liberalization of banking sectors.
19. The importance of foreign bank participation indeveloping countries has been discussed by several
authors (see Roldos 2002).
20. See World Bank (1997) for a discussion of the
globalization of production and the developing
countries.
21. The share declined from 1996 to 1999 because of
the abolition of tariffs under the EU’s Association Agreements, which resulted in companies switching from EU
to Eastern European firms for intermediate inputs.
22. This is a narrow definition of the share of tradeconducted through networks; it excludes imported
inputs that are processed and sold as a final good in
the domestic market.
23. Hummels, Ishii, and Yi (2001) attributed onethird of the growth in world trade over the past
25 years to trade in parts and components, rather thantrade in final goods.
24. Containerized shipment allows for better tracking of cargo, more efficient and reliable port services,and greater ease of switching to land transport.
25. The volume of cargo shipped by airlines
increased by 6 percent per year from 1978 to 1998,
and the share of revenue from international cargo intotal air shipments rose from about 40 percent to wellover half (Air Transport Association 1999).
26. Deardorff (1998) points out that tariffs caneither deter or stimulate participation in global networks, depending on where they are imposed andwhether they are on final or intermediate goods.
27. The easing of restrictions on FDI flows indeveloping countries has been discussed in various
editions of Global Development Finance.
28. Chen (1996) lists alternative forms of production relationships, including wholly owned affiliates, joint ventures, foreign minority holdings, fadingout agreements, licensing, franchising, management
contracts, turnkey ventures, contractual joint ventures,and subcontracting. See also Grosse (1996) for analternative categorization.

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29. FDI requires some advantage by the multinational over home production to compensate for domestic firms’ superior knowledge of local markets, consumer preferences, and business practices (Blomström
and Sjöholm 1998).
30. The example is given of a Singaporean company in which some technology was transferred to a
local subcontractor, but critical components wereunlikely to be outsourced.
31. One concern is whether these data are distorted
because multinationals may not report “true” prices ofgoods traded among affiliates, but they will insteadincrease the price (and therefore profits) of goods from
low-tax locations and will reduce the price of goods
from high-tax locations. There is some evidence that
U.S. firms have followed this practice; however, theoverall patterns of prices are similar to the pricing ofgoods traded between firms (Clausing 2001). Thus
these data may provide a reasonably accurate pictureof trends in intra-firm trade.
32. These data refer to product categories identified
as parts and components in the Standard International
Trade Classification (SITC) Revised 2 system. This
trade is a proxy for, but is not identical to, production
through networks. On the one hand, such trade may
also reflect the export of relatively undifferentiatedinputs to arm’s-length purchasers. Conversely, many
goods that are parts to consumer products are not
identified as such in the SITC system. On balance, thedata probably understate the extent of trade throughnetworks (see Kaminski and Ng 2001).
33. However, Rangan and Lawrence (1999) argue,
on the one hand, that the costs of search and assessment of reliability involved in choosing suppliers andoutlets will mean that even arm’s-length relationships
can be relatively insensitive to changes in relative prices
in the short term. On the other hand, multinationals
face smaller search and assessment costs because of
greater international experience, so they are more
likely to switch production rapidly in response to relative exchange rate changes. They provide some empirical support for this view.
34. For additional U.S. evidence, see Howenstineand Zeile (1994). Griffith (1999) presents similar
evidence for the United Kingdom; Globerman, Ries,
and Vertinsky (1994), for Canada; Aitken, Harrison,and Lipsey (1996), for Mexico and the República
Bolivariana de Venezuela; and Te Velde and Morrissey(2001), for five African countries.
35. Conceivably, all sectors may be perfectly competitive, and the benefits of increased productivity willaccrue to consumers.
36. This calculation excludes a few network participants that lack adequate time series data on manufacturing value added.

I N

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37. Excluding Korea, Malaysia, and Taiwan(China) from this set reduces the group’s average
growth rate of manufacturing value added to 4.3 percent per year, still much higher than other developing
countries.
38. General information on apparel is mainly
drawn from Gereffi (1999) and the apparel chaptersin Gereffi and Korzeniewicz (1994) and Gereffi and
Kaplinsky (2001).
39. The countries are classified into three categories: the worst group (more than half a standard
deviation from the average), below average (half a standard deviation or less from the average), or above
average.
40. Technological innovation also helped boost
investment in infrastructure over the 1990s. For example, flows to the telecommunications sector rose withthe dramatic reductions in the price of long-distanceservice.

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3
1
Domestic Policies to Unlock
Global Opportunities

Globalization makes it increasingly
important to get the “investment
climate” right—
Expanding global service and production networks can accelerate growth in developing
countries that successfully harness competition
to encourage efficient investment. Efficient investment does not simply mean more investment. In fact, recent research demonstrates
surprisingly little short-run correlation between investment levels and growth (Easterly1999). Instead, investment and its productivity
are inextricably linked to domestic policies
that, taken together, broadly make up the local
investment climate.
Sound enabling policies—including good
governance, institutions, and property rights—
can help attract more private investment, both
domestic and foreign. Policies that promotecompetition and entrepreneurship increase theefficiency of that investment. Complementary
public investment, meanwhile, further contributes to overall productivity growth. Taken
together, sound policies in these three areas
contribute to a positive investment climate,which is essential to accelerating growth andreducing poverty (Stern 2001).

—including having an enabling policy
framework—
A stable macroeconomic environment is essential for a country to realize its investment
potential. Good public governance—includingtransparent rules, low corruption, and re-spected property rights—encourages investment and promotes economic growth. Many
countries try to use specific investment policies, such as tax incentives, to attract investment or to channel it in particular directions.
Such schemes are often poorly designed, inadequately implemented, and costly, and maylargely benefit investors who would have invested anyway.

—and promoting competition that will
increase the productivity of private
investment
In many countries, policy and private barriers
either have discouraged private investment or
have channeled it into less-productive activities that reduce economic growth. Promoting
a positive investment climate, however, does
not imply a laissez-faire approach to the economy. Rather, it requires active government
efforts to reduce barriers that stifle entrepreneurship and competition. Four policy barriers to competition are especially common:barriers to trade, restrictions on foreign
investments, administrative barriers to entry
and exit, and monopoly positions granted tostate-owned enterprises (SOEs) and newly
privatized firms. While privatization has usually improved the performance of divested
firms, shortcomings abound in subsequentindustrial performance. Those shortcomings
may be associated with regulations that
reduce competition and grant exclusivity before sale of the enterprise. In addition, private77gep_ch03.qxd 12/5/02 2:48 PM Page 78

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2 0 0 3barriers to competition—including pricefixing and other collusive practices—can induce resource misallocation. After establishingan adequate macro policy framework, countries that lower both policy barriers and private barriers to competition can usually minimize investment distortions. They can also see
more capital inflows, more rapid growth intrade, and superior overall performance.

Public investment plays a critical rolein increasing productivity
The level and composition of public investment has changed over the past two decades.
The wave of privatizations has reduced thelevel and scope of public investment throughstate enterprises, and many sectors once
thought to be natural monopolies can now
be exposed to competition. Public resources
formerly used to subsidize loss-making SOEs
can potentially be used where the private sector is unlikely to invest enough: education,
rural roads, and expanded access to underserved areas in many networks. While always
a challenge, investment in effective infrastructure and human capital projects has an especially high return.

Investment climate and investment
policiesWhile foreign direct investment (FDI)
flows to developing countries receive
much attention and have special characteristics that can benefit recipients, most investment in these economies remains domestic in
origin (figure 3.1).1 This fact highlights theimportance of policies likely to affect the leveland productivity of all investment, not justforeign. Since the mid-1980s, the share attributable to public investment has remained
fairly constant, while private domestic investment has declined slightly as FDI has grown.

Governance, corruption, and property
rights matter—
One critical dimension of the domestic policy
environment is whether the government
operates with transparency, credibility, andstability. Good governance—including independent agencies, mechanisms for citizens tomonitor public behavior, and rules that constrain corruption—is essential to development(World Bank 2002b). Barro (1991) finds a positive relationship between growth and measures of political stability for 98 countries from

Figure 3.1 Domestic capital is the largest source of investment in developing countries(gross fixed capital formation, percent of GDP)
30
25
FDI

20
15

Private investment
10
5

Public investment

0
1975

1978

1981

1984

1987

1990

1993

1996

1999

Note: GDP is gross domestic product. These are the annual averages for 111 developing countries. Private investment is calculated
as the difference between gross fixed capital formation and the sum of public investment and FDI. Public investment data measure
total public investment, including SOEs.
Source: World Bank and International Monetary Fund data, and Everhart and Sumlinski (2001).

78

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1960 to 1985. For example, as discussed inchapter 2, countries with stronger rule of law
see more FDI (figure 2.17).
Transparency is among the most importantcomponents of the domestic enabling environment. Transparency relates to both the actions
taken by authorities and the broader businessenvironment of the host country. A nontransparent business environment increases thecost of information, diverts corporate energies
toward rent-seeking activities, and can be conducive to corruption. Case studies suggest thatcompanies may, for example, be willing toinvest in countries with legal and regulatory
frameworks that would not otherwise beconsidered “investor friendly,” provided theinvestors can obtain a reasonable degree ofclarity about the environment in which they
will be operating. Conversely, extremely
opaque business conditions can deter virtually all private investment, regardless of theextent of the incentives.
While these factors affect all participants in
the host country’s business sector, they arearguably more discouraging to outsiders who
are not privy to locally available information
and who have other choices about where toinvest. As with earlier relations, causality canrun both ways, because FDI may contribute tocreating a more transparent environment.
There are cases in which a foreign corporate presence encouraged more open government practices, raised corporate transparency,
and energized the fight against corruption.
More generally, by observing commonly
agreed standards such as those in the Convention on Combating Bribery of Foreign Public
Officials, implemented by the Organisation
for Economic Co-operation and Development (OECD), multinational firms can contribute to raising standards for corporatesocial responsibility in host countries.
Corruption can deter foreign investors byincreasing transaction costs and by raising
uncertainty regarding the enforcement ofcontracts, the predictability of operating
costs, and the likelihood of obtaining needed

P O L I C I E S

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O P P O R T U N I T I E S

licenses and permits. Recent empirical research confirms that measures of corruption
are significantly and negatively related to
FDI inflows (Smarzynska and Wei 2000; Wei
2000). Lipsey (1999) observes a strong negative correlation between corruption and thelocation choice of U.S. affiliates across Asian
countries.2 Hausmann and Fernandez-Arias(2000) find positive, albeit weak, evidence
that FDI as a share of gross domestic product(GDP) increases with institutional quality.3
Corruption and poor governance often go
hand in hand with lack of investor protections
and with poorly functioning institutions,
thereby deterring competition and investment.
No investor—domestic or foreign—is likely
to risk assets if there is a high probability thatthose assets will be arbitrarily seized. Securityof private property helps ameliorate asymmetric information between investors and the government and reduces investor uncertainties,
thus reducing risk premiums and the overall
cost of doing business. Empirical literatureprovides unambiguous support for this basic
point, finding that the institutions protecting
property rights are among the most criticalfor growth (Knack and Keefer 1995), that
productivity and economic growth will improve when governments impartially protect
and define property rights (Claugue andothers 1999), and that countries without
adequate property rights are likely to growmore slowly (Zak 2001). Moreover, historicalevidence from industrial countries suggeststhat when investors face the threat of asset
expropriation, they are likely to charge muchhigher prices to recoup investments quickly—
if they choose to invest at all (Keefer 1996;
Wallsten 2001c).

—but policies to channel private
investment warrant caution—
Building a strong and stable investment climate is neither easy nor quick. Governments
may hope to jump-start the process or to compensate for a poor investment climate throughtargeted policies intended to draw investors79

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2 0 0 3(usually foreign). Similarly, governments maycompete for foreign investment in higher
value added industries as a way of moving up
the technology hierarchy of international tradeand production. The lure of targeted policies
is clear: incentives can be legislated quickly,
and investment that occurs after the incentives
are in place can be touted as a success. Whileactual success stories exist, they tend to be theexception rather than the rule because a combination of design flaws and implementation
failures could limit the hoped-for response.
Moreover, such schemes can be expensive,with the risk that costs will outweigh any
benefits, that incentives will merely transfer
money to private investors who would haveinvested anyway, and that incentives can leadto a “race to the bottom” as developing coun-tries each try to give the biggest incentives toinvestors. In this section, we will consider
three common policies: tax incentives to encourage FDI, subsidies to promote industrial“clusters,” and measures to encourage industrial development through export processing
zones (EPZs).
Tax incentives for FDI. Given the perceived
benefits of FDI, many countries have explicit
policies to attract it. One recent study estimated that 116 countries take a proactive
approach to FDI and offer incentives to foreign investors (Moran 1998). Figure 3.2 illustrates the variety and frequency of fiscal andfinancial incentives for FDI that developing
countries offer. Typically, these policies focus
on attracting particular types of investment—

Figure 3.2 Incentives for FDI are varied and numerous
Subsidized loans
VAT exemption on exported inputs
Reduction in local, municipal taxes/duties
Loss write-off
Export income treated preferentially
Duty drawback
VAT exemption for raw materials
Raw material import duties exemptedOECD countries

Accelerated depreciation

Developing countries

VAT exemption for capital goods
Lower tax rate
Investment/reinvestment allowance
Tax exemption/holiday
Capital goods import duties exempted
0

10

20

30

40

50

Number of countries
Note: VAT is value added tax. Data on fiscal and financial incentives were compiled for 71 developing and 20 OECD countries. The
most common incentives (used in at least 18 percent of developing countries) are shown in the chart.
Source: Bora (2002).

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or changing investors’ conduct—rather thanon improving the general investment climate.
Incentives designed to lure FDI can take theform of up-front subsidies that are designed tohelp multinationals defray some of their fixed
costs (financial incentives), tax holidays (fiscal
incentives), and other grants. The main goal ofsuch policies is to alter either the magnitude or
the location of inward FDI.
There are three main categories of FDI
incentives: fiscal—policies that are designed
to reduce the tax burden of a firm (including
loss writeoffs and accelerated depreciation);
financial—direct contributions to the firmfrom the government (including direct capital subsidies or subsidized loans); and others
that do not fall easily into either category. In
contrast to the industrial world, where the incentives offered are usually financial, the overwhelming majority of developing-country
incentives are fiscal (see figure 3.2). In a recent
study that included 71 developing countries,
Bora (2002) concludes that fiscal incentives are
the most popular, accounting for 19 of the 29
most frequently used incentives. Furthermore,
the five most common incentives are all fiscal.
Despite the popularity of FDI incentives indeveloping countries, the evidence of theireffectiveness remains ambiguous. The United
Nations Conference on Trade and Development (UNCTAD 1996) reports that incentives
can have an effect on attracting FDI at themargin, especially when one considers the typeof incentive and the type of project. Conversely, Caves (1996) and Villela and Barreix(2002) conclude that incentives are generally
ineffective once the role of fundamental determinants of FDI is taken into account. Furthermore, in a recent review of the literature on tax
incentives and FDI, Morisset and Pirnia (2000)
conclude that such instruments rarely make up
for deficiencies in a host country’s overall economic environment, and they fail to generate
the desired externalities. Overall, recent evidence provides little support for those who
believe that incentives will bring in extra FDI.
To some extent, the ambivalent perspectives may reflect differences in views regarding

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what is meant by an incentive. It is important
to distinguish between the fiscal and financial
incentives (which are usually firm specific)
and the more general policies that promotebusiness activity. Evidence is uncontested thatgeneral policies matter a lot in attracting investment. In a recent empirical analysis of theeffect of U.S. state-level policies on the location of manufacturing investment, Holmes(1998) found that the manufacturing share of
employment in states with a pro-business regulatory environment is one-third greater thanthat in a bordering state without that environment. Policies that encourage the adoption
and adaptation of know-how—and other general incentives that apply across the board—
are important and help foster a sound enabling environment. Examples include effective
enforcement of contracts, absence of red tape,adequate infrastructure, and efficient training
and education programs.
Under special circumstances, targeted FDI
incentives may have positive effects. Many
government officials seem to think that suchincentives work, as illustrated by statementsfrom a number of representatives in the Working Group on Trade and Investment of theWorld Trade Organization (WTO [1998]).
Several studies find that fiscal incentives doaffect location decisions, especially for exportoriented FDI, although incentives seem to playa secondary role (see Devereux and Griffith
1998; Guisinger and others 1985; Hines
1996). However, fiscal incentives appear
unimportant for FDI that is geared primarily
toward the domestic market; instead, such FDI
appears more sensitive to the extent to which
it will benefit from import protection. Thus, amore nuanced view of the efficacy of incentives may be in order. Although useful for attracting certain types of FDI, incentives do notseem to work when applied at an economywide level (see Hoekman and Saggi 2000).
Moreover, even when targeted, FDI incentives may impose excessive costs on governments, especially when fiscal incentives areprovided through special tax provisions.
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2 0 0 3jobs created) are visible, whereas costs are hidden (tax revenues are forgone), governments
may offer too much. Also, the existence of excessive FDI incentives is not just a developingcountry phenomenon—in fact, such incentives
are far larger in industrial countries. For example, in 1996, Mercedes-Benz received a subsidy of $300 million, which amounts to a
subsidy of $200,000 per employee, from the
U.S. state of Alabama for establishing an auto
plant (Moran 1998). Similarly, following reunification, Germany paid a subsidy of $6.8 billion to Dow Chemical, which amounts to an
astounding $3.4 million per employee (Moran
1998).
Additional concerns about the use of incentives emerge from their effect on the distribution of rents between governments,
host-country firms, and large multinationals.
Developing countries may be tempted to offer
investment incentives to multinationals inpart because of an expectation of technology
spillovers to local firms. Yet, investment incentives to multinationals can put local firms
at a competitive disadvantage, at least initially.
The net effect is hard to estimate: perhaps
incentives impose a short-run cost on local
firms, which may gain from foreign investment in the long run.
A selective use of investment incentives
can have strategic consequences among foreign firms, especially when multinationals arepervasive in markets with a high level of concentration. For example, an exporting foreign
firm from a developing country (or a local hostfirm) may find itself at a disadvantage with respect to another foreign firm that experiencesa decline in costs resulting from an investment
subsidy. Thus, incentives can alter the distribution of rents among multinationals.
Finally, the use of investment incentives bydeveloping countries poses a possible international coordination problem in two respects.
First, as noted earlier, the possibility of excessive incentive “competition” among developing countries may increase the likelihood thatthe “winning” country will have given away
far more than it receives. This area allows

82

some scope for international action to prevent
suboptimal outcomes (see chapter 4). Second,
there is the possibility that incentives offeredby high-income countries will end up retaining or attracting FDI that would be more
efficiently used in developing countries(Hoekman and Saggi 2000). For example,
labor unions and local interest groups may
oppose plant closures by offering excessive
incentives for firms to remain. Similar motivations underlie the use of trade policy instruments such as antidumping. It is important,
therefore, to distinguish between the locational competition that may enhance efficiency
and the use of investment and trade policies(such as antidumping) that alter the incentives
for outward FDI. The latter policies are inherently inefficient because they protect industries
that are no longer competitive, and they induce various related distortions that are well
documented in the literature (Finger 1993).
Clusters. In the past decade or so, the concept
of industrial clusters has received a great dealof attention (see, for example, Porter 1990).
While there is no standard definition of a cluster, it is usually characterized as a regional
agglomeration of firms in related industries(along with complementary infrastructure andsupport services such as business, financial,and legal) that all work together in a virtuous cycle to attract new firms and to help
existing ones grow. California’s Silicon Valley
typifies the high-technology cluster, with its
concentration of high-tech firms, premier
universities that actively interact with local
businesses, and venture capitalists. Clustering, however, occurs in many other industries
as well and is quite widespread (Ellison
and Glaeser 1997; Krugman 1991, 1998). In
the United States, evidence of knowledge
spillovers within regions (Jaffe 1989; Jaffe,
Trachtenberg, and Henderson 1993) and verysmall areas (Wallsten 2001b) is consistent
with the idea that similar firms may benefit
from proximity with one another.
Although the policy interest may be relatively new, clusters have been recognized for agep_ch03.qxd 12/5/02 2:48 PM Page 83

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long time. In 1920, Alfred Marshall (as citedin Davenport 1935) hypothesized three reasons for the existence of clusters: the benefits
from a pooled labor supply, access to specialized resources, and information flows amongmarket participants. Today, these main benefits are still associated with clusters. In a successful cluster, these factors generate positive
feedback loops because the concentration ofpeople and firms will attract more people andfirms (Arthur 1994; Krugman 1991).
With these potential benefits, it seems natural that policymakers would want to start
clusters close to home. Unfortunately, there islittle evidence that active efforts to create clusters tend to be successful. This result is in part
related to the difficulty that governments
everywhere have in “picking winners.” Without any clear market signals about what activities or clusters might be viable, governments
have a fairly poor track record. Bergman andFeser (2001) argue that “in less developed
regions a policy decision to concentrate resources on key industries, instead of more general infrastructure needs or other strategies
that would serve best a broad array of industries, brings with it significant risks against
which the gains remain unverified.” In industrial countries, research suggests that efforts
to promote cluster development throughscience parks and public venture capital tend
to be unsuccessful (Braun and McHone 1992;
Felsenstein 1994; Wallsten 2001d).
Of course, this cautionary conclusion does
not mean that emerging clusters should be
ignored. Indeed, it may be that governments
can draw on the problems such clusters facewhen prioritizing where to undertake reforms.
In other words, cluster promotion may be
more successful when directed toward areas inwhich significant activity is already ongoing,
as well as areas where additional efforts on themargin by government may be the catalyst
needed for further expansion. This type of
selective intervention may underlie the successstories that do exist, such as Hsinchu Science
Park in Taiwan, China (Saxenian and Hsu
2000).

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In sum, while much evidence shows thatclusters of firms are beneficial and occur naturally over time, there is little understandingof how to create them from scratch and no
experience to suggest that governments haveany expertise in selecting activities where clusters might flourish. Bigger payoffs are likely
to come from interventions to improve thebroader business environment. If governments
are obliged to provide incentives to stimulate
cluster development, they may do better byencouraging expansion of existing clusters,
rather than by trying to pick winners andending up simply transferring resources to theprivate sector without generating any positive
externalities.
Export Processing Zones. EPZs have becomea prominent feature of many developing andtransition economies, increasing from 175 in
53 countries in 1987 to 500 in 73 countries
by 1995 (Kreye and others 1987 and OECD
1996, both cited in Schrank 2001). Alongwith this increased prevalence, it is not
surprising that EPZs now account for fairly
high shares of total employment in many
countries—for example, as much as 6 percent
in the Dominican Republic (de Ferranti andothers 2002). Despite EPZs’ ubiquity in thedeveloping world, there is little agreement onwhether EPZs are an effective development
tool. While some view EPZs as the first step
down a virtuous path of liberalizing domestic
markets (Rodrik 1999), others believe that, by
creating a special “property right” of value tothose who participate, EPZs represent an escape valve that curtails broader reform efforts
and that hampers overall liberalization anddevelopment.
The immediate benefit of EPZs to the hosteconomy lies in job creation, greater foreignexchange earnings, and, possibly, higher real
wages. In many instances, workers seem toperceive EPZ employment as an attractive
opportunity. For example, Brown (2001, citedin de Ferranti and others 2002) finds that
men and women employed in Mexico’s
maquila (manufacturing EPZ) sector earn 31

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2 0 0 3and 38 percent more, respectively, than theirpeers in non-EPZ sectors. Similarly, in a survey described by Sargent and Matthews(1999, cited in de Ferranti and others 2002),
73 percent of Mexican maquila workers interviewed reported their current job to be atleast as good as their previous employment.
Furthermore, worker welfare in EPZs is also
improved through employer practices ofproviding worker benefits (such as medical
insurance), stable work schedules, and weekends off. Moran (2002) evaluates worker conditions in EPZs in a number of countries andconcludes that there is “extensive evidence
that wages and working conditions in foreignowned or foreign-controlled factories compare favorably with those of alternative occupations.” Moran (2002) further notes that thedemand for jobs is high and that workers
tend to return to existing jobs following aholiday. English and de Wulf (2002) credit
EPZs with creating more job opportunities
for women in Bangladesh, with reducing female poverty in the Dominican Republic, andwith raising wages for EPZ workers above
wages for workers in the rest of the economy.
Beyond the direct effect of EPZs on job
creation, a comprehensive evaluation of themshould look at two additional criteria. First,
do EPZs actually encourage firms to export(or to increase exports), rather than causingfirms that already export to relocate into the
EPZ so they can take advantage of financial
incentives? Second, do EPZs produce spillover
effects by drawing local manufacturers into
the world markets, thereby indirectly bringing reform and enhanced competitiveness to agreater segment of the nation’s producers?
Schrank (2001) compares EPZs in the
Dominican Republic and in the Republic ofKorea, arguing that market size is a major
determinant of EPZ success. Despite the good
performance within the Dominican Republic’s
EPZ sector, few benefits appear to spill over
into the rest of the economy. Korean EPZs,
however, are increasingly integrated with local
suppliers, thereby helping to transform muchof the economy into world-level competitors.

84

Schrank suggests that smaller countries may
be unable to “transform feeble manufacturers into world market-oriented firms” and areless likely to draw themselves onto a “largecountry growth trajectory.”
Research does show that, in some instances, EPZs can be successful and can act
as a catalyst for the rest of the economy (forexample, Jayanthakumaran and Weiss 1997;
Johansson and Nilsson 1997). Moran (2002)
argues that EPZs will have only a limited
effect unless they are supported by efforts tointegrate them more fully into existing commercial and industrial hubs and unless they
are located near existing or potential poolsof better-educated labor. In particular, thisargument implies that government efforts to
use EPZs to encourage development of“backward” regions that are far from existing
industrial centers (where the infrastructure islimited and skilled labor is scarce) are unlikely
to be successful. The more successful EPZ
experiments that Moran considers are in
Costa Rica, the Dominican Republic, and thePhilippines. Those examples show how EPZs
have facilitated a shift in foreign investmentaway from lowest-skill operations that arelimited to export enclaves toward higher-skill
operations that are better linked to the rest of
the economy and that provide both employment opportunities for higher productivity(and higher wages) and better worker conditions. Without such complementary efforts,
EPZs risk becoming another entrenchedinterest that simply maintains trade barriersand delays broader market reforms.
Another view of EPZs focuses on their roleas “transition property rights.” It highlights
their function in helping the country steadily
improve its investment climate. That is, EPZs
may act as a catalyst for the host economy, thus
sparking a sequence of beneficial changes in theeconomy. The experience of Mexico is highly
illustrative in this case: the transition beganwith establishing maquilas in a 2-mile borderzone, which was next expanded to 12 miles,
then to entire states, and eventually to the wholecountry. In this case, EPZs were able to help

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improve the investment climate by acting asa bridge between the old and the new systems.

—and incentives cannot offset a poor
policy environment
Governments may hope to make up for an
unfriendly investment environment throughincentive mechanisms. But while there areclearly examples in which targeted interventions (such as fiscal incentives, EPZs, or support for clusters) may indeed lead to higher
investment levels—and the jobs and related
spillovers that go along with such levels—there
is unfortunately little evidence that such initiatives can be systematically successful. Instead,the impression is that these interventions work
best when they work in support of broader reform packages, either to catalyze support for
emerging opportunities (such as clusters) or tocreate an initial constituency for reform thatcan be progressively expanded (such as EPZs).
But more broadly, as Wells and others (2001)
note, “Incentives will generally neither makeup for serious deficiencies in the investment
environment nor generate the desired long-run
strategies.” To encourage productive investment and benefit from globalization, governments must tackle the challenges of promoting
competition and entrepreneurship and of undertaking complementarily productive public
investment in areas such as education. We now
turn to these issues.

Promoting efficient private
investment: harnessing
competitionWhile a stable macro environment andgood governance are important to attracting investment, policies that promote contestable markets and that protect against
abuses of market power are required to ensurethat new investment is both productive andefficient. Of particular importance in this regard are investment and competition policies,
which are important elements of the investment climate and also are basic pillars of theeconomy’s micro foundations that can have

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large effects on productivity and welfare. Industries generally function better when they
operate in a competitive environment, andricher and faster-growing countries tend tohave more competition and fewer barriers toentry. Changes in technology, global businessorganization, and regulation have created newopportunities for competition in areas that
had formerly been seen as natural monopolies(infrastructure) or that were considered necessary to preserve domestic sovereignty (services,
real estate, and the financial sector). Countries
that do not change their investment policies
and do not exercise well the powers and responsibilities of the state—such as regulating
privatized industries, providing education, or
enforcing conditions of competition—will
forgo poverty-reducing growth opportunities.
At the broadest level, competition and easeof entry are both positively correlated witheconomic growth (figure 3.3). A host of policy
and private barriers in developing countries
work to restrict competition. Restrictions on
trade and FDI rob an economy not only ofpotential sources of investment, but also of
one incentive for firms to improve productivity. While causality goes both ways, both tradeand FDI are correlated with higher productivity of firms in an economy. But potential
competition does not come solely from interactions with the global economy. Many developing countries still protect incumbent firms—
whether state-owned or private—by giving
them monopoly power even when there is little rationale for doing so. While such actions
may protect particular firms, they almost always impose net costs on everyone else in the
country. Finally, other private barriers—suchas collusion, price-fixing, and cartels—blockcompetition and reduce welfare. This sectionof the chapter reviews some of these barriers
to competition, and details how they can harm
developing countries’ economies.

Policy barriers to competition are a dragon productive investment
Barriers to competition stemming from government policies can emerge either through85

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2 0 0 3Figure 3.3 Competition and ease of entry are associated with higher growth(GDP growth rate, percent)(GDP growth rate, percent)

14

14

12

12

10

10

8

8

6

6

4

4

2

2

0

0

2

2

4

4

6

6
3

3.5

4

4.5

5

5.5

6

6.5

7

Competition

3.5

4

4.5

5

5.5

6

6.5

Entry

Note: “Competition” is the average response in each country to the question “In most industries, competition in the local markets is(1  limited and price-cutting is rare, 7  intense and market leadership changes over time).” “Entry” is the average response to thequestion“Entry of new competitors (1  almost never occurs in the local market, 7  is common in the local market).” Althoughcompetition and entry rankings suffer from methodological problems related in part to averaging of responses across respondents(see, for example, Lall 2001; Recanatini, Wallsten, and Xu 2000), those rankings can, nevertheless, provide a useful starting point
for more rigorous investigations. One important question that these figures cannot answer is that of causality: do entry andcompetition make countries richer, do richer countries have more competition, or does something else altogether drive both growthand competition? What does emerge clearly is that poorer and more slowly growing countries seem to have less entry andcompetition.
Source: World Economic Forum (2002); World Bank SIMA indicators.

direct channels (such as when governments
create state monopolies) or through indirectchannels (such as when policy choices made inpursuit of other objectives end up limiting
competition). In this section, we will focus onfour channels through which competition isaffected by policy choices:• Import competition• FDI competition• Administrative barriers• State monopolies and private barriers tocompetition.

Import competition can enhance
productivity
The important role that trade plays in promoting productive investment and growth
has long been recognized. Using different measures of openness to trade, including bothits relative size (as measured by import andexport shares) and its degree of distortion(as measured by average tariff rates and86

dispersion), research strongly suggests that
greater openness is associated with higher
growth in both industrial and developing
nations. Sachs and Warner (1995) find that
openness is a highly significant determinant ofgrowth and, combined with property rights,
may even represent sufficient conditions for
growth in poor economies. Kang and Sawada(2000) find a similar effect of openness on
growth. They argue that, combined with financial development, openness increases growth
rates in developing economies by decreasing
the cost of human capital investment. Maloney(2001) offers regional support for the above
result, citing evidence that Latin American
economies that are more open and that possessa more developed knowledge infrastructure
will grow faster. Consistent with this result,Cuadros, Orts, and Alguacil (2001) find that
openness positively affects Latin American
growth and trade through increasing FDI.4
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growth. One approach emphasizes the learning and productivity gains that occur as domestic firms confront more competitive world
market conditions, become more efficient,and begin exporting. Another more compelling approach emphasizes the rise in import
propensities that often comes with tradeliberalization. Increased imports place domestic firms under direct competitive pressuresand indirectly induce technological innovationor cost-cutting restructuring that further enhances competitiveness and productivity.
Research finds that price–cost margins(markups above cost) tend to fall with importcompetition, though the direction of causality
is not clear, and that foreign competition tends
to improve manufacturers’ efficiency (Tybout
2001). Hoekman, Kee, and Olarreaga (2001)
found that import competition (defined as theratio of import volume to domestic consumption in an industry) reduces industry markup.
The effect of import competition is particularly
powerful when a few oligopolists dominate

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markets. In figure 3.4, markups are lowest(measured on the vertical scale) when importcompetition is highest and when there are more
firms (the front corner), and markups are highest when import competition is low and whenthe market is more oligopolistic (back corner).
Import competition pressures domestic
firms to be more productive. A recent study ofBrazilian manufacturing firms, for example,
finds that foreign competition induces quick,marked improvements in domestic productivity and, over time, forces inefficient firms to
shut down (Muendler 2002). Cross-country
data are consistent with these findings, suggesting that higher tariff rates (which makeimports more costly and thus less competitive), are correlated with lower productivity(figure 3.5).
In addition to the direct competition afforded by greater openness to imports, higher
trade prevalence can create spillover opportunities through which domestic firms can gain
access to (improved) technology without paying full cost. In general, imports from industrial

Figure 3.4 Competition from imports checks markups in concentrated markets

2.000
1.800
1.600
Markup 1.400
1.200

0.800
4
33% 50%66% 75%
Imports /d
80% 83%
omestic
consump
tion

er

6
8
10

mb

12% 25%

Nu

0

3

of

0.600

firm

1
2

s

1.000

Note: Import penetration is defined as the ratio of import volume to the domestic output of an industry.
Source: Hoekman, Kee, and Olarreaga (2001).

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2 0 0 3Figure 3.5 High tariffs are correlated withlower productivity(percent)
40
35
30

Average productivity

25

Average tariff rate

20
15
10
5

f
Re
p.
o
a,
Ko
re

Ma
lay
sia

nd
ila
Th
a

es
ilip

pin

a
Ph

Ch
in

Ind

ia

0

Source: World Bank staff, based on survey of more than
5,000 firms.

countries are positively related to technology
diffusion and productivity growth (Eaton andKortum 1996; Lumenga Neso, Olarreaga, andSchiff 2001). Sjöholm (1996) finds a positive
relationship between bilateral import sharesand patent citations for Sweden.5 And Coeand Helpman (1995) find that industrial
countries that receive a larger share of imports
from countries with a high level of researchand development (R&D) expenditures will experience faster productivity growth.6 Despite
agreement that imports are an importantchannel for technology diffusion, studies reachsomewhat different conclusions on the conditions under which such diffusion is most likely
to occur. Coe, Helpman, and Hoffmaister(1997) extend the results of Coe and Helpman(1995) to developing countries and find thatdeveloping countries’ total factor productivity
is positively related to their openness to tradewith the industrial countries. Furthermore,productivity in developing countries increases
as imports’ share of GDP increases.
Some research finds that manufacturing
productivity in developing countries depends
on the complexity of imported machines(Navaretti and Soloaga 2001). Choudhri and
Hakura (1999) show that imports are significantly related to productivity growth only in88

manufacturing sectors in which productivity
increased moderately. Imports did not seem toaffect productivity in sectors with low or highproductivity growth. Using industry-level
data, Keller (2000) finds that imports may
boost technology diffusion if countries receivea relatively high share of total imports from ahigh-technology trading partner. Hakura andJaumotte (1999) find that the share of imports
from industrial countries has a positive effecton total factor productivity. Finally, Xu andWang (2000) find that the share of importsof capital goods from high-technology countries is significantly related to productivity
increases.

Competitive effects of FDI dependon policy—
FDI can be a potential vehicle for increasing competition. Multinational corporations(MNCs) tend to be more efficient and productive than smaller, purely domestic firms. While
MNCs’ entry into the domestic market can
put competitive pressures on local producers,
the mere presence of MNCs does not necessarily increase competition. Because they often
possess significant intangible assets (brandnames, technology, managerial skills, and soforth), MNCs often supply different markets
directly (through domestic production activities) rather than through exports. Such assets
may permit MNCs to wield considerable market power. Openness to trade, low barriers
to exit and entry, and other regulatory conditions can in turn help limit the capacity of
MNCs to abuse market power in the domestic
market.
While the relationship between competition and FDI remains complex, over time thecompetition-increasing association has become
more prominent. Historically, FDI was often
attracted to regions that were protected byhigh tariffs, as firms calculated that it waseasier to set up a subsidiary than to pay thetariffs required to serve the market throughexports. Such tariff-jumping investment wasalso motivated by the opportunity to service
the domestic market behind the tariff barriers

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while shielded from competition from abroad.
This type of FDI has a long history: in thepost–World War II period, many developing
countries encouraged both domestic and foreign firms to invest in high-priority industrial
sectors by imposing high tariffs, quantitative
restrictions, and other nontariff barriers,
along with providing various additional incentives (Caves 1996).
Investment induced in such a way, however,is unlikely to be efficient and, therefore, is lesscapable of providing a basis for sustained
growth. First, the empirical evidence suggeststhat tariff-jumping FDI is “likely to be transient, lasting as long as the artificial policyinduced incentives” (Balasubramanyam 2001).
Second, it can harm welfare by increasing consumer prices. In an era of much higher tariffs
than generally exist today, Lall and Streeten(1977) found that more than one-third of the
90 foreign investments they studied actually
reduced national income. This reduction was
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allowed high-cost firms to produce for the
local market at very high prices, even though
they could have imported much more cheaply.
An even higher share of domestic projects thatthey reviewed had negative value added.
Encarnation and Wells (1986) found that
25–45 percent of 50 projects studied (depending on analytical assumptions) reduced national income; again the main culprit was highprotection.

—and benefits are higher when tradebarriers are lower
One clear implication is that if countries areopen to foreign investment, trade barriers canand should be kept low. Such openness to international competition will keep MNCs fromusing high protective tariffs to exert market
power domestically and will discourage themfrom joining domestic vested interests that arelobbying for policies that perpetuate costly
rent-seeking activities. The cost of not doing
so can be enormous, as illustrated in box 3.1.

Box 3.1 Trade restrictions shield MNCs fromcompetitive forces at enormous cost: the caseof Argentina

Trade and tax policy often interact in ways thatmagnify their competition-restricting effects.
Newfarmer (2001) illustrates the importance ofpolicy in determining the net contribution of multinational corporations (and domestic firms) by using
the example of Argentina in the 1980s. In an effort
to encourage settlement of Tierra del Fuego, thesouthernmost tip of the country (partly in responseto territorial disputes with Chile), the government
set up a special production zone for assembling
electronic products with generous tariff protection
and tax subsidies. Firms were encouraged toassemble many types of electronic goods for resale
to the highly protected Argentine market atenormous markups. As a result, televisions inArgentina routinely exceeded international prices
by 150–400 percent. The regime protection andsubsidies were so lucrative that foreign (and somedomestic) firms bought finished products in Japan;
shipped them to Panama, where they were broken
down; and then shipped them to Tierra del Fuego
for subsequent reassembly and resale in the mainland of Argentina. By 1990, estimates of the costto the (then-bankrupt) Argentine treasury ranged
from 0.5 to 1 percent of gross domestic product.
The winners in this scheme were the producing
companies and a few thousand workers in Tierradel Fuego; the losers were Argentine consumers andbusinesses that had to pay high prices, thousands ofworkers who would have otherwise gotten jobs inmore internationally competitive new activities on
the mainland, and the Argentine poor, who, among
others, had to pay the tax of high inflation to close
the fiscal accounts.

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2 0 0 3In recent years, the incentives for tariffjumping FDI have declined. Barriers to trade
have come down considerably. As the importance of production networks has risen, foreign investors have found barriers to entry andless-competitive environments less appealing.
In more recent studies, foreign investment isdeterred by high taxes or nontariff barriers
on imported inputs and is attracted to moreopen economies. In reviewing cross-country
regressions on the determinants of FDI,
Charkrabarti (2001) argues that, after market
size, openness to trade has been the most reliable indicator of the attractiveness of a location for FDI (see Kolstad and Tøndel 2002).
As figure 3.6 illustrates, there is now a significant negative relationship between high entry
costs7 and the attractiveness of a market toforeign investors (controlling for other factors
such as market size, macroeconomic stability,and human capital).
MNCs can have an indirect effect on competition by affecting ownership and market
structure. For example, with a blend of deeper
financial pockets, marketing skill, and superior product or process technology, MNCs
may drive a significant number of domestic
competitors out of business. To the extent that

this outcome is based on advantages associatedwith greater efficiency, and if the resulting
market structure remains reasonably competitive, these effects are generally positive. Furthermore, MNCs could spark the entry of
productive suppliers, encourage greater innovation, increase the variety of available products, and drive down prices. However, if adomestic firm’s exit is driven more by the market power of the MNC and if the exit resultsin greater market concentration, then the longrun result may be less competition.
The case study literature provides both positive and negative examples. After reviewing
the evidence, UNCTAD (1997) concludes that
although there is substantial evidence that theentry of MNCs yields new products and improvements in existing products, there is no
systematic evidence on whether it ultimately
reduces consumer prices. The overall effectshould not be judged at one moment in time. In
the short run, some less-efficient producers will
likely be driven out of the market, while overtime, more productive entrants will emerge.
There is evidence that domestic suppliers to
MNCs enjoy higher productivity, both in levels
and growth (see Blalock 2001; Smarzynska
2002). Thus, the net effect of FDI on competi-

Figure 3.6 High entry costs inhibit FDI inflows
(FDI)
More

Less
Low

Entry costs

High

Note: Partial correlations control for market size, human capital, and macroeconomic stability. The entry cost measure used in the
figure refers to the costs of obtaining the necessary permits and licenses and other procedures required to set up a new establishment.
See Djankov and others (2002).
Source: World Bank staff.

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tion, per se, depends on the level of international competition in the industry and on theability of domestic firms to increase their productivity in response to increased competition.
Perhaps because the channels throughwhich FDI affects competition will vary depending on the institutional environment—
tariff structure, market size, competition
policy—the empirical findings about theeffect of FDI on growth are also mixed. FDIshould contribute positively to growth, because it can bring capital, technology, skilled
management, and technical staffs, plus business practices that are usually more modern.
Indeed, several econometric studies haveshown that, controlling for other factors, FDI
flows are positively associated with economic
growth (for example, see UNCTAD 1998 andWorld Bank 2001 for all developing countries; Van Ryckeghem 1994 for Latin America;and Chunlai 1997 for China).
However, the direction of causation is notclear: does FDI cause more rapid growth
because of its associated characteristics, or is
FDI simply attracted to more rapidly expanding markets to exploit growth opportunities?
The answer is probably both. Theory does notprovide a simple answer because the institutional settings and endowments are quite
varied and complex (see Cooper 2001). One
problem, for example, is that those elementsin the investment climate that are conduciveto FDI are also conducive to more domestic
investment and to greater growth in productivity. Many of the methodological critiques that Rodriguez and Rodrik (1999) andCooper (2001) apply to cross-sectional studiesof trade openness and growth also apply tothe somewhat less abundant literature on therelationship between FDI and growth.

Administrative barriers are usually highin developing countries—
Entrepreneurship is an important contributor
to economic growth and welfare improvements in transition and developing countries.
For example, new firms created 10 million
new jobs in Vietnam in the first seven years

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of reform and “have usually been the fastestgrowing segment in transition countries”(McMillan and Woodruff 2002). The scale ofentry that occurs when reforms promote competition can be impressive. Deng Xiaoping
expressed his surprise that “all sorts of enterprises boomed in the countryside, as if astrange army appeared suddenly fromnowhere” less than a decade after the first reforms in China in 1978 (Zhou 1996 as quoted
in McMillan and Woodruff 2002). Key topromoting entrepreneurship and to improving productivity is an environment that facilitates entry and exit of firms (see, for example,
Lansbury and Mayes 1996). Through thisprocess, poorly performing firms leave themarket and dynamic new ones enter. Unfortunately, many developing and transition
governments fail to recognize that firm
births and deaths are an inevitable corollaryof entrepreneurial risk-taking. Instead, those
governments erect a maze of administrative
obstacles to starting, operating, and closing
firms.
A growing body of literature documents
the difficulty that entrepreneurs face in establishing firms in developing countries (for example, Djankov and others 2002; Emery andothers 2000; Friedman and others 2000).
Djankov and others (2002) compiled data on
entry regulations in 85 countries and discovered enormous variation in the number ofprocedures required to start firms acrosscountries, ranging from a low of 2 in Canada
to as many as 21 in the Dominican Republic(with Bolivia and Russia close seconds at 20each). The time required to establish a firm
ranged from 2 business days in Canada to 152
in Madagascar. These procedures can be extremely costly to the economy. The cost of official procedures (that is, not including bribes)
for setting up a new business was 266 percent
of per capita income in Bolivia. Djankov andothers (2002) found that stricter regulationof entry is correlated with more corruption
and a larger informal economy. Moreover,“countries with more open access to politicalpower, greater constraints on the executive,91

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2 0 0 3and greater political rights have fewer required procedures for entry regulation—even
controlling for per-capita income—than do
the countries with less representative, less limited, and less free governments” (Djankov andothers 2002). In a study of such obstacles inAfrica, Emery and others (2000) discoveredthat “when added together, this whole mazeof often duplicative, complex, and nontransparent procedures can mean delays of up
to two years to get investments approved andoperational.”
Although policymakers and advisers tend
to emphasize market entry, exit is important
as well because it releases resources that canbe used in more productive ways. Healthy
economies have a high “churn rate” of firms,
and research demonstrates a strong positive
link between entry and exit (Love 1996).
Moreover, as Caves (1996) has pointed out,
barriers to exit can be barriers to entry bothby absorbing the scarce resources necessary
to start new enterprises and by making it difficult for new firms to compete. Entry barriers,
moreover, can become exit barriers (see figure 3.7). Claessens and Klapper (2002) find asmaller share of firms in bankruptcy proceed-

ings in countries where it takes longer tostart a firm, thus suggesting that keeping newcomers out of the market protects inefficientincumbents.
While exit barriers can be harmful, dealing
with a firm’s exit is not simple. Ideally, bankruptcy and insolvency procedures rehabilitate
viable but financially distressed firms andliquidate unviable firms. In practice, deciding
which firms are viable is difficult. Djankov,
Hart, and Nenova (2002) note that many
countries have crude insolvency laws thatpush financially distressed companies directly
into liquidation, while other countries allow
completely unviable companies to enter rehabilitation procedures. In the latter case, suchcompanies are often liquidated only after along and expensive period of rehabilitation. In
recent years, there is a growing movement in
insolvency reforms to introduce rehabilitation
procedures in countries that do not have them,but to allow creditors to replace management
during the rehabilitation process (Djankov,
Hart, and Nenova 2002).
Barriers that limit firms’ operating flexibility exist even when entry and exit is not atstake. Friedman and others (2000) compile

Figure 3.7 Barriers to entry can become barriers to exit
(ratio of bankruptcies to number of firms)
8
7
6
5
4
3
2
1
0
0

50

100
Days required to start a new business

150

200

Note: Averages for 35 industrial and developing countries, 1990–99. The data panel used for calculation of averages is unbalanced:
that is, the entire range of observations (1990–99) was not available for some countries. The measure of days required to start a new
business is taken from Djankov and others (2002).
Source: Claessens and Klapper (2002).

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indices of taxation levels and overregulation(essentially, indices of the business environment) of firms in 69 countries. AlthoughFriedman and others (2000) find no evidence
that higher tax rates drive firms underground, “. . . every available measure of overregulation is significantly correlated with theshare of the unofficial economy and the signof the relationship is unambiguous: more
over-regulation is correlated with a larger unofficial economy.” The important result hereis that higher tax rates do not seem to driveaway investors, but the myriad and often
arbitrary array of obstacles to starting andrunning a business do.

—and have real costs
The administrative obstacles have real costs tothe economy, which means that even potentially competitive firms often cannot compete
because any efficiency advantages they may
have are consumed by the costs of administrative hassles. Indian firms, for example, arepotentially competitive in a range of laborintensive industries; the combination of theirlabor productivity and their wages makes
them low-cost producers at the plant level.
The value added per unit of labor cost is lower
in India than in East Asian competitors such
as Malaysia, the Philippines, and Thailand.
However, in practice this potential competitiveness is often offset by investment climate
bottlenecks, resulting in lower Indian exports.
Several dimensions are of particular relevance.
The regulation of factor markets, particularlyof labor and land, severely restricts the entry
and exit of firms. For example, firms withmore than 100 employees have not been
allowed to retrench workers without government permission. Meanwhile, the lack of creditor rights and the severe backlog in judicial
cases mean that India has one of the lowest
levels of bankruptcies internationally. The
Confederation of Indian Industry estimatesthat proceedings can easily take more than
two years, and more than 60 percent of liquidation cases before the High Courts have beenin process for more than 10 years. It is easy to

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see how such costs could quickly undo otheradvantages that these firms might have whencompeting in world markets.
A telling indicator of whether markets arecompetitive in a country is the productivity
dispersion of firms within an industry. In a
competitive market with reasonably free entry
and exit, dispersion should be low because
unproductive firms either become more productive or leave the market. Higher dispersion
indicates that less-efficient producers are notbeing forced to improve their productivity or
to exit the market. Firm-level studies in a
number of countries bear this out.8 Subsidies
or strict regulations that impede entry or exit
can ultimately bolster high-cost producers.
When such firms remain in the market, moreproductive firms may not have either the adequate incentives or the ability to increase productivity or to grow. However, as competition
increases, firms face greater incentives to innovate and greater penalties for failure to do so.
Loss of protection and greater competition
from foreign firms can drive inefficient domestic producers to better exploit scale economies, eliminate waste, reduce managerial
slack, adopt better technologies, or shut down.
As a result, productivity dispersion should
shrink as productivity levels rise in the face ofgreater competition.
Productivity dispersion—a measure ofinefficiency—tends to be associated with barriers to competition, such as the administrative barriers to start a business for India,
China, the Philippines, Thailand, Malaysia,
and Korea (figure 3.8). In Indian textiles, garments, and electronics, the higher performers
have value added per worker that is five times
that of lower performers. The dispersion of
productivity is lower in four East Asian countries where the World Bank has conductedsimilar surveys. In Thailand and Malaysia,
the productivity dispersion ratios are justbelow 3, and in Korea not much more than 2.
Thus, more competitive countries in the group(as proxied by weeks to start a business) havelower levels of productivity dispersion than do
the less-competitive countries.

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2 0 0 3Figure 3.8 Barriers to entry and exit
allow inefficient firms to stay in themarket(for productivity dispersion, percent; for weeks, number)
14
12

Weeks to start business

10
Productivity dispersion

8
6
4
2

f
p.
o
Re
a,
Ko
re

Ma
lay
sia

d
an
Th
ail

ilip
pin

es

a
Ph

Ch
in

Ind

ia

0

Note: Productivity dispersion serves as a measure ofinefficiency—more productivity dispersion means more
inefficient firms are allowed to stay in business.
Source: World Bank staff, based on survey of more than
5,000 firms.

These obstacles can deter foreign investors.
Morisset and Lumenga Neso (2002) havecompiled data on the permits and procedures
required for entry, access to land and infrastructure, and operation in 32 developing

countries. These administrative procedures
vary across countries, with especially severe
delays in obtaining land and building permits.
They have found evidence that increased administrative barriers deter foreign investment.
These findings are supported by a WorldBank survey study that finds a similar resultin a larger sample of 69 developing countries:
there is a significant negative correlation between the amount of management time spent
on obtaining the necessary paperwork andthe levels of FDI (figure 3.9).
Another obstacle to competition is manifested in product delivery costs that go beyond producers’ control and yet can have anenormous effect on their overall competitive
positions. The effect of the quality of transportation, as well as the performance of government agencies such as customs administration, can more than offset the costadvantage that producers enjoy at the factorygate. Indian textiles provide one such example. India’s value added per unit of labor costis lower than almost all its East Asian neighbors. However, if one takes into account thelonger delays in clearing customs and thehigher shipping costs, Indian textiles are muchless competitive on international markets.

Figure 3.9 Difficulties in obtaining licenses and permits discourage FDI
(FDI)
More
y  0.5937x  0.1851

Less
Less

Time managers spend obtaining permits

Note: Partial correlations control for market size, human capital, and macroeconomic stability.
Source: World Bank staff.

94

More

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Figure 3.10 Inefficient customs hurt Indian exports(average number of days to clear customs)(average number of days in India to clear customs)

12

30

10

25

8

20

Longest
6

15

4

10

2

5

0

Last time

0
India

China

Korea, Rep. of

ThailandGarments

TextilesPharmaceuticals

Source: World Bank staff; figures based on firm survey data.

Furthermore, World Bank surveys report information on the number of days needed to clear
customs (see figure 3.10). Here, India scores
poorly relative to Korea and Thailand, with thetime about 50 percent longer in India (andtriple what many OECD countries report).9
But the issue is not only the average time,
but also the variances in clearance time. Figure 3.10 shows the longest delay in the past
year for a typical firm in three sectors in India.
Although the average clearance time is 11 days,
the longest delays averaged almost 28 days forgarments and 25 days for pharmaceuticals.10
The transportation costs associated withshipping a container of textiles to the UnitedStates from India are more than 20 percent
higher than shipping costs from Thailand and35 percent higher than shipping costs from
China (figure 3.11). Variations in maritime
distances explain only a small part of the gap.
Delays and inefficiencies in the ports accountfor a higher share of the difference in port
productivity. Together, inefficient customs andports can hurt the investment climate and canerode comparative advantage.

SOEs use resources inefficiently—
Another way in which states make competition and entrepreneurship difficult is by theirdirect ownership of many firms and industries.
By 1990, SOEs consumed nearly 20 percent
of gross domestic investment in developing

Figure 3.11 Inefficient ports raise India’stransport costs far above competitors’transport costs(percent cost advantage compared with India of shipping
textiles to the United States)
50

West coast, U.S.

All U.S.

40
East coast,
U.S.

30
20
10
0
10
BrazilChina

Indonesia Korea,
Rep. ofThailandSource: World Bank staff.

economies while producing just more than
10 percent of GDP (World Bank 1995). But
state ownership on such a scale was not sustainable. Many SOEs required large subsidies from cash-strapped governments to stayafloat, thus constraining government spending
on other priorities. For example, it was estimated that “diverting SOE operating subsidies to basic education . . . would increase
central government education expenditures by
50 percent in Mexico, 74 percent in Tanzania,
160 percent in Tunisia, and 550 percent inIndia” (World Bank 1995).

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2 0 0 3Figure 3.12 Privatization revenues
soared in the 1990s(in nominal billions of dollars)
70
60
50
40
30
20
10

19

84
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99

0

Source: World Bank privatization database.

Driven in part by the high and unsustainable fiscal costs of state ownership, countries
around the world embarked on a massive
privatization wave. Privatization revenues indeveloping and transition countries increased
from almost nothing in the early 1980s to
more than $60 billion in 1997, before decreasing somewhat to $50 billion in 1998
(figure 3.12). It was estimated that by 2000,
cumulative privatization revenues worldwide
had exceeded $1 trillion (Megginson andNetter 2001). The bulk of privatization indeveloping countries occurred in services, particularly infrastructure.

—and privatization improves firm
performance—
Overall, privatization has dramatically improved the performance of former SOEs. State
enterprises were substantially less efficientthan private firms. Shirley and Walsh (2000)
reported that most of the extensive literaturefinds private firms superior to state firms.
Of 52 empirical studies, 32 found that the performance of private and privatized firms is“significantly superior to that of public
firms,” and 15 studies found “either that there
is no significant relationship between ownership and performance, or that the relationshipis ambiguous (different evidence supports

96

both public and private superiority). The
dominance of studies finding superior private performance is robust across all subcategories” (Shirley and Walsh 2000).
Privatization usually improved financial
and operating performance in privatized firms(see Megginson and Netter 2001 for a comprehensive review of the literature). This result
holds in industrial and developing countries
alike (Boubraki and Cosset 1998a, 1998b;
Megginson and Netter 2001). The finding isrobust across case studies, cross-sections offirms from different industries within a given
country, cross-sections of firms from different countries, and performance of firms before and after privatization (Sheshinski and
Lopez-Calva 2000). Moreover, other researchsuggests that privatizations tend, overall, toincrease welfare (Galal and others 1994). In
other words, privatization tends not only to
improve the performance of privatized firms
and to benefit investors, but also to make thecountry better off.

—and is more successful when combinedwith competition
Simply pointing out the overwhelming evidence demonstrating improvements in privatized firms, however, masks importantdifferences across industries in the challenges
and pitfalls of privatization, especially withregard to introducing competition. Some sectors, such as manufacturing, generally lackany economic justification for state ownershipfrom the outset. SOEs that have been privatized into such competitive markets—while
being freed from unprofitable government
controls or social “mandates”—tend to perform quite strongly. Indeed, studies show thatthe most robust results occur from privatization in competitive sectors (Kikeri and Nellis2001).

Infrastructure industries present special
challenges
However, in infrastructure sectors such as
telecommunications, electricity, gas, andtransport, existing SOEs traditionally were

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considered “natural monopolies.” It wasalmost an article of faith that, in these industries, a single firm could provide services atthe lowest cost. In most of the world outsideof North America, such natural monopolies
translated into state-owned monopolies fromthe 1920s through the 1980s. But by the late1980s, the combination of technologicalchange, a clearer understanding of the costs ofstate ownership and monopolies, and a widespread failure of SOEs in developing countries
to deliver reliable services to consumers innatural monopolies made privatization andcompetition both technically feasible andpolitically desirable. The benefits from thisprocess are clear: studies suggest that privatization or contracting out of public services,
including many infrastructure services—ifdone right—can yield efficiency gains equivalent to 10 to 30 percent of previous cost
(Bartone and others 1991; Carnaghan andBracewell-Milnes 1993; Domberger and
Piggott 1994). When real competition is notor cannot be introduced, it is more likely thatprivatization will be less effective, and wellrun public firms may do as well as private
ones (Kwoka 1996). But even in these circumstances, many private projects haveoutperformed public enterprises. Examples
include the water sector in Argentina, Côte
d’Ivoire, and Guinea (Clarke, Menard, andZuluaga 2000; Noll, Shirley, and Cowan
2000).
At least two broad difficulties exist in promoting competition when privatizing infrastructure utilities. First, not all components ofinfrastructure industries are equally amenable
to competition; therefore, privatization might
not be appropriate for all activities in a sector.
For example, relatively low-cost wireless technologies make most elements of telecommunications potentially competitive, whereas generation of electricity is more likely to support
competition than is transmission of electricity.
The key to successful reform in any sector is,therefore, an adequate reform of market
structure to maximize the potential for realcompetition. Market structure reform tries to

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distinguish—and to varying degrees separate—
the true, natural monopoly elements of a system from the competitive segments. Second,even when competition is feasible, a dominant
incumbent in a network industry often has
both the incentive and the means to thwart
competition.
With privatization more likely to be successful in competitive sectors and with infrastructure sectors, in general, less amenable
to competition, it is not surprising that experiences in infrastructure privatization offer
more mixed outcomes. Perhaps not unexpectedly one key determinant of privatization success has been the degree of competition introduced in the regulatory regime. As Ambrose,
Hennemeyer, and Chapon (1990) note,“[S]imply moving a monopoly from the public to the private sphere will not result in competitive behavior.” Another factor affecting
success relates to the sequencing of sector
reforms (including privatization) and the creation of the regulatory institutions that arenecessary to achieve the broader objectives,
including promoting competition. Policy
reforms such as privatization often haveproceeded faster than the necessary supporting institutions manage (see, for example,
Wellenius 1992). This outcome is hardly surprising because privatizing a firm, complicatedthough it may be, is a relatively straightforward and discrete task when comparedwith building a regulatory agency where none
existed. Nonetheless, varied experiences withprivatization in the infrastructure sector caution developing countries to develop a systemof checks and balances before privatizing sectors in which competition has until recently
been a foreign phenomenon.
For several reasons, governments may sell
off state monopolies and may grant whole orpartial monopoly privileges to new private
incumbents. The government may face substantial pressure to maximize privatization
revenues, and the first metric by which thesuccess of the sale is likely to be judged is thesales price. Privatizations tend to be controversial, and the government may be wary of97

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2 0 0 3

being accused of giving away the crown jewels
if the sale price is too low. This wariness, plus
a need to build support for privatization, may
create an incentive to generate a high sales
price, even at the expense of future improvements in the network. These pressures may
have been especially intense during the firstprivatizations when there was little evidence
that privatizations could be successful or thatfailing state-owned firms could attract private
investors.
Consider the growth rate of networks intelecommunications when investors were
given “exclusivity”—temporary monopoly
rights—compared with when they were not.
In a sample of about 20 countries that privatized their telecommunications firms, one
study found that although private investors
were willing to pay more for an exclusivity
period (figure 3.13), telecommunications investment was substantially lower in countries
that gave exclusivity periods than in countries
that did not (Wallsten 2000). In other words,
investors were likely paying for the expected
stream of monopoly profits, not for the rightto invest.
Another reason for granting monopolies is
the mistaken belief that restricting competition can stimulate investment. As Noll (2000)
notes, both the firms operating in a competi-

Figure 3.13 Granting monopoly rights
brings in revenues

Figure 3.14 More competition means
more phones(dollars per line)(mobile subscribers per 100 inhabitants)

3,000

4.0

2,500

3.5
3.0

2,000

Competitive markets

2.5

1,500

2.0

1,000

1.5
1.0

500

Monopoly markets

0.5

0

0.0

No exclusivity

Exclusivity

Note: Average price paid in telecom privatizations.
Source: World Bank staff.

98

tive environment and the monopolists face thesame cost of capital, and neither will invest
unless the expected revenues make the investment worthwhile. The monopolist’s market
power makes it less, not more, likely to undertake a given investment because monopoly
profits are typically obtained by providing
lower quantities of the good or service at
higher prices. A firm with a guaranteed monopoly is also likely to invest less because it
does not have to worry about more efficientcompetitors stealing market share. Even thethreat of entry—which is typically the situation when reforms are introduced—can beenough to induce the incumbent to invest.
Indeed, in telecommunications, empirical
work consistently demonstrates that competition, typically in the form of mobile providers(which have much lower fixed costs thanwire line firms) is extremely successful in improving telephone penetration (for example,
Fink, Mattoo, and Rathindran 2002; Galal
and Nauriyal 1995; Li and Xu 2001; Ros1999; Wallsten 2001a, 2001c). Figure 3.14
illustrates how the penetration of the mobile
telephone market in Africa is influenced bycompetitive versus monopolistic regimes.
However, introducing competition—even
when technically feasible—can be difficult.
Incumbent firms can use their considerable

1996 1998 2000 2001 1996 1998 2000 2001

Source: African Telecommunication Research Project
Database, DECRG, World Bank.

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market power to ensure that competition neversucceeds. Taking full advantage of the competitive forces in the global economy requires
introducing a regulatory framework thatmaximizes competition. Establishing a clear
regulatory framework in advance of privatizing companies is key to achieving a competitive
outcome. Wallsten (2002) studied 200 countries from 1985 to 1999 and has found that,in telecommunications, creating a regulatory
capacity before privatization is significantly
and positively correlated with subsequent
performance (using measures of capacity andinvestment). Moreover, earlier existence of aregulator seemed to increase the price received
for privatized telecommunications firms by
reducing uncertainty over the future stream of
earnings.11 Regulatory agencies are discussed
in more detail on page 27 and page 33.

Private barriers to competition areoften difficult to identify and canbe pernicious
Even if policy barriers to competition are removed, private firms—usually in concentrated
industries—can raise barriers to competition.
In particular, dominant firms can exercise theirmarket power to prevent entry by competitors
in order to keep prices and profits high. Suchanticompetitive behavior may be especiallyprevalent among newly privatized firms inindustries that are traditionally dominatedby a single firm, such as telecommunications.
Another form of private barriers is collusive
behavior—often in the form of cartels—to fix
prices and discourage entry.
Early research explored links first between
concentration and profitability and then between concentration and prices. The underlying hypothesis in this line of research was thatfirms in highly concentrated markets would
earn higher profits (implying monopoly profits) and would be able to charge higher prices.
In general, empirical work supported thisview, finding that firms in highly concentrated
markets were more profitable and charged
higher prices (for example, Weiss 1989).
In addition, Newfarmer and Marsh (1994)

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O P P O R T U N I T I E STable 3.1 Profitability on equity,
concentration, and market share (percent):
Brazil, 1971–78
Four-firm
concentration
ratio (CR4)a

20
40
60
80
100

Relative market share (RMS)b

10
12.3
12.9
13.5
14.1
14.7

30
—
14.9
14.5
15.1
16.7

50
—
—
15.5
16.1
17.7

70
—
—
—
17.1
18.7

90
—
—
—
—
19.7

a. CR4 is the ratio of four largest plants to total industry
sales, weighted by the four-digit group product group to salesof firm.
b. RMS is the ratio of firm’s sales to industry sales, weighted
by four-digit product sales of the firm.
Source: Newfarmer and Marsh (1994). Figures are based on
regression coefficients holding other structural variables (forexample, size, leverage, capital intensity) at their means.

found a statistically significant relationshipbetween concentration and firm profitabilityin Brazilian manufacturing (table 3.1). Similar
results were reported by Connor (1977) for
Brazil and Mexico.
Interpreting these results, however, requires care. Both concentration and profits
could be high because firms exercise market
power and block entry, or because better,more efficient firms are more likely to succeed,
to capture higher market shares, and to be
more profitable (Bresnahan 1989; Feeny
and Rogers 2000). Nonetheless, empiricalresearch—primarily in industrial countries—
demonstrated that there is a great deal ofmarket power in some industries and that
anticompetitive conduct can lead to highprice–cost margins (Bresnahan 1989). And, as
Weiss (1989) noted, “[I]n smaller lands and/or
in nations with less enthusiasm for antitrust[than in industrial countries], the problem
must surely be greater.”
Many believe that markets in general areless competitive in developing countries. With
the exception of Brazil, China, India, andIndonesia, domestic markets tend to be small,with low human capital, poor infrastructure,
volatile economies, and few manufactured
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2 0 0 3though, some evidence suggests that manufacturing sectors, on average, are not less competitive than elsewhere. As Tybout (2000)
notes, “[B]ecause of institutional barriers,
labor market regulations, poorly functioning financial markets, and limited domestic
demand, the industrial sectors of developing
countries are often described as insulated,inefficient oligopolies. To date, however, there
is little empirical support for this characterization. Turnover is substantial in developing
countries that have been studied, unexploited
scale economies are modest, and evidence ofwidespread monopoly rents is lacking.”
Nonetheless, he notes, “[I]t would be foolishto conclude that market power is a non-issue
in developing countries.”

Collusive behavior and domestic cartels
limit competition
A single firm abusing a dominant market
position is not the only way firms can engage
in anticompetitive practices. Vertical restraints
between manufacturers or suppliers anddownstream distributors in the form of exclusive dealing and geographic market restrictions can also raise barriers. In addition, firmsthat would be price-takers individually—andunable alone to control any significant part ofthe market—can work together to control
the market, thus increasing prices and discouraging entry. Collusive behavior is notuncommon, and competition authorities indeveloping countries have prosecuted several
cases of price-fixing, as the illustrative list in
table 3.2 suggests. In one colorful example ofa bid-rigging conspiracy in the electrical equipment industry (high-voltage switchgears),participants used the phases of the moon todetermine which firm’s turn it was to submit
the “low” bid.12
During the past decade, a number of developing and transition market economies haveadopted or strengthened existing competition
laws (see box 3.2). More than 90 countries
have such legislation; more than half the laws
were enacted since 1990. Although the coreprovisions of these laws (addressing issues of100

horizontal and vertical restraints, of abuse of
dominant market position, and of mergers
and acquisitions [M&A]) are similar, theirscope, institutional design, budgets, staffing,and other resources vary widely. Competition
laws generally complement and buttress otherpolicies, such as policies on deregulation, privatization, and trade and investment liberalization, that enhance competition. However,
the overzealous application or misapplicationof competition law in the context of weakadministrative capacity can also have serious
negative consequences. Effectively implementing competition law requires an adequately
funded agency with well-trained, knowledgeable, and experienced staff members. This isa challenge in industrial countries and evenmore so in the developing world.13 In this regard, some developing countries have madenoteworthy progress, but it is still too early toform an overall view of the effectiveness of
their competition agencies. International investors have raised the issue that the proliferation of competition laws has led to higher
costs for M&A transactions—a primary vehicle for FDI. And in some cases, the decisions
arrived at by the competition authorities arehighly questionable.
The remedy for anticompetitive conduct offirms necessarily depends on a country’s capabilities. As the first order of business, allcountries are well advised to look for ways toreduce policy barriers to competition. Smallmarket countries in particular can look to
trade to discipline domestic pricing. Governments in countries with weak regulatory
capacity, high levels of corruption, and pooraccountability would be better advised to do
the following: first, limit the powers of a competition agency to review of government policies for their competitive consequences and,second, concentrate on improving information
and reporting requirements of firms so that
increased transparency will attract entry.
Trying to establish more comprehensive competition authorities in countries without anappropriate legal-economic framework may
simply create another avenue for corruption

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Table 3.2

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Cartel enforcement in selected developing countries

Country

Year

MarketActions

Bulgaria

2000
2000
2002

Intermediate transportation
Phone cards sales
Gasification

Price-fixing
Price-fixing
Contracts with non-compete clauses

China

1998
1998
1999

School building
Engineering construction
Brickyard

Bid-rigging conspiracy
Bid-rigging conspiracy
Bid-rigging conspiracy

Estonia

1999
1999
2000

Taxi services
Road transport
Milk products

Price-fixing
Price-fixing
Price-fixing

Indonesia

2000

Pipe and pipe-processing services

Bid-rigging

Latvia

1998–99

Aviation

1999

Courier post

Cooperation in organizationof passenger flights
Agreement between two
postservice companies

1995–96

Poultry market

1997
1999

Building and construction
Taxi tours

Romania

1997
1997–2000

Mineral water
Drugs

Price-fixing
Conspiracy in market-sharing inpharmaceutical distribution

Slovenia

2000
2000

Electricity
Organization of cultural events

Price-fixing
Cooperation and establishment ofentry barriersSouth Africa

1999

Citrus fruits

Conspiracy relating to the purchase,packaging, and sale of citrus fruits

Taiwan, China

1997–98

Wheat

1998

Mobile cranes
Liquefied petroleum gas

Buyer’s cartel imposing quantity
control and quota system
Bid-rigging
Price-fixing

Ukraine

1999
2000

Electronic cash machines
KaolinPrice-fixing
Noncompete contract

ZambiaNot available
1997

Poultry
Oil

Agreement foreclosing competition
Price-fixing

Peru

Price-fixing, volume control, andconspiracy to establish entry barrier
Bid-rigging
Price-fixing

Source: OECD (2001).

and rent seeking. Governments in countries
with stronger regulatory capacity have many
options that go beyond policy review forcompetitive consequences and for improved
disclosure. They may be able to prosecute
price-fixing and other horizontal restraints, aswell as prosecute restrictive marketing andother vertical restraints that hobble entry.

Regulatory agencies may help promotecompetition, but one size does not fit all
One way that regulatory authorities can playa positive role in encouraging competition
and investment has to do with bringing competition to industries that are dominated bya small number of firms or to industries inwhich cartels have developed. For example,

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2 0 0 3Box 3.2 Competition policy and competition law
share similar objectives across countries

In recent years, many countries have enacted specific legislation to safeguard and encourage competition. Enforcing competition (or antitrust andantimonopoly) laws can increase welfare and can
improve efficiency by combating the negative externalities generated by anticompetitive firm behavior.
The focus and objectives of competition agencies
entrusted with this task vary across countries:some, such as Canada, New Zealand, and theUnited States, place the emphasis on consumer welfare and economic efficiency, while others, such as
Brazil and the European Union (EU) member countries, look to serve the broader “public interest.” Buteven with these differences in scope, the underlying
principles are similar.
The conduct provisions of competition law
relate primarily to the following:• Horizontal agreements are entered into by firms to
fix prices (and agree to similar practices such as
bid-rigging; restricting output; and allocating market
shares, geographic markets, or customers). Suchagreements represent an unambiguous welfare loss toconsumers in terms of reduction in price or output
competition. Firms that enter into these agreements
are severely prosecuted and, in some countries(Canada and the United States), such conduct istreated as a criminal offense, with CEOs liable for
imprisonment. However, such anticompetitive behavior is often difficult to investigate because managers
generally avoid written communication. As a consequence, some countries have adopted amnesty orleniency programs for cartel members who are thefirst to “blow the whistle” against other members.
Encouraging new entry by removing both private
and policy barriers may be the best policy to combat
horizontal agreements because collusive behavior
drops as the number of firms rises.
• Abuse of dominant (AOD) market position (that is,monopolistic practices such as market foreclosure andpredatory pricing) is more difficult to enforce
because authorities must focus not on the firm’s sizeor dominance itself (which is not illegal) but rather
on the “abuse” of a dominant position. Competition
agencies must have the expertise to distinguishbetween dominance resulting from superior businesspractices and dominance from erecting anticompetitive barriers.
• Vertical restraints between manufacturers, suppliers,and distributors (such as resale price maintenance,
exclusive dealing, and geographic market restriction)
can be tricky because such measures can improve
efficiency just as easily as discourage competition.
The emerging consensus is that adverse effects are
more likely to dominate if the participant firms enjoy
a certain degree of market power. Therefore, vertical
restraints should be evaluated within the context of
AOD market competition laws.

The structural provisions relate primarily to thefollowing:• Mergers and acquisitions, where the principal concerns arise in horizontal transactions, and joint
ventures compose two structural approaches. Two
different views are prevalent. First, when transactions
significantly reduce firm numbers or increase concentration, competition may substantially decrease.
Second, transactions may be strongly motivated by
efficiency goals, and substantial anticompetitive outcomes are likely only if there are barriers to entry or
to new competition. Because most horizontal M&A
activity will lessen competition but may also increase
efficiency, a cost-benefit approach is often pursued inwhich mergers are exempted or are permitted toproceed on a restructured basis if the efficiency gains
are likely to be greater than the competition losses.

Source: Khemani (2002).

Galal and Nauriyal (1995) compare the performance of the telecommunications sector inseveral countries before and after reforms as
they explore how well countries were able to102

balance regulatory objectives: commitment,
information asymmetry, and pricing issues. In
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the greatest improvement, while the country(the Philippines) that did not experienced theworst performance. Countries that resolved
some issues but not others experienced mixed
success. A more recent study of competition,
privatization, and regulation hints at the importance of effective regulatory institutions(Wallsten 2001a). Like other research (for example, Petrazzini 1996; Ros 1999), the study
finds that competition resulting from privatization positively affects network growth,
but it also concludes that privatization brings
greater benefits in the presence of an independent regulator.
Given the potential importance of regulatory institutions in promoting competition, it
may seem surprising that regulation has been
given relatively little emphasis in developing
countries. Three factors may have worked todiminish the focus on regulation. First, the privatization wave was picking up strength justas the United States and other industrial countries were engaged in a process of deregulation, which often meant removing government
controls to allow the industry to compete or
to encourage new entry. Second, privatizationin developing countries often faced competing
objectives because governments want not only
to maximize revenues from privatizing stateowned firms but also to improve the deliveryof service by firms in the industry. The easiest(and most common) means to increase thefirm’s value for private investors is to include
monopoly rights in service provision, but, unfortunately, precluding competition is likely toretard investment.
Third, the challenge of building effective
regulatory agencies is enormous and will not
automatically lead to better outcomes. These
agencies are costly, require tremendous capacity in terms of human resources, and probably
work best in the presence of complementaryorganizations such as competition agencies.
Moreover, there is little evidence that, in general, regulatory agencies in developing countries have been successful. Regulation often
takes the form of regulating entry, and, asDjankov and others (2002) document, regula-

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O P P O R T U N I T I E Stion “is generally associated with greater corruption and a larger unofficial economy, but
not with better quality of private or public
goods. . . . The principal beneficiaries [of regulation] appear to be politicians and bureaucrats themselves.”
This observation does not mean that developing nations are doomed to failure whenbuilding effective regulatory institutions. It
also does not detract from the general pointthat introducing competition in potentiallycompetitive sectors that are dominated by asingle firm requires competent regulation thatboth protects consumers and assures investors
that their assets will not be expropriated. Instead, as already discussed, it suggests thatsuch agencies should focus on promoting entry,
not regulating it, and that they themselves
should operate in an especially transparent
fashion to gain credibility. This feat is not easy
to achieve, and such agencies must find the delicate balance between accountability and independence from short-term political pressures.

Public investment in infrastructureand human capitalW

hile the government plays a crucial rolein providing a general framework to
encourage investment and in establishing theconditions that use competition to create efficiency, its role as a direct investor is pivotal
in shaping investment climate. There is somequestion as to what effect public investment
has on private investment (see box 3.3). Moreover, all governments make public investmentsthat work through several channels: Governments can invest directly in physical andhuman infrastructure provision. In addition,
their involvement in less-tangible areas (providing policy stability, setting standards, andestablishing legal and regulatory frameworks)
affects opportunities even in areas in which
direct government involvement is minimal. In
this section, we will evaluate the scope andrationale for government engagement in theareas of infrastructure and human capitalprovision.

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2 0 0 3Box 3.3 Does public investment “crowd out” or“crowd in” private investment?

While direct government investment in the economy is necessary, direct expenditures should
be targeted carefully, because resources are scarce. In
particular, governments should not invest where theprivate sector is willing and able to go. A government
can crowd out private investment in two generalways. First, it can invest in areas where the private
returns are likely to be high. Such investments
may tempt politicians because they can then tout
“successful” investments on the basis of their highreturns. But such successes are illusory because
private investors would have undertaken the investments anyway, and there is an opportunity cost fromthe suboptimal use of scarce government resources.
Second, using high government deficits and borrowing to fund public investments can indirectly crowdout private investment by means of macro channels
such as pushing up interest rates—and thereby raisingborrowing costs—or creating credit constraints forprivate investors. Conversely, some government
spending can also crowd in investment by attracting
additional private investment that would not otherwise occur. The government may need to build
certain parts of the infrastructure to attract private
investors, to build roads that connect rural areas tomarkets, and to make education universally available.
In any particular country, it is likely that somepublic investment choices will crowd out private investment, while other choices will have the opposite
effect. It is, therefore, not surprising that the empirical research on which effect dominates is mixed.
Aschauer (1989) argues that while public investment
reduces private investment almost one-to-one byencouraging the private sector to take advantage of
public capacity instead of building its own, it is also
true that public capital (and infrastructure capitalin particular) complements private capital in the
production of goods and service. Hence, public
investment raises the marginal product of private
investment so that—despite the direct negative
effect—the long-term consequence of an increase inpublic investment on private investment is positive.
These results, however, were based exclusively
on the United States, and a subsequent wave of crosscountry tests of the crowd-out or crowd-in hypothesis has thus far failed to yield any clear conclusions.

104

Recent results from the developing world are ambiguous and show little consistency. For example, Ahmedand Miller (2000) find general evidence of crowding
out, but note that public infrastructure expenditures,such as spending on transport and communication,
seem to crowd in private investment.
Ghura and Goodwin (2000) report a crowd-in
result for a sample of 31 countries, but find morevariation on the regional level: Asian and Latin
American countries exhibit crowding out, while SubSaharan Africa shows that public and private investment are complements. In a slightly smaller sample,
Herrera and Garcia (2000) find crowding out inboth Latin America and East Asia, with the effectmuch stronger for Latin American countries.
Everhart and Sumlinski (2001) add SOEs to thedefinition of public investment and, with a sample
of 62 developing countries, find that corruption
exacerbates crowding out. In fact, the effect of thecorruption interaction variable is so significant thatin the long run there may well be no crowding out
if no corruption is present.
Finally, Wang (2002), using annual data for
East Asian economies (developing as well as industrial), finds evidence of substantial gains from positive
externalities generated by the public sector, therefore
hinting at crowding in. However, he cautions that in
the long run the influence of private production on
public capital expansion is stronger than the reverse,
which might indicate a causal chain in which higher
private demand leads to greater public investment.
There is thus no consensus within the literatureon whether crowding in or crowding out dominates.
Empirical results are often sensitive to sample choiceand vary with regard to individual countries andtime periods. Hence, whether crowding in or crowding out dominates may depend on complex interactions between private and public investment. It is
possible that, up to a certain level, higher public
investment may encourage private investment andgrowth. However, when undertaken in excess (orwhen existing capacity is used inefficiently), any
additional increases in the level of public capital
may crowd out private investment.
Source: World Bank staff.

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Infrastructure affects opportunities
for growth
The quality and availability of infrastructure
has a major effect on investment opportunities
in the private sector. World Bank (2002) notesthat “improvements in infrastructure services
can help promote competition in other markets, and there is evidence that infrastructure
has a positive impact on growth and poverty
reduction.” In a sample of 100 countries,
Easterly and Rebelo (1993) attach an important role to infrastructure capital—particularlytransportation and communications—in economic growth. Elements of infrastructure suchas paved roads, telephone density per worker,
and adequate generation of electricity havebeen found to have a strong effect on growth(see Easterly and Levine 1997; Canning 1999;
and Canning and Bennathan 2000). Even inindustries that have very low requirements
for energy and transportation services, such as
the software industry, the quality and availability of infrastructure play a key role in selecting firm locations because firms rely onsatellite facilities to export their products(Balasubramanyam 2001). In addition to promoting economic growth, greater coverage ofinfrastructure services is also a key determinant of FDI (Balasubramanyam 2001; Steinand Daude 2001).
Infrastructure is a key determinant of thequality of a nation’s investment climate. A
recent survey study that linked quantitative
measures of the investment climate to firm
investment and growth experiences demonstrates the potential for improvements in infrastructure. The study, which is based on
more than 1,000 firms in 10 Indian states,
finds that if each state could attain the “bestpractice” in India in terms of regulation andinfrastructure, the national economy could
grow about 2 percentage points faster (see figure 3.15). The gains would be particularly
large in the states with weaker investment
climates (an extra 3.2 percentage points ofgrowth), thus reflecting the fact that the movefrom current to best practice in India would
be a large improvement. But even in the states

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O P P O R T U N I T I E Swith stronger climates, there is significant
room for improving the climate in particularareas: moving to the best Indian practicewould add 1.5 percentage points to thegrowth rate for these states. Note that in many
ways this is a conservative counterfactual
scenario because it would raise states to thelevels of regulation and infrastructure qualitythat are already observed in India. If India
could achieve Chinese or Thai levels in various
investment climate areas, its potential growth
acceleration would be even more dramatic(World Bank 2002a).
The efficiency of infrastructure capacity
utilization is just as important as (if not more
important than) the capital stock itself.
Easterly and Levine (2001) propose that “creating conditions for productive capital accumulation is more important than accumulation per se and policymakers should focus on
encouraging TFP [total factor productivity]
growth.” Hulten (1996) notes that those lowand middle-income countries that use infrastructure inefficiently pay a growth penalty inthe form of a much smaller benefit from infrastructure investments. More than 40 percentof the growth differential is due to theefficiency effect, making it the single mostFigure 3.15 Better infrastructure means
higher growth(annual average GDP growth rate 1992–98, percent)98Potential

7
6

Actual543210Good and best
climate states

Poor climate
statesAll India

Note: Survey of more than 1,000 firms in 10 Indian states.
“Potential” refers to attainment of the “best practice” inIndia in terms of infrastructure and regulation.
Source: World Bank staff.

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important explanatory variable in differential
growth performance. Similarly, Aschauer(2000) attributes an important role to theefficiency variable, although he cannot reject
the hypothesis of parallel importance of thequantity and effectiveness of public capital atconventional levels. Aschauer (2000) also calculates the growth-maximizing level of public
capital, which is vastly exceeded by the actual
sample average of 46 developing countries.
Thus, it would seem that the average country
in his sample has overspent on capital expenditures, thereby lowering the productivity of
its public investment program.

Investments in human resources are
critical
Human capital is widely recognized as animportant determinant of development andgrowth. Seminal work by Mankiw, Romer, andWeil (1992) demonstrated a significant improvement in the explanatory power of the
Solow growth model when it included measures of human capital. Similarly, many endogenous growth models have benefited fromthe inclusion of an education variable (see,for example, Romer 1990). Barro (1991) foundthat for a sample of 98 countries, the growthrate of real per capita GDP during 1960–85
was positively related to initial human capital(proxied by 1960 school-enrollment rates).
Figure 3.16 illustrates this concept by showing
a clear positive relationship between the 1970
literacy rate and the growth in GDP per capita
between 1970 and 2000 for 75 developing
countries.
Easterly and Levine (2001) caution that
economic growth differences across countries
cannot be easily explained by factor (including
human capital) accumulation and should
focus instead on technology and productivity
growth. However, the success of dissemination of more advanced technologies in developing economies is largely determined by theabsorptive capacity of the host country. Thatis, to realize the growth potential of newtechnology, the country must possess a highenough stock of human capital to be able
to assimilate the technology. For example,
Borensztein, De Gregorio, and Lee (1998)
show that the magnitude of the effect of FDI
on growth depends on the available stock ofhuman capital in the host country. Within an
endogenous growth model, the researchers

Figure 3.16 Greater literacy is associated with higher growth(1970 literacy rate, in percent)
120

100

80

60

40

20

0
100

50

Source: World Bank data.

106

0

50
100
150
Percent GDP per capita growth rate, 1970–2000

200

250

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obtain a positive and highly significant coefficient on the interaction variable between FDI
and human capital. The results suggest that“the flow of advanced technology brought
along by FDI can increase the growth rate of
the host economy only by interacting withthat country’s absorptive capacity.”
Several other studies have looked at therelationship between FDI and human capital.
For example, Coughlin and Segev (1999),
Noorbakhsh, Paloni, and Youssef (2001),
and Kolstad and Tøndel (2002) show apositive link between FDI inflows and thestock of human capital in the host country.
Balasubramanyam (2001) notes that humanresources are a key determinant of FDI.
Countries with the highest levels of bothschooling and FDI grew much faster thancountries with the lowest levels in the period 1970–89 (figure 3.17). Human capital isalso important as an interaction variable between FDI and domestic private investment.
Countries with high levels of human capitalseem to experience crowding in of domestic
investment by FDI, while countries with lessFigure 3.17 Education raises the
productivity of FDI, which leads to higher
growth(per capita GDP growth rate, in percent)54High schooling

4
3
3

Medium schooling22

Low schooling

1
1

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human capital suffer the opposite effect(Herrera and Garcia 2000). Thus, high levelsof human capital may help increase the overalllevel of investment through a crowd-in mechanism. Countries with higher human capitalalso have lower fertility rates and higher ratiosof physical investment to GDP. Some evidence
suggests that additional government expenditure on education induces additional private
expenditures on education. For instance,
Foster and Rosenzweig (1996) show that inIndia higher returns to primary schoolingactually induce increased private investment
in schooling.
Despite the overwhelming consensus thathuman capital is one of the keys to sustained
economic growth, finding a robust empirical
relationship between education and growth
has proven difficult (see Easterly 2001 for areview). One striking example lies in comparing East Asia to Sub-Saharan Africa: Between
1960 and 1985 East Asia’s per capita GDP
grew more than 4 percentage points quicker
than incomes in Africa, yet Africa’s educational capital growth was actually higher thanAsia’s (Pritchett 1999). However, part of theanswer to this puzzle emerges from the multidimensionality of the investment climate:education matters only if people are given
opportunities to use their skills in productive
industries in a supporting enabling environment. Easterly (2001) contends that economies with low black-market premiums14
on foreign exchange grow faster with higher
schooling levels, while economies with highblack-market premiums grow slowly regardless of the levels of education. That is,“schooling pays off only when government
actions create incentives for growth rather
than redistribution.”0HighMediumLow

FDI-to-GDP ratio
Note: The low, medium, and high categories for FDI-toGDP ratio are below 0.01 percent, 0.01 percent to 0.2
percent, and more than 0.2 percent, respectively. For theschooling variable, the low, medium, and high categories
are below 0.4, 0.4 to 1, and more than 1, respectively.
Source: Borensztein, De Gregorio, and Lee (1998).

Policies to promote competitionWhile competition and entrepreneurshipare essentially private sector activities,
they require markets that function well. And
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2 0 0 3and entrepreneurship is rewarded, which is
not easy. Entrenched interests are powerful,and it is often hard to determine whether
any particular program is largely in the public interest or in the interest of a much smaller, but more vocal, private constituency. In
general, though, following certain basic principles can help promote competition andgrowth.
Governments and government agencies
should operate with transparent rules, should
minimize corruption, and should respect
property rights. They should also make it easier to start and run businesses. The maze of
bureaucratic paperwork that is often required
to start businesses in developing countries
seriously deters entry into many industries.
Moreover, such administrative hassles can beespecially pernicious: in some cases they may
punish small, local entrepreneurs who lack theresources to overcome such high hurdles.
Having more government agencies that can
block a firm’s path will lead inexorably tomore points at which a firm is required to pay
bribes to move the process forward.
The government’s role extends beyond
setting up a generally investment-friendly environment. Until the past decade or so, SOEs
have had monopolistic positions in many industries throughout the developing world.
The recent wave of privatizations not only has
led to large efficiency improvements in thesefirms and their provision of services, but also
has opened those industries to competition.
The greatest improvements in service have occurred in industries in which the government
promoted competition along with privatization and in which it avoided giving theprivatized firm any special monopoly rights.
Privatizations are often difficult and controversial. However, governments should beaware that while they can usually increase theprice that investors are willing to pay for a privatized firm by giving the firm a monopoly,that same exclusivity usually lowers subsequent investment. That is, investors will bepaying for the stream of monopoly profits,
not for the right to invest more.

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Competition and regulatory agencies canbe instrumental in reducing abuses of market
power and in ensuring that markets remaincontestable. Agencies can work toward thisgeneral vision by focusing on two objectives:protecting consumers while ensuring that theregulatory and market rules are credible toinvestors. These objectives, however, may bedifficult to balance when interests compete forregulatory favor. Moreover, there is the riskthat a new regulatory agency will become
another avenue for corruption, especially incountries with very poor investment climates.
An agency will be better able to accomplish its
objectives of correcting market failure while
avoiding government failure if it meets several criteria. In particular, it must operate ina transparent manner, be accountable, be independent from short-term political pressures, have limits on its discretion, and haveadequate capacity to do its job.
The downside associated with failing tomeet these criteria can be severe. For example,
investment will be difficult to attract if regulatory policies can be easily changed to benefit
any given politician’s short-term objectives.
Likewise, an agency that is not transparent
and accountable runs the parallel risks eitherof frightening away investors or of being captured by the industry it is supposed to regulate
at the expense of consumers. Without limits to
its discretion, meanwhile, an agency may seek
to expand its influence into new areas andmay become primarily another obstacle todevelopment and an avenue for rent seeking.
Finally, if the agency lacks the capacity to do
its job, it will simply be ineffective.
This range of criteria highlights the point
that—especially in regulatory and competition agencies—one size does not fit all. The
optimal type of regulatory and competition
agency (if any) depends not only on the conditions of the market (for example, to what
extent an individual firm can exercise market
power to thwart entry), but also on the extent
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countries with effective existing bureaucracies
are more likely to be able to meet all the criteria. Other countries may face great difficulties.
The resources required to build and adequately staff an agency can be quite sizeable,potentially making it unrealistic for a small,poor country. Some have suggested that whenresources and skills are scarce, countries could
work together to create regional agencies inorder to share the costs and responsibilities.
Countries with severe problems of corruption
and with a lack of transparency, meanwhile,
may have difficulty convincing consumers andinvestors that a new agency would behave differently from how the government behaved in
the past. A government intent on overcoming this reputation and on encouraging competition may make some progress in two
ways: increasing the amount of publicly available information on both firms and government agencies, and taking special steps toensure the transparency of any new initiatives
while emphasizing the discretionary limits of
those agencies.

Notes
1. Note that these investment categories are notstrictly comparable because the FDI flows are takenfrom balance of payments statistics and include foreign inflows intended for both new investment andacquisition of existing assets. Meanwhile, the otherinvestment figures are derived from national accounts
and refer only to new investment. The “domestic private” category is calculated as a residual and, therefore, may not match figures available from othersources.
2. However, his corruption indicator is correlatedwith other explanatory variables so that the coefficienton corruption is not significant once other explanatory
variables are included in the equation.
3. The rise in FDI is moderated because improvements in institutions are also associated with a reduction in FDI as a share of total capital inflows because
other types of capital inflows are more sensitive to
institutional quality.
4. Not everyone is persuaded by these crosscountry regression results. For example, Rodriguez andRodrik (1999) argue that some indicators of openness
are highly correlated with other indicators of economic
performance—including macroeconomic policy—or

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that they imperfectly reflect a country’s trade policy
regime. The high correlation of components of theSachs and Warner index with policy and institutionalvariables yields an upward bias in the estimation of
trade restriction effects. Meanwhile, tariff and nontariff barriers, the two variables that directly measuretrade openness, have little explanatory power when
considered separately in cross-country regressions.
5. Patent citations refer to a requirement in somepatent offices that inventors include in their patentapplication the citations of the patented technologythat they used in developing their invention (seeBranstetter 2000). These citations are used as evidenceof technological spillovers.
6. However, Keller (1998) finds that the role playedby import shares in determining productivity levels is
limited. Using the Coe and Helpman (1995) modelwith randomly generated import shares, he also finds
a positive relationship between foreign R&D andproductivity.
7. The entry cost measure used in figure 3.6 refers
to the costs of obtaining the necessary permits andlicenses and the other procedures required to set up a
new establishment. See Djankov and others (2002) for
further details.
8. See Hallward-Driemeier, Iarossi, and Sokoloff(2002) for a longer discussion; Levinsohn (1993);
Haddad and Harrison (1993).
9. Of the various regulatory agencies that are seen
as obstacles, customs officials ranked second—only
behind labor regulators—as a major constraint to doing
business in India.
10. Delays are similar for clearing imports throughcustoms. With such uncertainty, firms are likely to needto keep greater inventories of materials on hand, thus
incurring significant storage costs and tying up
resources that could otherwise be put to more productive use.
11. This will not always be the case, of course. A
country could easily enact a regulatory regime that
deters investors and increases the risk premium. Yet,on average, regulatory certainty seemed important toinvestors.
12. See Scherer and Ross (1990), chapters 7 and 8,
for a description of this case and others about
collusion.
13. Some commentators have suggested that it is a
mistake to encourage developing and emerging market
economies to enact competition laws because the risksof misapplication are high as a result of weak institutional capacity. Such laws may also become anotherform of government intervention in markets andmay give rise to corruption. However, such objections
could also be applied to other policy areas such as tax
collection, bank regulation, and so forth. The main109

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implication instead is that it is important, first, to design a system of checks and balances, including measures for accountability and transparency, and, second,to support institutional building of capacity.
14. The black-market premium here is seen as aproxy for available opportunities for legal and productive employment.

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Inter-American Development Bank.
Wallsten, Scott. 2000. “Telecommunications Privatization in Developing Countries: The Real Effectsof Exclusivity Periods.” SIEPR Policy Paper.
Stanford, Calif.
———. 2001a. “An Econometric Analysis of Telecom
Competition, Privatization, and Regulation in
Africa and Latin America.” Journal of Industrial
Economics 49(1): 1–20.
———. 2001b. “An Empirical Test of Geographic
Knowledge Spillovers Using Geographic Information Systems and Firm-Level Data.” Regional
Science & Urban Economics 31(5): 571–99.
———. 2001c. “Ringing in the 20th Century: The
Effects of State Monopolies, Private Ownership,
and Operating Licenses on Telecommunications
in Europe, 1892–1914.” World Bank ResearchWorking Paper. Washington, D.C.
———. 2001d. “The Role of Government in Regional
Technology Development: The Effects of Public
Venture Capital and Science Parks.” SIEPR Working Paper. Stanford, Calif.
———. 2002. “Of Carts and Horses: Regulation andPrivatization in Telecommunications Reforms.”
Policy Research Working Paper. Washington, D.C.
Wang, Eric. 2002. “Public Infrastructure and Economic Growth: A New Approach Applied to EastP O L I C I E S

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Asian Economies.” Journal of Policy Modeling24(5): 411–35.
Wei, Shang-Jin. 2000. “How Taxing Is Corruption on
International Investors?” Review of Economics
and Statistics 82(1): 1–11.
Weiss, Leonard. 1989. Concentration and Price.
Cambridge, Mass.: MIT Press.
Wellenius, Björn. 1992. “Telecommunications: WorldBank Experience and Strategy.” World Bank
Discussion Paper. Washington, D.C.
Wells, Louis T., Nancy J. Allen, Jacques Morisset, andNeda Pirnia. 2001. “Using Tax Incentives toCompete for Foreign Investment: Are They Worth
the Costs?” Foreign Investment Advisory Service Occasional Paper. World Bank, Washington,
D.C.
World Bank. 1995. Bureaucrats in Business: The Economics and Politics of Government Ownerships.
Oxford, U.K.: Oxford University Press.
———. 2001. Global Development Finance 2001:
Coalition Building for Effective Development
Finance. Washington, D.C.
———. 2002a. “Improving the Investment Climate inIndia.” Investment Climate Unit Working Paper.
Washington, D.C.
———. 2002b. World Development Report 2002:
Building Institutions for Markets. Oxford, U.K.:
Oxford University Press.
World Economic Forum. 2002. Global Competitiveness Report 2001–2002. Oxford, U.K., and New
York: Oxford University Press.
WTO (World Trade Organization). 1998. “Report of
the Working Group on the Relationship between
Trade and Investment to the General Council.”
WT/WG/TI/2. December 8.
Xu, Bin, and Jianmao Wang. 2000. “Trade, FDI, andInternational Technology Diffusion.” Journal of
Economic Integration (Korea) 15(4): 585–601.
Zak, Paul. 2001. “Institutions, Property Rights, and
Growth.” The Gruter Institute Working Papers
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2(1): Article 2.
Zhou, Kate Xiao. 1996. How the Farmers Changed
China. Boulder, Colo.: Westview Press.

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41
International Agreements to
Improve Investment andCompetition for DevelopmentF

ast-growing developing countries havecommonly been successful in setting up
investment regimes that facilitate private
investment and marshal competition to ensure
growth in productivity. As with trade reform,
most of the benefit from new sound investment and competition policies comes fromunilateral reforms of domestic policies. This
chapter explores the potential of international
collaboration—collaboration principally inthe form of international agreements—to help
developing countries consolidate sound investment climates.
International agreements that are associated with multilateral or regional arrangements can potentially provide additional
benefits when coupled with domestic reforms.
Benefits can take several forms. For investment
policies, international agreements usually havethe objective of eliciting more investment bylocking in reforms and providing additional investor protections. They can also reduce policy
externalities that have “beggar-thy-neighbor”
consequences. Moreover, participating in international negotiations can prompt partners
to undertake reciprocal reforms that would
not otherwise occur, as well as strengthen thehand of domestic reformers. For competition
policy, international agreements might lead to
removal of restraints that inhibit competition,
thereby unleashing new price competition that
benefits all countries. A central purpose of thischapter is to identify collective actions thathave the greatest development effects.

Ministers of the World Trade Organization(WTO) set an agenda for investment and competition when they met in Doha, Qatar, inNovember 2001, and decided to launch negotiations on a multilateral framework that covers investment and competition. These negotiations are subject to a decision to be madeby explicit consensus on modalities at the
Cancún Ministerial Conference, to be held in
2003. The purpose of the new framework is“to secure transparent, stable, and predictableconditions for long-term cross-border investment” that will expand trade and “enhance
the contribution of competition policy to international trade and development.”1
The international community, and developing countries in particular, therefore faces twoquestions: What types of new multilateral initiatives on investment and competition policy
can promote more—and more productive—
investment, and hence more rapid development? And, which issues are best tackled
through voluntary initiatives and multilateral
cooperation, and which are best handled
through binding commitments, such as those in
the WTO and regional arrangements? The answers to these questions require a separate discussion of investment and competition policy.

Can coordinated investment policies
increase flows to developing countries
and reduce beggar-thy-neighbor policies?
An overall purpose of coordinating an investment policy is to expand the flow of investment

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2 0 0 3around the world, to minimize distortions thathurt neighbors, and to help improve economic
performance. Coordination might contributeto achieving these goals through three main
channels: (a) protecting investors’ rights inorder to increase incentives to invest, (b) liberalizing investment flows to permit enhanced
access and competition, and (c) curbing policies that may distort investment flows andtrade at the expense of neighbors.
Analysis suggests several broad conclusions.
As with trade reforms, unilateral reforms toliberalize foreign direct investment (FDI) arelikely to have the greatest and most direct
benefit for the reforming country. Beyond
this, new international agreements that focus
on establishing protections to investors cannot
be predicted to expand markedly the flow ofinvestment to new signatory countries. This isbecause many protections are already covered
through bilateral investment treaties (BITs),and even these relatively strong protections do
not seem to have increased flows of investment
to signatory developing countries. These facts
suggest that expectations for new flows associated with protections emerging from any multilateral agreement should be kept low.
International agreements that allow countries to negotiate reciprocal market liberalization and to promote nondiscrimination canreinforce sound domestic policies and contribute to better performance. Because most of
the remaining investment restrictions are on
services, the existing General Agreement on
Trade in Services (GATS) provides an opportunity to meet this objective. Similarly, curbing beggar-thy-neighbor policy externalities
can benefit developing countries, especially
if agreements focus on two critical issues.
The first issue is the reduction of trade barriers that—by depriving developing countriesof market access and discouraging theirexports—will lessen the attractiveness ofopportunities for both foreign and domestic
firms to invest in developing countries’ exportindustries. In this regard, reducing trade barriers in developing countries is as important as

118

reducing trade barriers in rich countries. The
second issue is the curbing of emerging competition among countries in order to lureforeign investment through incentives. Unfortunately, information on the extent of investment incentives is inadequate to assess theireffects. Thus, a high priority for international
collaboration is to systematically compile thisinformation.
Finally, participating in international investment agreements may have benefits over
and above unilateral reforms if those agreements are accompanied by reciprocal market
access in areas of importance to developing
countries. These benefits can become clear
only in the course of negotiations.

Collective action can improve competition
Greater competition is associated with more
rapid development. Lowering policy barriers
to trade and foreign investment in developing countries, as shown in chapter 3 of thisvolume, is a powerful, procompetitive force.
International agreements on competition policy might bring benefits beyond unilateral
actions—provided that the agreements address
the major restrictions that adversely affectdeveloping countries.
Restrictions on competition in the global
marketplace that will most hurt development
can take three forms. First, policy barriers inmarkets abroad limit competition from developing countries in these markets. Particularly
harmful are the $311 billion in agricultural
subsidies and textile quotas, as well as thehigh border protection, tariff distortions (suchas tariff peaks and escalation), and protectionist use of antidumping. Those policy barriers
are common in all countries—rich and poor
alike. All of these restrictions limit the abilityof exporters in developing countries to compete in international markets.
Second, private restraints on competition
can adversely affect prices for consumers andproducers in developing countries. For example, companies that are based in high-income
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proven cartels have taxed consumers in developing countries by up to $7 billion in the
1990s. Actions that facilitate prosecution ofcartels should be high on the priority list.
Such actions can range from more systematicarrangements to exchange information, togranting developing countries the ability tosue under foreign antitrust laws when theirtrade is adversely affected. Indeed, developing
countries would benefit from much greater
efforts to identify and to document restrictive
business practices that adversely affect pricesof their trade.
Third, many governments in high-income
countries officially sanction trade restraints by
exempting their companies from domestic antitrust laws. For example, many governments
permit their companies to cartelize exports.
Although these cartels are shrouded in thesecrecy of government registries, national export cartels may well raise prices to developing countries. Efforts should be made to maketransparent any information on national export cartels. If cartels were found to haveadverse price effects, everyone would benefit
from reducing these officially sanctioned private restraints on trade. Similarly, antitrust
exemptions of ocean transport have given riseto price-fixing arrangements that systematically hurt consumers everywhere, including
consumers in developing countries.
Competition policies in developing countries themselves can, in many cases, be improved through increased transparency,
nondiscrimination, and procedural fairness.
However, international cooperation in thiscomplex area of regulation has to recognizethat countries have different capacities andinstitutional settings, which warrant caution
in recommending—much less in mandating—across-the-board policies. This is an area where
voluntary programs that facilitate learning andadoption of best practice in developing countries can pay high dividends.
This chapter analyzes first the investment
policy issues, and then the global competition
issues.

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C O M P E T I T I O NInternational efforts to promote
investmentAny pro-development effort to coordinate
investment policies through agreement
has as its objectives increasing the flow ofinvestment, minimizing distortions among
countries, and helping countries participate
in the potential gains from investment andinvestment-related trade. Chapter 3 of thisvolume singled out domestic policies that influence the quantity and productivity of private investment, both domestic and foreign.
Governments that have provided stable
macroeconomic policies and effective property rights for investors, and that have lowered policy barriers to competition have, by
and large, enjoyed greater success in creating
the conditions for sustained growth. International efforts to support these policies cantake several forms: bilateral, regional, andmultilateral. They can be binding, as in thecase of the WTO and the North American
Free Trade Agreement (NAFTA), or nonbinding, as in the case of the Organisation for Economic Co-operation and Development(OECD). The current regimen is a mixture ofbinding and nonbonding efforts.

Today’s international investment
framework is a patchwork quilt sewn
together over many years
The growing waves of FDI observed in recent
decades have been accompanied by a steadyrise in international agreements on investment. Agreements are typically founded on
the presumptions that cross-border investment
provides benefits to both investing and recipient countries, that rules can minimize disputes and provide for their resolution, andthat agreed-on rules can enhance both thequantity and quality of investment. The
Havana Charter, designed to create the International Trade Organization (ITO) at the endof the 1940s, proposed the inclusion of investment provisions together with trade provisions. The investment provisions were quite
limited in scope because many countries—

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particularly developing ones—feared foreign
control over their natural resources and strategic industries.2 Since then, a patchwork quilt
has emerged, made of differing bilateraltreaties, regional arrangements, and multilateral instruments relating to cross-border investment. This regulatory quilt stands in sharp
contrast to the more comprehensive system

Box 4.1

of norms and principles that govern international trade.
Bilateral agreements. Recent years havewitnessed a surge in BITs. The number of BITs
quintupled during the 1990s, reaching 2,099
by the end of 2001 (see box 4.1). During 2001
alone, 97 countries concluded 158 BITs (seeWhat is a BIT?

T

he number of BITs mushroomed in the 1990s(see box figures). These agreements typicallycontain broad definitions of foreign investment,
inclusive of nonequity forms, various types of investment assets (including portfolio investments), andintangible assets such as intellectual property. BITs
generally avoid a direct regulation of the right toestablishment, referring this matter to national laws
(and thus recognizing implicitly the right of hostcountries to regulate the entry of FDI). Most BITs

treatment, and treatment according to customaryinternational law. In addition, BITs prescribe specificinvestment protections, which cover topics such as
the transfer of funds, expropriation, and nationalization. They typically provide for the settlement ofdisputes between the treaty partners and between
investors and the host state. Provisions for so-called
investor-state arbitration normally refer to preexisting arbitration rules, notably those under theInternational Center for the Settlement of Investment

BITs are increasing...

...even among developing countries

2,000

500
400

1,500

With transition Europe
300
1,000

South-South BITs
200

500

100
0

0
1960s

1970s

1980s

1990s

Source: UNCTAD (2000).

also do not explicitly address ownership and control
issues, though they often cover some operational
restrictions, such as the admission of key managerial
personnel. Only a few BITs discipline the use of performance requirements.
Most BITs prescribe national treatment, mostfavored nation (MFN) treatment, fair and equitable

120

North-South

1960s

1970s

1980s

1990s

Source: UNCTAD (2000).

Disputes (or ICSID, which is affiliated with theWorld Bank); the United Nations Commission on
International Trade Law (UNCITRAL); or the International Chamber of Commerce (ICC).

Source: World Bank staff.

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UNCTAD 2002). For much of the post–WorldWar II period, BITs tended to be negotiated ona North-South basis. More recently, however,there has been strong growth in the numberof South-South BITs. In 2001, for example,
treaties between developing countries accounted for 42 percent of new BITs (UNCTAD
2002). BITs covered an average of 50 percent
of all foreign investment flows to developing
countries in 1999–2001.
Regional arrangements. Investment disciplines have figured prominently in regional
trade and integration agreements, particularly
the most recent ones. Some of these agreements embed foreign investment into a
broader framework of rules that are aimed atpromoting economic cooperation and deeper
integration. This framework includes theEuropean Union; NAFTA; the free trade
agreement linking the G-3 countries (Mexico,
the República Bolivariana de Venezuela, andColombia); the recently concluded SingaporeJapan agreement; and the European Free
Trade Area. Other agreements—such as theOECD’s Codes of Liberalization of Capital
Movements, the Colonia Protocol on the Promotion and Reciprocal Protection of Investments within the Southern Cone Common
Market (Mercosur), and the Asia Pacific
Economic Cooperation (APEC) Non-Binding
Investment Principles—are less comprehensivewith regard to their treatment of the tradeinvestment interface.
A distinguishing feature of regional agreements with investment disciplines is their tendency to address both investment protection
and liberalization (entry) issues, together withdisciplines on post-establishment operating
conditions and means to settle investment
disputes (both state-to-state and investorstate disputes). The architecture of the mostadvanced regional free trade and integrationagreements reflects the complex interrelations
among investment, trade, services, intellectual
property rights, competition policy, and the
movement of business people. Other important issues that are dealt with in some regional

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agreements include technology transfers, environmental protection, taxation, conflicting
requirements, and standards for the conductof multinational enterprises.
Multilateral accords. Significant multilateralrules for investment were put in place during the Uruguay Round, which concluded in
1994. All of the following agreements either
directly or indirectly address key investment
issues: the Agreement on Subsidies and Countervailing Measures (ASCM), the Agreement
on Trade-Related Investment Measures(TRIMs), the GATS, the Agreement on TradeRelated Aspects of Intellectual Property Rights(TRIPs), and the plurilateral Government Procurement Agreement.
Numerous multilateral agreements andarrangements that have been concluded outside the WTO also affect investment and canmake a positive contribution to enhancing
investment climates in developing countries.
Among others, these arrangements include
efforts to curb bribery and corruption (OECD,
Organization of American States [OAS]); rules
governing the conduct of multinational enterprises (OECD Guidelines on Multinational
Enterprises, United Nations [U.N.] Global
Compact); guidelines on corporate social
responsibility and corporate governance(OECD, World Bank); and cooperation on
best practices in investment promotion activities (U.N. Conference on Trade and Development (UNCTAD), World Bank).

New efforts exist for collective action on
investment
The rising tide of FDI around the world has
been, in part, a consequence of a progressive receptivity of developing countries to FDI flows.
Just as tariffs have fallen, so too have restrictions on incoming investments (particularly in
manufacturing) been lifted. Governments once
hostile to transnational corporations (TNCs)
now actively seek their participation—andeven compete for it. One indicator of this is thechange in investment regulations. Between
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2 0 0 3changes were introduced in national FDI
regimes, of which 1,315 (or 95 percent) were in
the direction of creating a more favorable environment for FDI (figure 4.1). During 2001
alone, a total of 208 regulatory changes weremade by 71 countries, only 14 of which (or6 percent) were less favorable for foreign investors (UNCTAD 2002). This opens the question of whether this evident willingness to improve the investment regime could be leveraged
to achieve some additional benefits, throughreciprocating in multilateral negotiations, anissue that we take up below.
The potential—and the challenge—of cooperation on investment policies become
clearer if it is broken down into the three coresubagendas that parallel the investment climate discussions in chapters 2 and 3. These
policies relate to liberalizing investment tofacilitate access and entry, establishing investor protections as an incentive to invest,
and curbing investment-distorting policies
that affect trade and investment location.

Liberalizing investment promotes
market access—
The inclusion of investment in international
negotiations may lead to greater openness ofinvestment regimes that can be accomplishedunilaterally. If investment is negotiated as partof a broader set of trade negotiations, rather
than in isolation, then the traditional mechanism of reciprocal access concessions can help
create support for greater openness at home
and abroad. For example, exporters in developing countries who obtain improved accessto foreign agricultural markets can be a countervailing force against those who resist theBox 4.2 The Multilateral Agreement on
Investment (MAI)

B

ecause investment regulations extend beyond tariffs into domestic regulation, the political difficulties of enticing large groups of countries to harmonize their domestic rules are not trivial. Thosedifficulties were evident in the latest—and failed—attempt at crafting a multilateral accord. In 1995,
developed countries pushed to establish a Multilateral Agreement on Investment (MAI) within theOECD that had the objective of setting “state of theart standards for investment regimes and investment
protection with effective dispute settlement procedures.”3 These efforts were unsuccessful, and the
MAI was not established.
One reason for the MAI’s demise was the waning support within the business community as it became apparent that the level of investment protection
afforded to MAI signatories would almost certainly
be lower than that offered in BITs. It was apparent
that prospects for significant investment liberalization would be held back, first, by concerns of freeriding by non-OECD WTO members (which stoodto receive many of the benefits of the MAI by virtue

122of the GATS’s MFN requirement without making
any reciprocal concessions). Also at play was thereluctance of OECD countries to open up sensitive
sectors to foreign investment (for example, to maritime transport and audiovisual services). Labor andenvironmental groups objected to the fact that the
MAI would give TNCs more power to ignore workers’ interests and environmental concerns whileproviding them with extensive rights to challenge
domestic regulatory conduct before international
arbitration panels. Meanwhile, many developing
countries, left out of the discussions because of the
MAI’s venue in the OECD, protested their unwillingness to accept rules that they had no voice in designing (Gilpin 2000).4 By the fall of 1998, negotiations
on the MAI were formally abandoned, thereby offering sobering insights on the complexity and politicalsensitivities involved in attempts at comprehensive
investment rulemaking.

Source: World Bank staff.

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Figure 4.1 Countries are increasingly liberalizing their investment regimes
National regulatory changes in FDI regimes, 1991–2000(number of regulatory changes)(number of regulatory changes)

80

250

70

More favorable to FDI

200

60

Less favorable to FDI

50

150

40
100

30
20

50

10

01
20

99

00
20

98

19

97

19

19

95

96
19

94

19

19

92

93
19

19

19

00

01
20

99

20

98

19

97

19

96

19

19

94

95
19

93

92

19

19

91

19

19

91

0

0

Source: UNCTAD (2002).

elimination of investment barriers in telecommunications. At the same time, the need tofight these battles about the domestic political economy makes a country a credible negotiator for improved access. The process, if itworks, could produce a double benefit: liberalizing countries would benefit from the increased competition that is associated with
FDI, and their firms would have improved
access to foreign markets. A key issue—which
can be determined only during the negotiation
process—is the extent to which an investment
agreement leverages reciprocal commitments
among trading partners. Because reciprocal
gains are difficult to gauge, an important prerequisite for each country is to ensure that any
domestic policy commitment makes sensewhen seen through the lens of promoting
national development.
Even though most foreign investment originates in rich countries and is destined forother rich countries, there may well be somescope for reciprocal agreements that benefit
developing countries, even within the narrowdomain of investment. Because developing
countries are increasingly becoming active as
investors themselves, they have a mutual interest in clear rules of access. They tend toinvest primarily in other developing countries.
Estimates suggest that nearly one-third offoreign investment flows to developing countries originated in other developing countries,
up from negligible amounts in the early 1990s(World Bank 2002a), so South-South FDI
flows have grown.5 (See figures 4.2 and 4.3.)

Figure 4.2 South-South FDI is rising
FDI flows to developing countries(billions of dollars)
100
90High OECD (North-South) countries
80
70

South-South

60
50
40
High non-OECD countries
30
20
10
0
1994

1995

1996

1997

1998

1999

2000

Source: Aykut and Ratha (2002).

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2 0 0 3Figure 4.3 Share of South-South FDI intotal FDI is risingSouth-South FDI is rising and so is its share in total
FDI(percent)
100
90
80
70
60
50
40
30
20
10
0

High-income
non-OECD/total FDI

North-South FDI/total FDI

South-South FDI/total FDI

1994

1995

1996

1997

1998

1999

2000

Source: Aykut and Ratha (2002).

The preceding argues that the potential
for benefits investment agreements to generate merits examination. Coordinated efforts toliberalize investments can subsume two issues:
first, transparency, and second, nondiscrimination in treatment of foreign investment inmarket access.
Transparency. Transparency involves making relevant laws and regulations available
to the public, notifying parties when lawschange, and ensuring uniform administration
and application. In addition, transparency canbe increased by offering affected parties theopportunity to comment on laws and regulations, which implies communicating the policy
objectives of proposed changes, allowing time
for public review, and providing a means tocommunicate with relevant authorities.
A nontransparent business environment ina host country raises information costs, diverts
corporate energies toward rent-seeking activities, and may give rise to corrupt practices. This
environment weighs down both domestic andforeign businesses, though in many cases it may
be particularly discouraging to foreigners who
are usually less privy to locally available information. This heightened risk of operating in124

the host country’s business environment eithertranslates into higher risk premiums (in the caseof pricing corporate assets) or imposes additional information costs on enterprises. To be
sure, transparency, alone, can add little if theunderlying laws and rules are inadequate or
unpredictable.
Case studies suggest that companies may,for example, be willing to invest in countries
with legal and regulatory frameworks thatwould not otherwise be considered “investor
friendly”—provided the companies are able toobtain a reasonable degree of clarity about theenvironment in which they will be operating.
Conversely, there appear to be certain threshold levels for transparency beneath which thebusiness conditions become so opaque that
virtually no investor is willing to enter, regardless of the extent of the inducement.
These policies do not lend themselves wellto including sanction-based dispute resolution
procedures in legally binding agreements.
Thus, international collaborative efforts should
perhaps take other forms such as increasing
developing countries’ participation in nonbinding best-practice instruments or developing assistance to strengthen institutions. To the extent that transparency obligations are anchoredin WTO agreements, monitoring by multilateral peer review and surveillance may provide
the best means for promoting governanceenhancing reforms in host countries.
Nondiscrimination in treatment of foreign
investment in market access. The practice of
placing foreign and domestic sellers on an
equal competitive footing is a hallmark of
trade agreements. This objective is no lessimportant in investment agreements. Promoting liberalization in international investment
essentially boils down to securing nondiscriminatory terms of entry and operation. Thisapproach has elements of both MFN treatment (that is, nondiscrimination as between all
foreign entities) and national treatment (thatis, nondiscrimination between “like” domestic
and foreign entities).

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Box 4.3 South-South flows: who invests and who
receives?

M

ost FDI flows within developing countries are
between the Association of Southeast Asian
Nations (ASEAN) countries, and, recently, among
the Latin American countries, especially the Mercosur
members (UNCTAD 1999). There are signs that
FDI flows from East and Southeast Asia to Latin
America and Africa are picking up. According to theChinese Ministry of Foreign Trade and Economic
Cooperation, China attracted $3 billion in investment from 22 developing countries in 1998. Though
this figure made up only 7 percent of total FDI inflows to China, the flows originated in a wide spectrum of countries (in terms of size and per capita
income levels) and extended to varying sectors(Aykut and Ratha 2002). In addition, Chinese TNCs
are becoming prominent in world markets. China
has invested, not only in Asian countries, but also in
Bangladesh, Brazil, India, the Islamic Republic of
Iran, and Poland, in addition to countries in Africa.
The Republic of Korea, an OECD member,
invested nearly one-third of its direct investment indeveloping countries (excluding those in Africa
and the Middle East) in 1998. By 1999, Korea had
invested nearly 50 percent of its aggregate investment in other developing countries. Malaysian FDI

Departures from nondiscriminatory treatment essentially take one of two forms: before
entry in the “pre-establishment” phase of aninvestment, and after entry in the “postestablishment” operating conditions of a business.
Governments everywhere have been reluctant
to extend full pre-establishment privileges toall potential entrants in every sector. Securing
nondiscriminatory conditions of treatment isequally important in the postestablishment
phase, because foreign investors will typicallyhave significant start-up costs and will beaverse to sudden, unanticipated changes inregulatory conditions that may tilt competitive conditions in favor of local competitors.
Nondiscrimination commitments in the post-

has also expanded its boundaries from East Asia to
Latin America and to parts of Africa. Since the second half of the 1990s, almost 30 percent of total
FDI inflows into India are from other developing
countries—the principal sources being Mauritius,
Malaysia, and Korea (Aykut and Ratha 2002). Outflows from Latin America in 2001 were directed primarily at other countries in the region (UNCTAD
2002). Chile continued to be the major player ininterregional investment, followed closely by Mexicoand Argentina. Some South African TNCs haverecently moved to a strategy of international growth,
partly through cross-border mergers and acquisitions. A noteworthy example of a global player isSouth African Breweries, which operates 108 breweries in 24 countries including China, large parts ofAfrica, and Europe (UNCTAD 2002). FDI outflows
from the Central and Eastern European countries
such as Croatia, Estonia, and Slovenia are also
headed primarily to neighboring countries. A tendency to invest in neighboring countries that are atsimilar or lower levels of development is another feature of South-South FDI (Aykut and Ratha 2002).
Source: World Bank staff.

establishment phase can thus send to foreign
investors powerful signals of the credibility ofa host country’s reform efforts.
By far the most contentious aspect of liberalization is the pre-establishment commitment
to openness, given the tendency to maintain
restrictions on entry in a few sensitive sectors.
Most countries now permit liberal access toforeign investors in manufacturing. The same
holds true—if to a lesser extent—in mining
and agriculture. Indeed, as a result of various
investment incentive schemes that are notavailable to domestic firms, foreign investors
in manufacturing often enjoy treatment thatis better than that available to domestic investors. Most governmental measures that125

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2 0 0 3overtly discriminate against foreign investors
and that restrict FDI inflows are maintained in
the service sector and concern key industries
such as telecommunications, broadcasting andrelated audiovisual services, satellite services,energy services, financial services (especiallybanking and insurance), civil aviation, andmaritime transport.6 Sauvé (2002) estimatesthat 80–85 percent of restrictions affecting international investment are maintained in service sectors. Among the most dynamic sectorsof the global economy, services are also wheresome two-thirds of cross-border FDIs havebeen directed in recent years (see chapter 2,
this volume).
One telling proxy of the potential of services for investment liberalization is provided
by the negative lists of measures drawn up byprospective signatories of the ill-fated MAI.
The lists identify those sectors in which thenegotiators wished to restrict access by foreign
investors (see figure 4.4). A similar trend is evident under the NAFTA. Simply put, the market access or agenda for investment is largely
centered on services (Hoekman and Saggi
2000; Sauvé and Wilkie 2000).
A multilateral vehicle already exists forrealizing the positive externalities that poten-

tially arise from the liberalization of investment in services: the GATS. The GATS has
several features that are attractive to countries,
potentially making it a useful tool to widen
nondiscriminatory access in a reciprocal framework. By having a positive list approach—in
which countries voluntarily schedule sectoralcommitments to apply national treatment
and to grant market access—governments
enjoy considerable flexibility to exempt sectors that they deem of special national interest.
Once commitments are undertaken, countries
accord all suppliers—foreign and national
alike—the same conditions of entry and operation in a nondiscriminatory fashion. To date,however, the GATS has fallen short of its
liberalizing potential. The coverage of commitments for a large number of countries islimited. About two-thirds of the WTO membership has scheduled fewer than 60 sectors(of the 160 or so specified in the GATS list)(see Stern 2002). In many cases, commitments
do not reflect the actual degree of openness(Mattoo 2000). In other cases, countries havenot moved actively to schedule sectors—even
when domestic policies are open to foreign
investments. Finally, sometimes countries’commitments serve to protect the privileged

Figure 4.4 Revealed preferences: governments shield services more often thanmanufacturing from the winds of investment competition

All sectors
21%

Services
63%

Goods
16%

Note: Listed are nonconforming measures reserved under the draft Multilateral Agreement on Investment.
Source: Sauvé (2002).

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Business

16%

Communication

16%

Construction

2%

Financial

21%

Tourism2%

Recreation

2%

Transport

37%

Other

4%

Total

100%

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position of incumbents, domestic or foreign,rather than to enhance the contestability ofmarkets.
Countries could take greater advantage ofthe opportunity offered by the GATS to lend
credibility to reform programs by committing
to maintain current levels of openness or byprecommitting to greater levels of future
openness. To advance the process of services
reforms beyond levels undertaken independently and to lead to more balanced outcomesfrom the developing countries’ points of view,countries could better harness the power ofreciprocity by devising negotiating formulasthat widen the scope for tradeoffs across sectors (both goods and services) and acrossmodes of delivery, notably temporary movement of workers (Mattoo 2002).

—but protecting investment may notincrease flows
A foundation of any country’s investment climate is the protection of property rights for
its investors. An agreement that encourages
countries to improve investor protections has
the potential for improving investment flows
from abroad and for eliciting more domestic
investment. The international community, in
general, and developing countries, in particular, might find three benefits from multilateraldisciplines on investment protection.
First, an agreement on common standards
would promote efficiency by carrying potentially significant economies of scale in making
rules: one multilateral agreement could become a “one-stop” substitute for the complex
and legally divergent web of existing BITs.
Second, a multilateral regime for investment protection could help counterbalance
the bargaining asymmetries built into BITs
and into regional agreements conducted along
North-South lines. In some cases, the negotiating asymmetries that are common to bilateral agreements have led to treaties in whichdeveloping countries have taken on substantive obligations without any reciprocity otherthan the promise of increases in future private
investment. However, there is an importantT O

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caveat to this argument: To the extent thatthe power imbalance is redressed in a multilateral agreement in favor of weaker states,
then the constituencies within the global business community may well prefer—as was thecase in the MAI negotiations—the stronger
level of investment protection flowing from
BITs, and may lose interest in a multilateralagreement.
Third, a multilateral set of disciplines oninvestment protection would arguably help
developing countries send a positive signal topotential foreign investors regarding the permanence of policy changes, the expected
standard of treatment afforded to foreign investors, and recourse to a dispute-settlement
procedure.
While these factors suggest that investment
flows might increase because of such anarrangement, care should be taken not tooverstate the response of investors. Five facts
argue for caution. First, the absence of a bodyof multilateral disciplines on investment
protection has hardly deterred cross-borderinvestment activity. Indeed, FDI has far outstripped trade and output growth over the
past decade and a half (see figure 4.5).
Second, the absence of an agreement has
not prevented substantial unilateral reform(see discussion above, and figure 4.1).
Third, a more precise indicator is the historical experience of the BITs in eliciting newinvestment. Does the signing of BITs increase
the flow of FDI? Hallward-Driemeier (2002)
finds few independent effects of BITs on subsequent increases in investment (box 4.4).
Fourth, it is not clear whether multilateral
investment disciplines—whether in the U.N.,
WTO, or OECD—will embody investment
protections that are superior—and, therefore,
additive—to BITs. In the case of the WTO, theDoha Ministerial Declaration reflects a significantly more-limited approach that clearly
does not view a multilateral framework on investment as a substitute for bilateral and regional arrangements. Recent negotiating briefs
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2 0 0 3Figure 4.5 FDI is growing faster than exports and output
Developing countries: merchandise exports, output, and FDI inflows, 1980–2000(index, 1980  100; average annual growth rates in parentheses)
3,000

FDI inflows(1981–90: 5.3%)(1991–2000: 20.8%)

2,500
2,000
1,500
1,000

GDP
(1981–90: 3.2%)(1991–2000: 4.4%)500

Merchandise exports(1981–90: 3.3%)(1991–2000: 9.6%)

01980 1982 1984 1986
1988 1990 1992

1994

1996

1998

2000

Source: UNCTAD (2001), Handbook of Statistics: World Bank (2002), World Development Indicators; and WTO (2001),
International Trade Statistics.

dispute settlement, which would tend to lessen
the additive value of investor protection in a
multilateral accord.
Dispute settlement is another critical—andas yet unresolved—issue that will influence
the content of any multilateral agreement tostrengthen investor protections. Most BITs
contain dispute resolution mechanisms thatallow investors to challenge government rulings before arbitration panels or international
courts. In the context of the WTO, while there
is generally little support for the inclusionof investor-state arbitration provisions in aprospective multilateral investment agreement, WTO rules on investment protection
could entail complications even when administered through state-to-state dispute settlement. For example, what would be the appropriate remedy in an instance of unlawful
expropriation of a foreign investment? Thesedifficult and contentious issues will take time
to resolve in any international agreement.

Beggar-thy-neighbor investment
distortions must be minimized
Governments have adopted policies that may
affect the location and performance of trans-

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national investment. Three negative policy
externalities—when one country’s policies
adversely affect another—merit discussion.
The first and most powerful of these negative
policy externalities are investment-distorting
trade barriers. Tariffs, tariff escalation,and other forms of protection discourage
investment—both foreign and domestic—inexport industries in developing countries.
Said differently, if developing countries confront impediments to market access abroad,the effect of the barriers is to lower the potential stream of earnings in their export activities.
This change reduces the incentive for foreignand domestic investors to invest in production for export in developing countries. Quota
arrangements, antidumping actions, subsidies,overly restrictive rules of origin, and othertrade restrictions distort not only trade, butalso investment, and these distortions arearguably the largest negative policy externality
affecting investment in developing countries.
Two other sets of policy externalities figure
prominently in investment decisions: performance requirements—to compel multinational companies to locate a greater part of thevalue added chain in the domestic market—

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Box 4.4 Do BITs increase investment flows?
Only a bit

B

ITs are instruments used by countries to protect
their foreign investors, while host countries view
BITS as an important means of attracting foreign
investors. BITs can provide the basis for resolving
disputes; they can also impose potentially extensive
obligations on the part of the governments hosting
the investment. For example, almost all treaties stipulate compensation for the expropriation of investments. In some cases, treaties proscribe any government action—even environmental actions or otherregulations—that would reduce the value of theprivate investment and they establish grounds forcompensation. Such compensation could either
entail extensive liabilities for the host government
or compel it to refrain from making certain policy
choices. Against this backdrop, the question ofwhether BITs actually increase FDI is important.
Surprisingly little empirical work has been done
to test BITs’ role in attracting FDI. UNCTAD, in a
recent study, found little evidence that BITs increased
FDI (UNCTAD 1998). That work looked at a single
year of investments and tested whether the numberof BITs signed by the host was correlated with theamount of FDI it received. Hallward-Driemeier(2002) redid that test, but applied it to 20 years ofdata, looking at the bilateral flows of OECD members to 31 developing countries. The HallwardDriemeier test covered the vast majority of FDI
flows, as well as those relationships that were historically the bulk of such treaties. Overall, the evidence
is, at best, weak that BITs increase the amount of
FDI. By the end of the 1990s there were many more
BITs, and FDI had increased dramatically. However,controlling for a time trend, there was little independent role for BITs in accounting for the increase in
FDI. Countries that had concluded a BIT were no
more likely to receive additional FDI than werecountries without such a pact.
Another question is whether a BIT would draw
attention to a particular location, thus leading to anincrease in flows in the aftermath of negotiations.
However, comparing flows in the three years after a
BIT was signed to those in the three years before, there
was no significant increase in FDI (see box figure).
A third question is whether the relative amountof FDI that a source country allocated to a particular

The share of FDI received by developing
countries is relatively unaffected by thesigning of a BIT(share of annual FDI flow)
0.3

0.2

0.1

0
3

2

1

Year
signedYears before signing

1

2

3

Years after signing

Source: Hallward-Driemeier (2002).

host country was affected by the presence of a BIT.
The evidence here is that concluding a BIT is positively associated with receiving a larger share of asource country’s FDI outflows, but that the result is
not statistically significant.
Some countries have looked to BITs as a way ofsignaling their respect for property rights. Particularly
if their reputation for protecting such rights is weak,
they have seen the signing of a BIT as a way of assuaging the concerns of foreign investors. Conversely, thecredibility of such a signal may not be that strong. It
may be that the domestic rule of law must be sufficiently strong before foreigners are willing to consider
the terms of the BIT as being enforceable. To test between these hypotheses, the study ran regressions that
included measurements of the rule of law, government
effectiveness, and regulatory quality. These measures
were then interacted with the presence of a BIT. The
results indicate that in weak investment climates, theBIT does not serve to attract additional FDI. However,in countries with stronger investment climates, thepresence of a BIT does weakly increase the amountand relative share of FDI that the host receives.
Source: Hallward-Driemeier (2002).

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2 0 0 3and investment incentives—usually throughtax breaks or direct transfers from the state to
attract FDI. Even when these policies benefit
the domestic economy, they both have the potential for adversely affecting trade and investment flows with neighbors. Therefore, further
international cooperation to curb their negative effects can create positive benefits for all.
Unlike restrictions on entry that primarily
affect services, performance requirements andinvestment incentives usually affect manufacturing. In general, performance requirements
have been the instrument of choice for developing countries that are seeking to ensure that
TNCs’ activities generate the greatest possible
spillovers for their economies. OECD countries have been the predominant users of investment incentives to attract investment,
though in recent years numerous developing
countries have followed suit (see chapter 3,
this volume; see also UNCTAD 2002).
The trade-distorting effects of performancerequirements—termed TRIMs—have forsome time been subject to negotiated disciplines at both the regional and multilaterallevels. WTO disciplines on performance requirements were codified with the TRIMs
Agreement in 1995. Among performance requirements, the most prevalent measuresrelate to local content, joint ventures (ordomestic equity participation), exports, technology, and employment requirements. The
initial rationale for export requirements wasin part to relieve the pressure on the trade balance that inward investment—particularly
import-substituting investment—was generating. Local content requirements were designed
to maximize vertical linkages and development of local skills.7 Current discussions ofchanges to the TRIMs Agreement are associated with the review process that is mandated
under Article 9 of that agreement.8 At present,
these debates are not on the Doha Agenda.
In contrast with disciplines on performancerequirements, disciplines on investment incentives are—with the exception of the European
Union’s comprehensive set of disciplines onstate aids—more limited. The Uruguay

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Round’s ASCM introduced limited disciplines
on the granting of investment incentives.
These disciplines are largely indirect because
they apply solely to export subsidies and othergoods-related transactions—that is, a government may invoke the agreement’s provisions
only when certain types of investment incentives used by certain types of members can beshown to distort trade in goods.9
Strengthening disciplines on investmentdistorting incentives could benefit developing
countries because those disciplines would reduce the scope for this zero-sum tax competition. However, progress in crafting a set of
multilateral disciplines on investment incentives has been negligible to date. One reason
for this stalemate is that in large federal governments many investment incentive programs
originate at the subnational level as instruments to promote regional development.
Another reason is that many emerging developing countries have themselves become heavy
users of incentives in recent years. Consequently, investment incentives have not figured
prominently among topics to be discussed ininternational forums such as the WTO. The illfated discussions in the MAI were also unsuccessful in broaching investment incentives.
Nonetheless, competition among governments for FDI through incentives is becoming
increasingly common in many parts of theworld. Developing countries often find themselves in competition with each other, but few
examples can be found of developing countries in direct competition with developed
countries. Also, competing developing countries are often middle-income countries. Fourreasons seem to explain these patterns.
First, studies show that the bulk of
incentive-bidding activity among governments
takes place within regions, rather than globally (Oman 2000; Charlton 2002). Only ahandful of developing countries situated close
to developed nations experience direct competition with the deep pockets of the treasuriesof rich countries. Mexico’s automotive industry under NAFTA is perhaps the most prominent example of this situation.10

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Second, locational competition tends to bestrongest between close neighbors with similar
economic conditions, factor endowments, andpolicy regimes. Competition is also strongest
in high-skill, technologically intensive industries, particularly for firms producing goods
for export. Automakers, silicon chip producers, and pharmaceutical firms are among themost sought-after investments. Only a limited
number of higher-income developing countries
are likely to qualify for such a category ofinvestment.
Third, competition is likely only when investors are somewhat indifferent about where
to locate an investment among alternative locations. This indifference implies that only themore relatively advanced economies (emerging or transition economies) could have cause
to bid against developed nations.11
Fourth, overt bidding wars between countries are relatively rare—even though bidding
may be intense within particular countries—
and are typically limited to a few sectors. They
generally occur when individual projects are exceptionally large and when the sectors in question (for example, automobiles or electronics)
are considered a high priority for national orregional economic strategies (Charlton 2002).
To be sure, striving for a ban on all incentives may be counterproductive because, insome cases, incentives can offset local disadvantages or can be used to capture spillovers
from inward FDI (see Hoekman and Saggi
2000). In the case of Ireland and Portugal,
for example, incentive programs have playeda significant role in attracting investment toless-developed regions. In the case of Brazil,
some evidence shows that incentives competition may have contributed to reducing regional disparities, because FDI in some sectors(particularly automobile manufacturing) is increasingly located outside the traditional industrial heartland around São Paulo (Cano
1998). While it is probable that, with respect to incentives, stories of failures andexcessive expenditures outnumber successes,
agreements must contain some elements offlexibility. A first step is generating adequateT O

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information that can be used to assess thetrade- and investment-distorting consequencesof incentives—and, more broadly, to evaluate
their net development benefits.
Taken together, the existing multilateralagreements do provide limited discipline on
certain types of beggar-thy-neighbor policies
that are currently in use around the world.
With respect to curbing incentives, eventhough potential benefits for countries exist
from a multilateral accord, the absence ofevident momentum at the multilateral level—
when combined with a regional pattern ofpossible tax competition and trade effects—
suggests that regional arrangements may be
more promising for international collective actions. However, data are lacking. Multilateralefforts to improve information on investment
incentives, perhaps through a WTO mechanism, would help remedy that lacuna andallow better analysis of the extent of investment distortions.

Summary: Getting the biggest
development benefit from international
collaboration on investment
Developing countries can benefit from international collaboration to liberalize market
access for investment, to address investor protections, and to minimize investment distortions. Five conclusions emerge.
First, in each of these areas the primary
benefits of attracting high-quality investment
from sound investment policies are likely toresult from unilateral enacting of domestic
reforms. Long a truism for trade liberalizing
reforms, this conclusion—given the apparent
lack of investor responsiveness to international agreements—is increasingly germane toinvestment. Many of the remaining restrictions are on services. As we have seen in chapter 3, progressive liberalization in services can
produce substantial economy-wide benefits
and should be a priority for consideration aspart of any development strategy. Bettertelecommunications, banking, auditing services, retail and wholesale trade, and the otherservice industries have multiple linkages to the131gep_ch04.qxd 12/5/02 2:49 PM Page 132

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Box 4.5 Disciplines on corporations can also improve
the investment climateC

urrently, proposed investment rules in the
WTO focus exclusively on disciplines for governments, but they say little about responsibilities
of corporations (see Moran 2002). Improper corporate behavior—bribery or improper accounting—can corrode the social fabric of developing and developed countries alike. In the wake of the Enron,
Arthur Andersen, and WorldCom accounting scandals in the United States, efforts to improve corporate transparency and good conduct assume a newimportance. Many such activities outside the WTO
are under way.
To help combat bribery and corruption, theOECD has recently established the Convention on
Combating Bribery of Foreign Public Officials inInternational Business Transactions. The convention,
put into force in 1999, currently includes all 29
OECD members and five nonmembers (Argentina,
Brazil, Bulgaria, Chile, and the Slovak Republic) as
signatories. The convention makes bribing a foreign
public official a criminal offense. It also encompasses
noncriminal rules for prevention, overall transparency, and cooperation between countries, and it
ends the practice of allowing tax deductibility offoreign bribes. Many countries, however, have yet tomodify their national legislation to implement theconvention fully. Regional forums of cooperation canalso help. For example, the Inter-American Convention against Corruption was established in 1996 in
the OAS; in April 2001, the Summit of the Americas
created an implementation mechanism for the InterAmerican Convention. Experience shows that, for
anticorruption initiatives to be effective, participation by civil society, private agencies, and the generalpublic is critical. In this context, cooperative efforts
by nongovernmental organizations (NGOs), such as
Transparency International, the Global Coalition for
Africa, the Novartis Foundation, and the Public

Affairs Center, and by international organizations
and banks, such as the World Bank, the International
Monetary Fund (IMF), the Asian Development Bank,
the U.N. Development Programme, and the U.S.
Agency for International Development, in developing
approaches to counter corruption are noteworthy.
Other programs have a more technical focus.
The World Bank’s work on corporate governanceemphasizes disclosure, transparency, the rights andtreatment of shareholders and stakeholders, and theduties of board members. Using the OECD’s Principles of Corporate Governance as a benchmark, theBank prepares corporate governance assessments for
its client countries to assess their institutional frameworks for corporate governance. In addition, theWorld Bank and the IMF together initiated the
Financial Sector Assessment Program and theReports on the Observance of Standards and Codes.
More broadly, the U.N. adopted the Global
Compact in July 2000 to allay concerns about thesocial effects of globalization on the developingworld. About 100 major multinationals and 1,000
other companies across the world’s regions are currently engaged in the Global Compact. Projects
relate to making microcredit more accessible, reducing carbon dioxide emissions, fighting against humanimmunodeficiency virus/acquired immune deficiency
syndrome (HIV/AIDS), and expanding of basic education in local communities. In a similar vein, theOECD significantly revamped its Guidelines on
Multinational Enterprises in 2000 by adding
recommendations about eliminating child and forcedlabor, improving internal environmental management, addressing human rights, finding methods tocombat corruption, and improving disclosure andtransparency.
Source: World Bank staff.

rest of the economy, and can be sources of
productivity growth for the whole economy.
But the pace and form of investment liberalization necessarily must vary across sectors
and across countries, because they require reg-

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information exchanges, and private efforts to
inform and assist governments.
Second, international agreements that
focus on liberalizing conditions of entry by removing barriers that discriminate against foreign competition may help consolidate domestic reforms at the same time that they open
new avenues for reciprocity abroad. Becauseof the sensitivity of investment regimes, especially in services, any agreement has to allow
for country diversity and must permit governments the flexibility to design liberalization in
ways consistent with their development strategies. Because the GATS provides this flexibility and addresses most of the remaining outstanding restrictions, multilateral efforts could
concentrate on expanding the still-limited coverage of the GATS by increasing the number
and quality of commitments that allow commercial presence. Harnessing the full force ofreciprocity—both across modes (especially byputting on the table any temporary movementof workers) and across sectors—may help
motivate this expanded coverage.
Third, an international agreement thatseeks to substantially increase investment
flows by increasing investor protections seems
destined, on the basis of available evidence, tofall short of expectations. Some key issues are
already covered by relatively strong investor
protections in BITs. Moreover, it is not clearthat any investor protections emerging frommultilateral negotiations would add markedly
to existing protections found in bilateralagreements. Finally, merely creating new protections does not seem to be strongly associated with increased investment flows. For
these reasons, the overall additional stimulusof multilateral rules that apply to new investment over and above unilateral reforms would
probably be small—and virtually nonexistent
for low-income developing countries.
Fourth, international agreements can usefully discipline two forms of beggar-thyneighbor policy externalities that are particularly adverse to development. The first andmost important are investment-distorting
trade measures. Tariff escalation, tariff peaks,

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quota arrangements, and other barriers—
barriers that are common among developing
countries as well as between rich and poor
countries—stifle developing countries’ exports
and the investment needed to supply them.
Reducing these trade barriers would precipitate new investment in exports as these activities expand, and some portion of this newinvestment can be predicted to come fromabroad. The second set of externalities concerns disciplines for investment incentives that
distort the allocation of investment. Cooperative measures at the multilateral level have theadvantage of being conceptually clean andbroad based. However, because investments
tend to affect countries in close regional proximity, countries may find it easier to work on
rules that curb disadvantageous competition
on investment incentives through regionalarrangements. A prerequisite for collective
action is information on the extent of investment incentives and their effects; thus, a multilateral inventory of investment incentives isa high priority. One option is to set up an annual surveillance process, perhaps under the
auspices of the WTO or as part of the IMF’s
annual surveillance.
Finally, if new investment arrangements
leverage reciprocal commitments for reforms
abroad on other issues on the trade agenda,
particularly new market access, then agreements would certainly help developing countries. These matters can be decided only in thecourse of negotiations.

International agreements topromote competition andcompetition policyPromoting development requires not only
policies to encourage investment, but also
policies to ensure that investment is productive; among these policies, competition is oneof the most powerful. Most policies to promote competition are domestic, and an important conclusion of chapter 3, this volume, isthat the reduction of policy-related barriers tocompetition is essential to raising domestic

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2 0 0 3productivity. Among the many domestic policy
barriers to competition, the most prominent
often involve aspects of globalization, such as
tariffs, restrictions on FDI (especially in services), state monopolies, and competitionlimiting regulations in postprivatized sectors.
Competition policy that disciplines private restraints in domestic markets is also important.
However, competition laws have to be appropriate to local circumstances because they rely
heavily on the strength and independence ofthe judiciary, the enforcement capacity oflegal authorities, and probity in public administration. A well-intentioned law in an inappropriate institutional environment can become a source of bureaucratic harassment andcorruption.
Governments working together in a multilateral or regional framework may be able toenact policies that widen the scope of competition and thereby confer benefits beyond
those obtained from unilateral reforms. Analysis has to begin with the restraints on competition in the global marketplace that mostadversely affect developing countries and that,
if removed, would provide the biggest stimulus to development.
Three categories of restraints on competition in the global marketplace are particularly
adverse. First are those that involve policy
barriers to trade that disadvantage exporters
in developing countries by directly limiting
their ability to compete in markets. The mostimportant barriers affect agriculture, textiles,
and other labor-intensive manufactures andservices. Second are private restraints on international competition that can raise prices to
consumers or to producers in developing
countries. These restraints include international cartels that are commonly illegal inOECD countries when they affect OECD markets. Third are officially sanctioned restraints
that may adversely affect developing countries’ import or export prices. We discuss
below the effects of exemptions from antitrust
laws that governments grant to their firms
national export cartels, and the price-raising
effects of ocean transport and aviation

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arrangements that systematically hurt developing countries. Competition policies in developing countries themselves can, in manycases, be improved through increased transparency, nondiscrimination, and procedural
fairness. All of these policies are subjects ofinternational negotiation, but they have quite
different potential effects on development.

The most important restraints oncompetition are policy barriers to trade
Exporters from developing countries—
particularly exporters of agricultural products, textiles, and labor-intensive manufactures and services—confront significant
restraints on their ability to compete in global
markets. Developing countries generally facehigher barriers to exports than do industrial
countries (World Bank–IMF 2002). Japan andthe United States provide maximum protection against imports from developing countries, while European Union protection isskewed against imports from middle-income
countries. Developing countries, with averagebarriers higher than those in rich countries,
also raise barriers against competition fromother developing countries. Taken together,protectionist measures such as high tariffs,
tariff peaks, restrictive tariff rate quotas on
low-tariff imports, and domestic and export
subsidies are ubiquitous and raise barriers tocompetition from all developing countries. Because the world’s poor people usually produce
agricultural and labor-intensive products, theworld trading system is tilted against the poor.
The average poor person selling into theglobal marketplace confronts tariffs that are
twice as high as those faced by people who are
not poor (World Bank 2002c; see also Oxfam
2002).
Subsidies and trade barriers in agriculture
are particularly pernicious. In developed
countries tariff rates in agriculture are twice
those of manufactures. Sheltering of agriculture by hefty subsidies aggravates the effectsof these tariffs (OECD 2001; World
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protected markets—those consumers who
spend a large proportion of their income onfood, while the supports benefit only a handful of large farmers. The U.S. subsidies tocotton producers, for example, cost taxpayers
nearly $4 billion a year—three times the U.S.
aid budget for Africa—while adversely affecting low-income West African economies that
produce cotton. High protection and supportof the sugar industry in the European Unionand the United States is another example ofthese harmful policies. Total OECD support
for agriculture amounted to 1.3 percent of thegross domestic product of those countries in
2001, with the producer support estimates12
the highest in the European Union in absoluteterms (see figure 4.6). Prices received by
OECD farmers were on average 31 percent
above world prices (measured at the border)(World Bank–IMF 2002). Though efforts
have been made to lower protection for agriculture in OECD countries, the recently enacted 2002 U.S. Farm Bill increases support
spending to a projected $45 billion, or 21 percent of producer income during fiscals
2002–07 (see appendix 2). This increase may
well aggravate secular deterioration in devel-

Figure 4.6 OECD countries spent $230
billion in 2001 to support agricultural
producers
Producer support estimate by the OECD countries
totaled $230 billion in 2001

Japan
$47,242 million
European Union$93,083 million

United States$49,001 million

Source: World Bank–IMF (2002).

T O

I M P R O V E

I N V E S T M E N T

A N D

C O M P E T I T I O N

oping countries’ terms of trade through its
effects on long-term world prices. Protectionof agriculture is also common in developing
countries—comparable in weighted ad valorem equivalent terms—but is much lower
when subsidies are taken into account (seeWorld Bank–IMF 2002).
Policy barriers restrain competition inclothing and textiles with similarly adverse
effects on developing countries. Developing
countries account for about 50 percent ofworld textile exports and 70 percent of worldclothing exports (World Bank–IMF 2002).
Under the Uruguay Round Agreement on
Textiles and Clothing, quota restrictions are to
be abolished gradually during 1995–2005.
The slow pace of removing restrictions oncompetition in textiles and clothing has resulted in sizable losses in export earnings andproductive employment in many developing
countries. The combined negative income effect for developing countries caused by quotas
and tariffs on industrial-country imports
amounts to $24 billion annually, and theexport revenue loss is $40 billion (World
Bank–IMF 2002).
Impediments to competition take otherforms as well. Between 6 and 14 percent of thetariff lines of Canada, the European Union,
Japan, and the United States are subject totariff peaks, in some cases at rates well over
100 percent (Hoekman, Ng, and Olarreaga2001). Developing-countries’ exporters may
be displaced by high tariff peaks in Canada
and the United States (in textiles and clothing)and in the European Union and Japan (in agriculture, footwear, and food products). Even
though France exports 12 times more to theUnited States than Bangladesh, U.S. tariff
revenues on imports from Bangladesh wereroughly the same tariff revenues on imports
from France (Gresser 2002). Escalating
tariffs—in which protection is lower for primary products but increases as the local value
added increases—discourage development offorward processing. Chilean firms, for example, can export fresh tomatoes to the UnitedStates, paying a tariff of 2.2 percent; however,135gep_ch04.qxd 12/5/02 2:49 PM Page 136

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if they dry and package the tomatoes, the U.S.
tariff is 8.7 percent; and if they make salsa
out of the tomatoes for export, the duty is
11.6 percent (Schiff 2001). By reducing thedemand for higher-processed imports from developing countries, tariff escalation prevents
developing countries from diversifying exports
into areas of their competitive advantage.
These tariff structures are common in poor aswell as in rich countries (see World Bank
2002c: 45).
Another restraint on competition is frequent recourse to antidumping and othertypes of contingent protection. Antidumping
laws were originally created to counteract
predatory practices of foreign sellers into ahome market. This was the original rationale
for U.S. antidumping legislation of 1916. The
fear was that a foreign firm (or cartel) coulddeliberately price products low enough todrive existing domestic firms out of businessand to establish a monopoly. Once established, the monopolist could more than recoup its losses by exploiting its market power.
For predation to work, the monopolist or cartel would not only have to eliminate domestic
competition, but would also have to be able toblock entry by new competitors. It would,
therefore, need to have a global monopoly,

Table 4.1

need to convince the importing government toimpose or tolerate entry restrictions, or need
to be able to raise private entry barriers(Hoekman and Kostecki 2001).
In practice, post–World War II cases of successful predatory dumping are the exception,
not the rule. More than 90 percent of all antidumping investigations would never havebeen launched if a competition standard—potential threat of injury to competition—had
been used as a criterion (Messerlin 2000).13 As
it has evolved, antidumping has become a favored vehicle for restricting competition fromimports, and it is applied with increasing frequency by developing countries against eachother. Since 1995, countries have initiatedmore than 1,800 antidumping investigations(table 4.1). Although industrial countries havetraditionally been the main users of such measures, developing countries have been more
active in recent years, led by India, Argentina,
Brazil, and South Africa. In the seven years to
2001, developing countries initiated almost
two-thirds of all investigations, well in excessof their share in world trade. However, developing countries have also been the target ofnearly 60 percent of investigations, mostly initiated by other developing countries. The recent steep rise in antidumping investigations

Many antidumping investigations were initiated during the 1995–2001 period
Affected countries

Initiating country

Number of investigations
Industrial countries
Of which
United States
European Union
Developing countries
Transition countries
Percentage of investigations
Industrial countries
Of which
United States
European Union
Developing countries
Transition countries

Industrial
countries

UnitedStatesEuropean
Union

Developing
countries

Transition
countries

Total

511
128

102
17

313
67

1,086
363

248
114

1,845
605

79
15
379
4
28
21

0
6
85
0
6
3

46
0
242
4
17
11

146
165
718
5
59
60

30
66
131
3
13
19

255
246
1,228
12
100
100

31
6
31
33

0
2
7
0

18
0
20
33

57
67
58
42

12
27
11
25

100
100
100
100

Source: WTO Secretariat, as reported in World Bank–IMF 2002.

136

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puts the predictability and nondiscriminatory
application of trade policies at risk.
Removing these restraints on competition
from developing countries would have a big
development payoff. These issues and detailed
policy recommendations have been well analyzed elsewhere (see, for example, World Bank
2002c). Suffice it to say that dismantling bothworldwide trade barriers and agricultural subsidies could increase long-term growth in developing countries by as much as 0.5 percent
annually, which, when taken together withterms-of-trade improvements, could reduce
the number of people living in poverty by asmuch as 13 percent by 2015. One-third to
one-half of the welfare gains would accrue tothe developing world (World Bank 2002c).
Because of the growing importance of SouthSouth trade and the remaining high barriers
among developing countries, removing thebarriers to competition among themselves
would produce substantial gains (see WorldBank 2002a; and World Bank–IMF 2002).
These facts underscore the importance of the
Doha Development Agenda of the WTO andthe various regional efforts around the worldthat could lower trade barriers to developing
countries’ exports. Because not all countries
will benefit from some reforms (such as removing the textile quotas), a broader reformthat covers all trade issues and is linked todevelopment assistance is vital.

Private restraints on international
competition can raise prices
to developing countries
Besides policy barriers to competition, large
international companies with market power
can form cartels that fix prices, allocate markets, and restrain competition. Although tradereform and the expansion of potential competitors in markets around the world haveundoubtedly reduced the scope for private
cartels, the numerous international cartels uncovered in the 1990s suggest that market
forces alone do not offer complete protection
against price-fixing and market-allocation
arrangements that raise prices to developingT O

I M P R O V E

I N V E S T M E N T

A N D

C O M P E T I T I O N

countries. These cartels are typically illegal
when they adversely affect a country’s own
commerce. However, OECD governments
have no authority to prosecute cases whencartel activities function outside their national
jurisdictions and cannot be shown to affectprices of imports or domestic goods.
The 1990s saw the uncovering of several
international cartels. Prosecutions of international cartels picked up after 1993 when the
United States revised its anticartel enforcement practices to grant amnesty to the firstcartel member that cooperated with authorities. Before 1993, approximately one firm ayear applied for leniency under anticartel
laws, and big cases were rare; now, one firm amonth applies for leniency. U.S. fines against
domestic and international cartels during the
1990s totaled $1.7 billion. The publicity associated with these prosecutions (many of which
affected international markets as well as theUnited States) encouraged prosecutions byother enforcement agencies, including those in
several middle-income countries (for example,
Brazil and Korea). Antitrust authorities in the
United States and European Union alone
prosecuted 40 international cartels during the
1990s.
Cartels that have been uncovered throughlaw enforcement have had a substantial role inincreasing the prices to developing countries.
Although estimates vary, the average international price increases caused by international
cartels have been estimated to be on the orderof 20–40 percent. The estimated price increases resulting from cartels, as shown in six
high-profile international cartel prosecutions(table 4.2), vary widely—from 10 percent for
stainless steel tubes to 45 percent for graphite
electrodes. Cumulative overcharges to developing countries over the life of the cartels inthe six cases ranged from $3 billion to $7 billion, depending on whether SITC or HS codes
are used. Developing countries imported 12
products that had a value of sales of $11 billion in 2000 and that were sold by international cartels prosecuted during the 1990s(figure 4.7); if price collusion were to raise137gep_ch04.qxd 12/5/02 2:49 PM Page 138

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Table 4.2

International cartels can be expensive: estimates of sales and overcharge
Possible overcharge todeveloping countries

Cartel sales
Product

Vitamins
Citric acid
BromineSeamless steel tubes
Graphite electrodes
LysineYears ofcartelNumberof firms

SITC

HS

Price
increase

SITC

HS

Fines

111
2
8
23
5

$26.4 billion$9.9 billion$598 million$26.6 billion$9 billion$4.8 billion$10.8 billion$447 million$409 million$21.7 billion$7 billion$913 million

35%
20%
15%
10%
45%
10%

$3.05 billion$402 million$46 million$1.63 billion$1.35 billion$294 million$1.71 billion$67 million$8 million$1.19 billion$975 million$43 million

Almost $2 billion
Over $250 million$7 million
99 million euros
Over $560 million
About $200 million

1990–99a
1991–95
1995–98
1990–95
1992–97
1992–95

SITC  Standard International Trade Code; HS  Harmonized System Classification.
Notes: Figures for each cartel span the entire period of the conspiracy. Sales are approximated using export statistics from countries of origin of indicted
firms and thus exclude domestic sales. If participating firms are multinationals and the locations of their subsidiaries are known, sales are calculated bytaking into account the exports of countries of subsidiaries. When that information is unavailable and production is understood to be global, sales arecalculated by using exports of all countries producing the cartel product. Overcharge refers to imports to developing countries / (1  price increase) 
price increase. Sales calculations provided are based on the SITC Revision II and the HS 1988.
a. Because the cartel ended in February 1999, sales and overcharge estimates are aggregated from 1990 to 1998.
Source: Connor (2001), Levenstein and Suslow (2001), OECD (2000), and World Integrated Trade Solution database.

questions about the effectiveness of prosecution as a deterrent for cartel behavior. Moreover, 24 of the 40 cartels prosecuted by theUnited States and the European Union lasted
for at least four years, indicating that market
forces are not always adequate to rapidly
eliminate cartels. The history of cartels

prices by an average 20 percent, the total overcharges would have reached almost $2 billion
in 2000.
Despite the rise in prosecutions, reining
in international cartels remains difficult. The
fines imposed by authorities often fall wellshort of the estimated overcharges, raising

Figure 4.7 Imports affected by cartels rose from 1981 to 2000 for both richand poor countries
Total imports of twelve products where proven cartels existed(in billions of dollars)
35
30
25

Imports to industrial countries
20
15
10

Imports to developing countries
501981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year
Source: World Bank staff.

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Box 4.6

A G R E E M E N T S

T O

I M P R O V E

I N V E S T M E N T

A N D

C O M P E T I T I O N

The lysine cartel, 1995–2001

Lysine is a food additive used in hog and poultry
feeds. The global lysine cartel lasted from 1992
to 1995. During that period the five participants
controlled more than 97 percent of global capacity.
Cartel members engaged in price-fixing, allocating
sales quotas, and monitoring volume agreements. In
1994, at the peak of the cartel’s effectiveness, theprice of lysine reached about $1.20 per pound, approximately $0.50 above the competitive price level.
Estimates of the overcharges to U.S. customers
during this period vary and are as high as $141 million. Although no formal analysis of non-U.S. overcharges is available, the observed lower prices in
Asia suggest overcharges in the rest of the world
were lower than those in the United States. According to Connor (2001) a reasonable projection of the
global overcharge by the lysine cartel would be in
the $200 million to $250 million range. A more conservative estimate assumes a 10 percent overcharge
on $1.4 billion in global sales during the life of thecartel, for a total of $140 million (OECD 2000: 16).

indicates that some operate intermittently overdecades.14

New initiatives to discipline illegal
international cartels
Firms will be deterred from price fixing andforming cartels if the fines for doing so, multiplied by the probability of being caught (thatis, the expected value of the cost), exceed theextra profits that result from this anticompetitive behavior (that is, if the potential punishments for creating cartels exceed the benefits).
Reforms that raise the sanctions on cartels andthat increase the probability of successfullyprosecuting cartels will tend to dissuade more
firms from forming cartels, whether domestic
or international. The secret nature of mostcartel agreements poses a special problem
because it implies that governments must actively search for evidence or must encourage
cartel members to come forward with evidence; otherwise, firms will perceive the prob-

The cartel had a significant effect on both potential producers and users of lysine. Lysine production in 1994 was at least 20 percent less than undercompetitive conditions, resulting in lower production
among the feed and meat industries that dependon lysine. Moreover, the cartel limited potential
developing-country competitors by using price discrimination across regions, and it froze the relative
positions of the leading firms in the market, whencompared with the very fluid situation before theconspiracy. Although a few relatively small producers entered the market during the 1990s (mainly in
Hungary, the Slovak Republic, and South Africa),
most new entrants began production only after thelysine cartel had been broken up in 1995. China, inparticular, has been a source of increasing lysine production. Nevertheless, the five original participantsin the cartel continued to control 95 percent of
global capacity at the end of the decade.
Source: Connor (2001).

ability of prosecution to be very low (Evenett,
Lehmann, and Steil 2000).
One option for curbing illegal international
cartels is to extend further the extraterritorial
reach of industrial nations’ anticartel laws
(Hoekman and Mavroidis 2002). When acompetition authority in an industrial economy uncovers a cartel that affects markets
both inside its own borders and in other countries, then that authority could take enforcement action on behalf of all affected nations.
A stronger version would have the competition authority take action even if the cartel
affected a foreign market without affecting thehome market. In both cases, the authority
could request help in collecting evidence fromenforcement bodies in other nations. Fines
and sanctions against the cartel would be determined on the basis of its detrimental effects
on all affected economies.
Yet another option is to grant governmentsof developing countries—or their citizens—139gep_ch04.qxd 12/5/02 2:50 PM Page 140

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2 0 0 3standing in the major OECD countries sothose affected could initiate private injury
suits against companies headquartered under
the jurisdiction of a particular antitrust authority. Because most antitrust actions are driven by private complaints and through private
suits, such legal changes would markedly
strengthen the hand of consumers and businesses in developing countries to curb private
restraint practices. The principal attraction ofsuch a proposal is that it would allow developing countries to benefit from the sophisticated investigative powers and regulatory
expertise in the OECD competition authorities. The enforcement record in the 1990s suggests that the overwhelming majority of cartel
members have their headquarters in industrial
economies. A drawback to the proposal is thatextraterritorial application is a perennial
source of tensions among countries, and the
incentives are low for OECD governments totake actions against their own firms for effects
in foreign markets.
A more modest option for reform could
focus on notification and information exchanges by national enforcement authorities.
This exchange would build on the growing
number of bilateral cooperation agreementson competition matters, thus expanding theirscope to include many more economies. The
objective here is to raise the probability of successfully prosecuting cartels by encouraging
the sharing of conspiracy-related information
between enforcement authorities. The modalities for this type of international cooperation
have received considerable attention in recent
years, not the least of which is the OECD’s
nonbinding Recommendation on Hard Core
Cartels. However, this approach essentially offers gains only to those economies that haveeffective competition laws, and many developing economies do not. Furthermore, theamount of information that can be exchanged
on cartel cases today is highly constrained
because most countries have laws against
sharing confidential information. The original
intent of those laws was to protect legal business secrets and plans, and the confidentiality

140

provisions have, unfortunately, been applied
to illegal conduct uncovered during cartel investigations. These restrictions on informationexchange are especially worrisome at a time
when so much evidence about international
cartels is being collected through national
leniency programs, thereby suggesting that thepotential for information exchange could beconsiderable.
Another approach is a multilateral agreement. Proponents of including competition on
the multilateral agenda have gravitated toward a relatively narrow focus. They are seeking disciplines on (a) the so-called core issuesof nondiscrimination, national treatment, andtransparency; and (b) private “hard core” international cartels. These disciplines would
apply to all WTO members, both industrial
and developing, with technical assistance andcapacity building envisaged. Most recent discussions have emphasized the need for voluntary international cooperation (Anderson andJenny 2001).15
In summary, policies that help developing
countries discipline international cartels more
effectively would have a potentially large benefit, for consumers in rich and poor countries
alike.

Officially sanctioned private restraints canhurt trade to developing countries . . .
Officially sanctioned restraints on trade makeup the third major category of competition
restrictions that adversely affect developing
countries. These restraints take the form of
exemptions from domestic antitrust laws andpertain to certain types of international activity. Many governments legally permit theirown private firms to cartelize export markets—as long as markets affected are outside
the country, and export cartels do not provide
an opportunity for producers to fix prices
at home. Indeed, numerous economies have
explicitly exempted export cartels fromtheir domestic competition laws—essentiallyproviding some legal cartel privileges fortheir national firms, but not foreign firms(table 4.3). U.S. soda ash producers have

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Table 4.3

A G R E E M E N T S

T O

I M P R O V E

I N V E S T M E N T

A N DNational exemptions to competition law for exporters

CountryType of exemption

Reporting requirement

Australia

Contracts for the export of goods or
supply of services outside Australia
Joint ventures for exports, as long as there
are no effects on the Brazilian market
Export activities that do not affect domestic
competition
Agreements that contain restrictions that aim
to improve the competitive power ofundertakings on the international market
Activities that do not affect the domestic market
Activities that do not affect the domestic market
Agreements regarding exports or among
domestic exporters
Activities that do not affect the domestic market
Activities that do not affect the domestic market
Associations and cooperatives that export
Arrangements that relate exclusively to exports
and that do not affect the domestic market
Activities that do not affect the domestic market
Activities that do not affect the domestic market
Webb-Pomerene Act: activities that do notaffect domestic competition
Export Trading Companies Act: strengthened
immunities granted by Webb-Pomerene Act

Submission of full particulars to the national
authority within 14 days
Approval by the national authority

BrazilCanadaCroatia

Estonia
HungaryJapan
LatviaLithuania
MexicoNew ZealandPortugal
SwedenUnited States

C O M P E T I T I O N

None
Notification of the agreement to national authority
within 30 days after conclusion of the agreement
None
None
Notification of and approval by the industry
administrator
None
None
None
Authorization of the national authority
None
None
Webb-Pomerene Act: filing of agreements with the
U.S. Federal Trade Commission
Export Trading Companies Act: Certificates ofReview provided by U.S. Department of Commerce

Source: Evenett and Ferrarini (2002); drawn from OECD (1996), OECD (2000), and <http://www.gettingthedealthrough.com>(accessed May 2002).

taken advantage of these provisions in U.S.
law to form an export cartel, which has
subsequently been the target of European
and Indian enforcement actions. Generally,
these cartels may attempt to raise prices intheir export markets to the detriment ofoverseas consumers. Their success depends on
the number of other foreign competitors inthese markets. Because competition is more
likely to be limited in the smaller markets
of developing countries, it is probable that developing countries are adversely affecteddisproportionately.
Because cartel registers are secret in Europe
and Japan, and virtually secret in the UnitedStates, information on their extent, products,
and geographic coverage is nil. The legal exemptions are known, and the latest available
information—from the OECD in 1974—has
indicated a broad proliferation. The initialrationale for export cartel exemptions was that
small exporters could join to share theallegedly substantial costs of marketing theirproducts abroad. Even if such arguments werelegitimate in the past, most small- and mediumsized enterprises in industrial economies today
export without a need for cartels, so the rationale is moot.
Another exemption from OECD antitrust
laws is maritime transport, which inadvertently put developing countries at the mercyof price fixing. The exemption in U.S. law
extended to maritime transport has facilitated, through shipping conferences, collusive
arrangements in ocean-liner shipping. Agreements among private shipping companies
have a long history, beginning with trade between the United Kingdom and India in the1870s. Such arrangements have taken different forms, including the conclusion of agreements on uniform freight tariff rates andconditions of service, the establishment of exclusive or preferential working relationships
between shipping lines, or the integration ofshipping networks through strategic alliances.
The power of such arrangements haseroded in recent years because outside shipping lines have gained a significant share of141

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Table 4.4 Breaking up floating cartels
could help developing countries(Economic effects of ending private restrictions
on ocean-liner competition)
EffectAmountReduction in price of ocean transport
Projected total savings for U.S. imports
Projected savings for developing-country
imports

20%$2.1 billion$2.3 billion

Source: Fink, Mattoo, and Neagu (2001); World Bank
(2002c).

the market and regulators have moved to encourage greater price competition. Nonetheless, Fink, Mattoo, and Neagu (2001) conclude that a breakup of cooperative working
agreements and price-fixing arrangements
among the major private carriers could reducetransport prices by 20 percent on U.S. routes,
for a savings of $2 billion or more (seetable 4.4; see also Francois and Wooton 2001).
If developing countries could save the same
percentage of their import costs, then their
total import bill would fall by $2.3 billion.
This figure is probably an underestimate of
the effect of breaking up private constraints
on ocean trade services for developing countries. Their freight charges are more likely tobe subject to price-fixing than are freightcharges on industrial-country routes because
low traffic volumes limit the number of commercially viable competitors. For example, theEuropean Commission found that the Associated Central West African Lines abused its
dominant position by providing rebates toshippers that complied with its policies, aswell as carrying out other anticompetitive
practices.16. . . and international agreement could
rein in their adverse effects
Multilateral efforts to curb national export
cartels, as well as to rein in private restraints
in regulated industries that have been rooted
in exemption from antitrust laws, are particularly well suited to the WTO. Most governments today either encourage or acquiesce tonational cartels that adversely affect markets

142

beyond their borders. Government support
for beggar-thy-neighbor export cartels isanachronistic in an era of global trade rules.
Reciprocal international agreements offer thepromise of reducing foreign distortions todomestic markets in return for commitments
to desist from such practices. Agreements on
international cartels involve giving up somerents from exporting in return for the benefitsof more competitive markets at home.
A multilateral accord to curb export cartels
would probably benefit developing countries.
An alternative and less-ambitious approach is
to narrow the coverage to sectors in which it
can be demonstrated that small- and mediumsized enterprises cannot compete internationally without a mechanism to share burdens
such as marketing costs, and so on. Because
the extent of injury to foreign consumers is
not known, a minimalist policy toward export
cartels involves disclosure. If export cartels areallowed to retain their legality, governments
should agree to require that firms seeking toestablish an export cartel publicly register assuch—and that those registries be updated annually and made accessible to the public overthe Internet. Furthermore, if these cartel exemptions were specifically to aid small firms,
then there is no argument for permitting large
firms to participate.
Similarly, countries could agree to end antitrust exemptions for maritime transport and,at the same time, give standing so exporters
in developing countries that are harmed bysubsequent cartel activities can sue under antitrust statutes. This change would have significant effects by unleashing competition inthis sector and by altering an arrangementthat today drives up the cost of exportingfrom many developing countries.

International collaboration can strengthen
domestic competition policies
Domestic policies in developing countries
have a significant effect on competitive conditions. Chapter 3 underscored the particular importance of policy barriers to competition, particularly in trade, in restrictions on

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incoming FDI, and in restrictions on newentry (foreign or domestic) in regulated industries. Chapter 3 also concluded that the potential role of a domestic competition agency
was shaped largely by the domestic institutional environment. In some countries withstrong legal and judicial systems, a competition agency could help augment competition;in other countries with weak legal and judicial
systems, establishing a competition agency
could be counterproductive if they become asource of rent-seeking and corruption.
International discussions on trade policy
have, since their inception, seen domestic
competition policy as an issue associated withmarket access. Competition policy is intrinsically related to the principles of national treatment and MFN treatment insofar as competition law allows recourse to address certain
kinds of discriminatory policies and arrangements that deny foreigners access to markets.17
The launching in 1997 of the WTO Working Group on Trade and Competition Policy
signaled the beginning of the most recent international discussions about the interface
between trade and competition, as well as thepossibility of multilateral cooperation oncompetition law. Not all domestic competition
matters give rise to international trade problems, and vice versa. There are situations
when the lack of, or inappropriate applicationof, competition law can impede trade andmarket access, however. After five years of
discussions, governments have progressively
retreated from ambitious applications (such as
harmonization) to proposals that focus oncore principles, transparency, nondiscrimination, and procedural fairness. Governments
may perhaps also focus on provisions addressing illegal international cartels (see discussion
above). Aside from these general principles,the exact content of national competition
laws could vary considerably in the range ofconduct and structural disciplines that they
include.
From a national point of view, for competition law to be a priority it must yield ahigher payoff than other choices. Competi-T O

I M P R O V E

I N V E S T M E N T

A N D

C O M P E T I T I O Ntion law is technical and requires the use ofskills that are in short supply in many developing countries. Building capacity to applycompetition legislation effectively will taketime. Given that competition law is applied
on a case-by-case basis, dealing with systemic
trade and investment barriers and with government regulations that restrict competition
may generate a higher rate of return (seechapter 3). Kee and Hoekman (2002) haveinvestigated the effect of the existence of acompetition law on estimated industry
markups over cost. They used cross-country,
cross-industry time series panel regressions
that include data on the number of firms byindustry (turnover), sales (market size), andimport competition. They concluded that
antitrust legislation on its own has no effecton markups, but that imports and entry havea major and statistically significant effect inreducing markups (see chapter 3). Competition law is found to have an indirect effect,
however, by reducing the first order marginal
effect of imports and by reinforcing the marginal effect of domestic competition. That
effect is stronger in the more-developed andlarger economies.
The effect of government policies that restrict competition for nontradables may be
more important from a development perspective than is antitrust enforcement, because
those policies affect the price and quality of
key intermediate inputs that determine thecompetitiveness of industries on world markets (for example, Fink, Mattoo, and Neagu
2002; Francois and Wooton 2001). Depending on the capacity of government, a role may
exist for a competition agency that reviews
new policy and regulatory barriers to competition (see chapter 3, this volume, as well as
Anderson and Holmes 2002).
As Winters (2002) notes, administration ofcompetition law is complex, and its misapplication can have a costly and chilling effect on
investment. Issues relating to the institutional
design, the independence of investigating authorities, the effective judicial review andappeal mechanisms, and the availability of143

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2 0 0 3expertise—both legal and analytical—are all
critical issues for the effective application of
antitrust law. Therefore, the development ofcompetition law in many countries has occurred gradually over a long period, and continues to evolve. The necessary administrative
apparatus cannot be put into place within ashort time frame. The institutional guarantees
necessary for a competition authority to be
independent from eventual political influence(so that it can concentrate on its mandate) require government acceptance that branches of

the national administration will operate outside its direct control. Until a few decades ago
most European Union member states had noexperience in the field of antitrust. Before agovernment determines national priorities,
both the costs and benefits of competition enforcement ought to be considered, including
the possibility of perverse outcomes throughcapture or corruption.
This discussion suggests that the reciprocal
bargaining and enforcement framework of
the WTO is less well suited to collective action

Box 4.7 International cooperation aids
competition policy

Several entities outside the WTO have activities thatare germane to competition policy. For example,
the OECD launched a Global Forum on Competitionin October 2001 to stimulate a comprehensive policy
dialogue about competition, and that goes beyond its
previous activity of providing technical assistance.
The Forum, backed by the OECD’s Committee on
Competition Law and Policy, engages in high-level
discussions with key officials from member and nonmember countries, including countries that do nothave well-developed competition enforcement authorities. The objective of the Forum is, first, to encouragecommon understanding and sharing of experiencesamong a larger number of competition officials and,second, to generate benefits through cooperation,
conflict prevention, and voluntary convergence. Its
first meeting successfully highlighted the role ofcompetition policy and of its authorities in economic
reform; it also fomented greater international cooperation on such matters. The latest semiannual meetingin February 2002 discussed the merits of competition
policy for developing economies, international cooperation in merger and cartel cases, capacity building,and technical assistance. In addition, the forum benefits from contributions of regional organizations suchas the Common Market for Eastern and Southern
Africa and international organizations such as theWorld Bank, UNCTAD, and the WTO.
Another example of an entity outside the WTO
with activities germane to competition policy is the144

ICN, created on October 25, 2001, to deal with international antitrust enforcement through regularconsultations between government officials, private
firms, and NGOs from around the world. According
to its mandate, the ICN will “formulate proposals
for procedural and substantive convergence througha results-oriented agenda and structure.” Its special
status stems from the fact that it is maintained by theenforcement authorities themselves, has voluntary
membership, and is not bound by rules, but rather
by a community of interests. The first annual conference was held in Italy during 2002 and sparked discussions on reforms to the merger review process;the advocacy role and activities of competition agencies (especially in developing and emerging
economies); and recommendations on best practices.
Individual enforcement authorities will have the flexibility to make decisions on the most suitable meansof implementing the recommendations. The ICN willaddress complex issues, and newly established competition authorities will no doubt benefit from thecollective experience of other member agencies.
Though it is too early to gauge the success of
the Global Forum on Competition and the ICN interms of fostering global cooperation, they play auseful role in disseminating information on bestpractices for implementing a competition law policy.

Source: World Bank staff.

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on competition law than international collaboration through development assistanceand other venues. To be sure, international
negotiations can help reinforce progressive
domestic reforms in competition law (seeBirdsall and Lawrence 1999).18 However, in
this complex area of domestic regulation, one
size does not fit all, and, as many WTO members have noted, cooperation on competitionlaw policy requires establishing a domestic
enforcement capacity that at present is beyond
the reach of many developing countries. Other
channels can help disseminate best practices tocountries wishing to strengthen their competitive conditions. Several agencies and forums
have work programs on international competition policy. These agencies include theOECD, UNCTAD, and the International
Competition Network (ICN) (see box 4.7).
The OECD and UNCTAD have developed
their own guidelines or recommendations fortackling international cartels, but they have nopowers of enforcement or investigation. The
nascent ICN has focused more on international mergers and acquisitions, and it is intended to facilitate information exchange anddissemination of best practices.

Conclusions

For both investment and competition policy,
domestic reforms that are implemented
unilaterally in the national interest of promoting a sound investment climate and a morecompetitive economy are likely to yield themost direct and positive effect on growth andpoverty reduction. The international community can assist the reform process throughmultilateral and bilateral development assistance, government-to-government information exchanges, and private efforts to informand assist reform-minded governments. Countries may be able to use regional and multilateral agreements to motivate progressive reforms at home at the same time that they use
reforms to leverage reforms abroad to promote development. Yet to be effective, these
agreements must be designed to achieve spe-T O

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C O M P E T I T I O N

cific objectives that will be important to developing and reinforcing positive domestic
policies rather than distorting them.
For investment policy, international agreements may help increase flows of foreign
investment, but evidence suggests that thesebenefits are likely to be limited unless they
focus on creating nondiscriminatory termsof liberalization and on eliminating adverse
policy externalities. Agreements that curb
beggar-thy-neighbor investment policies that
distort investment location are particularly
important in two areas. One critical area isinvestment-distorting trade barriers—that is,border protections, agricultural subsidies, tariff escalation, and other practices that bias investment flows away from developing countries’ export activities because such barriers
discourage imports from those countries. A
second critical area is disciplining competition
among governments to lure foreign investment through wasteful investment incentives.
An important initial step is developing an inventory of the extent, costs, and distorting
consequences of those incentives. Agreements
should be carefully designed to limit theirscope to areas where international externalities exist. In the case of the WTO, the design
should focus on reducing discrimination andincreasing market access. International cooperation on the design of domestic regulation ismore effectively provided through development assistance—whether bilateral, regional,or multilateral.
For competition policy, an agreement
would potentially have large benefits if it
addressed those restrictions on competition in
the global marketplace that most adversely
affected developing countries: policy barriers
to competition that hurt exporters, private restraints in the form of international cartels,
and officially sanctioned private restraints emanating from antitrust exemptions. Much
more information is needed in this area on theprevalence and effects of policies that restrict
competition. The international community
can collaborate with developing countries by
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to foster mutual learning, information exchanges, and cooperation on competition
policy.

Notes
1. WTO 2001a, Paragraphs 20 and 23 in the DohaWTO Ministerial Declaration. The need for enhanced
technical assistance and capacity building in theseareas was also recognized.
2. See Ostry 1997; see also Hart 1996.
3. United States 1998, as cited in Gilpin 2000: 184.
4. See Smythe 1998.
5. South-South FDI is calculated by comparing
developing countries’ FDI inflows with recorded outflows from other regions. This figure may be more accurate than others because developing countries often
underreport FDI outflows. In addition, round trippingof a country’s own capital can overestimate the FDI
figure (World Bank 2002a).
6. For a cogent description of the predominance ofservices in the NAFTA reservation lists, see Rugman
and Gestrin 1994. See also Gestrin and Rugman 1993.
7. By 2003, all members must have completely
phased out performance requirements that were inplace at the time of the agreement and that were grandfathered through a notification process. All 27 notifications of policies not consistent with the agreement
were from developing countries. Almost half of notified measures related specifically to the automotive sector. Many of these performance requirements havealready been phased out during the transition period.
Ten countries that requested an extension of the transition were granted an additional four years, to 2003.
8. WTO members are faced with two options.
First, they can agree to re-open the agreement, which
seems unlikely. Second, they can seek to reduce or elaborate on the length of the Annex Illustrative List. The
issue is that, even though both notifications and disputes have, to date, centered primarily on the “illustrated” list (notably on local content and, less so, on
trade-balancing requirements), the agreement arguably
prohibits a greater range of as-yet unspecified performance requirements. Introducing greater specificity inthe language could enlarge the effective coverage of theagreement or confine it to the illustrated list.
9. Within the framework of the ASCM the scopefor discipline lies in the challenge of an investment incentive that can be shown to be specific, to be within
the meaning of the agreement, and to be contingent onexport or on having an “adverse effect” on the trade ofanother member. The difficulty of such a challenge depends on the specific types of policies that are in question. One of the key factors in determining a subsidy is

146

the “financial contribution” that could cover the rangeof fiscal and financial incentives that are used by developed and developing countries. These disciplines
have yet to be tested. In the case of services, the GATS
provides a mandate for developing “necessary multilateral disciplines to avoid such trade-distortive
effects.” The work has progressed slowly.
10. There is evidence of significant investment diversion away from the Caribbean Basin countries and toward Mexico, but Mexico’s adherence to NAFTA has
almost certainly been a more important motivating factor than the use of fiscal or financial incentives, which
it can generally ill afford.
11. This is not to deny the potential risk of “investment poaching,” including within developing countries. Studies have indeed documented the negative
welfare implications that derive from incentive packages that merely transfer investment from one location
to another without creating new jobs or improving
productivity. In the case of Brazil, for instance, the consensus among researchers is that heavily indebted
states have granted very large tax breaks to automotive
companies to build factories that the companies had
intended to build in Brazil anyway (Rodríguez-Poseand Arbix 2001).
12. Producer support estimates are the annual
monetary value of gross transfers from consumers
and taxpayers to support agricultural producers. These
numbers are taken from World Bank–IMF 2002.
13. The fact that predation has very little to do withantidumping as it is practiced is perhaps best illustrated
by the United States, which has two antidumping
statutes. One, the Antidumping Act of 1916, maintains
a predation standard for antidumping; the other, theTariff Act of 1930, as amended, has a price and costdiscrimination standard. Invariably cases invoke thesecond act and not the first.
14. Epstein and Newfarmer 1980, for example,
found that a cartel for heavy industry operated off andon from December 1939 through the mid-1970s, withovercharges of more than 20 percent on sales of steam
turbines and other products.
15. WTO members with established competition
enforcement seem to insist that a precondition for cooperation is that developing countries adopt legislationand establish enforcement capacity: “[C]ooperation
with respect to competition matters [is] only possible
when a competition regime [is] already in operation;that is, when there [is] a domestic competition law ofsome sort and a domestic competition authority existed with sufficient powers to effectively enforce that
law . . . . While cooperation could be provided within avoluntary framework of mutual interest, it would not
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markets unless it also developed a national competition
law” (WTO 2001c: 27, para. 79).
16. See World Bank 2002c for a fuller discussion ofconferences on ocean liners.
17. See WTO 2002.
18. Birdsall and Lawrence (1999) write: “When developing countries enter into modern trade agreements,
they often make certain commitments to particulardomestic policies—for example, to antitrust or othercompetition policy. Agreeing to such policies can be in
the interests of developing countries (beyond the trade
benefits directly obtained) because the commitment
can reinforce the internal reform process. Indeed, participation in an international agreement can make feasible internal reforms that are beneficial for the country
as a whole [and] that might otherwise be successfully
resisted by interest groups.”

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Appendix 1
Regional Economic Prospects

East Asia and Pacific
Recent developments

T

EAST ASIA ECONOMIC RECOVERY
that began in late 2001 continued tostrengthen in the first half of 2002, but
momentum slowed after the summer and uncertainties have increased. Output growth indeveloping East Asia is estimated to have risen
to 6.3 percent in 2002 from about 5.5 percent
in 2001, led by China growing at more than
7 percent. Output growth has rebounded
most rapidly in those economies, such as theRepublic of Korea, Malaysia, Taiwan (China),
Singapore, and Thailand, that had been hardest hit by 2001’s steep fall in world trade andhigh-tech demand. Annualized growth in thefirst half of 2002 over the last half of 2001
jumped to a 5- to 10-percent range in most ofthese economies, although industrial production and trade data indicate that output
growth softened in the second half of the year.
Elsewhere in the region growth had in any
case slowed less among transition economies
such as China and Vietnam, because of continued strength in domestic demand and aless marked slowdown in exports. Growth inIndonesia and the Philippines had fallen lesssharply to a 3- to 3.5-percent pace in 2001
from a 4- to 5-percent pace in 2000, andthe cyclical rebound in these countries (whilemore pronounced in the Philippines), has also
been less clear-cut than elsewhere in theregion.
HE

The recovery so far has been underpinnedby both external and domestic demand. A
gradual pickup in world conditions from2001’s severe global slowdown supported a
revival of exports, including exports in the important high-tech sector. U.S. dollar prices formany important East Asian primary commodity exports such as rice, rubber, palm oil, coconut products, and lumber also rose sharply
after late 2001, although they rose from thevery low levels reached following several years
in which steep declines in the terms of tradeinflicted large income losses in many East
Asian countries. Intraregional exports havebeen strong, most notably those to China,
which jumped an amazing 50 percent in thefirst half of 2002. Supportive monetary and(in several cases) fiscal policy conditions have
fueled domestic demand. Household spending
in the region has been especially robust, boosting spending on cars and other consumer
durables, but private investment still lags.
Debt-equity ratios, though they have fallen
in some instances, remain high by international standards in most cases, and together
with low corporate profitability, continue todepress the investment climate and undermine
the prospects for accelerated medium-term
growth.
World semiconductor sales and orders forhigh-tech equipment in the United States rebounded strongly in late 2001, but growth
rates had already peaked before the summerof 2002, and the levels remained far below the151gep_app01.qxd 12/5/02 1:04 PM Page 152

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2 0 0 3Figure A1.1 Emerging high-tech Asia:
semi-conductor dollar sales andindustrial production*(percent change, 3m/3m saar)
125

50
Semiconductor
sales (left axis)

100

40

75

30
Industrial production(right axis)

50

20

25

10

0

0

25

10

50

20
Jan.
2000

Jul.
2000

Jan.
2001

Jul.
2001

Jan.
2002

Jul.
2002

Note: Through August 2002. *Rep. of Korea, Malaysia,
Singapore, and Taiwan (China).
Source: SIA and national sources through Datastream,
World Bank staff estimates.

record levels of 2000 (figure A1.1). A sharp fallin North American semiconductor equipment
bookings in August and September suggeststhat this year’s incipient revival in the depressed
global high-tech industry may have faded. Several East Asian countries report some slippage
in August-September export and industrial
production growth from the high rates reachedaround midyear.
Steep falls in global equity markets in June
through September, evidence of renewed
weakness in industrial country growth, continued turmoil in emerging markets, risingworld oil prices, and terrorist attacks in thePhilippines and Indonesia are among the factors that have substantially increased uncertainty about prospects for the region.

Near-term outlook
How well are East Asian countries able to rideout new external and internal shocks that may
arise? Here the experience of the last two
years is cautiously encouraging. Neither theserious export decline of 2001 nor the hefty
terms-of-trade losses of recent years led to a
new wave of corporate and financial failuresin the countries previously hit by the 1997152

crisis. Local East Asian financial markets havebeen remarkably resilient in the face of the
global equity and emerging market turmoil.
On balance, countries in the region appear
comparatively well placed to weather the present high levels of external risk, especially
if they can build on recent successes and continue to advance reforms that further reduce
their vulnerability to external shocks and foster sources of domestic productivity growth.
Improvements in macroeconomic conditions
have been key to cushioning the impact ofexternal shocks and volatility in international
capital markets on East Asian countries overthe last three years. Most countries havestrengthened national balance sheet positions
by running continuous current account surpluses since the 1997 crisis, reducing foreign
debts (including short-term debt), and building up foreign reserves. The adoption of more
flexible exchange rate regimes has also allowed
countries to adapt to external shocks moresmoothly (while the recent fall in the U.S. dollar has alleviated concerns about a loss ofcompetitiveness in countries with currencies
on a dollar peg, such as China and Malaysia).
A potential source of macroeconomic vulnerability in East Asia, however, is the higher
level of public sector debt (including contingent liabilities) accumulated after the 1997
crisis in several countries. Public debt levels
are quite high in Indonesia and the Philippines,
and are not insignificant elsewhere. Public
debt-to-GDP levels are now starting to fallbecause of rising currencies and lower interest
rates, and well-judged fiscal policy measures
can build on this trend so as to secure mediumterm fiscal sustainability.
Private investment in the crisis-affected
countries still remains weak, compared withpre-1997 crisis levels. However, these peaklevels were based on overoptimistic expectations and abundant foreign capital. Continued
economic growth, macroeconomic stability,
low interest rates, rising currencies, and policy
efforts to improve the investment climate
should lay the groundwork for an investment

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revival in due course. Equity markets in East
Asia also fell sharply in this period, but overthe last one or two years they have generally
outpaced industrial country equity markets.
In countries with flexible regimes, currencies
generally rose against the dollar during 2002
while remaining steady or depreciating modestly against the yen. The stronger trend incurrencies occurred despite the fact that domestic interest rates in most countries weresignificantly lower than average 2001 levels,and is striking evidence of improving investor
perceptions of the region.
The October terrorist attack in Bali isalso expected to reduce near-term growth inIndonesia. Receipts from tourism represent 4 to
5 percent of gross domestic product (GDP) in
Indonesia, and in Southeast Asia generally.
Indonesian tourist arrivals could fall byaround 20 percent, based on the experience ofthe 1997 terrorist attack on tourists in Luxor,
the Arab Republic of Egypt, and the impact ofprevious political unrest in Indonesia itself.
Lower levels of tourist arrivals and the adverse
impact of the attack on consumer and busiTable A1.1

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P R O S P E C T S

ness confidence could reduce Indonesia’s
growth by 1 percentage point in 2003. Governments in Southeast Asia must now grapple
with a major security challenge that also has
potentially divisive domestic political implications—all at a time when many countries are
moving into the next turn of their electoral
cycles. A loss of focus on development andreform priorities could result.
In this environment, acceleration of growthis unlikely, although there are also no signs of
sharp deterioration. Regional GDP is expected
to grow 6.1 percent in 2003 and 6.4 percent in2004. Growth in the region, excluding China, isexpected to reach 3.8 and 4.3 percent in 2003
and 2004 respectively. Median inflation is expected to remain low, albeit probably above thehistorically low 2.5 percent in 2002. With export volumes growing at a rate of around 9 percent, the current accounts remain on average at
a comfortable surplus of 2.5 percent of GDP.

Long-term outlook
East Asian countries face growing demands
for better-quality public goods and services,

East Asia and Pacific forecast summary(percent per year)
Baseline forecast
Growth rates/ratios

Real GDP growth
Private consumption per capita
GDP per capita
Population
Gross domestic investment/GDPa
Inflationb
Central gvt. budget balance/GDP
Export market growthc
Export volumed
Terms of trade/GDPe
Current account/GDP
Memorandum items
GDP growth: East Asia excluding China

1991–2000

2000

2001

2002

2003

2004

2005–15

7.7
5.8
6.4
1.2
28.7
5.6
1.2
9.7
11.4
0.0
0.5

7.0
6.0
5.9
1.0
29.2
5.0
3.3
14.1
22.5
0.0
3.6

5.5
6.2
4.5
0.9
30.1
6.6
3.3
2.5
2.5
0.4
2.7

6.3
5.7
5.4
0.9
32.8
2.5
3.6
3.6
15.9
0.5
2.7

6.1
5.2
5.2
0.9
33.9
3.6
3.4
9.2
15.7
0.1
2.7

6.4
5.6
5.6
0.8
34.9
3.6
3.3
8.7
11.3
0.3
2.5

6.2
5.6
5.4
0.7
30.4
…
…
…
…
…
…

4.5

5.4

2.3

3.6

3.8

4.3

5.0

… Not available.
a. Fixed investment, measured in real terms.
b. Local currency GDP deflator, median.
c. Weighted average growth of import demand in export markets.
d. Goods and nonfactor services.
e. Change in terms of trade, measured as a proportion to GDP (percentage).
Source: World Bank baseline forecast, November 2002.

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2 0 0 3not least for better law and order. Protecting
the lives and property of the public and upholding rule of law are essential complements
to the ongoing emergence or consolidationof representative or democratic government in
the region, as well as a basic underpinning for
economic development. The Bali terrorist attack underlines the importance of strengthening security and law and order, through bothnational and cooperative regional efforts.
Continued public sector and governance reforms are important if greater fiscal discipline in
East Asia is to be combined with meeting public demand for more and better public goods
and services, such as law and order, health, education, basic research, technology dissemination, and infrastructure generally. Many of thesethings are valuable to consumers in their own
right, are key elements of a productive investment climate, and provide a crucial underpinning for political legitimacy and stability. Thereis now open discussion and acknowledgment ofthese issues in the region, though the pace of reform is generally slow, except in the Republic ofKorea, Malaysia, and Singapore.
Countries have generally continued to makesome progress (at varying rates) on corporate
and financial restructuring, reforms to improvefinancial supervision and regulation, andstrengthening corporate governance. However,most countries need to deepen corporate andfinancial sector reform efforts, as well as further the broader institutional agenda of fostering private sector development and strengthening the investment climate. It is notable thatthe sectors which are more dynamic are thosewhere the corporate restructuring agenda isless urgent, for example, small- and mediumscale enterprises or large exporters who have
moved more quickly to resolve their debts.
This is especially important because China’s
World Trade Organization (WTO) accession isleading to a restructuring of regional production networks, a surge in foreign direct investment (FDI) to China, and an increase in competitive pressures in other countries in theregion, especially those competing directlywith China in low wage sectors.

154

Efforts to strengthen regional cooperationin East Asia have gained ground in recent
years, alongside the region’s long-standing
commitment to multilateral trade liberalization and integration. The Association ofSoutheast Asian Nations (ASEAN) Free Trade
Area (AFTA) came into force at the beginning of 2002 among the six original members.
Association members now seek to build on
their success in reducing tariff barriers andfostering deeper integration by tackling issues
such as non-tariff barriers, product standards,
customs procedures, trade in services, transport and logistics, and investment flows. At
the same time the Initiative for ASEAN Integration (IAI) has been launched to help newand less-developed members (Cambodia, theLao People’s Democratic Republic, Myanmar,
and Vietnam) build capacity and integrate
more fully into the AFTA over time. Regional
discussions and cooperation in the ASEAN3(ASEAN, China, Japan, and Korea) and othernew forums also continue to develop.
Against this background, per capita GDP
in the region could grow solidly at a rate ofaround 5.5 percent during the coming decade,although this implies a slowing by 1 percentage point compared with the previous decadeof rapid catching up. As population growth
also slows during the coming 15 years—being
0.5 percentage point lower than during the
1990s—the long-run trend in GDP growth isestimated to be 6.2 percent, 1.5 percentage
point below the trend during the 1990s.

South Asia
Recent developmentsGrowth in the South Asia region is projected to average 4.6 percent in 2002.
This downward revision from the
Global Economic Prospects 2002 forecast of
5.3 percent GDP growth for the year largely
reflects adverse weather conditions, continued
internal and external security concerns, andthe more protracted than anticipated recent
global economic slowdown. As a consequence,gep_app01.qxd 12/5/02 1:04 PM Page 155

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Figure A1.2 Industrial production inSouth Asia
(3-month moving average, y/y percentage change)
25

Bangladesh

20

Pakistan
India

15
10
5
0
5
10
n.
19
99
Ju
l. 1
99
9
Ja
n.
20
00
Ju
l. 2
00
0
Ja
n.
20
01
Ju
l. 2
00
1
Ja
n.
20
02
Ju
l. 2
00
2

Ja

98

98

19

Ju
l.

19

n.
Ja

19

97

15

Ju
l.

given slower demand growth, inflation has
remained low throughout most of the region,
notwithstanding high oil prices. Further, government budget balances are expected to post
rising deficits in most countries. On an aggregate level, current account balances—which strengthened during 2001, reaching asurplus in the case of India—are projected
to show a slight improvement during 2002.
This is partly due to lower levels of imports,
which are generally projected to more thanoffset the negative impact of slow export
volume growth dampened by weak external
demand.
Because agriculture is a key sector in the region’s economies, important to both employment and growth, the recent drought has restrained output, although the late rains (insome cases flooding) have somewhat ameliorated the shortfall for the season. As a consequence, 2002 harvests are expected to be generally smaller than in 2001, an outcome that is
expected to put some additional pressure on
government coffers through increased transfers for drought relief.
Security issues are an ongoing concern, although there has been some easing of tensions
in parts of the region, paving the way for
improved growth conditions. The diminishedfighting in Afghanistan from late 2001, andthe more recent introduction of a new government in June 2002, has led to a rebound in activity to begin rebuilding the economy fromextremely low levels and contraction in 2001.
Throughout the region, the weakening of
economic conditions has complicated efforts
at fiscal consolidation. Although some countries were able to achieve budget targets by
cutting expenditures—including spending on
development programs—to offset revenue
losses, India notably did not cut expenditures.
Citing concerns about the magnitude ofIndia’s domestic debt—estimated at 70 percent of GDP—Standard and Poor downgraded Indian government paper to junk bondstatus in October 2002.
External demand in South Asia’s major
markets has been subdued in the first half of

E C O N O M I C

Source: International Monetary Fund, International
Financial Statistics.

2002, although it shows some firming relative
to the contraction witnessed in 2001 for mostof the region’s economies. During the second
half of 2002, preliminary data suggest somefurther acceleration of export volume growth,
although not as strong as projected in Global
Economic Prospects 2002, given the more
protracted recovery in world trade volumes.
Import volume growth has been dampened bysluggish demand for raw materials and intermediate goods by exporters and by weak domestic demand conditions. The overall impactof these factors has led to a net improvementin the region’s trade balance. This improvement, combined with a rise in the region’s aggregate worker remittances—reflecting portfolio shifts following the September 11 attacks
and, in the case of Bangladesh, a sharp increase in private inflows due to improvementsin the speed with which remittances are transferred through official channels—has contributed to an increase in the region’s foreign
reserve holdings. Given the recent weakness of
the U.S. dollar, a number of currencies in theregion have appreciated during 2002. However, a general monetary stance of maintaining
competitiveness suggests that these short-term

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2 0 0 3cross-currency dynamics will reverse and that
regional exchange rates will resume a path ofdepreciation.

provides the largest share of employment.
Higher rural incomes will feed through into
stronger private consumption growth, butprospects for investment—particularly in theprivate sector—are more mixed, as continued
concerns over stability will at least partially
offset the impetus to invest generated bystronger domestic and external demand. Industrial production will marginally underpace
real GDP growth, as the service sector continues to provide the main near-term contribution to growth over much of the region.
Our global projections of a recovery inworld trade prospects translate into strengthening external demand conditions for the
economies in the South Asia region. Partly because of the above assessment of the domestic
economy, the region is forecast to post a firming of growth to an average of 5.4 percent in2003 and 5.8 percent in 2004. Trade balances
should benefit, although import growth will
also strengthen along with external demand,
given the high import content of exports
and high import intensity of consumption.
Coupled with a modest deterioration in the

Near-term outlook
Our near-term outlook is premised upon continued improvement in both domestic
political stability and regional security issues—
although tensions will remain evident. A
marked improvement in Sri Lanka’s politicaland policy environment, for example, should
allow that country to enjoy a sharp acceleration of GDP over the near term—and, indeed,
into the medium term. In contrast, continued
domestic political pressures would cause Nepal
to underperform relative to regional growth
averages in the near-term forecast horizon.
We are also assuming a return to morenormal weather patterns over the next two
years, in contrast to the recent drought conditions discussed above. Agriculture accounts
for approximately one-fourth of regional output, but the impact of improved harvests will
be even more pronounced for the poorest
households, for whom the rural economy

Table A1.2

South Asia forecast summary(percent per year)
Baseline forecast
Growth rates/ratios

Real GDP growth
Private consumption per capita
GDP per capita
Population
Gross domestic investment/GDPa
Inflationb
Central gvt. budget balance/GDP
Export market growthc
Export volumed
Terms of trade/GDPe
Current account/GDP
Memorandum items
GDP growth: South Asia excluding India

1991–2000

2000

2001

2002

2003

2004

2005–15

5.2
2.0
3.3
1.9
21.9
7.9
10.3
12.8
10.9
0.1
1.5

4.8
1.4
2.9
1.9
24.2
3.9
9.7
13.1
7.4
0.8
0.8

4.4
4.1
2.6
1.7
24.9
6.1
10.3
0.4
5.3
0.4
0.3

4.6
2.6
2.9
1.7
25.8
5.0
10.3
2.8
8.3
0.0
0.1

5.4
3.6
3.8
1.6
25.8
5.1
9.8
7.3
8.8
0.2
0.2

5.8
4.0
4.2
1.6
25.5
6.8
9.2
7.9
8.5
0.2
0.2

5.4
3.2
4.1
1.3
24.8
…
…
…
…
…
…

4.3

4.2

3.8

3.9

4.8

5.2

5.3

… Not available.
a. Fixed investment, measured in real terms.
b. Local currency GDP deflator, median.
c. Weighted average growth of import demand in export markets.
d. Goods and nonfactor services.
e. Change in terms of trade, measured as a proportion to GDP (percentage).
Source: World Bank baseline forecast, November 2002.

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terms of trade, these growth patterns are expected to translate into a slight increase in theregional average current account deficit to
GDP ratios.
Macroeconomic policies in the region havehistorically been biased toward accommodating growth and have generated fiscal imbalances. Generally, revenue mobilization remainsa challenge in the region. The unsustainable
nature of fiscal deficits has been widely recognized by governments across the region—
although this does not imply that a consensus
has been reached. Therefore, the introductionof prudent fiscal policies over the next two
years could be tempered by political considerations, and by the need to address the lagged
effects of the current downturn in agricultural
output. Indeed, budget deficits in many countries could deteriorate in the next fiscal year.
One of the key problems is the scale of publicdebt—large servicing requirements limit thescope for cutting expenditures, especially in
conditions of extreme poverty. The main issue
for the region is extending the tax base, but
progress to date has not been as rapid as anticipated. The introduction of tax reforms in
India, for example, has been delayed.
Most regional economies have a generalmonetary policy posture involving depreciation aimed at shoring up foreign reserves andpromoting exports through increased competitiveness, which is forecast to also have a positive impact on current account balances. This
conduct of monetary policies had been facilitated by relatively weak inflationary pressuresacross the region. In general, consumer priceinflation in the region has been relatively low,
despite the droughts and firm oil prices of recent years. Several countries have subsidies forfuel and some foods, a policy that cushions
the impact of imported inflation on consumer
prices. However, these are being lifted in somecases (for example, Pakistan). While the recent
slowdown in demand will restrain price rises
initially, inflation is forecast to rise moderately
later in 2003 and in 2004 as growth momentum builds, and as the average prices of nonoil imports rise.

E C O N O M I C

P R O S P E C T S

Long-term prospects
Long-term growth in South Asia is forecast
to average about 5.5 percent, in line withthe growth forecast in Global Economic
Prospects 2002. This forecast is somewhat
higher than the 5.2 percent average real
growth posted during the 1990s. The higher
projected growth over the coming decade,through 2015, reflects a number of underlying assumptions, such as the assumption of alarger contribution of growth by the private
sector. This in turn reflects the expectation ofprogress with fiscal consolidation and continued structural reforms, including reforms in
trade, banking, privatization, and infrastructure. These factors, combined with the improvement in human capital indicators inrecent years—such as rising literacy rates andschool enrollments, and declining infant mortality rates—will lead to an increase in productivity. Despite a projection of declining
infant mortality rates, overall the South Asian
population growth rate is projected to decelerate because birthrates are expected to decline
faster. Lower population growth in the coming decade, along with the forecast growth
rates, implies that per capita GDP growth will
be close to 4 percent per year.

Risks
Downside risks to the forecast include a weaker
than anticipated recovery in global demand,translating into slower export growth andlower regional GDP. Similarly, a continuationof adverse weather conditions would result in
lower than anticipated growth caused bylower agricultural output. Domestic politicaluncertainty could slow down implementationof fiscal and other structural reforms.
Regional political tensions also pose important threats to the growth forecasts, potentially aggravating economic disruptions andincreasing poverty rates, as well as generating
less severe effects, such as declines in tourism
revenues and the reduction of foreign assistance. Generally, the region faces a number ofvulnerabilities, as evidenced by the covariant
shocks over recent years—such as droughts in157

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2 0 0 3

Pakistan, floods in Bangladesh, natural disasters in parts of India, and civil war in Sri
Lanka. Vulnerability to such shocks has contributed to the high incidence of transientpoverty in a country such as Pakistan, andprobably explains the large year-to-year fluctuations in income and poverty that are observed. Such vulnerability can also have a
profound impact on the growth prospects ofa country, since uninsured risk can affect theex ante behavior of economic agents.

Latin America and the Caribbean
Recent developmentsUnlike most other developing regions
where economic growth strengthenedin 2002, GDP contracted 1.1 percent
in Latin America, about 1.6 percentage points
lower than anticipated in the spring. This
growth deceleration from 0.4 percent in 2001,
however, was the result of enormous economic contraction in a handful of countries,
fueled in large part by the external environment and aggravated by domestic factors.
Growth performance in the region, excluding
Argentina, is expected to be 0.7 percent in
2002, somewhat lower than last year’s growth

Figure A1.3 GDP growth in LAC,
1997–2002(percent y/y)12
Argentina

8

Other LAC*

4
0
4
8
12
16
20
Q1
1997

Q1
1998

Q1
1999

Q1
2000

Q1
2001

Note: *Other LAC  Brazil, Chile, Mexico.
Source: Datastream and World Bank staff estimates.

158

Q1
2002

of 1.2 percent. Negative spillover effects fromthe meltdown in Argentina began to affectneighbors in the region in the second half ofthe year.
The external environment for most of Latin
America was more adverse than expected at
this stage of the global economic recovery.
Despite low interest rates in industrial countries, capital flows to developing countries fell,
and the decline was especially pronounced
in the Latin America and the Caribbean(LAC) region, partly because of the crisis in
Argentina and its small neighbors. After
falling for most developing countries between
October 2001 and April 2002, spreads on
external debt rose sharply for many LAC
countries—Chile, Mexico, and small Central
American and Caribbean countries had only asmall rise (figure A1.4). Few countries were able
to attract the necessary capital flows to sustain a strong growth recovery in the absenceof rising domestic savings. U.S. growth, after astrong start in the first quarter of 2002, weakened significantly thereafter, while European
growth was anemic, resulting in lower growth
expectations for LAC principal markets in the
short term. The region’s export market growthrate was a disappointing 1.2 percent in 2002
and was not helped by the price fall in key
commodities exported by the region (for example, sugar fell by 26.5 percent, arabica
coffee by 8.8 percent, bananas by 7.4 percent, aluminum by 6.5 percent, and copperby 0.2 percent). Moreover, tourism revenues
were weak because of reduced air travel from
North America (affecting the Caribbean countries), and the collapse of income in Argentina
significantly affected tourism in Paraguay
and Uruguay as well as workers’ remittances
to Bolivia and Paraguay.
Domestic factors are important in explaining the weak economic performance in a small
set of countries, and these countries contributed most to the region’s dismal growth
performance in 2002. In Argentina, the lack ofpolitical consensus on a sustainable macroeconomic framework has delayed an International Monetary Fund (IMF) program, shrunk

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Figure A1.4 Spreads for selected LAC countries(basis points above U.S. Treasuries)
2,500

7,500

2,000

6,000
Argentina (right axis)

1,500

4,500
BrazilCountries outside
Latin America

Uruguay

1,000

3,000

Mexico
500

1,500

Chile
0

0
Jan.
2001

Apr.
2001

Jul.
2001

Oct.
2001

Jan.
2002

Apr.
2002

Jul.
2002

Nov.
2002

Source: Datastream and World Bank staff estimates.

net capital flows even further, and led to a
deep, protracted economic contraction in excess of 10 percent. This affected other Mercosur affiliates deeply, especially Uruguay and, toa lesser extent, Paraguay and Bolivia. In Brazil,
uncertainty associated with the elections aswell as with the global outlook weighed oninvestor confidence in spite of sound macroeconomic policies, slowing the pace of growthrecovery. In the República Bolivariana deVenezuela, an acute political crisis that culminated in a short-lived coup contributed to aresurgence in large-scale capital outflows, little
investment outside of the oil sector, and a steep
decline in growth.
The confluence of these factors weakened
the acceleration in growth that one would expect in the context of recovering global activity. Policy responses, constrained by high debt
levels, high external borrowing requirements,
and contracting external financing, were unavoidably contractionary. In Uruguay, a financial crisis ensued as Argentines withdrew
a large amount of dollar deposits, depleting

reserves and causing the currency to float,
and forcing the authorities to embark on fiscal consolidation and monetary tightening.
GDP growth is estimated to have fallen by
about 10 percent. Brazil was forced to tighten
fiscal policy but was able to lower short-term
policy rates only temporarily and experienced
significant increases in long rates. The initialsurge in Brazilian investment at the beginningof the year gave way to a more muted secondhalf growth. In Colombia, the fiscal accounts
remain vulnerable, with the government making small progress in reducing the fiscal deficit
to bring debt dynamics onto a sustainable
path in the wake of presidential elections,escalating civil war, and lower-than-expected
growth. Peru, in contrast, was able to makeprogress in addressing the fiscal deficit andin keeping the public debt situation undercontrol; growth accelerated in 2002. Ecuador
benefited from relatively high oil prices, but
the authorities had difficulty in reducing
the fiscal deficit, a move necessary to maintain macroeconomic discipline in a dollar

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economy. In Central America, low export
earnings from falling coffee prices and weak
demand in the United States, and relatively
high fiscal and external deficits, limited fiscal
expansion. And some Caribbean countries
were faced with little scope for fiscal expansion or monetary easing in light of declining
tourism revenues; weak prices of bananas,sugar, and aluminum; and, in the case of
Jamaica, a large debt overhang that was exacerbated by the financial sector crisis in the
mid-1990s. In Mexico, the government stuck
to fiscal discipline—helped by higher-thanexpected oil prices—and is making slow
progress with key reforms, while being only
partially successful in increasing non-oil government revenues.
Overall, policies in Latin America were instrumental in keeping inflation from accelerating in most countries. However, countries that
had a sharp adjustment in their exchange rates
due to a sharp fall in net capital flows did face
inflationary pressures. Inflation (as measured
by consumer price index—CPI) rose to fairly
high levels in Argentina (about 45 percent), in
Venezuela (in excess of 20 percent), and in
Uruguay (about 20 percent). Given high debt
levels and worsening public debt dynamics—
due to high interest rates and depreciating
currencies—most authorities were unable topursue countercyclical policies, and unemployment remained high throughout the region(21.5 percent [May] in Argentina, 19 percent[September] in Uruguay, 16.2 percent [June]in Venezuela, 17.2 percent [September] inColombia, and 9.7 percent [September] inChile).
Slow world growth and external financing
constraints compelled an adjustment in the region’s external accounts. Import volumes fell
for a second consecutive year (mostly due tosharp declines in Argentina, Uruguay, andVenezuela), and the current account deficit
narrowed from over $50 billion (or 2.9 percent of GDP) in 2001 to below $25 billion (or1.5 percent of GDP) in 2002, with most of
the adjustment coming after April. The levelof foreign reserves in August was around160$10 billion lower than at the end of last year,
due primarily to sharp declines in Argentina
and Uruguay.
Near-term outlook
The region’s growth prospects are expected to
improve in 2003, supported by strengtheningof the global economy, particularly in tradevolumes, commodity prices, and capital flows.
The region’s GDP is now expected to grow by
1.8 percent in 2003—still almost 2 percentage
points lower than the spring forecast and inline with the downgrading of world growth,
provided there is a turnaround in the current
uncertain political and financial market outlook. Greater fiscal adjustment in a number ofcountries with high debt and relatively large
financing requirements is a necessity for reducing economic vulnerabilities. This, along withreforms currently on the agendas of many
countries, is needed to restore investor confidence (which will lower interest costs), attract
more equity external financing, and reinvigorate growth.
In the baseline forecast, it is assumed thatArgentina will put in place an externally supported macroeconomic program that will bereaffirmed by the new government after theelection in March 2003. Depending on its
actual timing, this would lead to a revival ofgrowth, possibly by midyear—but may notshow up in strong annual growth until 2004.
If this scenario were to materialize, it would
improve prospects for the smaller Mercosur
countries. The base case also depicts a new
Brazilian government that maintains prudent
macroeconomic policies and succeeds inrestoring market confidence. Regional GDP
growth is expected to rise to 3.7 percent in
2004.
There are a number of positive factors forthe region that give credence to the baseline
forecast. Mexico has weathered the recent
global downturn very well. Sound policies
have kept investors confident and inflows
large, and the upturn in U.S. growth shouldbolster a rapid expansion in 2003. Chile also
has fared well in light of negative effects from

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Table A1.3 Latin America and the Caribbean forecast summary(percent per year)
Baseline forecast
Growth rates/ratios

Real GDP growth
Private consumption per capita
GDP per capita
Population
Gross domestic investment/GDPa
Inflationb
Central gvt. budget balance/GDP
Export market growthc
Export volumed
Terms of trade/GDPe
Current account/GDP
Memorandum items
GDP growth: LAC excluding Argentina
Central America
Caribbean

1991–2000

2000

2001

2002

2003

2004

2005–15

3.3
2.3
1.6
1.7
19.8
12.5
3.1
11.4
8.6
0.2
2.8

3.7
2.4
2.1
1.6
19.7
6.4
1.8
11.9
10.5
0.6
2.4

0.4
1.1
1.2
1.6
19.3
6.9
1.8
1.5
1.4
0.5
2.9

1.1
2.8
2.6
1.5
18.0
5.0
2.6
1.2
4.7
0.1
1.5

1.8
0.3
0.3
1.4
17.3
4.2
3.1
8.2
11.1
0.3
1.3

3.7
1.9
2.3
1.4
18.1
4.4
3.0
8.8
10.9
0.5
1.8

3.8
2.5
2.6
1.2
22.0
…
…
…
…
…
…

3.1
4.4
3.5

4.5
2.9
6.2

1.2
1.6
2.7

0.7
2.1
3.6

1.9
3.1
4.3

3.6
3.6
4.3

3.8
4.0
4.2

… Not available.
a. Fixed investment, measured in real terms.
b. Local currency GDP deflator, median.
c. Weighted average growth of import demand in export markets.
d. Goods and nonfactor services.
e. Change in terms of trade, measured as a proportion to GDP (percentage).
Source: World Bank baseline forecast, November 2002.

Argentina and adverse terms of trade, andexpected firming of copper prices should underpin growth. The policy stance of the newColombian administration has been positivefor investors, and it has strong support fromthe United States for assistance in resolving
the guerrilla war. Expected strengthening of
metals prices next year should help Peru to
reduce the rise in external financing as the
economy recovers from the 2001 recession.
And the small island states in the Caribbean
have shown resilience in the face of strongly
negative external and domestic factors—
Jamaica has stayed the course with tight fiscal
policy (a primary surplus of 9 to 11 percent of
GDP in the past three years); Trinidad andTobago’s economy continued to grow despite
political uncertainty.
However, risks are on the downside in the
short term. Argentina faces enormous obstacles in its financial system, and while thesituation has stabilized somewhat in 2002,
the authorities will face a difficult situationin containing inflation in 2003—with themonetary overhang and weak public finances.
While it is assumed that the required politicalconsensus will be attained before the March
2003 elections, there are risks that the consensus may not materialize that quickly. The
incoming Brazilian administration will haveto take confidence-building measures to reverse the current market uncertainty. Should
Brazil fail to maintain a sustainable macroeconomic policy framework, its correspondent weak economic performance will havea major impact on regional economic prospects. Venezuela will be facing lower oil
prices, which will make necessary adjustment
even more painful. And Caribbean countries
face the possibility of a delayed recovery intourism, which would reduce the fiscal
space to tackle the ever-present risk of natural
disasters.

Long-term prospects
Per-capita GDP growth over the long term(2005–15) is projected to average 2.6 percent
a year, 1 percentage point higher than the161gep_app01.qxd 12/5/02 1:04 PM Page 162

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2 0 0 3growth achieved by the region in the 1990s.
Improvement in macroeconomic management
in a number of countries throughout the
1990s, albeit emanating from crises, should
provide the basis for a good investor climate.
This has already encouraged FDI into the region at the fastest pace of all regions, eventhough this has been due partly to privatization of public enterprises and mergers and acquisitions. The next wave of FDI is likely to be
in greenfield activities, as witnessed in Costa
Rica’s attracting high-tech firms. Regulationand supervision of financial sectors have beenstrengthened since the early 1990s, but there
remains room for further improvement. Potential gains from global trade have increased
with trade liberalization during the 1990s,
leading to high and rising ratios of trade to
GDP (Chile, Mexico, the Caribbean Community and Common Market, and other small
economies are examples). Moreover, the region has been proactive in deepening trade integration, especially with North America,
through negotiations to establish a Free Trade
Association of the Americas (FTAA) and bilateral agreements (Chile and Central America
with the United States).
At the same time, the region remains more
vulnerable than many other developing regions. First, a high debt overhang from the
1980s remains a problem to finance in many
countries. In the 1990s, some countries continued to rely on significant debt financing,particularly in the public sector. Public debtto-GDP ratios rose in some countries and thematurity of that debt shortened in duration,
increasing their vulnerability to shifts in investor sentiment as they question debt sustainability. LAC countries may have to learn tolive with less debt in the future, adjusting public expenditures as required. Countries need tocreate fiscal space during good times (boomyears) to be able to conduct countercyclicalpolicies in future downswings in economic
activity. Second, many countries, especially the
low-income coffee producers, also need tofurther diversify their export base to reduce
vulnerability to large swings in commodity

162

prices. Finally, the region still lags in financial
deepening (which could help raise nationalsaving rates), infrastructure, and quality of
institutions—areas that need to be improved
before the region can attain high sustainablegrowth rates.

Europe and Central Asia
Recent developmentsT

he slack external environment, especially in Western Europe, is contributing to a general slowdown of growth
in most of the countries of the Europe andCentral Asia (ECA) region in 2002 relative to
2001. However, the region has weathered therecent global economic downturn relatively
well, largely because of fairly strong domestic
demand throughout most ECA countries, andsustained high oil prices to the benefit of theoil-exporting Commonwealth of Independent
States (CIS) countries. Whereas almost all ECA
countries are facing a moderation of growth in
2002, Turkey is expected to post a recovery—a massive swing from the over 7 percent collapse in GDP that it posted in 2001—which israising the region’s average growth for theyear. As a consequence, aggregate growth for
the ECA region is projected to expand from anestimated 2.3 percent in 2001 to 3.6 percent in2002. Growth in the ECA region (excluding
Turkey) is forecast to decelerate to 2.3 percent
in 2002 from 2.9 percent in 2001.
The Central and Eastern European (CEE)
countries, in particular, have been affected byweakening demand from Western Europe—
their main export market—as well as by exchange rate appreciation in many of the subregion’s economies. As a result, export volume
growth has slowed significantly, although it
still remains at impressive levels in a numberof countries (such as the Czech Republic,
Hungary, and Poland), as they have increased
market penetration (see box 1.2 in chapter 1).
Thus, the consequent drag on GDP is not ashigh as it might have been. Furthermore, easing import volumes—which largely reflectgep_app01.qxd 12/5/02 1:04 PM Page 163

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Figure A1.5 German imports and CEECs exports in dollars, 1999–2002(3-month moving average, y/y percentage change)
25
20
15
CEEC-exports
10
5
0
5
10
15

German imports

20Jun. Aug. Oct. Dec. Feb. Apr. Jun. Aug. Oct. Dec. Feb. Apr. Jun. Aug. Oct. Dec. Feb. Apr. Jun. Aug. Oct.
1999 1999 1999 1999 2000 2000 2000 2000 2000 2000 2001 2001 2001 2001 2001 2001 2002 2002 2002 2002 2002
Source: International Monetary Fund, International Financial Statistics.

high import intensity of exports in all of the
CEEs—are helping to reduce the impact of theslowdown in export volumes. Strong domestic
demand, witnessed in most of the CEE countries, is partially offsetting the loss in impetus
to growth from the slowdown in the external
sector. Domestic demand has been generally
supported by lower inflation, easing interest
rates, and expanding private consumption. In
some countries, fiscal policy has become more
expansionary, notably in the Czech Republic,
Hungary, and the Slovak Republic. Poland is
the main exception to this picture of relatively
strong domestic markets, with tight monetaryconditions, weak wage growth and record
unemployment rates translating into anemic
domestic demand. While inflationary pressures have generally been subsiding in the CEE
subregion, they remain significant (in double
digits) in Romania, Turkey, and the Federal
Republic of Yugoslavia. Many of the CEE
countries continue to run relatively high current account deficits of above 4 percent, although sufficient external financing has beensustained. Continued significant FDI inflows,in particular, are helping to finance the current
account deficits, in addition to generally supporting domestic demand and regional growth.

Turkey remains a key question mark. Indicators for early 2002 point to a recovery, facilitated in part by the new reform program,lower interest rates, and improved confidence
relative to 2001. However, uncertainty linked
to the continued implementation of the current economic program of the new government, as well as heightened political instability
in the Middle East, could contain the building
growth momentum, as interest rates havebegun to rise and market sentiment is becoming more cautious. Lowering interest rates remains important to achieving a sustainablepublic debt.
Relatively firm oil prices—fueling fiscal
linkages in oil producers and bolstering intraCIS trade—have sustained the recent recovery
in the CIS subregion, partially buffering itfrom the deterioration in external conditions.
Nevertheless, given the moderation in external
demand, exchange rate appreciation in a
number of countries (such as the Russian Federation), and some easing in oil prices in thefirst half of 2002, growth is moderating
throughout the CIS subregion. Hydrocarbon
exporters—Azerbaijan, Kazakhstan, Russia,
and Turkmenistan—in particular have experienced robust growth, although growth has

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2 0 0 3slowed significantly from 2001. Increased investment in production capacity in the energy
sector has also supported economic activity inthese countries. Among the energy-importingCIS countries, other factors have contributed
to the continued strong growth, including relatively good harvests in the Kyrgyz Republic(combined with increased gold production),
Tajikistan (combined with increased aluminum production), and Ukraine. Not only
because Russia represents the largest weight inthe subregion, but also because it represents amajor export market for many of the CIS
countries (in addition to some of the CEEs),
continued strong growth in Russia has alsosustained growth in the subregion. As in many
CEE countries, domestic demand has been underpinned in the CIS countries by falling inflation rates and lower interest rates. While inflationary pressures have eased in all the CIS
countries, they remain a source of concern insome cases, particularly in Belarus and Uzbekistan. Inflation rates in Russia and Tajikistan
are also expected to post in the double digits
in 2002, but at more moderate levels. Whileenergy-related receipts boosted revenues, fiscal positions remained relatively prudent in
the energy-exporting CIS countries, although
they became somewhat more expansionary
in Azerbaijan and Kazakhstan. To provide
for budgetary smoothing, Azerbaijan andKazakhstan have created national funds for
windfall oil rents. With the decline in energy
prices posted in 2001 (in both real and nominal terms) from the spike posted in 2000, thefiscal surplus in Russia narrowed, although recent firming in oil prices should contribute tosome stabilization of budget receipts for 2002
over 2001. In other CIS countries, fiscal policy
has been more expansionary, in general, generating widening deficits (for example, in
Ukraine). Throughout the CIS subregion, current account surpluses (for instance, in Russia
and Ukraine) are narrowing and deficits (inmost of the remaining CIS economies) are
widening somewhat, because of exchange rate
appreciation, rising imports, and, until more
recently, moderating oil export earnings.

164

Russia’s current account surplus has narrowed, although it remains very large.

Near-term outlook
Growth in the CEE countries is expected to
begin increasing again in 2003, assuming afirming of European Union (EU) import demand in 2003, which is projected to strengthen
significantly in 2004. For Turkey, assuming relative political stability and the continued pursuit of the current reform program by the new
government, the recovery is expected to be sustained in 2003. Growth in the CEE subregion
is forecast to accelerate from 2.3 percent in2002 to 3.1 percent and 4.3 percent in 2003
and 2004, respectively. As the EU accession
process moves forward, it is expected that thefirst round of new members in particular willcontinue to receive significant FDI inflows (inaddition to EU transfers), which will remain an
important source of external finance and underpin long-term growth.1 While a number ofimportant hurdles remain—linked in particular to the negotiations on the existing common
agricultural policy (CAP), on the EU’s budget,and on transfers to new member countries—
the process is still on schedule.2 Growth is expected to slow in the CIS subregion (throughfiscal and trade linkages) through 2004, assuming significant declines in oil prices in both2003 and 2004 (from a projected $25 per barrel in 2002 to a forecast of $23 per barrel and$20 per barrel in 2003 and 2004, respectively).
CIS GDP is forecast to decline from a projected 4.4 percent in 2002 to 3.5 percent andto 3 percent in 2003 and 2004, respectively.
While Russia’s current account is expected toremain in surplus over the near term, it isforecast to narrow markedly as energy prices
soften. In 2003 and 2004, growth is expected
to average 3.4 percent and 3.6 percent, respectively, for the ECA region as a whole.

Long-term prospects
In the CEE, during the second decade of transition, a number of factors are expected tocontribute to stronger growth than posted
during the previous decade. These include

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Table A1.4

E C O N O M I C

P R O S P E C T S

Europe and Central Asia forecast summary(percent per year)
Baseline forecast
Growth rates/ratios

Real GDP growth
Private consumption per capita
GDP per capita
Population
Gross domestic investment/GDPa
Inflationb
Central gvt. budget balance/GDP
Export market growthc
Export volumed
Terms of trade/GDPe
Current account/GDP
Memorandum items
GDP growth: transition countriesf
Central and Eastern Europef
CIS

1991–2000

2000

2001

2002

2003

2004

2005–15

1.7
0.2
1.9
0.2
23.6
128.0
4.4
10.7
9.4
0.0
2.3

6.6
9.1
6.4
0.1
22.1
9.8
5.4
12.9
10.9
1.6
4.9

2.3
1.5
2.2
0.1
21.9
7.0
6.5
6.7
8.8
3.0
1.8

3.6
4.8
3.5
0.1
20.6
3.2
6.2
2.1
6.4
2.5
2.4

3.4
4.0
3.3
0.1
20.8
5.8
6.0
6.4
8.2
1.3
2.4

3.6
3.8
3.5
0.1
21.2
5.7
5.5
8.1
7.5
0.1
2.3

3.6
3.7
3.5
0.1
28.6
…
…
…
…
…
…

2.6
0.6
4.4

6.4
3.8
8.4

4.6
2.9
5.9

3.5
2.3
4.4

3.3
3.1
3.5

3.5
4.3
3.0

…
…
…

… Not available.
a. Fixed investment, measured in real terms.
b. Local currency GDP deflator, median.
c. Weighted average growth of import demand in export markets.
d. Goods and nonfactor services.
e. Change in terms of trade, measured as a proportion to GDP (percentage).
f. Excluding Turkey.
Source: World Bank baseline forecast, November 2002.

higher investment rates and ongoing restructuring of the capital base. Continued improvements in the policy environment, including
greater macroeconomic stability, are expected
to underpin the projected higher growth rates.
The EU accession process and coming membership will continue to act as an anchor for
structural reforms and will help attract significant inflows of FDI. While structural reforms
are being pursued in many CIS countries, ingeneral, implementation is not as advanced
or as widespread as in the CEE subregion’s
economies, and in some cases there is significant resistance to structural reforms. Thisimplies lower long-run growth in comparison.
The recent boom in hydrocarbon rents has
provided an impetus to growth, facilitated theintroduction of a number of reforms in manyof the oil-exporting countries, and contributed
to an increase in investment outlays (particularly in the energy sector). However, given
the volatility of energy market prices, these
economies will not be able to sustain recently

achieved higher growth rates until diversification from energy becomes much more broadly
based. Given the degree of energy dependence
in many of the CIS economies, particularly
Russia, the projected softening of oil prices—to an average nominal price of about $18
to $19 per barrel for the 2005–10 period, inthe underlying forecast—implies a ratcheting
down of the subregion’s growth from recent
high rates.

Risks
Weaker than anticipated recovery in the EU
area would reduce external demand for regional economies, particularly for the CEE
countries, and thus translate into lower
growth. In many CEE countries high current
account deficits could become an important
downside risk for international credit, if FDI
inflows suddenly dry up (which a pronounced
delay in the EU accession process could
trigger). For CIS hydrocarbon exporters,
which are highly dependent on energy prices,165gep_app01.qxd 12/5/02 1:04 PM Page 166

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2 0 0 3a sharper decline in oil prices than forecast
poses a significant downside risk. In Russia, as
a consequence, a more rapid decline in growththan projected would result in lower external
demand for a number of the other economiesof the CIS and of some CEEs (that is, theBaltic states). Greater political uncertainty ora reversion from the reform program in
Turkey could undermine its fledgling recovery
and result in much lower than anticipatedgrowth—and affect some of its trade partners(including Bulgaria). Some of the poorest CIS
countries (Georgia, the Kyrgyz Republic, andTajikistan) have relatively high external debt
(up to 200 percent of exports), placing them atrisk of default if growth does not materialize
as anticipated and external assistance is notforthcoming. Greater political instability andheightened tensions in the Middle East could
prove destabilizing to economic (and political)
positions in the neighboring ECA countries,
particularly in Turkey and in some of thesouthern-tier CIS countries. Aside from potentially undermining tourism revenues, there
could be trade disruptions and a general rise in
the perception of risks in the region leading tohigher interest rates.

Sub-Saharan Africa
Recent developmentsS

ub-Saharan Africa was not immune tothe chilling effects of the global recession.
The slowdown may have been less pronounced there than elsewhere, but the collapse
in world trade and steep declines in commodity prices had a depressing effect on economic
performance. Services exports, primarily
tourism, were further affected by the September 11 terrorist attacks. In real terms, GDP
growth slowed from 3.2 percent in 2000 to
2.9 percent in 2001 and 2.5 percent in 2002.
With the exception of Nigeria, oil exporters
generally outpaced the region, especially thosewhere production was increasing—Angola,
Equatorial Guinea, Sudan—as oil prices,though down from 2001, remained relatively

166

strong. Meanwhile, countries where severe
drought put a damper on agricultural production fared worse and, as usual, the worst
outturns were to be found in countries experiencing civil and political strife. But slowdown
was widespread throughout the region.
The subdued economic performance in2002 is attributable to the region’s export dependence on European markets, where growth
was weak. As a result, exports remained basically stagnant in real terms. On the plus side,
there was a turnaround in non-oil commodity prices, albeit from historically depressed
levels. After reaching a low in October 2001,
non-energy commodity prices rebounded
sharply, gaining 26 percent in export weighted
terms by August 2002. The main contributor
was cocoa, which was up 80 percent, but othercommodities gained as well—robusta coffee
up by 20 percent, cotton up by 33 percent,copper by 7 percent, and gold by 10 percent.
Because the upward momentum began late in
the year, on an annual basis many commodity
prices exhibited declines in 2002, and most remain well below peak levels of the mid-1990s.
Nevertheless, modest real price gains over the
medium term will deliver a measure of relief
to external balances. Oil prices, too, remained
stronger than expected, an outcome that,though unwelcome to non-oil exporters, wasa positive benefit to the region as a whole.
The disappointing results for tourism,
which accounts for 11 percent of regional export receipts, reflected not only the weaknessof Europe’s economy, but the aftermath of
September 11. Some important destinations—such as Mauritius, which benefits from its reputation as a safe destination—saw an increasein the flow of arrivals in 2002. Most othercountries, however, only partially recoveredfrom the impact of September 11. According
to estimates by the World Travel and Tourism
Council (WTTC),3 Sub-Saharan travel andtourism exports slowed to just 1.5 percent
growth in 2001 before recovering to 4.3 percent in 2002. Both years represent growth significantly below potential. The WTTC estimates September 11 to have cost 3.2 percent

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of exports and 1.3 million jobs over the period
2001–02.
In the domestic sphere, agricultural production was disrupted by drought and, in thecase of Zimbabwe, political disturbances. As
a result, nearly 30 million persons were left
in need of emergency food aid. Approximately
half of them were in southern Africa, which
experienced a second successive year of poor
harvests. Malawi, Zambia, and Zimbabwe
were most affected, and because agriculture
constitutes a large share of their economies,
incomes and consumption spending were depressed. But Ethiopia suffered the worst, withdrought putting at risk an estimated 15 million persons. However, the effects were quite
localized. South Africa experienced a bumper
maize harvest, which gave a strong boost to
domestic spending.
South Africa sustained a recovery throughthe first half of 2002, with broad-basedstrength in agriculture, as well as in exportoriented mining and manufacturing, which
benefited from the rand’s weakness. On the

Table A1.5

E C O N O M I C

P R O S P E C T S

Figure A1.6 Real GDP growth of
Sub-Saharan Africa oil and non-oil
exporters(percent)
5
Oil
4
Non-oil
3
2
1
0
2001

2002

2003

2004

Source: World Bank staff estimates.

expenditure side, domestic demand grew at a2.3 percent annual pace in the first half, reflecting buoyant fixed investment, strong private consumption, and a moderately expansionary fiscal stance, though weak inventory
accumulation slowed the pace. In the external

Sub-Saharan Africa forecast summary(percent per year)
Baseline forecast
Growth rates/ratios

Real GDP growth
Private consumption per capita
GDP per capita
Population
Gross domestic investment/GDPa
Inflationb
Central gvt. budget balance/GDP
Export market growthc
Export volumed
Terms of trade/GDPe
Current account/GDP
Memorandum items
GDP growth: SSA excluding South Africa
Oil exporters
CFA countries

1991–2000

2000

2001

2002

2003

2004

2005–15

2.2
0.6
0.4
2.6
16.9
9.8
3.0
14.4
4.1
0.0
2.1

3.2
1.4
0.7
2.5
17.9
6.3
0.6
10.8
4.3
2.1
2.3

2.9
0.7
0.5
2.4
18.7
5.4
0.3
0.1
2.8
1.1
2.2

2.5
0.3
0.1
2.4
18.9
4.3
0.4
2.4
1.1
1.5
3.0

3.2
0.8
0.9
2.3
18.6
3.9
0.5
7.1
5.3
0.2
1.8

3.8
1.3
1.5
2.3
18.2
4.2
0.3
7.8
5.8
0.8
1.2

3.7
1.2
1.5
2.2
21.1
…
…
…
…
…
…

2.7
2.5
2.6

3.3
4.8
2.3

3.6
4.4
3.2

2.7
2.0
2.9

3.7
3.6
3.3

4.2
3.8
3.8

…
…
…

… Not available. SSA is Sub-Saharan Africa. CPA is Communaute Financiere Africaine.
a. Fixed investment, measured in real terms.
b. Local currency GDP deflator, median.
c. Weighted average growth of import demand in export markets.
d. Goods and nonfactor services.
e. Change in terms of trade, measured as a proportion to GDP (percentage).
Source: World Bank baseline forecast, November 2002.

167

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2 0 0 3

accounts, tourism has been slow to recoverfrom the effects of September 11, but the
weaker rand boosted net visibles trade, andthe current account balance moved back into asmall surplus. The main concern for the South
African economy was an uptick in inflation—
not surprising after a nearly 40 percent depreciation of the rand in 2001, but neverthelessputting upward pressure on interest rates.
Robust wage gains were only partially offset
by higher productivity, resulting in a substantial rise in unit labor costs. Nevertheless, indications are that monetary restraint will prevail,and the outlook is for inflation to ease. The
rand stabilized at an average of 10.9 against
the dollar in the first three quarters of the year,
after weakening to above 12 in late 2001.
In Nigeria, adherence to reduced Organization of Petroleum Exporting Countries(OPEC) quotas more than offset the impact ofstronger-than-expected oil prices, while budget gridlock constrained government spending, resulting in a real GDP decline estimatedat 0.6 percent from 2001. Unfortunately, thestrength of oil revenues may have also relievedpressure to implement urgently needed structural reforms, as evidenced by the discontinuation of the informal monitoring arrangementwith the IMF. Politically, the situation remains
tense. Local elections have been postponed
twice, and national elections are now scheduled for April 2003. President Obasanjo hascome under strong pressure by the National
Assembly on budgetary issues. If oil prices decrease, as expected in the near term, Nigeria’s
problems will mount, though there are indications that these problems may be offset bya significant medium-term expansion of theenergy sector, consistent with expected OPEC
policies. The United States is particularlyinterested in expanding oil purchases from
Nigeria in an effort to diversify sources ofsupply to decrease dependence on the Middle
East.

Near-term outlook
The forecast calls for growth to accelerate in
2003–04 on the strength of a pickup in exter-168

nal performance. Overall, the forecast anticipates real growth rising to 3.2 percent in 2003
and 3.8 percent in 2004, around 1.1 percent inper capita terms. Faster growth in Europe will
boost export volumes, and price trends willremain broadly favorable as supply-demandbalances for most commodities tighten withthe recovery in the world economy. Cocoa, already at a 15-year high, is the main exception.
Oil prices are expected to ease, though theyremain significantly above late-1990s lows.
While large, real price gains for commodities
important to Sub-Saharan Africa are unlikely
to be sustained in the medium term, the widespread introduction of structural reforms andmarket liberalization are expected to raise
export competitiveness, and the region should
remain a significant commodity supplier for
the foreseeable future. On balance, with import price inflation remaining low, non-oil
exporters’ terms of trade are forecasted tostrengthen marginally in 2003–04.
Along with a modest improvement in external sectors, the forecast assumes a stronger
domestic performance. The expectation is fora return to more normal weather conditions,which will underpin a recovery of agriculture
and consumption spending, while faster
growth stimulates a cyclical upturn in investment. Overall, domestic demand will remain
the primary source of GDP growth, as rising
import demand—constrained mainly by theavailability of financing—holds net exports incheck. Indeed, current account balances are
expected to narrow marginally as foreign direct investment eases back from recent levels
with a slowdown in privatization offerings
such as Air Madagascar, though at the sametime more favorable economic conditions
overseas should have a positive impact onremittances.
For the region’s oil producers, weaker export prices will be offset by higher production.
Major new offshore developments are scheduled to come onstream in the Gulf of Guinea(Angola, Equatorial Guinea, and Nigeria)
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profitable. As in the past, however, moregeneral spillovers to non-oil sectors will be
relatively muted. As a result, growth of oil
producers will improve from 2 percent in2002 to 3.6 percent in 2003 and 3.8 percent in2004. Falling terms of trade will widen current account deficits, though oil prices are
expected to remain comparatively strong,
above $20 per barrel, containing the pressure
on external performance and fiscal accounts.

Long-term prospects
The forecast anticipates per capita growth averaging 1.5 percent over the 2005–15 period,
near the levels achieved in the mid-1990s. The
outlook is optimistic—such a result would signify a reversal of the region’s long-term historical decline—but even so growth will fall shortof what is needed to reduce poverty andachieve the Millennium Development Goals.
Sub-Saharan Africa will continue to lag behind
other developing regions, and by 2015 thenumber of persons living on less that $1 per
day is forecasted to rise by nearly 30 percent,from 315 million to 404 million.
The outlook is predicated on a continuationof broad trends toward better standards ofgovernance and economic policies. The great
majority of countries in the region have begun
preparing Poverty Reduction Strategy Papers,
and nine are in different stages of implementation of the strategies. Early results seempromising. At the same time, NEPAD (the New
Partnership for Africa’s Development) andother regional initiatives are enhancing thecredibility of governments and strengthening
intraregional cooperation. There has beenencouraging progress as well toward resolving
intractable conflicts in central Africa, eventhough events in Côte d’Ivoire, Madagascar,
and Zimbabwe underscore the fragility of
the region’s political processes. Improved policy environments should stimulate faster productivity growth and diversification fromagriculture, and reduce export dependence on
primary commodities.
These internal developments, coupled withmodest improvements in the external environ-

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P R O S P E C T S

ment, will promote diversification, encourage
higher savings and investment, and stimulate
productivity growth. Despite a dismal overall
record, the region boasts a number of exemplary performers (Botswana and Mauritius)and cases in which policy reform has produced dramatic turnarounds (Ethiopia,
Mozambique, Tanzania, and Uganda). At thesame time, a panoply of deep-rooted problems
will continue to plague economic performance. There are no quick solutions to lowlevels of human and physical capital, poor
infrastructure, HIV/AIDS, civil strife and negative perceptions of international investors,
and excessive export specialization will continue to expose external sectors to high pricevolatility. Nevertheless, if the new realism thatappears to be taking hold on the continent
proves to be more than just rhetoric, there isadequate reason to believe the moderate improvement in overall performance that theforecast anticipates can be achieved.

Middle East and North Africa
Recent developments

Despite a continuation of high oil
prices, growth in the Middle East andNorth Africa (MENA) region slowedin 2002 to 2.5 percent, down from 3.2 percent
in 2001 as the events of September 11, 2001,
continue to reverberate throughout the region.
For the oil-exporting countries, growth remained above 2 percent. The larger increases
in growth that might have been expectedfrom both high oil prices and increased public
expenditures were offset by a slowdown in
production and exports, a result of tightened
OPEC quotas put into place in 2001 to support higher oil prices. To counter these effects,
some oil exporters have implemented expenditure programs financed with increased oil revenues. In the absence of a strong private investment response to the reform program it
had implemented, Algeria, for example, put afour-year economic recovery program in placeworth about 10 percent of 2001 GDP, aimed at169

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2 0 0 3Figure A1.7 Oil prices and current
accounts(dollars/barrel)(billions of dollars)29
27
Oil prices

25
23
21
19

Current account

17
15
2000

2001

2002

2003

40
35
30
25
20
15
10
5
0

2004

Source: World Bank staff estimates.

supporting growth in domestic demand while
enhancing social and economic infrastructure.
Diversified exporters faced worsening conditions in 2002, with GDP growth falling to
2.2 percent, a decline of 2 percent from 2001.
External factors leading to this decline include
the deterioration in export market growth for
Egypt, Morocco, and Tunisia, as well as sharp
declines in the tourism sector in North Africa
and the several countries in the Levant, following the events of September 11, 2001. In
Egypt, the number of tourists fell 41 percent
year-on-year in the last quarter of 2001, andeven by the end of the first half of 2002,
tourism had not yet returned to precrisis levels. In Morocco, tourist arrivals were down by
over 20 percent in the first half of 2002. For
some countries in the region, however, thedeclines in tourism from abroad have been
partially offset by MENA nationals diverting
their tourism to within the region. Tourist
receipts may likely show an even larger decline
than tourist numbers, as many firms in the
tourist sectors have discounted heavily. Exports to the EU have also suffered, in particular Moroccan textiles and electronics exports
to the EU. Jordan has been somewhat insulated from this situation, as its export demand
from India and the United States continued to
grow quite strongly in 2002.
Internal factors have also contributed toa decline in growth in several countries. The

170

positive agricultural growth of 2001 in
Morocco slowed down somewhat in 2002
because of the less favorable weather conditions. To prevent a potentially steep increasein the current account deficit, fiscal and monetary policies were tightened in Tunisia; thisaction contained domestic demand pressuresand reduced pressures on external balancebut exacerbated the impact of the slowdown
stemming from the external shocks. Though
tourism has begun to recover gradually in
Egypt, the recovery of the private sector has
been hampered by unresolved problems withthe exchange rate regime, which have theirroots in the late 1990s.

Short-term prospects
Growth prospects for MENA are clearly contingent upon whether military actions aretaken in the region. Assuming that there is noconflict over the next year (and thus that there
is a gradual resumption in confidence in theregion), the region’s growth is forecast at
3.7 percent for 2003–04. A recovery would be
expected for both oil-exporting countries anddiversified exporters. The public expenditure
programs being implemented by oil-exporting
countries over the next several years to improve infrastructure, agriculture, and support
reforms in social sectors would help to increase
the public sector’s contribution to growth.
Growth is expected to average 3.6 percent

Figure A1.8 Export volume growth(percent)
8
7
6
5
4
3
2
1
0

(percent)
Export market growth (right axis)
Export growth

2000

2001

2002

Source: World Bank staff estimates.

2003

2004

14
12
10
8
6
4
2
0
2

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Table A1.6

E C O N O M I C

P R O S P E C T S

Middle East and North Africa forecast summary(percent per year)
Baseline forecast
Growth rates/ratios

Real GDP growth
Private consumption per capita
GDP per capita
Population
Gross domestic investment/GDPa
Inflationb
Central gvt. budget balance/GDP
Export market growthc
Export volumed
Terms of trade/GDPe
Current account/GDP
Memorandum items
GDP growth: Oil exporters
Diversified exporters

1991–2000

2000

2001

2002

2003

2004

2005–15

3.2
0.3
1.0
2.2
21.2
6.0
1.1
10.1
5.0
0.5
2.1

4.2
1.4
2.2
2.0
21.6
4.8
1.4
13.3
7.6
8.4
6.8

3.2
1.1
1.3
1.9
22.0
4.2
1.1
1.0
2.4
0.9
5.2

2.5
0.6
0.6
1.9
22.5
4.1
2.1
3.0
2.7
0.9
3.3

3.5
0.8
1.5
1.9
22.7
4.0
2.4
7.8
5.7
1.1
2.3

3.7
0.8
1.7
1.9
22.9
4.0
2.4
8.2
5.8
1.4
0.9

3.2
1.1
1.4
1.8
24.3
…
…
…
…
…
…

2.4
4.0

3.6
3.7

2.4
4.3

2.4
2.2

3.7
2.7

3.6
3.6

…
…

… Not available.
a. Fixed investment, measured in real terms.
b. Local currency GDP deflator, median.
c. Weighted average growth of import demand in export markets.
d. Goods and non-actor services.
e. Change in terms of trade, measured as a proportion to GDP (percentage).
Source: World Bank baseline forecast, November 2002.

for the oil-exporting countries, supported bylikely increases in OPEC oil quotas in 2003 tomeet growing demand in a period of tightcrude inventories. Additionally, Algeria’s crude
production capacity is set to increase, and its
gas exports are expected to experience growth
unfettered by quotas, indicating higher growthin the short term. However, much of thegrowth increase in Algeria in the medium term
would come from the large public sector stimulus currently under way. This would revive
domestic demand for the duration of the expenditure program. In Saudi Arabia, the stock
market is performing well, and credit to theprivate sector is rising, auguring favorably for
2003–04. The Islamic Republic of Iran will see
the revival of the agricultural sector after several years of drought, with the expansion ingas exports and the continuing relaxation ofimport restrictions buttressing growth in the
non-oil sector.
Growth in diversified exports would be expected to increase to 2.7 percent in 2003 and3.6 percent in 2004. Export market growthwould be expected to rise considerably in
2003–04, and the tourism industry would
also be expected to recover from its slide since
September 11, 2001, as the external environment gradually improves through 2004. Someof the diversified exporters, such as Morocco
and Tunisia, will not be able to rely on government stimulus for growth because of theneed to pursue fiscal consolidation and keep
large inflexible expenditures, especially thegovernment wage bill, under control. Overcoming the vulnerabilities unveiled by theexternal shocks would call for a faster pace ofstructural reforms to improve prospects forprivate sector investment. Morocco must rely
on privatization receipts to lower budget
deficits, but this financing option will diminish over the medium term as the better candidates for privatization are sold off and therevenues from the former parastatals decrease,
implying higher deficits in the future unless
expenditure reforms occur. This will require,among other things, public sector reforms,
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2 0 0 3that underlie high expenditures. Weaknesses
will remain in the private sectors of several
countries. Jordan is weathering the downturn
more successfully than other countries because of the high demand for its exports in
India and the United States, but weak consumer demand and subdued rates of lending
to the private sector indicate that domestic
weakness will continue. Egyptian private sector activity is weak, reflecting credit conditions and tight monetary policy (although
the recent 100 basis point fall in the discountrate to 10 percent will help somewhat); fallingbank earnings in 2002 indicate that private
sector investment will remain sluggish in the
short term. In the current policy context, thegovernment will continue expansionary fiscal
policy despite already high deficits and will
put off the implementation of reforms thatmight have the potential for high social costs.
Recent political events obviously cast ashadow over prospects in the region. The continuing uncertainty stemming from the potential actions against Iraq would significantly
affect the gradual recovery in the short-term
forecast. Oil exporters would benefit fromincreased quotas and higher oil prices initially,
but these impacts would probably be short
lived. Diversified exporters would suffer
more, particularly from declines in the
tourism industry. Even the expectations surrounding military action within the region
could significantly affect growth in the shortterm. Moreover, the effects of military action
on confidence in already fragile global capital
markets may lead to increased spreads and aflight to quality, particularly from countries in
the region close to the field of war.

Long-term prospects
Even if relatively stronger growth performance is managed in the short term, growth in
the long term is expected to average just over
3.2 percent.
The policy environment affecting long-term
growth is gradually improving in many countries in the region, albeit at a gradual pace.

172

Jordan is reaping the benefits of a more open
trade regime, and many of the North Africancountries are pressing ahead with more liberal
trade relations. However, budget deficits inthese countries could lead to problems, particularly in those countries that rely heavily on
privatization revenues to finance increased expenditures. The temporary nature of receipts
from privatization makes reforms in public
expenditures (and the public sector policies
that underlie them) and taxation of paramount importance in the future. Furthermore,
many of the Mediterranean countries are currently facing sluggish growth or stagnation in
the private sector, with low levels of growth inprivate investment. This indicates the need forstrengthening the investment climate and removing bottlenecks in access to finance andbackbone productive inputs that hamper private sector investment. In Egypt, long-term
prospects appear weak. The policy reform
agenda has slowed, mirroring the slowdown
in the domestic economy. The current policy
mix includes an expansionary fiscal policy tocounter the tight monetary policy necessary
to support the exchange rate.
In the oil-exporting countries, Iran has unified its exchange rate, allowed the formationof private banks, reaffirmed its commitment
to privatization, and is pushing ahead withfiscal reforms. Algeria is considering the
deregulation of the power industry and opening the sector to private investment, and hasannounced the privatization of public companies. In Saudi Arabia, customs tariffs havebeen reduced to pave the way for a customs
union with the Gulf Cooperation Council in
2003, negotiations are under way with the
WTO, and new legislation is being prepared
to increase competition in domestic capital,
labor, and insurance markets. However, manyof these changes are occurring very gradually,and some are being greatly delayed. Algeria
has not pushed ahead with its announced privatizations, and reform in the power sector isvery slow. Many of the oil-exporting countries
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public sectors, and low rates of private investment in the non-hydrocarbon sectors. Reforms in these sectors leading to efficiency
gains and higher potential growth rates will be
required.
In the long term, the region has to continue
to address several obstacles. The region relies
very heavily on a narrow range of external
revenue sources, particularly oil, remittances,and tourism, and this reliance introduces thepotential for vulnerability in export earnings.
Although several countries have adjusted
nominal exchange rates in recent years, fixedexchange rate regimes in several countries
may adversely affect export competitivenessand offset gains made from trade and customs
reforms. Receipts from tourism and remittances are vulnerable to the sluggish income
growth in source countries and recurring
political conflicts and potential military actionin the region. Oil revenue windfalls are usually temporary, and real long-term oil prices
are expected to decline, particularly after

E C O N O M I C

P R O S P E C T S

2005–06, when Caspian oil production is expected to come onstream.

Notes
1. At both the June 2002 summit in Seville andOctober 2002 summit in Brussels, the European
Community (EC) confirmed that eight of the ECA EU
accession candidate countries (the Czech Republic,
Estonia, Hungary, Latvia, Lithuania, Poland, theSlovak Republic, and Slovenia) are on track to conclude accession negotiations at the end of 2002 andto sign formal accession treaties in 2003. The official
target is for enlargement to happen in time for the
mid-2004 European Parliament elections. Bulgaria andRomania are at an earlier stage in the accession process and are expected to accede somewhat later. Turkey
is also an accession candidate, although it has yet tobegin formal negotiations.
2. Following the forthcoming EC Copenhagen summit in mid-December 2002, the existing 15 EU member
countries’ national parliaments will vote to approve or
reject enlargement.
3. WTTC. 2002. The Impact of Travel and Tourism
on Jobs and the Economy—2002. http://www.
wttc.org.

173

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Appendix 2
Global Commodity Price Prospects

C

rude oil prices increased about 3 percent
in 2002 as a result of tight supplies andMiddle East tensions. Non-oil prices increased about 5 percent, led by a 9 percent increase in agricultural commodities, which morethan offset a 4 percent decline in metals andminerals (figure A2.1). Uncertainty about thestrength of the global economic recovery contributed to the decline in metals and mineralprices, but the effect of uncertainty on agricultural prices was offset by lower supplies of
selected commodities, such as grains andoilseeds, because of drought. The weakness in
the U.S. dollar supported commodity prices.
Crude oil prices are expected to remain
firm in early 2003 because of the potential for
military action against Iraq and tight supply
conditions resulting from production restraint
on the part of the Organization of Petroleum
Exporting Countries (OPEC). Once Middle
East tensions ease, oil prices are expected to
decline because non-OPEC oil supplies will increase and Iraqi oil will return to the market.
The average price of crude oil is projected
to decline from $25 per barrel in 2002 to$23 per barrel in 2003. By 2005, crude oil prices
are projected to decline to $19 per barrel.
Non-oil prices are in the early stages of
price recovery. That recovery is expected tolast about three years before nominal prices will
begin to weaken. The strength of the global
economic recovery will strongly influence thetiming and strength of the recovery in metals
and mineral prices. However, the recovery ofagricultural prices will be more strongly influenced by supply increases and by recent
weather disturbances such as El Niño anddroughts. The index of nominal non-oil
commodity prices is projected to increase by
5.8 percent in 2003 and by nearly 8 percent by
2005 in real terms. (Specific forecasts for commodity price and price indexes for 2002, 2003,
2005, 2010, and 2015 in current and constantdollars are given in tables A2.13–A2.15 laterin this appendix.)
Agricultural commodity prices appear tohave reached a cyclical low, after declining
since mid-1997, and by 2005 nominal prices
are expected to increase about 13 percent over2002 levels. The increases will leave nominal
prices of most agricultural commodities well
below 1997 highs. Prices of specific agricultural commodities have declined much morethan the average decline because of large supply increases, weak demand, or both. Some ofthose prices are not expected to recover to1997 levels for the foreseeable future. Becauseof large supply increases from Vietnam andBrazil and because of slow growth in demand
despite low prices, robusta coffee prices, forexample, have fallen to nominal lows not seen
since the 1960s. In 2002, cotton prices fell tonominal levels, which were last seen in 1986
and the mid-1970s. Palm oil prices declinedby more than half from 1998 to 2002 andreached nominal levels last seen in 1986.
In real terms,1 robusta coffee prices fell
85 percent from 1980 to 2001, and cotton

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2 0 0 3Figure A2.1 Commodity price trends(index, January 1997  100)160
Crude oil
140
Agriculture
120
100
80
60

Metals & minerals

40
20
0
Jan.
1997

Jan.
1998

Jan.
1999

Jan.
2000

Jan.
2001

Jan.
2002

Source: World Bank.

prices fell 61 percent from 1980 to 2002. Realpalm oil prices declined 60 percent from 1980
to 2001. The extreme price declines in agricultural commodities resulted from a numberof factors, including large increases in productivity, slow growth in demand caused byfalling population growth rates and income
elasticities, and policies that support production in high-income countries. Several largecommodity exporters experienced depreciation of exchange rates. That depreciation,
which was linked to Asia’s economic crisis,
further contributed to price declines.
Metals and mineral prices fell about 4 percent in 2002 as a result of weak demand, highstocks, and continued production increases. A
recovery in prices following the October 2001
lows stalled in 2002 as the economic recovery
slowed and as industrial demand failed to rebound as expected. Most metal markets werein surplus, and stocks remained high. A number of metal producers closed their production
facilities in an attempt to prevent further stockbuilding and price declines. Despite such efforts, production increased in a number ofcountries. That increase, coupled with an absence of strong growth in demand, pressured
prices lower. Nickel has been the one major176

metal to sustain price increases that can be attributed to low stocks and expectations of tightsupplies. Gold prices also rose strongly in
2002, mainly because of the buyback of producers’ hedge positions. However, the decline
in equity markets, weakening of the U.S. dollar,
and nervousness about military activity in the
Middle East also contributed to the price rise.
Crude oil prices began 2002 below $20 per
barrel because of weak demand, increasing
supplies from non-OPEC producers, and overquota production in several OPEC members.
Nevertheless, OPEC production restraint has
been sufficient to bring prices back to the top of
OPEC’s targeted range of $22 to $28 per barrel.
Significant OPEC cutbacks, which commenced
in early 2001, started to draw down crude oilstocks during the second half of 2002 and generally supported higher prices. In addition,
increasing uncertainty about a supply disruption from a possible U.S. attack on Iraq helped
push prices higher—to near $30 per barrel.
Real commodity prices declined significantly from 1980 to 2001, with the WorldBank’s index of agricultural prices down
53 percent, crude oil prices down 46 percent,and metals and mineral prices down 35 percent (figure A2.2). Such declines in commodity

Figure A2.2 Real commodity prices(index, 1980  100)
140
Agriculture
120
Metals & minerals
100
80
60
40
Crude oil
20
0
1970

1980

Source: World Bank.

1990

2000

gep_app02.qxd 12/5/02 12:52 PM Page 177

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prices, relative to manufactures prices, pose
real challenges for developing countries that
depend on primary commodities for a substantial share of their export revenues. The declines are expected to continue in the longer
term as productivity increases in commodities
continue to outpace those in manufactures.

AgricultureA

gricultural commodity prices are expected
to increase about 9 percent in 2002 after
falling 9 percent in 2001. The increase follows
sharp declines from 1997 to 2001 that reduced
the World Bank’s index of annual agricultural
prices by 38 percent. Prices are expected to increase 13 percent from 2002 to 2005 in nominal terms. That increase will recover a little
more than one-third of the 1997–2001 decline.
The recovery of prices is expected to be modest because of weak growth in demand, continued rapid increases in production andproductivity, and high stocks in some com-

Box A2.1

O

C O M M O D I T Y

P R I C E

P R O S P E C T S

modities, such as coffee, cotton, and sugar.
Real prices will rise an estimated 11 percent
from 2002 to 2015. However, the rise in real
prices is a reflection of current low prices
rather than a change in the long-term trend of
declining prices relative to manufactures.
There has been considerable disparity
among commodities: prices of some commodities (cocoa) reached multiyear highs in
2002, while others (coffee and cotton) haverecently reached new lows or continue todecline. The disparity is related partly to thedifferent levels of carryover stocks, and partly
to the effects of weather conditions on supply.
Droughts in Australia, Canada, and theUnited States reduced yields and contributed
to increases in grain and oilseed prices.
The United States enacted a new farm bill,which will be in effect from 2002 to 2007. The
bill raised price supports for many commodities and included some commodities that had
not previously been included under government programs (see box A2.1). The European

U.S. Farm Billn May 13, 2002, the United States enacted a new
farm bill, the Farm Security and Rural Investment Act of 2002. The new bill covers a six-year
period, from 2002 to 2007. Low commodity prices
had led to a series of annual bailouts to supplement
regular subsidy programs under the previous law. The
new farm bill essentially extends those temporary
bailouts through the six-year life of the bill.
The key features of the new farm bill are higher
price supports for major crops, the revival of target
prices to give more subsidies to producers whenworld prices fall, and a large increase in conservation
programs. The bill continues fixed annual payments
to grain and cotton farmers. It creates a new target
price system similar to the one abolished in 1996,
to provide supplemental payments when prices fall
below certain levels—except that acreage set-asides
are no longer necessary for farmers to qualify for
payments under the new bill. It allows farmers to
update planting records that are used in calculating
certain program payments. The bill also establishes

new subsidies for dairy farmers as well as for producers of lentils, chickpeas, peanuts, honey, wool,
and mohair. It expands the Conservation Reserve
Program, which pays farmers to let environmentallysensitive land stand idle, and it establishes a newConservation Security Program to pay crop farmers
for improved environmental practices.
Under the 1994 Uruguay Round Agreement on
Agriculture, the United States agreed to limit spending on domestic agricultural support programs, which
are considered trade distorting, to $19.1 billion per
year. Since payments are not fixed, but are determined by the levels of market prices as well as the levels of support, it is not possible to know whether payments under the new farm bill will exceed the agreed
limit. If it appears that this limit will be met or
exceeded, the U.S. Congress has instructed the U.S.
Department of Agriculture (USDA) to take steps toreduce payments so as not to exceed this limit.
Source: Bank staff.

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Box A2.2

P R O S P E C T S

2 0 0 3

E.U. Common Agricultural PolicyP

resident Chirac of France and Chancellor Schroeder
of Germany reached a budget agreement on the
Common Agriculture Policy (CAP) in Brussels
October 26–27, 2002. The agreement limits CAP
budgets to increases of 1 percent annually from 2006
to 2013 from an estimated budget of 45.6 billion
euros in 2006. Total direct and indirect support toE.U. agriculture was estimated at 117.9 billion euros
in 2001 by the OECD; more than half of that support
comes from higher food prices paid by consumers.
Participants in the Brussels summit proposedthat agricultural support to new E.U. accession
countries increase from 25 percent of current
member-support levels when those countries join in
2004 to 40 percent in 2007 and parity by 2013. The
agreement puts a limit on CAP spending increases
even after the 10 accession countries join in 2004,
a limit that could necessitate CAP reforms as theaccession countries’ support levels increase or that
could require shifting of funds from farmers incurrent member countries.

E.U. Agriculture Commissioner Franz Fischler
had proposed radical CAP reforms in July 2002 in
the Midterm Review of Agenda 2000. The reforms
would shift income support away from productionof surpluses and toward meeting of tough environmental, animal welfare, and food safety standards.
According to the proposal, E.U. farmers would geta single decoupled payment based on historicalreferences—regardless of whether they continue
production on the same scale. Direct spending on
farmers would be cut by 3 percent per year overseven years, and the savings would be spent on ruraldevelopment. Aid to large farms would be capped.
This proposal has proved controversial, and several
European states have indicated their opposition tochanging the current system.
Sources: Agra Europe Ltd., London and European Commission.
Information about the Common Agricultural Policy can befound on the European Union Web site:
http://europa.eu.int/pol/agr/index_en.htm.

Union reached an agreement that limits futurebudget increases for the Common Agricultural
Policy through 2013 (see box A2.2).

Beverages
The World Bank’s index of beverage prices(comprising coffee, cocoa, and tea prices)increased about 17 percent in 2002, largely
because of a 70 percent increase in cocoa
prices. In contrast, coffee and tea prices
remained weak. The sharp increase in cocoa
prices reflects production problems and therecent coup attempt in Côte d’Ivoire, a major
producer of cocoa. The weakness in coffee
prices can be attributed to large stocks, weak
demand, and large production increases bymajor exporters. Tea prices declined as a result of abundant supplies and weak growth indemand.
Coffee. Coffee prices fell to record lows andbecame the most visible symbol of the declines
in agricultural commodity prices during 2002.

178

In real terms, coffee prices are currently lessthan one-third of their 1960 level. The declinereflects mostly the surge in supplies, but theequally important longer-term problem is
weak demand. According to the U.S. Department of Agriculture (USDA), per capita annual
coffee consumption in the major importing
countries has been stagnant, at about 4.5 kilograms of green coffee equivalent, during thepast decade.
Global coffee production in the 2002–03
season is expected to increase 10.7 percent
from last season’s 110.7 million bags
(table A2.1). Brazil, the dominant producer
with one-third of global output, is expected to
produce a record 46.9 million bags, while
Colombia and Vietnam, the second and thirdlargest producers, will each reach about 10 million bags.
A number of unsuccessful attempts havebeen made to arrest the price decline. The
Association of Coffee Producing Countries,
which has urged coffee producers to join its

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Table A2.1

C O M M O D I T Y

P R I C E

P R O S P E C T S

Coffee production in selected countries(million bags)

BrazilColombia
Côte d’Ivoire
Indonesia
MexicoVietnamWorld

1997–98

1998–99

1999–2000

2000–01

2001–02

2002–03

22.8
12.2
3.7
7.8
5.1
6.9
96.4

35.6
10.9
2.2
6.9
5.0
7.5
108.4

30.8
9.5
5.7
6.7
6.2
11.0
113.3

34.1
10.5
4.3
6.5
4.8
15.3
117.0

33.7
11.0
3.3
6.0
4.7
12.3
110.7

46.9
10.9
3.3
5.8
5.2
10.5
122.6

Source: U.S. Department of Agriculture.

export retention scheme for the past three seasons, ceased operating on February 1, 2002.
A plan backed by the International Coffee
Organization, which called for removal of lowquality coffee beans from the market, was notwell supported by some coffee-producing countries because it did not compensate producersof low-quality beans. A number of countries
have also undertaken their own price-support
schemes or stock-holding mechanisms. Brazil,
for example, has subsidized put options toeffectively guarantee a minimum price to producers. While such schemes may be partiallysuccessful in the short run, they could exacerbate the oversupply problem in the long run.
We project a recovery in both robusta andarabica prices in 2003 and a further recovery
in arabica in 2004. Nevertheless, we recognize
the risk that it may take longer for the recovery to materialize if the recent supply surge
persists. Over the long term, real coffee prices
are expected to recover, but they will remain
well below the historical highs of the 1970s
and more recent highs of the 1990s. By 2015,
real arabica and robusta prices are projected
to increase about 75 percent from the 2002
levels. Prices would still be about only half of
their 1990s peaks.
Cocoa. Cocoa prices led the recovery of agricultural commodity prices, after falling to athree-decade low in February 2000. Since then,cocoa prices have more than doubled to a 16year high amid supply disruption in major
producers from political instability and fromproducers’ responses to extremely low prices.

Production in two major producers, Côte
d’Ivoire and Ghana, is estimated to be down
4 percent and 2 percent, respectively, in thejust-ending 2001–02 marketing season. The
extreme price increases in response to such
relatively small changes in output were partly
caused by speculative buying by commodity
funds. In addition, uncertainty about the reliability of supplies prompted strong demand
from processors.
Cocoa prices are expected to remain attheir 2002 level next year. They will decline
12 percent in 2004 as production continues
to increase. This forecast is based on the assumptions that (a) the strong prices enjoyedthis season have already given incentives togrowers to maintain their trees and to increase
production; (b) part of the recent surge inprices may have been caused by speculative
activities of a short-term nature that are unlikely to be carried over into the next year;
and (c) the recent coup attempt in Côte
d’Ivoire has been repelled.
In response to high prices, growth in demand for cocoa in the current and next marketing season is expected to slow from the
1990–2000 average of 2.4 percent. But itshould then return to historical growth rates(table A2.2). By 2015, real prices are projected
to decline 25 percent from 2002 levels.
Tea. The three-auction average tea price fell
6 percent in 2002 as supplies continued to increase relative to demand and stocks remained
high (table A2.2). Production in major exporters (India, Kenya, and Sri Lanka) was up

179gep_app02.qxd 12/5/02 12:52 PM Page 180

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P R O S P E C T S

Table A2.2

2 0 0 3Global balance for beverages
Annual growth rate (%)
1970

1980

1990

1999

2000

2001

1970–80

1980–90

1990–00

Coffee (thousand bags)
Production
Consumption
Exports

64,161
71,53654,186

86,174
79,10060,996

88,84996,30076,163

113,345
104,670
92,256

117,049
106,580
89,968110,773
108,450
88,788

2.11
1.01
0.78

1.36
1.97
2.41

1.20
0.22
1.68

Cocoa (thousand tons)
Production
Grindings
Stocks

1,554
1,418
497

1,695
1,556
675

2,506
2,335
1,791

3,073
2,967
1,341

2,812
3,014
1,111

2,750
2,823
1,101

0.46
0.16
2.38

4.62
4.48
13.89

1.16
2.58
4.66

Tea (thousand tons)
Production
Exports

1,286
752

1,848
859

2,516
1,132

2,900
1,259

2,960
1,330

3,030
1,389

4.09
2.35

2.87
2.39

1.49
1.62

Notes: Time reference for coffee (production and exports) and cocoa are based on crop year shown under the year that
production begins: October to September for cocoa and April to March for coffee. Coffee consumption and tea data are basedon the calendar year.
Sources: International Coffee Organization (ICO), International Cocoa Organization (ICCO), Food and Agriculture Organization(FAO) of the United Nations, International Tea Committee (ITC), U.S. Department of Agriculture, and World Bank.

4 percent in 2001—the last year for whichdata are available. Other exporters, such as
China and Vietnam, have also been increasing
exports rapidly, and such increases could further weaken prices.
Prices are projected to increase modestly
from the 2002 lows (up 3 percent in 2003), butthey will remain depressed relative to the highs
in 1997 and 1998. If emerging exporters, suchas Vietnam, continue to increase exports, there
is a significant risk that prices could continue
to fall. However, higher petroleum export
prices in the Russian Federation and in major
consuming countries in the Middle East havehistorically supported demand, and we expect
tea prices to begin a gradual recovery. By 2005,
we project nominal tea prices to rise 10 percent
from 2002 levels, which would leave nominal
prices down 20 percent from 1997 levels.

Food
The index of food prices has not changed forseveral years after declining sharply during
1997–99 (figure A2.3). The index rose about
4 percent in 2002 and is expected to rise 7 percent in 2003 and 2 percent in 2004 because ofhigher grain and oilseed prices following thisyear’s drought in major grain- and soybean-

180

Figure A2.3 Food prices(index, 1990  100)
130

120

110

100

90

80

70
Jan.
1997

Jan.
1998

Jan.
1999

Jan.
2000

Jan.
2001

Jan.
2002

Source: World Bank.

exporting countries. By 2015, real prices should
decline about 2 percent from 2002 levels.
Fats and oils. Prices of fats and oils recovered 13 percent in 2002 after falling 40 percent from 1997 to 2001. The increase wasgreatest in vegetable oils such as palm oil (up35 percent) and coconut oil (up 30 percent)gep_app02.qxd 12/5/02 12:52 PM Page 181

G L O B A L

because of lower production. Meal prices remained weak, with soymeal down 3 percent
because of weak demand for livestock andpoultry feeds. Prices of most fats and oils are
expected to increase during 2003–05, and theindex of prices is expected to increase 13 percent in nominal terms from 2002 to 2005.
Global production of the major fats andoils is expected to increase about 2 percent
in 2002–03, while consumption is expected
to increase by 3.2 percent, causing stocks to
decline and prices to continue increasing. Palmand soybean oil production is the largest among
the vegetable oils. Together they represent
40 percent of total vegetable oil production.
World soybean production is expected to remain constant in 2002 because of drought in
the United States, after growing by 5.3 percent
per year since 1990. This stoppage in growth
has led to higher soybean prices and reduced
stocks in 2002 and is expected to support
higher prices in 2003. Other major producers(table A2.3) are expected to increase soybean
production despite economic problems and uncertainties.
Palm oil production has more than doubled
since 1990 (table A2.4), with the largest increases coming from Indonesia and Malaysia.
However, production is expected to increase amore modest 2 percent in 2002–03.

Grains. World grain stocks, relative to use,are expected to fall significantly during thecurrent crop year (table A2.5), and the declines
are expected to keep grain prices rising through2003. Prices should then decline as production
Table A2.3

Soybean production(million tons)
Year

Argentina

BrazilUnited States

World

1990
1995
2000
2001
2002

11.5
12.4
27.8
29.5
30.0

15.8
24.2
39.0
43.5
48.0

52.4
59.2
75.1
78.7
71.5

104.1
124.9
175.1
183.7
183.3

Note: Argentina, Brazil, and the United States account for
about 80 percent of global production.
Source: U.S. Department of Agriculture.

Table A2.4

C O M M O D I T Y

P R I C E

P R O S P E C T S

Palm oil production(million tons)
Year

Indonesia

Malaysia

World

2.41
4.22
7.53
8.20
8.50

6.10
7.81
11.94
11.65
11.82

11.03
15.22
23.54
23.98
24.53

1990–91
1995–96
2000–01
2001–02
2002–03
Source: Oil World.

Table A2.5

Global grain stocks-to-use(percentages, excluding China)
Year

Maize

Rice

Wheat

Total grains

1997–98
1998–99
1999–2000
2000–01
2001–02
2002–03
1990s low

10.1
11.5
11.4
11.5
10.1
6.0
6.0

8.8
9.6
11.5
12.9
13.7
10.9
7.8

17.0
18.6
17.7
19.0
21.1
19.9
13.9

13.1
14.0
13.7
14.3
15.1
12.7
9.7

Source: U.S. Department of Agriculture.

increases in response to price increases. Thereis a risk that grain prices could continue to riseeven more sharply than projected if thedrought continues in the major exporting
countries, or if other major grain producers
have lower-than-expected production. Wheat
prices are projected to rise an additional
19 percent in nominal terms by 2003 after
increasing nearly 20 percent in 2002. Prices arethen expected to decline 6 and 12 percent in2004 and 2005, respectively, as production
responds to the higher prices. Maize prices rose
12 percent in 2002 and are expected to rise anadditional 25 percent by 2003 before declining
in 2004 and 2005. Rice prices rose 11 percent
in 2002 and are expected to rise an additional
22 percent by 2005.
Stocks in the major grain exporting countries—the United States, the European Union,
Canada, Australia, and Argentina—are expected to fall to the lowest level in 2003–03,
relative to total use, since 1997–98. The decline is mostly attributable to the droughts
in the United States, Canada, and Australia,
which are expected to reduce grain yields by 9,181gep_app02.qxd 12/5/02 12:52 PM Page 182

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2 0 0 37, and, 6 percent, respectively, in 2002–03
compared with yields in the previous year. An
El Niño weather pattern has contributed to theunfavorable weather pattern in Australia andcould further reduce production next year.2
The lower yields in the United States, Canada,
and Australia have been partially offset byrecord grain yields and production in theEuropean Union. Economic problems in
Argentina have contributed to lower production and exports from that country, but thelargest effect of the economic turmoil is expected to be in the next crop year, because mostof the planting and input-use decisions had
already been made before the economic crisis
fully emerged.
Grain production in developing countries
is projected to be down 1.8 percent in
2002–03, with production generally strong in
Asia, Latin America, and the Middle East, but
lower in Eastern Europe and Russia. Production in China is expected to be up 2.3 percent,while production in India is expected to be
down 4.9 percent because of a poor monsoon
season.
There is considerable variation in the stock
situation in individual grains, with the global
stocks-to-use percentage for maize at the lowest levels of the 1990s, while rice and wheat
percentages are above previous lows. However, grain prices are highly correlated, andprice increases in one grain would normallybe reflected in the prices of others. Higher
grain prices would benefit developing-country
net exporters such as Argentina (which is
expected to export more than 22 million tonsof grain in 2002–03) while harming net importers such as Mexico and the Arab Republicof Egypt, which are expected to import 13 million and 10 million tons of grain, respectively,
in 2002–03.

keting year that just ended in August, and anincrease in carryover stocks to nearly 50 percent of annual consumption. Brazil, the largest
exporter, is expected to have a sugar cane cropthat could exceed the previous year’s crop by
8 or 9 percent. Imports are expected to be
weak because of large production in importing countries. Hence, prices are unlikely torecover significantly in 2003.
Brazil has nearly 30 percent of the export
share in recent years and has been the primarysource of increased global exports, with production and exports growing rapidly in thepast decade (figure A2.4). The other major
exporters, Australia and Thailand, increased
production by 50 and 70 percent, respectively,from 1990–91 to 1997–98, when sugar prices
were attractive. However, they have cut production as prices have declined.
Sugar prices are expected to begin to recover in 2004 as low prices reduce global
supplies. However, prices are expected to remain relatively weak for the next several years,
with fluctuations depending on the year-toyear balance of production and consumption.
By 2005, nominal sugar prices are expected
to increase 17 percent over 2002 levels. In thelong term, nominal prices are expected toreturn to the center of the trading range,
and real prices are expected to average about
18 cents per kilogram (8.2 cents per pound).

Figure A2.4 Sugar exports(million tons, raw equivalent)
40

30
25
20
15

Sugar. Sugar prices fell to 15 cents per kilogram in 2002 (down 21 percent from 2001) toreturn to the lower end of the trading range of
10–30 cents per kilogram of the past 20 years.
The decline follows an estimated 5 percent increase in world sugar production in the mar-

182

Rest of world

35

10

Brazil

5
0
1990

1992

1994

1996

1998

Source: U.S. Department of Agriculture.

2000

2002

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Table A2.6

C O M M O D I T Y

P R I C E

P R O S P E C T S

Global balance for foods
Annual growth rates (%)
1970

1980

1990

1999

2000

2001

1970–80

1980–90

1990–2000

Grains (million tons)
Production
Consumption
Exports
Stocks

1,079
1,114
119
193

1,430
1,451
212
309

1,769
1,717
206
490

1,871
1,869
245
529

1,839
1,868
233
500

1,860
1,890
231
470

2.88
2.58
6.35
7.24

1.55
1.78
0.13
3.83

1.04
1.02
0.94
0.56

Soybean (thousand tons)
Production
Consumption
Exports
Stocks42,13345,96812,342
3,394

62,17368,052
20,822
10,266

104,093
104,307
25,38820,569159,904
160,541
46,68327,908175,098
172,166
55,07430,803

183,724
184,228
57,12730,218

6.84
6.53
5.24
13.83

1.87
2.04
0.80
0.66

5.08
4.99
2.88
0.20

Sugar (thousand tons
[raw equivalent])
Production
Consumption
Exports
Stocks70,91965,39521,931
19,61484,742
91,062
27,571
19,494

109,403106,807
34,07819,299138,094130,281
38,71031,702

143,220
133,104
42,01535,939136,111
134,71238,49535,474

2.80
3.30
3.26
3.96

1.59
1.40
0.83
0.77

3.26
3.00
3.12
4.52

Fats and oils (million tons)
Production
Consumption
Exports
Stocks

39.78
39.82
8.83
5.18

58.09
56.80
17.76
9.25

80.84
80.87
26.89
12.15

113.42111.9835.55
14.26

117.09116.9438.10
14.47

119.42120.74
39.57
13.19

3.68
3.55
7.05
7.09

3.54
3.69
4.19
2.44

3.70
3.64
3.39
0.69

Note: Time references for grains, soybeans, and sugar are based on marketing years, shown under the year in which production
begins, and they vary by country. For fats and oils, crop years begin in September.
Source: U.S. Department of Agriculture and Oil World.

The global balances for major foods are
given in table A2.6. The balances show that therate of growth of production and consumptionof grains has slowed during the 1990s compared with previous decades, while growth
rates have increased for soybeans and sugar.
The growth rates for fats and oils were relatively constant during the 1980s and 1990s.

Agricultural raw materials
The index of agricultural raw materials prices(comprising prices of tropical hardwoods,
cotton, and natural rubber) declined sharply
during Asia’s economic crisis and then stabilized before declining again as supplies
of commodities continued to increase (figure A2.5). Prices reached a low in 2001 andhave since recovered because of higher cottonand natural rubber prices. Nominal prices areprojected to increase 16 percent by 2005 from2002 levels, while real prices are projected torise 18 percent by 2015 over 2002 levels.
Cotton. Cotton prices declined an additional
5 percent in 2002 after declining 19 percent in2001 because of large production increases in
the United States and China, the two largest
producers (table A2.7). Prices in 2002 wereless than half of their 1995 highs, and theyreached 30-year nominal lows. The extreme
price weakness was caused by a number offactors, such as slow growth in demand, large
production, and competition from synthetic
fibers. Subsidies to cotton producers in the
United States and China have contributed tothe production surplus. During the past threeseasons, U.S. support to its cotton producers
averaged almost $3 billion, and China’s support averaged $2 billion.
Cotton production in the coming season is
expected to be 19.2 million tons—10 percent

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Table A2.7

2 0 0 3

Cotton production in selected countries(thousand tons)
Country

1998–99

1999–2000

2000–01

2001–02

2002–03

China
Franc zone
India
Pakistan
United States
Uzbekistan
World

4,501
897
2,710
1,480
3,030
1,000
18,551

3,830
928
2,650
1,800
3,835
1,150
18,887

4,350
700
2,350
1,750
3,818
960
19,126

5,320
1,034
2,686
1,853
4,420
1,055
21,422

4,420
921
2,500
1,731
3,826
1,015
19,157

Source: International Cotton Advisory Committee.

Figure A2.5 Raw materials(index, 1990 100)
130

120

110

100

90

80

70
Jan.
1997

Jan.
1998

Jan.
1999

Jan.
2000

Jan.
2001

Jan.
2002

Source: World Bank.

lower than in the previous season, with theUnited States and China accounting for mostof the decline. In the United States, the droughthas reduced production from the record
2001–02 season. Global consumption is expected to increase about 2.6 percent, according
to the latest forecasts by the International
Cotton Advisory Committee. Given lower production in combination with higher consumption, we forecast the A Index cotton price toincrease 10 percent in 2003 and 16 percent
in 2004. By 2015, real prices are projected toincrease 30 percent relative to 2002 prices.
Natural rubber. After prolonged weakness
following the Asian crisis, natural rubber

184

prices gained momentum at the beginning of
2002, with average 2002 prices rising about
32 percent from 2001. The recovery is mainly
a response to adverse weather conditions inThailand and a slowdown in Malaysia’s output growth as natural rubber plantations
are being converted to more profitable palm
oil plantations. Demand, however, remains
weak as car tire manufacturing (the largest
demand for natural rubber) in Organisation
for Economic Co-operation and Development(OECD) countries is estimated to be down
2 percent in 2002.
The strength in natural rubber prices islikely to persist because supply controls by the
Tripartite Rubber Corporation—a trilateralorganization formed last year by Indonesia,
Malaysia, and Thailand following the collapse of the International Natural Rubber
Organization—may restrict exports. We expected natural rubber prices to remain firm,
but not increase significantly, in 2003 from2002 levels because of weak demand that accompanies the apparent slowing of growth in
the global economy. By 2005, nominal prices
are expected to increase 6 percent from 2002
levels. Over the longer term, real prices areprojected to decline—down 3 percent from2002 to 2015.
Tropical timber. The decline in Asian tropical timber prices since the mid-1990s appears
to have ended, and prices have begun to recover from the lows reached at the end of
2001. Nominal timber prices increased about
9 percent in 2002 compared with 2001 prices

gep_app02.qxd 12/5/02 12:52 PM Page 185

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as a result of the improved demand fromJapan, the weakening of the U.S. dollar
relative to the yen, and the continued strong
import demand from China. Prices are expected to continue to recover in 2003 and2004, with annual average increases of 8 percent per year, resulting from improved economic growth in Asia. African sapelli log prices
have declined less than Asian log prices, as
demand has remained firm in Europe. Sapelli
nominal log prices are expected to increaseabout 5 percent from 2002 to 2005.
Real tropical timber prices are expected torecover from lows, but they are not expected
to reach new highs during the forecast period
to 2015. By 2015, real meranti log prices areprojected to rise 47 percent, while sapelli log
prices are projected to rise by only 18 percent.
The difference is due to the smaller decrease
and, therefore, smaller rebound of African
sapelli logs prices compared with Asian meranti log prices.
The global balances for raw materials
are given in table A2.8. The data show that
cotton production, consumption, and exports
Table A2.8

C O M M O D I T Y

P R I C E

P R O S P E C T S

slowed dramatically during the 1990s compared with the 1980s. Exports of cotton grew
only 0.2 percent during the 1990s, which contributed to the sharp price decline. Growth
rates of natural rubber production, consumption, and exports remained nearly constantduring the 1990s compared with the 1980s.
Tropical timber log production slowed while
production of sawnwood increased as timberproducing countries shifted to increased domestic processing. Sawnwood imports increased while plywood imports slowed during
the 1990s compared with the 1980s.

Fertilizers

F

ertilizer prices remained nearly constantin 2002 after several years of large adjustments (figure A2.6). Import demand remained
weak because of low commodity prices andincreased local production. However, fertilizer
production in major exporters contracted in
response to low fertilizer prices. Hence, amarket balance was achieved with little pressure on prices. Acreage used for global grain

Global balance for raw materials
Annual growth rates (%)
1970

1980

1990

1999

2000

2001

1970–80

1980–90

1990–2000

Cotton (thousand tons)
Production
Consumption
Exports
Stocks

11,740 13,832
12,173 14,215
3,875 4,414
4,605 4,895

18,97018,576
5,081
6,645

19,126
19,796
6,142
9,559

19,40819,762
5,750
9,274

21,422
20,0706,430
10,630

1.2
1.1
0.9
1.7

3.1
3.1
2.8
2.8

0.8
0.2
0.5
1.4

Natural rubber (thousand tons)
Production
Consumption
Net exports
Stocks

3,140
3,090
2,820
1,480

3,820
3,770
3,280
1,480

5,080
5,190
3,950
1,500

6,810
6,660
4,670
2,540

6,740
7,330
4,940
1,950

7,170
7,030
5,160
2,090

1.8
1.6
1.3
0.6

3.2
3.2
2.1
0.2

3.1
3.3
1.8
3.7

Tropical timber (thousand cubic meters)
Logs, production
Logs, imports
Sawnwood, production
Sawnwood, imports
Plywood, production
Plywood, imports

210
36.1
98.5
7.1
33.4
4.9

262
42.2
115.8
13.2
39.4
6.0

300
25.1
131.8
16.1
48.2
14.9

286
18.3
103.9
21.2
52.6
18.9

287
21.1
101.5
24.3
55.4
19.8

276
21.0
99.3
23.5
54.9
20.3

1.5
0.2
1.2
5.0
1.2
0.7

1.7
5.1
1.7
2.6
2.0
9.1

0.5
5.4
2.0
3.3
0.5
3.6

Notes: Time reference for cotton is based on the crop year beginning in August. For natural rubber and tropical timber, timerefers to the calendar year.
Sources: International Cotton Advisory Committee, International Study Rubber Group, FAO, and World Bank.

185

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2 0 0 3Figure A2.6 Fertilizer prices(dollars per ton)
200
180
TSP

160
140
120
100
80
60

MOP

Urea

40
20
0
1980

1985

1990

1995

2000

Note: TSP  triple super phosphate; MOP  muriate ofpotash.
Source: Fertilizer Week.

production, which accounts for more than halfof total fertilizer use, declined for the sixth
consecutive year in 2002, but it is expected toincrease in 2003 and 2004 in response to recent and expected grain price increases. Production capacity remains substantially larger
than demand for all major fertilizers, but it ismost extreme in potash, where surplus capacity may be as high as 30 percent of demand,
according to industry estimates.
Nitrogen fertilizer prices (as represented byurea prices) were down about 2 percent in
2002, as exports from major producers inEastern Europe fell because of rising natural
gas prices, currency changes that made exports less profitable, and increased local fertilizer demand. This fall was partially offset by
reduced demand in major importing countries
as a result of low commodity prices and increased local fertilizer production. Urea prices
are expected to continue to increase becauseof higher grain prices and reduced exports
from Eastern Europe. By 2005, nominal urea
prices are projected to increase 36 percent
from 2002, but then increases are expected toslow, and real prices should decline. By 2015,
real urea prices are expected to remain 19 per-186

cent above 2002 levels, as the industry continues to rationalize and reduce surplus capacity.
Prices for potassium chloride (also known
as muriate of potash, or MOP) declined 5 percent in 2002 from weak demand and large
surplus capacity. Price declines could havebeen much larger without aggressive supply
controls by major exporters. Increased domestic production in China is expected to weaken
future import demand and, along with a large
surplus in global production capacity, to keep
price increases small, despite the increased use
for grain production, which accompanies therecovery in grain prices. By 2005, nominal
MOP prices are projected to increase 10 percent from 2002 levels, and real prices are projected to fall 6 percent by 2015 compared with
2002 prices.
Triple super phosphate (TSP) prices increased 5 percent in 2002 after falling 27 percent from 1998 to 2001. Production fell in2001 in response to low prices, and imports
declined slightly because of increased local
production in China and India. Demandshould increase along with increased grain
prices and area planted. Surplus capacity issmaller than for other major fertilizers and is
expected to decline over the next several years.
This decline will cause nominal TSP prices toincrease by an estimated 13 percent by 2005.
Real prices are projected to decline by 5 percent by 2015 from 2002 levels.
The large surplus of global production capacity in the fertilizer industry is largely a resultof the sharp declines in consumption in former
Soviet bloc and Eastern European countries
following the collapse of the former Soviet
Union and the transition of those countries
to market economies. Many countries (suchas Russia and Ukraine) were left with large
production capacities and reduced domestic
demand—which led to export growth of nearly
4 percent per year since 1993 from the former
Soviet Union. Those increased exports displaced traditional exports and depressed pricesof nitrogen and phosphate fertilizers. Global
fertilizer consumption fell about 17 percent
from 1988 to 1993 and has only recently

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Table A2.9

C O M M O D I T Y

P R I C E

P R O S P E C T S

Global balance for fertilizers(million tons)
Annual growth rates (%)
1970

1980

1990

1998

1999

2000

1970–80

1980–90

1990–2000

Nitrogen
Production
Consumption
Exports

33.30
31.76
6.77

62.78
60.78
13.15

82.28
77.18
19.59

88.30
82.77
23.00

87.75
84.95
23.94

84.62
81.62
24.70

6.53
6.86
7.23

3.12
2.60
5.10

0.28
0.56
2.34

Phosphate
Production
Consumption
Exports

22.04
21.12
2.92

34.51
31.70
7.51

39.18
35.90
10.50

33.09
33.35
12.59

32.51
33.46
12.70

31.70
32.65
12.11

3.72
3.85
8.37

1.70
1.39
5.01

2.10
0.90
1.44

Potash
Production
Consumption
Exports

17.59
16.43
9.45

27.46
24.24
16.72

26.82
24.68
19.82

25.01
22.04
22.23

25.01
22.12
22.65

25.54
22.16
23.41

3.97
3.93
4.89

0.03
0.05
0.73

0.49
1.07
1.68

Note: All data are in marketing years.
Source: Food and Agriculture Organization.

recovered to near the 1988 peak. Table A2.9
gives the global balances for fertilizers.

Figure A2.7 Aluminum and copper prices(dollars per ton)

Metals and minerals

P

rices for metals and minerals rallied fromthe October 2001 lows because of expectations of a robust economic recovery thatwould lead to a strong demand for metals.
However, the price rally stalled in the second
quarter of 2002, as it appeared the recovery
would be more muted than anticipated. With
weak demand and large inventories, mostmetal prices have receded to at or below end2001 levels (see figure A2.7 for aluminum andcopper). Even with the rally, the index of metals and minerals prices during the first ninemonths of 2002 averaged 5.6 percent lower
than for the same period a year earlier.
Growth in demand has been very sluggish
in 2002, with little indication of strong growthin the near term. Meanwhile, production continues to rise, despite efforts to shut capacity.
As a result, the London Metal Exchange (LME)
inventories of most metals have continued torise to relatively high levels (see figure A2.8 foraluminum and copper). A number of production cutbacks, notably in copper and alumi-

2,700
Copper
2,300

1,900

1,500
Aluminum
1,100
Jan.
1997

Jan.
1998

Jan.
1999

Jan.
2000

Jan.
2001

Jan.
2002

Source: Platt’s Metals Week.

num, have helped support prices, but moreclosures may be necessary to prevent further
stock building and even lower prices.
The price recovery will likely be delayed
until 2003, and the strength of the recovery
will largely be determined by the timing andstrength of the rebound in the global economy.

187

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P R O S P E C T S

2 0 0 3Figure A2.8 Aluminum and copper stocks(thousand tons)
1,400
1,200
1,000
Aluminum
800
600
400
Copper
200
0
Jan.
1997

Jan.
1998

Jan.
1999

Jan.
2000

Jan.
2001

Jan.
2002

Source: London Metal Exchange.

There is a possibility that during the upturnof the next economic cycle metal prices could
rise significantly, augmented by strong buying from investment funds. However, this rise
would induce the development of new capacity and the restart of idle facilities, and prices
would eventually decline. Real metals andminerals prices are expected to decline in thelong term, as production costs continue to fallwith the implementation of new technologies
and of improved managerial practices.

Aluminum
Aluminum prices have fallen back near thelows of October 2001 because of relatively
weak demand, rising production, and soaring
stocks. Prices have been partly supported by
reductions in capacity caused by high electricity prices and rationing in the Pacific Northwest and Brazil, but reactivations in Brazil andto a lesser extent in North America have contributed to the surplus. Production in China
has grown significantly, and despite demand
growth of more than 10 percent per year,
the country became a net exporter this year,
adding to the downward pressure on prices.
Growth in demand is expected to accelerate
in 2003, but the market is expected to remain in

188

surplus over the next two years, which should
prevent any substantial increase in prices.
Chinese exports are expected to continue risingover this period, contributing to the surplus.
The market is not expected to move into deficit
until 2005, but there are many risks in the nearterm, such as the strength of the economic
recovery, the reactivation of idle capacity, andthe amount of Chinese net exports.
Real prices for primary aluminum are expected to decline in the long term, as new lowcost capacity is developed to meet expected
growth in demand. However, investment in
new aluminum plants will continue to require
low-cost power supplies. There is not expected
to be any significant constraint on alumina supply in the medium term, because several new
alumina capacity expansions are under way.

CopperCopper prices led the rally in base metals during
the past year following a series of production
cuts, with prices rising 20 percent from October
2001 to June 2002. Prices have since recededbecause of prospects of weak demand in thenear term. However, the market is expected to
be in reasonable balance this year as world mine
production declines about 2 percent because ofgep_app02.qxd 12/5/02 12:52 PM Page 189

G L O B A L

industry curtailments. LME inventories remain high, although they started to decline in
May largely as a result of the strong growth ofChinese imports.
Demand is expected to strengthen nextyear, and supply is expected to almost keep
pace, largely because of the recent commissioning of Chile’s Escondida Phase IV project
and the restart of idle capacity. The firm market balance should help support prices, buthigh stocks may prevent sharply higher gains
next year. The market is expected to remain inmodest deficit over the next few years, whichshould support rising prices during the forthcoming economic cycle. In the longer term, increases in new low-cost capacity are expected
to result in the continued decline of real prices.
A major uncertainty over the forecast period
will be the volume of Chinese imports.

P R I C E

P R O S P E C T S

60,000 tons of stock as collateral against a
three-year loan from Western banks, which
may keep the material off the market for theduration of the loan. Demand for nickel has
been relatively strong in the stainless steel sector, largely because of the shortage of scrap
supply.
The nickel market is expected to move into
deficit in 2003 and over the next few years because production increases are expected to fallshort of a strong growth in demand. No major
new projects are being commissioned until
2005. Poor technical and financial performance with pressure-acid-leach technology inAustralia has been a major reason for the current lack of investment, which could result in
fairly strong prices over the next couple ofyears. Over the long term, large new developments are expected to come onstream, such
as Inco’s Goro project in New Caledonia (in2005) and Voisey Bay in Labrador, Canada (in2006). Supply will originate from other new
projects, expansions, and Norilsk’s stockpiled
material. New technologies will lead to lower
costs, and real prices are expected to decline.
Table A2.10 shows the production, consumption, and LME ending stocks for aluminum, copper, and nickel from 1970 through2001.

NickelNickel has been one base metal to sustain priceincreases this year, with a 38 percent gain
between October 2001 and September 2002.
Relatively low stocks and Russian Norilsk’s
efforts to keep surplus supplies off the export
market have supported prices that are significantly higher than would be expected at thebottom of the business cycle. Norilsk is using

Table A2.10

C O M M O D I T Y

Global balance for metals and minerals(thousand tons)
Annual growth rates (%)
1970

1980

1990

1999

2000

2001

1970–80

1980–90

1990–2001

10,257
9,996

16,027
14,771
68

19,362
19,244311

23,71023,358775

24,46524,871
322

24,521
23,525
821

3.2
3.2
n.a.

1.9
1.8
0.3

2.2
1.8
9.2

CopperProduction
Consumption
LME ending stocks

7,583
7,294
72

9,242
9,400
123

10,80910,780179

14,463
14,024790

14,831
15,104357

15,571
14,583
799

1.9
2.5
7.4

1.1
1.0
5.6

3.4
2.8
14.6

Nickel
Production
Consumption
LME ending stocks

0
0
2,130

717
742
4,554

842
858
4,344

1,028
1,059
47

1,102
1,146
10

1,128
1,150
19

n.a.
n.a.
n.a.

1.6
1.5
0.5

2.7
2.7
15.2

Aluminum
Production
Consumption
LME ending stocks

Sources: World Bureau of Metal Statistics, London Metal Exchange, and World Bank.

189

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P R O S P E C T S

2 0 0 3Gold
Gold prices have averaged more than $300 per
troy ounce (toz) since April 2002, which is thefirst time since 1997 that prices have been
above $300 for more than a month. Much of
the strength has been from buybacks of hedged
positions by gold producers. In addition, increased investment demand—partly in reaction to declining U.S. equity markets and thedeclining dollar—has helped support prices.
However, the recent rally in gold prices is
not expected to endure as producer buybacks
end and central bank selling continues. At
present, hedging by producers is unattractive
because of low interest rates, but at somepoint producer hedging could again become
attractive, which would push prices lower. Although the United Kingdom’s central banksales program ended in March 2002, othercentral banks (such as Switzerland’s) are proceeding with their programs.
If prices remain above $300/toz, they will
weaken the price-sensitive jewelry demandmarket and will stimulate investment in new
supply. Even when prices fall below $300 per
toz, mine production is expected to continue
to increase moderately as new low-cost opera-

Table A2.11

tions come onstream. An important determinant of medium-term prices will be thedecision by central banks on whether official
gold sales should be stemmed further when
the Washington Agreement expires in 2004.3
Table A2.11 shows the demand for end supply of gold from 1991 through 2001.

PetroleumO

il prices slumped after September 11,
2001, because the economic recession,
mild weather, and reduced air travel weakened demand. Also, OPEC made no attempts
to prop up falling prices (figure A2.9). However, as OPEC prices fell well below theorganization’s target range of $22 to $28 perbarrel (OPEC basket $17.53 per barrel in
December 2001), 10 OPEC countries, excluding Iraq, agreed to reduce production quotas
6.5 percent at the start of 2002. This reduction
was the fourth cut in quotas in less than a year,
totaling 5 million barrels per day or 19 percent(figure A2.10).
Prices started to rebound at the end of 2001
on expectations that markets would tighten because of a recovery in world oil demand, OPEC

Global balance for gold

(tons)
Percent per year
1991

1995

1996

1997

1998

1999

2000

2001

1991–2001

DemandJewelry
Other fabrication
Bar hoarding
Other
Total demand

2,358
518
252
2,358
3,128

2,618
457
231
n.a.
3,305

2,791
503
306
6
3,606

2,851
484
182
n.a.
3,518

3,349
560
325
n.a.
4,234

3,149
595
240
170
4,154

3,188
564
214
n.a.
3,982

2,995
487
220
n.a.
3,804

2.4
0.6
1.3
n.a.
2.0

SupplyMine production
Net official sales
Old gold scrap
Net hedging
Other
Total supply

2,159
111
482
66
310
3,128

2,279
81
617
163
173
3,305

2,274
173
625
535
n.a.
3,606

2,361
279
640
142
95
3,946

2,479
626
628
504
297
4,154

2,568
464
616
506
n.a.
4,154

2,580
471
608
n.a.
322
3,982

2,595
468
695
n.a.
46
3,804

1.9
15.5
3.7
n.a.
n.a.
2.0

n.a.  Not available.
Sources: Gold Field Minerals Service and World Bank.

190

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C O M M O D I T Y

P R I C E

P R O S P E C T S

Figure A2.9 Oil price and OECD stocks(dollars per barrel)(million barrels)

35

2850
Stocks2800

WB price

30

2750
2700

25

2650
2600

20

2550
2500

15

2450
10

2400
Jan.
1997

Jan.
1998

Jan.
1999

Jan.
2000

Jan.
2001

Jan.
2002

Source: World Bank and International Energy Agency.

Figure A2.10 OPEC-10 production and quotas(million barrels per day)30
Plus Iraq production
29
28
27
26
OPEC-10 production

25

OPEC-10 quotas

24
23
22
21
Jan.
1997

Jan.
1998

Jan.
1999

Jan.
2000

Jan.
2001

Jan.
2002

Source: International Energy Agency and Organization of Petroleum Exporting Countries.

output restraint, and declining stocks. In addition, perceived threats of a supply disruption
from a United States–led invasion of Iraq also
helped push prices higher, and those anxieties
deepened as the year progressed. The WorldBank’s average price rose above $20 per barrel

in March and approached $30 per barrel in
September as U.S. President George W. Bush
took his case for war against Iraq to the United
Nations (U.N.). Market fundamentals also
started to tighten heading into the peakdemand winter season.

191

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P R O S P E C T S

Table A2.12

2 0 0 3Global balance for petroleum(million barrels per day)
Annual growth rates (%)
1970

1980

1990

2001

2002

2003

1970–80

1980–90

1990–2001

Consumption
OECD
Former Soviet Union
Other non-OECD countries
Total

34.0
5.0
6.8
45.7

41.5
8.9
12.3
62.6

41.5
8.4
16.1
66.0

47.7
3.7
25.1
76.5

47.6
3.8
25.3
76.6

48.0
3.9
25.7
77.5

2.0
6.0
6.1
3.2

0.0
0.6
2.7
0.5

1.3
7.2
4.1
1.3

Production
OPEC
Former Soviet Union
Other non-OPEC countries
Total
Stock change, miscellaneous
Memo item: Iraq

23.5
7.1
17.4
48.0
2.3
1.6

27.2
12.1
24.6
63.9
1.3
2.7

24.5
11.5
30.9
66.9
0.9
2.0

30.2
8.6
38.2
76.9
0.4
2.4

28.5
9.3
38.6
76.4
0.2
1.9

28.7
9.9
39.1
77.7
0.3
2.0

1.5
5.4
3.5
2.9

1.0
0.5
2.3
0.5

1.9
2.6
1.9
1.3

5.5

2.7

1.5

Sources: BP, International Energy Agency, and World Bank.

Fundamentally, the market was in reasonable balance for much of 2002, and inventories were at fairly typical levels, althoughstocks could fall to relatively low levels during
the winter without higher OPEC production.
World oil demand is likely to rise only marginally this year (table A2.12), similar to thegain in 2001. Meanwhile non-OPEC supplies
continue to increase strongly, rising by an estimated 1.2 million barrels per day, with morethan half of the gain expected to come from
Russia.
It is only through significant production
restraint that OPEC has kept prices within its
target range—notwithstanding some overproduction by members of the group. In addition,
Iraq’s exports have been less than half of thecountry’s potential for much of the year, because of disputes with the U.N. about Iraq’s
surcharges, which the U.N. sought to eliminate
with a retroactive pricing scheme. However,buyers are exposed to large risks with thismechanism, and crude oil purchases from Iraq
were curtailed.
Expectations of an attack on Iraq have
led to a wide range of estimates of a “warpremium” on prices this year. Estimates range
from very little (prices reflect the market balance) to several dollars per barrel. It is very

192

difficult to quantify such a premium, and no
precise definition exists. Energy expert Philip
K. Verleger Jr. defines the premium as theincremental amount a buyer is willing to pay
for ensured prompt supply over deferred oil
given the level of inventories. He argues according to that definition that no war premium existed at the end of September 2002.4
The near-term outlook for the oil market
depends heavily on developments in Iraq andon OPEC’s production decisions. While there
is agreement between the United States andU.N. to allow weapons inspectors back into
Iraq, there is likely to be less agreement on
how to proceed if Iraq refuses U.N. demands.
Should an attack occur in the coming months,
prices could spike sharply higher, dependingon the prevailing level of inventories, the response from OPEC producers, and the drawdown of strategic reserves. During the 1990
war in the Persian Gulf, more than 4 mb/d ofoil from Kuwait and Iraq were removed frominternational markets, and prices exceeded$40/bbl. There was substantial surplus production within OPEC, and the organization
raised output—but not immediately. Importantly, prices did not fall until the war commenced (and its success was quickly assured)and the strategic stocks were released.

gep_app02.qxd 12/5/02 12:52 PM Page 193

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Since Iraq is exporting only around 1 mb/d,
much less oil is at risk, although it is conceivable that Iraq could launch scud missiles into
Kuwait and Saudi Arabia and could temporarily disrupt supplies. There is more surplus capacity within OPEC than in 1990, andsufficient spare capacity within Saudi Arabia
alone could easily replace lost oil from Iraq.
However, OPEC desires prices of at least$25/bbl, and it is not clear how quickly its
members will raise production to prevent asurge in prices. In such an environment, crude
prices could be bid up sharply because ofhigher demand, speculation, and hoarding.
Buyers might have to pay a substantial premium for prompt supplies, and prices could
rise to 1990 levels.
Once war ends, prices could fall precipitously as a result of a higher OPEC production, a draw from strategic stocks, and thereturn of Iraqi exports. Disputes within OPEC
over market share could take prices well below$20/bbl.
In the absence of an attack, OPEC’s production decisions will heavily influence prices.
The group will likely attempt to keep prices
at $25/bbl. Higher OPEC production will be
required during the winter to keep prices

C O M M O D I T Y

P R I C E

P R O S P E C T S

below $30/bbl, but the organization may haveto reduce output at winter’s end to keep prices
within its price target. The demand for OPEC
oil is expected to rise only modestly in 2003.
An increase in non-OPEC supply of 1 mb/d
is expected to capture the bulk of the growth
in world oil demand. Rising capacity within
OPEC, requests for higher quotas (from
Algeria and Nigeria), and a recovery of Iraq’s
exports could strain OPEC’s efforts to support
higher prices. But as long as the risk of a supply disruption hangs over the market, prices
are likely to remain well within OPEC’s target
range.
Oil prices are expected to decline from$25 per barrel in 2002 to $23 per barrel in2003 as a result of rising supply competition
and below-trend growth in demand. By middecade, prices are expected to fall below$20 per barrel (figure A2.11). A risk to theforecast is that OPEC could maintain strong
production discipline over the next few years
to keep prices at or above $25 per barrel. Ifsuch efforts prove successful, they would
add to the growing pressures on prices—bynegatively affecting demand and by stimulating competing supplies—and prices would still
be expected to fall below $20 per barrel by

Figure A2.11 Crude oil prices(dollars per barrel)
50
45
40
35
30

Nominal1990 dollars

25
20
Real
15
10
5
0
1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2110

2015

Source: World Bank.

193

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P R O S P E C T S

2 0 0 3

mid-decade. By 2005–06, significant new supplies from West Africa, the Caspian Sea, andelsewhere are expected to become available.
Coupled with rising capacity within OPEC,
those supplies will exert severe downward
pressure on prices.
In the long term, growth in demand will
be only moderate, as it has been for the past
20 years (table A2.12), but new technologies,
environmental pressures, and government
policies could further reduce this growth.
Prices somewhat below $20 per barrel are sufficiently high to generate ample developmentof conventional and unconventional oil supplies, and there are no apparent resource constraints far into the future. In addition, newareas continue to be developed (for example,

194

deep water offshore and the Caspian Sea), anddevelopment costs continue to fall from newtechnologies (shifting supply curves outward).
In addition, OPEC members are increasing
capacity and will add to the supply competition in the coming years. Consequently, realoil prices are expected to continue their longterm decline.
As mentioned at the beginning of this appendix, we will now present tables showing
actual commodity prices for 1970 through2001, plus price projections for 2002 through2015. Table A2.13 gives the commodity prices
and forecasts in current dollars, table A2.14
uses constant 1990 dollars, and table A2.15
displays weighted indices of commodity prices
and inflation.

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Table A2.13

C O M M O D I T Y

P R I C E

P R O S P E C T S

Commodity prices and price projections in current dollars
ActualProjections

Unita

1970

1980

1990

2000

2001

2002

2003

2005

2010

2015

EnergyCoal, Australia
Crude oil, average
Natural gas, Europe
Natural gas, U.S.

$/mt
$/bbl
$/mmbtu$/mmbtu

n.a.
1.21
n.a.
0.17

n.a.
36.87
3.40
1.55

39.67
22.88
2.55
1.70

26.25
28.23
3.86
4.31

32.31
24.35
4.06
3.96

26.50
25.00
3.00
3.25

26.00
23.00
2.80
3.20

27.00
19.00
2.60
3.00

29.50
19.00
2.75
3.00

32.00
21.00
3.00
3.25

Nonenergy commodities
Agriculture
Beverages
Cocoa
Coffee, other milds
Coffee, robusta
Tea, auctions (3) average

c/kg
c/kg
c/kg
c/kg

67.5
114.7
91.4
83.5

260.4
346.6
324.3
165.9

126.7
197.2
118.2
205.8

90.6
192.0
91.3
187.6

106.9
137.3
60.7
159.8

182.0
133.0
63.9
150.0

182.0
141.1
70.6
155.0

160.0
187.4
83.8
165.0

157.0
242.5
110.0
175.0

168.0
280.0
142.6
180.0

$/mt
$/mt
$/mt
$/mt
$/mt
$/mt
$/mt

397.2
224.8
378.6
260.1
102.6
286.3
116.9

673.8
452.7
858.8
583.7
262.4
597.6
296.2

336.5
230.7
963.7
289.8
200.2
447.3
246.8

450.3
304.8
713.7
310.3
189.2
338.1
211.8

318.1
202.1
680.3
285.7
181.0
354.0
195.8

415.0
268.0
680.0
385.0
175.0
440.0
210.0

450.0
375.0
750.0
390.0
200.0
450.0
230.0

600.0
450.0
820.0
400.0
205.0
430.0
235.0

645.0
480.0
850.0
450.0
215.0
460.0
240.0

670.0
500.0
875.0
475.0
220.0
505.0
250.0

Grains
Maize
Rice, Thailand, 5%
Sorghum
Wheat, U.S., HRW

$/mt
$/mt
$/mt
$/mt

58.4
126.3
51.8
54.9

125.3
410.7
128.9
172.7

109.3
270.9
103.9
135.5

88.5
202.4
88.0
114.1

89.6
172.8
95.2
126.8

100.0
192.0
102.0
151.5

125.0
210.0
125.0
180.0

115.0
235.0
116.6
150.0

120.0
260.0
119.5
160.0

130.0
265.0
128.0
165.0

Other foodBananas, U.S.
Beef, U.S.
Oranges
Shrimp, Mexico
Sugar, world

$/mt
c/kg
$/mt
c/kg
c/kg

166.1
130.4
168.0
n.a.
8.2

377.3
276.0
400.2
1,152
63.16

540.9
256.3
531.1
1,069
27.67

424.0
193.2
363.2
1,513
18.04

583.3
212.9
595.5
1,517
19.04

530.0
215.0
588.0
1,040
15.00

518.1
230.0
550.0
1,150
15.00

529.1
228.0
500.0
1,650
17.60

568.0
222.0
525.0
1,700
21.00

590.0
230.0
550.0
1,720
22.00

Agricultural raw materials
TimberLogs, Cameroon
Logs, Malaysia
Sawnwood, Malaysia

$/cum
$/cum
$/cum

43.0
43.1
175.0

251.7
195.5
396.0

343.5
177.2
533.0

275.4
190.0
594.7

266.1
159.1
481.4

265.0
163.0
528.0

275.0
170.0
560.0

300.0
215.0
625.0

338.0
260.0
720.0

385.0
295.0
820.0

Other raw materials
CottonRubber, RSS1, Malaysia
Tobacco

c/kg
c/kg
$/mt

67.6
40.7
1,076

206.2
142.5
2,276

181.9
86.5
3,392

130.2
69.1
2,976

105.8
60.0
3,005

100.0
79.4
2,770

110.2
81.6
3,000

127.9
83.8
3,250

149.9
87.7
3,275

160.0
95.1
3,300

Fertilizers
DAP
Phosphate rock
Potassium chloride
TSP
Urea, East Europe, bagged

$/mt
$/mt
$/mt
$/mt
$/mt

54.0
11.00
32.0
43.0
n.a.

222.2
46.71
115.7
180.3
n.a.

171.4
40.50
98.1
131.8
119.3

154.2
43.75
122.5
137.7
101.1

147.7
41.77
118.1
126.9
95.3

158.0
40.80
113.0
133.0
93.0

168.0
41.00
120.0
140.0
108.6

170.0
43.00
124.0
150.0
126.7

175.0
45.00
127.0
150.0
131.3

180.0
46.00
130.0
155.0
135.8

Metals and minerals
Aluminum
CopperGold
Iron ore
Lad
NickelSilver
Tin
Zinc

$/mt
$/mt
$/toz
c/dmtu
c/kg
$/mt
c/toz
c/kg
c/kg

556
1,416
35.9
9.84
30.3
2,846
177.0
367.3
29.6

1,456
2,182
607.9
28.09
90.6
6,519
2,064
1,677
76.1

1,639
2,661
383.5
32.50
81.1
8,864
482.0
608.5
151.4

1,549
1,813
279.0
28.79
45.4
8,638
499.9
543.6
112.8

1,444
1,578
271.0
30.03
47.6
5,945
438.6
448.4
88.6

1,340
1,545
310.0
29.50
45.0
6,700
460.0
405.0
77.0

1,400
1,650
300.0
30.00
48.0
7,500
480.0
450.0
84.0

1,500
1,900
275.0
31.00
55.0
7,500
500.0
525.0
100.0

1,600
2,000
300.0
32.00
60.0
6,700
525.0
540.0
105.0

1,700
2,050
300.0
32.50
62.5
6,800
550.0
550.0
110.0

Commodity

Food
Fats and oils
Coconut oil
Copra
Groundnut oil
Palm oilSoybean meal
Soybean oil
Soybeans

n.a.  Not available.
a. $  U.S. dollar, c  U.S. cent, bbl  barrel, cum  cubic meter, dmtu  dry metric ton unit, kg  kilogram, mmbtu  million British thermal unit,
mt  metric ton, and toz  troy ounce.
Note: Projections as of November 12, 2002.
Source: World Bank, Development Prospects Group.

195gep_app02.qxd 12/5/02 12:52 PM Page 196

G L O B A L

Table A2.14

E C O N O M I C

P R O S P E C T S

2 0 0 3

Commodity prices and price projections in constant 1990 dollars
ActualProjections

Unita

1970

1980

1990

2000

2001

2002

2003

2005

2010

2015

EnergyCoal, Australia
Crude oil, average
Natural gas, Europe
Natural gas, U.S.

$/mt
$/bbl
$/mmbtu$/mmbtu

n.a.
4.31
n.a.
0.61

n.a.
46.80
4.32
1.97

39.67
22.88
2.55
1.70

26.97
29.01
3.96
4.43

33.68
25.38
4.23
4.12

27.48
25.92
3.11
3.37

26.18
23.16
2.82
3.22

26.06
18.34
2.51
2.90

26.53
17.09
2.47
2.70

27.00
17.72
2.53
2.74

Nonenergy Commodities
Agriculture
Beverages
Cocoa
Coffee, other milds
Coffee, robusta
Tea, auctions (3) average

c/kg
c/kg
c/kg
c/kg

240.6
408.8
325.7
297.7

330.5
440.0
411.7
210.6

126.7
197.2
118.2
205.8

93.1
197.3
93.8
192.8

111.4
143.1
63.3
166.6

188.7
137.9
66.3
155.5

183.2
142.1
71.0
156.1

154.5
180.9
80.9
159.3

141.2
218.1
98.9
157.4

141.8
236.3
120.3
151.9

1,416.0
855.3
801.6
574.7
1,349.5 1,090.1
927.1
740.9
365.7
333.1
1,020.8
758.6
416.8
376.0

336.5
230.7
963.7
289.8
200.2
447.3
246.8

462.7
313.1
733.3
318.8
194.4
347.4
217.7

331.5
210.6
709.0
297.7
188.6
368.9
204.1

430.3
277.9
705.0
399.2
181.4
456.2
217.7

453.0
377.5
755.1
392.6
201.4
453.0
231.6

579.2
434.4
791.6
386.1
197.9
415.1
226.9

580.1
431.7
764.5
404.8
193.4
413.7
215.9

565.4
421.9
738.3
400.8
185.6
426.1
211.0

Commodity

Food
Fats and oils
Coconut oil
Copra
Groundnut oil
Palm oilSoybean meal
Soybean oil
Soybeans

$/mt
$/mt
$/mt
$/mt
$/mt
$/mt
$/mt

Grains
Maize
Rice, Thailand, 5%
Sorghum
Wheat, U.S., HRW

$/mt
$/mt
$/mt
$/mt

208.2
450.3
184.7
195.7

159.0
521.4
163.6
219.3

109.3
270.9
103.9
135.5

91.0
208.0
90.4
117.2

93.4
180.1
99.3
132.2

103.7
199.1
105.8
157.1

125.8
211.4
125.8
181.2

111.0
226.9
112.6
144.8

107.9
233.9
107.5
143.9

109.7
223.6
108.0
139.2

Other foodBananas, U.S.
Beef, U.S.
Oranges
Shrimp, Mexico
Sugar, world

$/mt
c/kg
$/mt
c/kg
c/kg

592.1
465.0
599.1
n.a.
29.32

478.9
350.3
508.0
1,462
80.17

540.9
256.3
531.1
1,069
27.67

435.7
198.5
373.2
1,554
18.5

607.9
221.9
620.6
1,581
19.8

549.5
222.9
609.6
1,078
15.6

521.6
231.6
553.7
1,158
15.1

510.8
220.1
482.7
1,593
17.0

510.9
199.7
472.2
1,529
18.9

497.9
194.1
464.1
1,451
18.6

Agricultural raw materials
TimberLogs, Cameroon
Logs, Malaysia
Sawnwood, Malaysia

$/cum
$/cum
$/cum

153.3
153.8
623.9

319.5
248.2
502.7

343.5
177.2
533.0

283.0
195.2
611.1

277.3
165.8
501.7

274.8
169.0
547.4

276.9
171.2
563.8

289.6
207.6
603.3

304.0
233.9
647.6

324.9
248.9
691.9

Other raw materials
CottonRubber, RSS1, Malaysia
Tobacco

c/kg
c/kg
$/mt

241.1
145.2
3,836

261.7
180.8
2,889

181.9
86.5
3,392

133.8
71.0
3,058

110.3
62.6
3,131

103.7
82.3
2,872

111.0
82.1
3,020

123.4
80.9
3,137

134.8
78.9
2,946

135.0
80.2
2,785

Fertilizers
DAP
Phosphate rock
Potassium chloride
TSP
Urea, East Europe, bulk

$/mt
$/mt
$/mt
$/mt
$/mt

192.5
39.2
114.1
153.3
n.a.

282.1
59.3
146.9
228.8
n.a.

171.4
40.5
98.1
131.8
119.3

158.5
45.0
125.9
141.5
103.9

154.0
43.5
123.1
132.2
99.3

163.8
42.3
117.2
137.9
96.4

169.1
41.3
120.8
140.9
109.4

164.1
41.5
119.7
144.8
122.3

157.4
40.5
114.2
134.9
118.1

151.9
38.8
109.7
130.8
114.6

Metals and minerals
Aluminum
CopperGold
Iron ore
Lead
NickelSilver
Tin
Zinc

$/mt
$/mt
$/toz
c/dmtu
c/kg
$/mt
c/toz
c/kg
c/kg

1,982
1,848
5,047
2,770
128.1
771.6
35.1
35.7
108.0
115.0
10,1478,275
631.0 2,619.4
1,309.6 2,129.3
105.5
96.6

1,639
2,661
383.5
32.5
81.1
8,864
482.0
608.5
151.4

1,592
1,863
286.7
29.6
46.6
8,876
513.7
558.5
115.9

1,505
1,645
282.4
31.3
49.6
6,196
457.1
467.4
92.3

1,389
1,602
321.4
30.6
46.7
6,947
476.9
419.9
79.8

1,409
1,661
302.0
30.2
48.3
7,551
483.2
453.0
84.6

1,448
1,834
265.5
29.9
53.1
7,240
482.7
506.8
96.5

1,439
1,799
269.8
28.8
54.0
6,026
472.2
485.7
94.4

1,434
1,730
253.1
27.4
52.7
5,738
464.1
464.1
92.8

n.a.  Not available.
a. $  U.S. dollar, c  U.S. cent, bbl  barrel, cum  cubic meter, dmtu  dry metric ton unit, kg  kilogram, mmbtu  million British thermal unit,
mt  metric ton, and toz  troy ounce.
Note: Projections as of November 12, 2002.
Source: World Bank, Development Prospects Group.

196gep_app02.qxd 12/5/02 12:52 PM Page 197

G L O B A L

Table A2.15

C O M M O D I T Y

P R I C E

P R O S P E C T S

Weighted indices of commodity prices and inflation (1990 = 100)
Projectionsa

Actual
Index

1970

1980

1990

2000

2001

2002

2003

2005

2010

2015

Current dollars
Petroleum
Nonenergy commoditiesb
Agriculture
Beverages
Food
Fats and oils
GrainsOther food
Raw materials
TimberOther raw materials
Fertilizers
Metals and minerals

5.3
43.8
45.8
56.9
46.7
64.4
46.7
32.2
36.4
31.8
39.6
30.4
40.4

161.2
125.5
138.1
181.4
139.3
148.7
134.3
134.3
104.6
79.0
122.0
128.9
94.2

100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0

123.4
86.9
87.7
88.4
84.5
96.2
79.5
77.7
91.4
111.0
78.0
105.8
83.0

106.4
79.0
79.7
72.1
86.0
89.0
78.2
87.9
77.4
90.2
68.6
98.8
75.1

109.3
82.9
86.5
84.4
89.8
100.2
89.0
81.9
83.6
98.1
73.7
102.0
72.4

100.5
87.7
91.7
87.5
96.3
108.2
104.5
81.9
88.8
103.9
78.5
104.4
76.5

83.0
94.2
98.0
97.8
97.8
113.1
99.4
84.4
98.4
117.8
85.2
111.0
83.2

83.0
102.7
108.9
115.1
104.3
120.9
106.6
89.4
110.2
136.6
92.2
112.8
86.4

91.8
109.9
118.0
130.6
108.2
126.1
111.1
92.0
121.2
155.5
97.8
116.1
89.5

Constant 1990 dollarsc
Petroleum
Nonenergy commodities
Agriculture
Beverages
Food
Fats and oils
GrainsOther food
Raw materials
TimberOther raw materials
Fertilizers
Metals and minerals

18.9
156.3
163.3
202.8
166.5
229.5
166.6
114.9
129.8
113.3
141.1
108.3
143.9

204.6
159.3
175.3
230.3
176.8
188.7
170.5
170.5
132.7
100.3
154.9
163.6
119.6

100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0

126.8
89.3
90.1
90.8
86.8
98.9
81.7
79.9
93.9
114.1
80.1
108.7
85.3

110.9
82.3
83.1
75.1
89.6
92.8
81.5
91.6
80.6
94.0
71.5
102.9
78.3

113.3
86.0
89.6
87.5
93.1
103.8
92.3
84.9
86.7
101.7
76.5
105.7
75.1

101.2
88.3
92.3
88.1
96.9
109.0
105.2
82.4
89.4
104.6
79.0
105.1
77.0

80.2
90.9
94.6
94.4
94.5
109.2
96.0
81.5
95.0
113.7
82.2
107.2
80.3

74.7
92.4
97.9
103.5
93.8
108.8
95.9
80.4
99.1
122.9
82.9
101.5
77.7

77.5
92.7
99.5
110.2
91.3
106.4
93.8
77.6
102.3
131.2
82.5
98.0
75.5

28.05

78.78
10.88

100.00
2.41

97.32
0.27

95.95
1.40

96.45
0.53

99.33
2.98

103.592.12

111.181.42

118.51
1.29

33.59

65.93
6.98

100.004.25

123.732.15

126.422.18

127.691.00

129.731.60

136.032.40

153.012.38

172.27
2.40

Inflation indicesd
MUV indexe
Percentage change per annum
US GDP deflator
Percentage change per annum

a. Commodity price projections as of November 12, 2002.
b. The World Bank primary commodity price indices are computed from 1987–89 export values in U.S. dollars for low- and middle-income economies,
rebased to 1990. Weights for the subgroup indices expressed as ratios to the nonenergy index are as follows: agriculture—69.1 percent, fertilizers—
2.7 percent, and metals and minerals—28.2 percent; beverages—16.9 percent, food—29.4 percent, and raw materials—22.8 percent; fats and oils—
10.1 percent, grains—6.9 percent, and other food—12.4 percent; timber—9.3 percent and other raw materials—13.6 percent.
c. Computed from unrounded data and deflated by the manufactures unit value (MUV) index.
d. Inflation indices for 2002–15 are projections as of November 8, 2002. MUV for 2001 is an estimate. Growth rates for 1980, 1990, 2000, 2005,
2010, and 2015 refer to compound annual rate of change between adjacent endpoint years; all others are annual growth rates from the previous year.
e. Unit value index in U.S. dollar terms of manufactures exported from the G-5 countries (France, Germany, Japan, the United Kingdom, and the UnitedStates) weighted proportionally to the countries’ exports to developing countries.
Source: World Bank, Development Prospects Group. U.S. Department of Commerce for historical U.S. GDP deflator.

197gep_app02.qxd 12/5/02 12:52 PM Page 198

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 3Notes
1. As measured relative to the manufactures unit
value (MUV) index, which is the unit value index in U.S.
dollar terms (1990  100) of manufactures exported
from the G-5 countries (France, Germany, Japan, theUnited Kingdom, and the United States) weighted by thecountry’s exports to developing countries.
2. An El Niño occurs when the Pacific Ocean
warms, as occurred this year. But this year’s El Niño issignificantly weaker than the last one, which occurredin 1997. The Pacific is about 1 degree Centigrade
warmer than usual this year compared with 3 degrees

198

Centigrade warmer in 1997. Thus the effects of thisyear’s El Niño are expected to be smaller than in 1997,
when drought in Southeast Asia led to wildfires andpoor crop harvests.
3. The European Central Bank and 14 European
central banks agreed in September 1999 to limit sales
to only 400 tons of gold per year, and not more than
2,000 tons in total, over the subsequent five years.
4. Verleger, Philip K. Jr. The Petroleum Economics
Monthly. August 2002, p. 11, and September 2002,
p. 1.

gep_app03.qxd 12/5/02 12:17 PM Page 199

Appendix 3
Global Economic Indicators

gep_app03.qxd 12/5/02 12:17 PM Page 200

G L O B A L

E C O N O M I C

P R O S P E C T S

Table A3.1

2 0 0 3Growth of real GDP, 1971–2015

GDP in 1995 prices and exchange rates, average annual growth (percent)
Growth percent

GDP in 2001
(current billionsof dollars)

1971–80

1981–90

1991–2000

2001

Estimate
2002

Forecast
2003–15

World

30,790

3.7

3.0

2.6

1.1

1.7

3.1

High-income economies
Industrial countries
G-7 countries
United StatesJapan
G-4 Europe
GermanyaEuro area
Non-G-7 industrial
Other high income
Asian NIEs

24,852
24,08820,632
10,082
4,166
5,678
1,856
6,090
3,456
764
531

3.5
3.4
3.4
3.3
4.5
2.9
2.7
3.2
3.2
7.7
9.5

3.1
3.1
3.1
3.2
4.1
2.4
2.2
2.3
2.9
5.1
7.4

2.5
2.4
2.3
3.2
1.3
1.8
1.7
2.0
3.0
5.1
6.1

0.7
0.8
0.5
0.3
0.3
1.4
0.7
1.5
2.0
0.7
1.4

1.5
1.4
1.3
2.3
0.0
0.7
0.4
0.8
2.2
2.3
2.6

2.6
2.5
2.5
3.1
1.6
2.2
1.9
2.3
3.0
4.3
4.7

Low- and middle-income economies
Excluding CE.Eur / CIS
Asia
East Asia and Pacific
China
Indonesia
South Asia
India
Latin America and the Caribbean
BrazilMexicoArgentina
Europe and Central Asia
Russian Federationb
TurkeyPolandMiddle East and North Africa
Saudi Arabia
Iran, Islamic Rep. of
Egypt, Arab Rep. of
Sub-Saharan Africa
South Africa
Nigeria

5,938
5,101
2,205
1,573
1,150
145
632
495
1,882
503
618
269
977
310
148
176
568
188
114
96
306
113
41

4.8
5.5
5.2
6.6
6.2
7.9
3.1
3.0
5.9
8.5
6.7
3.0
3.5
3.7
4.1
5.1
6.5
10.3
1.8
6.6
3.3
3.5
4.7

2.6
3.0
6.8
7.3
9.3
6.4
5.7
5.8
1.1
1.5
1.8
1.5
1.7
1.5
5.2
1.7
2.5
0.4
2.7
5.5
1.7
1.3
1.1

3.2
4.7
7.0
7.7
10.1
4.2
5.2
5.6
3.3
2.7
3.5
4.5
1.7
4.0
3.5
3.7
3.2
2.2
4.1
4.4
2.2
1.7
2.6

2.9
3.0
5.2
5.5
7.3
3.3
4.4
4.5
0.4
1.5
0.3
4.4
2.3
5.0
7.4
1.0
3.2
1.2
4.8
2.9
2.9
2.2
4.0

2.8
2.7
5.8
6.3
7.8
3.2
4.6
4.8
1.1
0.7
1.3
11.9
3.6
4.3
4.1
1.0
2.5
1.1
4.5
1.0
2.5
2.2
0.6

4.6
4.7
6.0
6.2
…
…
5.4
…
3.6
…
…
…
3.6
…
…
…
3.3
…
…
…
3.7
…
…

Middle Eastand North
AfricaSubSaharanAfricaa. Data prior to 1991 covers West Germany.
b. Data prior to 1992 covers former Soviet Union.
Note: Growth rates over intervals are computed using compound average methods.
Source: World Bank data and staff estimates.

Figure A3.1 Real GDP growth(percent)
10.0
8.0

1991–2000

2003–15

6.0
4.0
2.0
0.0
2.0
4.0
High-income
countries

East Asia
and Pacific

South
Asia

Source: World Bank data and staff estimates.

200

Eastern
Latin America
Europe andand theCentral Asia
Caribbeangep_app03.qxd 12/5/02 12:17 PM Page 201

G L O B A L

Table A3.2

E C O N O M I C

I N D I C A T O R S

Growth of real per capita GDP, 1971–2015

GDP in 1995 prices and exchange rates, average annual growth (percent)
Growth percent

GDP per capita
2001 (current
dollars)

1971–80

1981–90

1991–2000

2001

Estimate
2002

Forecast
2003–2015

World

5,260

1.8

1.3

1.2

0.1

0.5

2.0

High-income economiesa
Industrial countries
G-7 countries
United StatesJapan
G-4 Europe
Germanyb
Euro area
Non-G-7 industrial
Other high income
Asian NIEs

26,37526,92629,73636,33232,85821,984
22,62920,114
17,21416,01916,195

2.6
2.6
2.7
2.2
3.3
2.6
2.6
2.7
2.2
5.1
7.2

2.5
2.5
2.5
2.2
3.5
2.1
2.0
2.1
2.2
3.3
5.9

1.8
1.8
1.7
2.2
1.1
1.5
1.4
1.7
2.4
3.6
4.7

0.3
0.4
0.1
0.5
0.4
1.4
0.8
1.4
1.6
2.0
2.4

1.1
1.1
0.9
1.6
0.1
0.7
0.5
0.8
1.9
1.0
1.6

2.3
2.3
2.2
2.4
1.8
2.3
2.2
2.4
2.8
3.3
3.9

Low- and middle-income economies
Excluding CE.Eur / CIS
Asia
East Asia and Pacific
China
Indonesia
South Asia
India
Latin America and the Caribbean
BrazilMexicoArgentina
Europe and Central Asia
Russian Federationc
TurkeyPolandMiddle East and North Africa
Saudi Arabia
Iran, Islamic Rep. of
Egypt, Arab Rep. of
Sub-Saharan Africa
South Africa
Nigeria

1,204
1,112
737
956
912
679
468
480
3,678
2,917
6,122
7,165
2,101
2,127
2,110
4,235
2,099
8,229
1,595
1,444
454
2,543
316

2.6
3.1
3.0
4.6
4.3
5.4
0.7
0.7
3.3
5.9
3.6
1.3
2.5
3.1
1.7
4.2
3.6
5.1
1.4
4.4
0.5
1.2
1.7

0.7
0.9
4.8
5.6
7.7
4.4
3.4
3.6
0.9
0.4
0.3
2.9
0.7
0.8
2.8
2.4
0.6
4.8
0.7
2.9
1.2
1.2
1.9

1.6
2.9
5.4
6.4
9.0
2.5
3.3
3.7
1.6
1.2
1.7
3.2
1.9
3.9
1.9
3.5
1.0
1.2
2.4
2.4
0.4
0.3
0.2

1.4
1.4
3.9
4.5
6.5
2.0
2.6
2.9
1.2
0.4
2.2
5.7
2.2
5.3
8.7
1.0
1.3
1.8
3.1
1.6
0.5
0.7
1.2

1.5
1.2
4.5
5.4
7.0
1.9
2.9
3.2
2.6
0.5
0.5
12.9
3.5
4.6
2.7
0.9
0.6
1.9
2.8
0.6
0.1
1.0
3.3

3.4
3.5
5.0
5.4
…
…
4.1
…
2.4
…
…
…
3.5
…
…
…
1.4
…
…
…
1.5
…
…

a. Regional aggregates computed as sum(GDPi)sum(POPi), where “i” indicates country in the region, and are unweighted bypopulation or other measures.
b. Data prior to 1991 covers West Germany.
c. Data prior to 1992 covers former Soviet Union.
Note: Growth rates over intervals are computed using compound annual methods.
Source: World Bank data and staff estimates.

Figure A3.2 Real per capita GDP growth(percent)
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
1.0
2.0
3.0

2003–15
1991–2000

High-income
countries

East Asia
and Pacific

South
Asia

Eastern
Latin America
Europe andand theCentral Asia
Caribbean

Middle Eastand North
AfricaSubSaharanAfricaSource: World Bank data and staff estimates.

201

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E C O N O M I C

P R O S P E C T S

Table A3.3

2 0 0 3

Inflation: GDP deflators, 1971–2015

Deflators in local currency units; 1995100; percentage changea
Growth percent
1971–80

1981–90

1991–00

2001

Estimate
2002

Forecast
2003–15

World

9.0

5.8

3.7

2.3

1.7

1.9

High-income economies
Industrial countries
G-7 countries
United StatesJapan
G-4 Europe
Germanyb
Euro area
Non-G-7 industrial
Other high income
Asian NIEs

8.8
8.7
8.3
7.0
7.8
9.9
5.3
9.6
11.1
19.3
9.5

5.3
4.6
4.2
4.3
2.0
5.7
2.6
6.1
7.1
33.1
4.7

2.0
2.0
1.7
2.1
0.1
2.6
2.6
2.8
3.3
3.8
2.4

1.5
1.5
1.2
2.4
1.2
1.8
1.4
2.3
2.9
0.4
0.4

1.0
1.1
0.9
1.1
0.9
1.9
1.4
2.1
2.1
0.4
1.0

1.3
1.3
1.1
1.4
0.0
1.7
1.2
1.6
1.9
1.9
1.5

Low- and middle-income economies
Excluding CE.Eur / CIS
Asia
East Asia and Pacific
China
Indonesia
South Asia
India
Latin America and the Caribbean
BrazilMexicoArgentina
Europe and Central Asia
Russian Federationc
TurkeyPolandMiddle East and North Africa
Saudi Arabia
Iran, Islamic Rep. of
Egypt, Arab Rep. of
Sub-Saharan Africa
South Africa
Nigeria

9.6
11.4
10.5
9.6
0.9
20.6
11.9
8.9
14.6
39.7
18.1
117.7
0.3
0.3
32.8
4.4
11.7
23.8
20.2
11.0
10.4
13.3
13.4

8.3
10.0
7.2
5.5
5.4
8.8
9.0
8.5
19.3
330.8
63.7
439.5
2.4
2.3
46.6
72.1
8.7
3.1
15.6
13.1
9.4
15.1
16.6

11.7
9.2
6.9
5.6
6.3
15.0
7.9
8.1
12.5
206.1
18.1
10.2
50.3
104.5
71.7
24.1
6.0
2.9
25.6
8.6
9.8
9.8
28.6

5.8
5.7
6.3
6.6
0.0
11.4
6.1
4.0
6.9
7.3
5.4
1.1
5.9
18.0
47.2
1.7
4.2
7.0
8.6
4.5
5.4
7.1
5.9

4.4
4.3
3.4
2.5
0.4
11.4
5.0
2.8
5.0
7.9
3.3
36.5
4.7
5.8
27.9
3.8
4.1
4.8
5.1
4.1
4.3
12.0
4.5

4.2
4.1
4.5
3.4
…
…
5.5
…
4.1
…
…
…
4.0
…
…
…
4.0
…
…
…
4.0
…
…

a. High-income group inflation rates are GDP-weighted averages of local currency inflation; LMIC groups are medians; world is
GDP-weighted average of the two groups.
b. Data prior to 1991 covers West Germany.
c. Data prior to 1992 covers former Soviet Union.
Note: Growth rates over intervals are computed using compound annual methods.
Source: World Bank data and staff estimates.

Figure A3.3 GDP inflation(percent)
50.3
14.0
12.0
10.0

1991–2000

8.0

2003–15

6.0
4.0
2.0
0.0
High-income
countries

East Asia
and Pacific

South
Asia

Source: World Bank data and staff estimates.

202

Eastern
Latin America
Europe andand theCentral Asia
Caribbean

Middle Eastand North
AfricaSubSaharanAfricagep_app03.qxd 12/5/02 12:18 PM Page 203

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Table A3.4

E C O N O M I C

I N D I C A T O R S

Current account balances, 1971–2015

Expressed as shares of GDP (percent)Current Acct
2001 (billionsof dollars)

Shares percent
1971–80

1981–90

1991–2000

2001

Estimate
2002

Forecast
2003–15

Worlda

187

0.1

0.5

0.4

0.6

0.7

0.6

High-income economies
Industrial countries
G-7 countries
United StatesJapan
G-4 Europe
Germanyb
Euro area
Non-G-7 industrial
Other high income
Asian NIEs

190
247
289
393
89
4
2
10
42
57
50

0.1
0.3
0.1
0.0
0.3
0.1
0.5
0.1
1.5
12.3
1.8

0.2
0.5
0.4
1.9
2.3
0.3
2.4
0.4
0.6
10.3
6.9

0.0
0.1
0.3
1.8
2.5
0.1
0.7
0.3
0.8
4.0
5.4

0.8
1.0
1.4
3.9
2.1
0.1
0.1
0.2
1.2
7.7
9.5

0.9
1.1
1.6
4.8
2.8
0.6
1.7
0.8
1.3
6.6
10.3

0.7
0.9
1.3
3.3
2.3
0.4
0.4
1.0
1.3
3.0
4.2

Low- and middle-income economies
Excluding CE.Eur / FSU
Asia
East Asia and Pacific
China
Indonesia
South Asia
India
Latin America and the Caribbean
BrazilMexicoArgentina
Europe and Central Asia
Russian Federationc
TurkeyPolandMiddle East and North Africa
Saudi Arabia
Iran, Islamic Rep. of
Egypt, Arab Rep. of
Sub-Saharan Africa
South Africa
Nigeria

4
11
42
42
17
7
0
1
54
23
18
4
7
36
3
7
29
13
7
0
7
0
0

0.0
0.2
0.7
0.8
0.1
2.3
0.5
0.2
2.8
4.4
3.9
0.4
0.8
2.1
2.1
0.9
9.5
22.0
11.8
3.4
1.8
1.3
1.5

1.7
1.9
1.6
1.4
0.2
3.1
2.0
1.7
1.8
1.6
0.8
2.2
0.5
3.5
1.3
1.4
1.7
7.2
0.4
3.4
2.7
0.4
0.7

1.6
1.6
0.1
0.5
1.6
0.4
1.5
1.2
2.8
2.2
3.7
3.2
2.3
4.7
1.1
3.6
2.1
6.6
1.9
1.5
2.1
0.2
0.4

0.1
0.2
1.9
2.7
1.5
4.8
0.0
0.2
2.9
4.6
2.9
1.7
2.0
11.7
2.5
4.4
5.2
6.9
7.1
0.4
2.2
0.2
0.4

0.4
0.6
1.9
2.7
1.6
2.6
0.1
0.2
1.5
2.8
2.7
9.4
2.4
8.0
0.6
3.7
3.3
5.5
4.3
0.2
3.0
0.3
4.8

0.3
0.1
1.6
1.8
…
1.1
…
2.3
…
…
…
1.6
…
…
…
1.0
…
…
…
2.0
…
…

a. Current account as defined in Balance of Payments (BOP) version 5.0, world represents statistical discrepancy; shares over intervals are period averages.
b. Data prior to 1991 covers West Germany.
c. Data prior to 1992 covers former Soviet Union.
Source: World Bank data and staff estimates.

Figure A3.4 Current account balance-to-GDP ratio(percent of GDP)
3.0
2.0

1991–2000

2003–15

1.0
0.0
1.0
2.0
3.0
4.0
High-income
countries

East Asia
and Pacific

South
Asia

Eastern
Latin America
Europe andand theCentral Asia
Caribbean

Middle Eastand North
AfricaSubSaharanAfricaSource: World Bank data and staff estimates.

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P R O S P E C T S

Table A3.5

Exports of goods, 2001

2 0 0 3Merchandise exports (FOB), millions of dollars; average annual growth rate 1992–2001 (percent); effective market growth (EMG) 1992–2001 (percent)Exports

Growth

EMGb

World

6,056,976

7.0

10.6

All developing
countries

1,509,357

8.2

9.4

Asia

574,958

11.3

8.8

East Asia
China
Fiji
Indonesia
Malaysia
Myanmar
Papua New
GuineaPhilippines
Thailand
Vietnam

509,540
266,322483
56,321
87,980
...

11.7
16.0
4.3
8.2
8.7
...

8.5
8.3
6.1
8.5
8.6
...

1,813
31,24265,37915,470

3.7
12.3
8.1
19.2

6.5
7.9
8.8
8.1

South Asia
Bangladesh
India
Nepal
Pakistan
Sri Lanka

65,4185,790
43,268
698
9,665
5,998

8.5
13.1
9.6
8.1
3.0
8.5

11.3
11.2
11.3
8.9
10.1
13.4

Latin America
Argentina
Bolivia
BrazilChile
Colombia
Costa Rica
Dominican
Republic
EcuadorEl Salvador
GuatemalaJamaica
MexicoPanamaParaguay
Peru
Trinidad andTobagoUruguay
Venezuela,
R. B. de351,608
26,6701,196
58,22318,505
13,281
5,709

8.2
7.1
7.1
5.3
6.7
2.3
10.3

9.7
9.0
12.5
11.9
10.2
11.0
14.7

5,594
4,923
3,367
2,975
1,520
158,449
5,919
2,251
7,518

19.9
4.6
13.7
5.6
1.0
13.2
2.8
3.2
3.3

11.8
10.3
13.6
10.0
6.8
8.3
8.9
10.3
10.4

3,153
2,081

6.9
0.3

7.4
10.1

25,9285.4

8.3

325,981
327
2,110

8.3
8.2
0.5

10.1
30.1
9.7

Europe andCentral Asia
Armenia
Azerbaijan

Exports

Europe andCentral Asia (continued)
Belarus
7,421
Bulgaria
4,872
Czech Republic
33,690Estonia
3,347
Georgia
505
Hungary
28,244
Kazakstan
10,569Kyrgyz Republic
548
Latvia2,091
Lithuania
4,706
Poland42,674
Romania
11,385
RussianFederation
104,501
Slovak Republic
12,534
Tajikistan
858
Turkmenistan
1,619
Turkey28,121
Ukraine17,319Uzbekistan
3,428
Middle East and
N. Africa
AlgeriaEgypt, Arab
Rep. ofIran, Islamic
Rep. of
JordanMoroccoOman
Saudi Arabia
Syrian Arab Rep.
Tunisia
Yemen, Rep. of
Sub-SaharanAfricaAngolaBotswana
Côte d’Ivoire
Cameroon
Ethiopia
Gabon
Ghana
Kenya
Madagascar
Nigeria
SenegalSouth Africa

Growth

EMGb

9.6
2.2
8.7
35.1
15.0
8.7
44.8
10.4
13.6
22.1
10.8
10.3

10.4
9.6
9.0
8.6
8.0
9.1
9.8
19.5
9.6
9.5
9.4
9.8

4.3
10.4
48.6
44.4
9.3
10.1
48.0

10.9
10.4
16.2
8.3
9.1
9.7
15.0

164,753
19,567

2.2
0.8

9.0
10.5

6,830

3.6

10.2

24,5172,192
7,139
10,56378,342
5,151
6,684
3,769

2.1
8.6
1.7
6.0
1.5
2.3
2.9
9.9

10.1
6.9
9.5
8.1
8.1
5.7
12.7
8.5

92,057
7,944
...
3,741
2,262
396
2,540
2,021
1,712
796
16,443
1,024
30,198

3.3
6.7
...
6.4
1.9
13.9
1.1
9.5
4.9
9.6
0.7
3.6
2.8

12.5
12.3
...
9.0
9.0
6.9
7.9
11.3
7.7
11.5
7.3
6.5
6.1

Growth

EMGb

1,797
789
2,063

14.4
0.5
7.8

7.3
13.1
9.2

High-income
countries

4,547,619

6.7

10.9

Industrial
countries

4,010,686

6.7

11.1

G-7 countries
2,793,252
Canada267,706
France323,886
Germany
543,416
Italy
264,390Japan
384,482
United Kingdom
276,076
United States733,297

5.7
7.9
6.5
6.3
4.9
2.7
5.8
6.6

11.3
8.3
16.1
13.6
9.9
9.1
12.5
9.8

Other industrial
Australia
Austria
Belgiuma
Denmark
Finland
GreeceIceland
Ireland
Korea, Rep. of
Netherlands
New Zealand
NorwayPortugal
Spain
SwedenSwitzerland

1,217,435
63,75963,459178,698
50,91243,006
10,615
2,035
83,242
150,494
193,239
13,91859,701
114,427
114,427
77,63586,497

6.7
6.7
7.7
40.4
1.9
7.1
4.3
0.9
12.3
13.6
7.0
3.5
4.2
8.8
8.8
7.4
3.8

7.8
7.8
8.5
6.1
8.2
10.0
8.1
7.8
10.9
8.3
20.3
7.9
9.4
9.6
9.6
10.8
9.0

536,932
6,260
3,156

7.0
5.0
1.1

9.1
7.4
6.5

189,842
31,275
17,968
121,747
122,495

7.2
9.0
29.0
7.4
5.7

9.9
13.3
7.5
8.4
8.3

37,6382.7

6.4

Exports

Sub-SaharanAfrica (continued)
Sudan
ZambiaZimbabwe

Other highincome
BahrainBruneiHong Kong,
China
Israel
KuwaitSingapore
Taiwan, China
United ArabEmirates

FOB is free on board.
a. Includes Luxembourg.
b. Effective market growth (EMG) is a weighted average of import volume growth in the country’s export markets.
Source: See Technical Notes.

204gep_app03.qxd 12/5/02 12:18 PM Page 205

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E C O N O M I C

I N D I C A T O R S

Figure A3.5a Merchandise exports as share of GDP, 2001
(percent)
40
30
World

20
10
0

Industrial
countries

SubSaharanAfricaEast Asia
and Pacific

South
Asia

Eastern
Latin
America and Europe andthe Caribbean Central Asia

MiddleEast andNorth Africa

Source: World Bank data.

Figure A3.5b Annual growth rate of export volumes, 1992–2001(percent)
15

10
World

5

0
Industrial
countries

SubSaharanAfricaEast Asia
and Pacific

South
Asia

Eastern
Latin
America and Europe andthe Caribbean Central Asia

MiddleEast andNorth Africa

Source: World Bank data.

205

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E C O N O M I C

P R O S P E C T S

Table A3.6

Imports of goods, 2001

2 0 0 3Merchandise imports (CIF), millions of dollars; average annual growth rate 1992–2001 (percent); merchandise imports share of GDP (percent)
Imports

Growth

Share

World

6,079,466

6.2

18.1

All developing
countries

1,375,828

6.2

19.7

Asia

502,434

9.2

22.7

East Asia
China
Fiji
Indonesia
Malaysia
Myanmar
Papua New
GuineaPhilippines
Thailand
Vietnam

424,657
232,322503
30,962
69,595
…

9.7
15.8
1.8
4.9
6.8
…

26.8
20.1
29.9
21.4
79.0
…

932
28,496
61,847
15,059

3.2
8.7
3.0
17.0

31.5
39.9
53.9
45.8

South Asia
Bangladesh
India
Nepal
Pakistan
Sri Lanka

77,776
8,601
51,624
1,047
10,484
6,020

6.7
9.9
8.0
7.1
0.6
7.2

12.3
17.1
10.4
20.8
16.7
33.2

Latin America
Argentina
Bolivia
BrazilChile
Colombia
Costa Rica
Dominican
Republic
EcuadorEl Salvador
GuatemalaJamaica
MexicoPanamaParaguay
Peru
Trinidad andTobagoUruguay
Venezuela,
R. B. de352,347
19,1001,600
55,573
16,412
11,826
5,995

10.2
9.7
6.2
9.6
7.6
9.8
12.9

18.8
7.1
19.9
11.1
24.7
13.9
37.3

8,963
4,674
5,055
4,672
2,906
168,440
6,890
2,793
7,408

17.4
6.7
13.8
10.0
5.9
12.6
3.4
3.4
6.9

43.9
34.3
36.2
23.9
37.3
27.3
67.6
36.4
14.5

3,216
2,971

9.5
6.0

38.2
15.0

16,6774.4

14.1

265,272
841
1,976
8,149
5,771

2.5
6.7
2.2
6.0
3.3

30.6
40.3
31.9
26.0
46.1

Europe andCentral Asia
Armenia
Azerbaijan
Belarus
Bulgaria

CIF is cost insurance and freight.
a. Includes Luxembourg
Source: See Technical Notes.

206

Imports

Europe andCentral Asia (continued)
Czech Republic
36,746
Estonia4,255
Georgia
1,047
Hungary
30,759
Kazakstan
9,322
Kyrgyz Republic
552
Latvia3,351
Lithuania
5,740
Moldova...
Poland53,874
Romania
14,124
RussianFederation
65,387
Slovak Republic
13,978
Tajikistan
1,290
TFYR
Macedonia…
Turkmenistan
2,073
Turkey41,460
Ukraine15,959Uzbekistan
3,331
Middle Eastand N. Africa
AlgeriaEgypt, Arab
Rep. ofIran, Islamic
Rep. of
Iraq
JordanMoroccoOman
Saudi Arabia
Syrian Arab
Rep.
Tunisia
Yemen, Rep. of
Sub-SaharanAfricaAngolaBotswana
Côte d’Ivoire
Cameroon
Ethiopia
Gabon
Ghana
Kenya
Madagascar
Nigeria
SenegalGrowth

Share

14.1
22.3
30.3
11.9
25.2
1.2
14.7
25.2
...
13.1
10.1

67.0
83.0
37.0
63.7
46.9
37.5
46.9
49.7
...
32.8
35.6

4.1
10.6
1.0

21.1
65.8
22.0

…
35.4
6.4
5.0
25.2

…
34.8
29.7
42.2
33.8

Imports

Sub-SaharanAfrica (continued)
South Africa
27,873
Sudan
1,439
Zambia1,018
Zimbabwe920

Growth

Share

5.5
2.4
2.8
5.9

25.3
11.5
27.9
10.2

High-income
countries

4,703,638

6.9

18.9

Industrial
countries

4,188,176

6.9

17.4

G-7 countries
3,037,774
Canada226,372
France307,429
Germany
457,102
Italy
243,055
Japan
312,894
United Kingdom
324,362
United States
1,166,561

6.7
6.7
5.5
5.1
3.9
5.2
6.9
9.3

14.7
32.1
23.5
24.6
22.3
7.5
22.8
11.6

1,150,401
61,85664,325
168,485
43,95630,341
29,6842,066
51,300141,096
174,344
12,44733,682…
146,449
62,331
89,251

7.3
7.0
6.1
38.4
3.3
3.8
6.0
3.4
9.7
7.1
6.9
5.3
2.4
…
7.5
5.4
3.2

33.3
17.2
34.2
73.3
27.2
24.9
25.5
27.4
49.7
33.4
45.8
25.8
20.0
…
25.1
29.7
36.3

515,462
4,929
1,427

7.4
1.8
1.9

67.6
83.3
48.4

198,588
35,111
6,764…
109,852
107,298

7.8
7.1
3.0
…
7.0
6.8

21.1
30.3
19.8
…
28.3
38.1

39,76911.1

82.6

106,531
11,775

1.3
5.2

19.2
20.4

15,016

3.4

16.1

16,665…
4,061
10,273
4,735
28,427

5.0
…
5.5
3.9
3.8
0.8

16.1
…
46.9
28.3
24.6
15.1

3,757
9,349
2,473

4.8
6.0
1.9

21.2
44.4
26.6

Other industrial
Australia
Austria
Belgiuma
Denmark
Finland
GreeceIceland
Ireland
Korea, Rep. of
Netherlands
New Zealand
NorwayPortugal
Spain
SwedenSwitzerland

76,253
2,477
2,258
2,741
1,359
1,019
1,034
2,326
3,279
954
10,598
1,351

4.8
9.2
3.6
0.2
3.6
0.8
3.5
9.2
0.3
7.6
2.7
1.5

22.3
27.1
34.1
28.3
13.5
15.7
18.8
30.6
27.9
20.9
25.7
29.2

Other highincome
BahrainBruneiHong Kong,
China
Israel
Kuwait
Qatar
Singapore
Taiwan, China
United ArabEmiratesgep_app03.qxd 12/5/02 12:18 PM Page 207

G L O B A L

E C O N O M I C

I N D I C A T O R S

Figure A3.6a Merchandise imports as share of GDP, 2001
(percent)
30

World

20

10

0
Industrial
countries

SubSaharanAfricaEast Asia
and Pacific

South
Asia

Eastern
Latin
America and Europe andthe Caribbean Central Asia

MiddleEast andNorth Africa

Source: World Bank data.

Figure A3.6b Annual growth rate of import volumes, 1992–2001(percent)
15

10
World

5

0
Industrial
countries

SubSaharanAfricaEast Asia
and Pacific

South
Asia

Eastern
Latin
America and Europe andthe Caribbean Central Asia

MiddleEast andNorth Africa

Source: World Bank data.

207gep_app03.qxd 12/5/02 12:18 PM Page 208

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E C O N O M I C

P R O S P E C T S

2 0 0 3

Table A3.7

Direction of merchandise trade, 2001

(percentage of world trade)
Low- and middle-income importers
High-income importers
All
Other
All
indus- highhightrial income income

Sub
SaharanAfrica

East
Asia
and
Pacific

EuropeandSouth Central
Asia
Asia

Latin
Middle America All
East
andlowandtheandNorth Carib- middleAfrica
bean income

Source of exports

UnitedStates

EU-15

Japan

Other
industrial

High-income
economies
Industrial
United States
EU-15
Japan
Other industrial
Other high-income

12.8
11.0
…
3.7
2.2
4.5
1.9

27.8
26.4
2.6
20.4
1.1
2.0
1.4

3.3
2.4
1.0
0.7
…
0.4
0.9

6.6
6.3
3.4
2.2
0.3
0.3
0.3

52.1
47.3
7.4
27.2
4.1
7.3
4.8

5.7
4.4
1.1
1.4
1.2
0.3
1.2

57.8
51.8
8.5
28.6
5.3
7.6
6.0

0.9
0.8
0.1
0.5
0.1
0.0
0.1

6.1
3.7
0.8
0.9
1.2
0.3
2.4

0.8
0.5
0.1
0.2
0.1
0.1
0.3

3.4
3.3
0.2
2.9
0.1
0.1
0.1

1.5
1.4
0.2
0.8
0.1
0.1
0.1

4.5
4.3
2.8
0.9
0.3
0.1
0.2

17.1
13.9
4.2
6.2
1.8
0.8
3.2

74.9
65.7
12.8
34.8
7.1
8.4
9.2

6.7
0.3
1.9
0.3

6.1
0.5
1.3
0.3

2.1
0.0
1.5
0.0

0.7
0.0
0.3
0.0

16.4
0.9
5.5
0.7

2.8
0.1
2.0
0.1

19.2
1.0
7.5
0.8

0.5
0.2
0.1
0.0

1.4
0.1
0.7
0.1

0.4
0.0
0.2
0.1

1.8
0.0
0.2
0.0

0.5
0.0
0.1
0.0

1.3
0.1
0.2
0.0

5.9
0.4
1.6
0.3

25.1
1.4
9.1
1.1

0.3

0.8

0.3

0.0

1.7

0.3

2.0

0.1

0.3

0.1

0.1

0.1

0.0

0.6

2.6

0.3

0.8

0.3

0.0

1.7

0.3

2.0

0.1

0.3

0.1

0.1

0.1

0.0

0.6

2.6

3.6

0.7

0.1

0.2

4.6

0.1

4.7

0.0

0.1

0.0

0.1

0.1

0.9

1.2

5.9

19.5

33.9

5.5

7.3

68.5

8.5

77.0

1.4

7.5

1.2

5.2

2.0

5.8

23.0

100.0

Low- and middleincome economies
Sub-Saharan Africa
East Asia and PacificSouth Asia
Europe andCentral Asia
Middle East andNorth Africa
Latin America
and the Caribbean
World

EU is European Union.
a. Expressed as a share (percent ) of total world exports. World merchandise exports in 2001 amounted to some $6,000 billion.
b. Other high-income group includes the Asian newly industrializing economies, several oil exporters in the Gulf region, and Israel.
Source: International Monetary Fund, Direction of Trade Statistics.

208

World

gep_app03.qxd 12/5/02 12:18 PM Page 209

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Table A3.8

E C O N O M I C

I N D I C A T O R S

Growth of current dollar merchandise trade, by direction 1992–2001(average annual percentage growth)
Low- and middle-income importers

Sub
SaharanAfrica

East
Asia
and
Pacific

EuropeandSouth Central
Asia
Asia

Latin
Middle America All
East
andlowandtheandNorth Carib- middleAfrica
bean income

3.4
3.1
4.3
2.4
1.8
5.8
5.8

1.7
1.6
3.8
1.6
2.6
2.7
2.6

9.1
8.6
9.4
7.6
7.2
6.0
10.0

5.2
2.4
4.0
1.1
1.0
5.8
12.1

8.2
8.1
3.0
9.3
1.9
1.4
11.5

0.4
0.3
0.4
0.1
2.5
3.4
1.6

8.7
8.7
9.9
7.4
3.2
6.1
8.0

7.0
6.6
8.2
5.9
4.3
4.6
9.4

4.1
3.8
5.5
2.9
2.3
5.7
6.9

7.7
24.0
7.4
9.8

8.8
7.5
10.7
8.1

12.8
12.4
16.4
11.7

15.6
22.1
16.4
15.6

11.0
17.9
14.6
11.6

9.5
9.0
12.2
2.3

5.5
8.9
8.2
4.8

11.2
16.8
22.0
24.3

11.0
14.6
15.1
8.4

9.3
9.1
11.4
8.2

3.1

5.9

3.5

16.0

18.5

7.8

2.7

3.4

0.0

7.5

4.3

0.4

3.1

5.9

3.5

16.0

18.5

7.8

2.7

3.4

0.0

7.5

4.3

0.9

9.0

9.6

2.1

9.5

7.7

13.1

10.0

8.3

5.7

10.3

10.0

9.6

4.1

4.7

4.3

6.2

4.5

4.3

10.1

7.0

8.6

1.4

9.2

7.9

5.2

High-income importers

Source of exports

High-income
economies
Industrial
United States
EU-15
Japan
Other industrial
Other high-income
Low- and middleincome economies
Sub-Saharan Africa
East Asia and PacificSouth Asia
Europe andCentral Asia
Middle East andNorth Africa
Latin America
and the Caribbean
World

UnitedStates

EU-15

Japan

Other
industrial

All
Other
All
indus- highhightrial income income

6.7
6.9
…
8.0
2.9
8.8
5.5

1.7
1.6
3.0
1.4
0.7
2.8
4.8

2.7
1.9
1.8
2.6
…
0.3
5.1

4.3
4.3
6.4
2.6
0.5
3.8
3.7

3.2
3.0
4.2
2.2
1.5
5.9
5.4

5.5
4.9
5.2
6.6
2.8
3.2
7.7

12.2
9.1
15.5
12.5

6.9
4.9
11.5
5.8

6.9
9.1
9.8
0.5

9.0
7.5
13.1
7.5

9.0
6.9
12.3
7.8

1.3

2.4

3.8

0.4

1.3

2.4

3.8

12.6

2.5

8.2

2.4

World

EU is European Union.
Note: Growth rates are compound averages.
Source: International Monetary Fund, Direction of Trade Statistics.

209gep_app03.qxd 12/5/02 12:18 PM Page 210

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Table A3.9

2 0 0 3Structure of long-term debt, 2000

Share of long-term debt (percent): concessional debt; nonconcessional debt at variable interest rates; nonconcessional debt atfixed interest rates
Nonconcessional
Concessional

Variable

Fixed

18.7

40.3

41.0

Asia
East Asia
China
Indonesia
Korea, Rep. of
Malaysia
Myanmar
Papua New
GuineaPhilippines
Thailand
Vietnam

28.5
20.1
20.9
27.9
1.8
6.1
79.6

38.3
44.9
26.4
61.8
53.8
60.7
10.4

33.2
35.0
52.7
10.4
44.4
33.2
10.0

36.1
29.6
14.9
68.2

12.3
33.0
52.0
16.6

51.6
37.4
33.1
15.3

South Asia
Bangladesh
India
Nepal
Pakistan
Sri Lanka

55.5
97.9
39.4
99.8
60.7
85.7

17.4
0.0
20.2
0.0
27.3
5.8

27.0
2.1
40.4
0.2
12.1
8.5

Latin America
Argentina
Bolivia
BrazilChile
Colombia
Costa Rica
Dominican Republic
EcuadorEl Salvador
GuatemalaJamaica
MexicoNicaragua
PanamaParaguay
Peru
Trinidad and Tobago
Uruguay
Venezuela, R. B. de

4.7
1.5
60.3
1.1
1.0
3.1
16.7
42.7
16.7
38.9
40.3
25.9
0.8
53.6
5.6
34.4
16.3
0.6
3.5
0.2

56.1
45.5
27.0
76.1
55.2
60.8
24.1
33.7
29.9
34.4
30.1
24.4
44.5
22.2
45.1
44.0
58.4
39.2
51.0
60.3

39.2
53.0
12.7
22.8
43.7
36.1
59.2
23.6
53.4
26.7
29.6
49.7
54.7
24.2
49.3
21.7
25.3
60.3
45.5
39.5

Europe and Central
Asia
Armenia
Azerbaijan
Belarus

5.9
71.7
50.4
12.0

34.8
18.0
23.4
59.6

59.3
10.3
26.3
28.3

All developing
countries

Nonconcessional
Concessional

Variable

Fixed

Europe and Central
Asia (continued)
Bulgaria
Czech Republic
Estonia
Georgia
Hungary
Kazakhstan
Kyrgyz Republic
LatviaLithuania
Moldova
PolandRomania
Russian Federation
Slovak Republic
Tajikistan
Turkmenistan
TurkeyUkraineUzbekistan

4.3
1.8
1.6
61.0
1.2
3.6
58.3
5.5
3.2
19.3
12.1
3.4
0.3
3.9
76.6
…
5.9
23.3
22.3

75.9
27.4
23.6
8.8
17.7
16.8
15.6
60.4
21.0
45.0
56.0
41.9
19.7
22.6
7.7
…
45.3
35.0
58.2

19.7
70.9
74.8
30.1
81.0
79.6
26.1
34.1
75.8
35.6
31.9
54.7
80.0
73.6
15.8
…
48.7
41.6
19.5

Middle East and
N. Africa
AlgeriaEgypt, Arab Rep. of
JordanMoroccoOman
Syrian Arab Rep. of
Tunisia
Yemen, Rep. of

36.9
13.3
84.5
56.1
31.5
16.7
93.0
26.8
95.9

28.8
49.8
6.2
30.2
32.4
30.6
0.0
20.8
1.8

34.3
36.9
9.3
13.7
36.1
52.7
7.0
52.4
2.3

Sub-Saharan Africa
AngolaBotswana
Côte d’Ivoire
Cameroon
Ethiopia
Gabon
Ghana
Kenya
Madagascar
Nigeria
SenegalSouth Africa
Sudan
ZambiaZimbabwe

47.5
22.4
64.2
39.1
54.6
90.3
39.6
82.2
76.4
66.9
4.4
86.8
0.0
50.0
79.3
46.5

11.2
9.9
10.2
46.6
11.0
0.2
9.5
4.6
5.9
5.0
6.0
9.5
20.2
17.9
6.1
21.2

41.4
67.6
25.6
14.3
34.4
9.5
50.9
13.2
17.7
28.1
89.6
3.7
79.8
32.2
14.7
32.4

Note: Nonconcessional debt data are available only for countries which report to the World Bank’s Debtor Reporting System. For
aggregate figures, missing values are assumed to have the same average value as the available data.
Source: World Bank data; see Technical Notes.

210gep_app03.qxd 12/5/02 12:18 PM Page 211

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I N D I C A T O R S

Figure A3.9a Structure of long-term debt, by group, 2000
(percent)
100
Concessional
80
Variable rate
60
40
20
Fixed rate0
Severelyindebted
middle-income
countries

Moderately
indebted
low-income
countries

Severelyindebted
low-income
countries

Other
countries

Moderately
indebted
middle-income
countries

Source: World Bank data.

Figure A3.9b Structure of long-term debt, by region, 2000
(percent)
100
Concessional
80
Variable rate
60
40
20
Fixed rate
0
Sub-SaharanAfricaEast Asia
and Pacific

Latin
America andthe Caribbean

South Asia

Europeand Central
Asia

MiddleEast andNorth Africa

Source: World Bank data.

Figure A3.9c Top ten ratios of nonconcessional debt to GDP, 2000
(percent)
140
120
100
80
60
40
20
f
ep
.o
Co
ng
o,
R

Mo
ldo
va

ria
Bu

lga

la
go

iqu
mb
za
Mo

An

e

r
do
ua
Ec

a

Yu
Fe gosd. lav
Re ia,
p.
of

eri
Nig

m. ConRe go,
p.
of
De

Nic

ara
g

ua

0

Source: World Bank data.

211gep_app03.qxd 12/5/02 12:18 PM Page 212

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P R O S P E C T S

Table A3.10

2 0 0 3Long-term net resource flows to developing countries, 2000

(millions of dollars)
Private212

Total
millions $Percent
GDP

All developing countries

261,133

4.3

Asia
East Asia
China
Indonesia
Korea, Rep. of
Malaysia
Myanmar
Papua New Guinea
Philippines
Thailand
Vietnam

87,82274,55660,525
9,156
13,875
3,411
244
335
2,401
525
1,790

4.0
4.7
5.6
6.0
3.0
3.8
...
9.6
3.2
0.4
5.7

South Asia
Bangladesh
India
Nepal
Pakistan
Sri Lanka

13,265
1,207
9,928
237
526
530

2.2
2.6
2.2
4.3
0.9
3.3

9,254
269
8,771
4
53
262

Latin America
Argentina
Bolivia
BrazilChile
Colombia
Costa Rica
Dominican Republic
EcuadorEl Salvador
GuatemalaJamaica
MexicoNicaragua
PanamaParaguay
Peru
Trinidad and Tobago
Uruguay
Venezuela, R. B. de99,315
16,7191,230
43,934
4,733
3,312
573
1,103
1,172
467
415
972
11,035
797
946
99
2,291
633
719
5,708

4.9
5.9
14.8
7.4
6.7
4.0
3.6
5.6
8.6
3.5
2.2
12.6
1.9
38.5
9.4
1.3
4.3
8.2
3.6
4.7

Europe and Central Asia
Armenia
Azerbaijan
Belarus
Bulgaria
Czech Republic
Estonia
Georgia
Hungary
Kazakhstan
Kyrgyz Republic
LatviaLithuania
Moldova
PolandRomania
Russian Federation
Slovak Republic
Tajikistan
Turkmenistan
TurkeyUkraineUzbekistan

54,000
270
305
125
1,363
3,441
514
207
1,643
1,979
112
669
910
269
13,413
2,606
2,508
2,234
134
…
12,217169
303

Middle East and N. Africa
AlgeriaEgypt, Arab Rep. of
Iran, Islamic Rep. of
JordanMoroccoOman
Syrian Arab Rep.
Tunisia
Yemen, Rep. of

1,470
1,6782,312
2,253
807
460
69
68
1,009
12

Official

Total

Debt flows
(net)

FDI

Portfolio

Total

ODA

Other

225,846

8,288

166,691

50,86735,28738,088

2,801

74,947 14,686
65,693 18,721
58,295 2,302
11,210 7,039
13,215 3,852
3,229
1,027
188
66
128
50
2,459
140
1,383 5,793
581
717

55,22352,13038,399
4,550
9,283
1,660
255
130
2,029
3,366
1,298

34,41132,28522,198
379
7,784
542
0
48
290
1,044
0

12,874
8,863
2,230
2,053
660
182
55
207
57
858
1,209

10,918
6,649
992
1,173
73
52
55
118
528
1,129
1,195

1,956
2,214
1,238
881
733
131
0
90
585
271
14

4,035
14
4,340
8
361
83

3,093
280
2,315
4
308
173

2,126
3
2,117
0
0
6

4,011
938
1,157
240
578
268

4,269
931
1,463
240
580
239

258
7
306
0
1
28

97,304
16,620923
45,672
4,834
3,130
610
1,142
904
338
178
898
11,536
395
947
16
1,553
673
574
5,454

12,839
4,504
190
7,877
1,141
728
201
115
194
153
52
442
5,267
141
344
98
668
23
276
919

75,088
11,665733
32,779
3,675
2,376
409
953
710
185
230
456
13,286
254
603
82
680
650
298
4,464

9,378
450
0
5,016
18
26
0
74
0
0
0
0
3,517
0
0
0
205
0
0
71

2,010
100
307
1,738
101
182
36
40
268
129
238
74
502
401
1
115
738
40
145
254

3,245
222
341
340
0
119
31
22
98
56
173
8
80
429
15
12
613
0
8
57

1,235321
34
2,078
101
63
6
17
170
73
65
81
422
28
14
103
125
39
152
197

5.8
14.1
5.8
1.2
11.4
6.8
10.3
6.8
3.6
10.8
8.2
9.4
8.0
20.9
8.5
7.1
1.0
11.7
13.5
…
6.1
0.5
2.2

45,446
159
175
122
1,114
3,299
485
155
1,721
1,900
65
583
799
209
13,195
1,900
2,200
2,185
64
…
11,416927
18

11,5601945
32
107
1,901
126
24
29
650
62
176
269
81
2,982
875
1,589
133
40
…
7,733
332
82

28,495
140
130
90
1,002
4,583
387
131
1,692
1,250
2
407
379
128
9,342
1,025
2,714
2,052
24
…
982
595
100

5,391
0
0
0
5
617
29
0
0
0
0
0
151
0
871
0
1,075
0
0
…
2,701
0
0

8,553
111
130
3
249
142
29
52
78
80
177
86
111
60
218
706
308
49
70
…
801
759
284

8,138
119
168
26
337
154
48
64
11
111
178
50
63
62
470
177
661
51
70
…
37
785
261

416
8
38
23
87
12
19
12
89
31
1
36
48
2
251
529
354
3
0
…
763
26
24

0.2
3.1
2.3
2.2
9.6
1.4
0.5
2.1
5.2
0.1

1,074
1,212
1,967
610
455
293
57
107
966
201

931
1,226
114
649
115
449
23
4
214
0

1,209
10
1,235
39
558
10
23
111
752
201

795
4
619
0
12
147
11
0
0
0

396
465
345
1,643
352
167
12
40
44
189

3,223
81
541
11
369
96
21
14
190
210

2,827
384
196
1,632
17
263
9
26
146
21

gep_app03.qxd 12/5/02 12:18 PM Page 213

G L O B A L

Table A3.10

E C O N O M I C

I N D I C A T O R SLong-term net resource flows to developing countries, 2000 (continued)(millions of dollars)
PrivateSub-Saharan Africa
AngolaBotswana
Côte d’Ivoire
Cameroon
Ethiopia
Gabon
Ghana
Kenya
Madagascar
Nigeria
SenegalSouth Africa
Sudan
ZambiaZimbabwe

Total
Millions $Percent
GDP

18,527
1,407
11
56
185
587
24
483
374
298
706
349
2,957
563
778
108

5.7
15.9
0.2
0.5
2.1
9.2
0.5
9.7
3.6
7.7
1.7
8.0
2.3
5.0
24.0
1.5

Official

Total

Debt flows
(net)

FDI

7,074
1,206
27
47
21
42
142
71
53
83
907
106
2,736
392
191
29

494
492
3
159
52
8
8
57
61
0
177
2
911
0
9
50

6,676
1,698
30
106
31
50
150
110
111
83
1,082
107
961
392
200
79

Portfolio

893
0
0
6
0
0
0
17
4
0
2
0
864
0
0
1

Total

ODA

Other

11,453
201
16
103
205
545
166
412
321
215
201
243
221
171
587
79

12,563
230
10
237
292
565
9
442
403
219
113
276
219
173
620
145

1,110
29
26
134
87
20
175
29
82
3
314
33
3
2
33
66

FDI is foreign direct investment; ODA is official development assistance.
Source: World Bank data; see Technical Notes.

Figure A3.10a Distribution of long-term net resource flows, 2000
(percent)
100

Official

80
60
Private40
20
0
Sub-SaharanAfricaEast Asia
and PacificSouth Asia

Latin
America andthe Caribbean

Europeand Central
Asia

Middle Eastand North
AfricaSource: World Bank data.

Figure A3.10b Change in share of private long-term flows, 1990–2000(percent)
80
60
40
20
0
Sub-SaharanAfricaEast Asia
and PacificSouth Asia

Latin
America andthe Caribbean

Europeand Central
Asia

Middle Eastand North
AfricaSource: World Bank data.

213

gep_app03.qxd 12/5/02 12:18 PM Page 214

Technical Notes

The principal sources for the data in this appendix are the World Bank’s central databases
and several International Monetary Fund
databases, combined with data sourced fromthe OECD and from Oxford Economics Inc.
(OEF), covering the industrial and other highincome economies. The cut-off date for data
updates was November 15, 2002. Data revisions and new releases since that time have notbeen incorporated in the tables. Regional aggregates are based on the classification of
economies by income group and by region, following the Bank’s standard definitions (seecountry classification tables that follow).
Debt and finance data (appendix tables A3.9 and A3.10) cover the 137 countries
that report to the World Bank’s Debtor Reporting System (DRS), supplemented by data
for non-DRS countries, for which commercial
market information has been utilized. Small
countries have generally been omitted from thetables, but are included in the regional totals.
Current price data are reported in U.S. dollars.

Notes on tables
Tables A3.1 through A3.4. Historic data
sourced from the databases noted above, while
projections are consistent with those highlighted in chapter 1 and appendix 1.
Tables A3.5 and A3.6. Merchandise trade
data is sourced from combined IMF, World
Bank, OECD, and OEF sources. Merchandise
exports and imports exclude trade in services.
Imports are reported on a cost-insurance-andfreight basis. Trade values are expressed in214

millions of current U.S. dollars, while growth
rates are based on constant price data, which
are derived from current values deflated byrelevant price indices or unit value measures.
Effective market growth (EMG) in table A.3.5
is the export-weighted growth of each country’s trading partner imports.
Tables A3.7 and A3.8. The IMF’s Direction of Trade database serves as the underlying source for the bilateral trade share- andgrowth information highlighted in these tables.
Growth rates are compound annual averages,
and are computed from current U.S. dollar
measures of trade flows.
Table A3.9. Long-term debt covers public
and publicly guaranteed debt but excludes
IMF credits. Concessional debt is that with an
original grant element of 25 percent or more.
Nonconcessional variable interest-rate debt
includes all public and publicly guaranteedlong-term debt with an original grant elementof less-than 25 percent, whose terms dependon movements in a key market interest rate.
This item conveys information about the borrower’s exposure to changes in international
interest rates.
Table A3.10. Long-term net resource
flows are the sum of net resource flows on
long-term debt (excluding IMF) plus non-debtcreating flows. Foreign direct investment refers
to net inflows of investment from abroad.
Portfolio equity flows are the sum of country
funds, depository receipts and direct purchasesof shares by foreign investors.

gep_app03.qxd 12/5/02 12:18 PM Page 215

Classificationof Economies

gep_app03.qxd 12/5/02 12:18 PM Page 216

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 3

Classification of economies by income and region, July 2002
Sub-Saharan Africa

Incomegroup

Subgroup

Lowincomecountries

Middleincome
countries

Subtotal

216

East andSouthern
AfricaAngolaBurundiComoros
Congo, Dem.
Rep. of
Eritrea
Ethiopia
Kenya
LesothoMadagascar
MalawiMozambique
RwandaSomalia
Sudan
Tanzania
UgandaZambiaZimbabwe

West
AfricaEast Asia
and Pacific

Benin
Cambodia
Burkina Faso Indonesia
Cameroon
Korea, Dem.
CentralRep.
AfricanLao PDR
Republic
Mongolia
Chad
MyanmarCongo, Rep. of Papua New
Côte d’Ivoire
GuineaEquatorial
SolomonGuineaIslands
Gambia, The Timor-Leste
Ghana
VietnamGuineaGuinea-Bissau
Liberia
Mali
Mauritania
Niger
Nigeria
São Toméand Principe
SenegalSierra Leone
Togo

Lower

Namibia
Cape Verde
South Africa
Swaziland

China
Fiji
Kiribati
MarshallIslands
Micronesia,
Fed. Sts. ofPhilippines
Samoa
Thailand
Tonga
Vanuatu

Upper

Botswana
Mauritius
MayotteSeychelles

American
Samoa
Malaysia
Palau

156

25

Gabon

23

Europe andCentral Asia

Asia

23

South
Asia

EasternEurope andCentral Asia

Middle Eastand North Africa

Rest ofEuropeMiddleEast

Americas

North
AfricaAfghanistan
Bangladesh
BhutanIndia
Nepal
Pakistan

Armenia
Azerbaijan
Georgia
KyrgyzRepublic
Moldova
Tajikistan
UkraineUzbekistan

Yemen,
Rep. of

Maldives
Sri Lanka

Albania
TurkeyBelarusBosnia andHerzegovina
Bulgaria
Kazakhstan
Macedonia,
FYRa
Romania
RussianFederation
Turkmenistan
Yugoslavia,
Fed. Rep. of

Iran, Islamic
Rep. of
Iraq
JordanSyrian Arab
Republic
West Bankand Gaza

Algeria
Djibouti
Egypt, Arab
Rep. of
MoroccoTunisia

BelizeBolivia
Colombia
Cuba
Dominican
Republic
EcuadorEl Salvador
Guatemala
GuyanaHonduras
JamaicaParaguay
Peru
St. Vincent
and theGrenadines
Suriname

Croatia
Czech
Republic
Estonia
Hungary
LatviaLithuania
PolandSlovakRepublic

LebanonOman
Saudi
Arabia

Libya
Malta

Antigua andBarbudaArgentina
Barbados
BrazilChile
Costa Rica
Dominica
GrenadaMexicoPanamaPuerto Rico
St. Kitts andNevis
St. Lucia
Trinidadand Tobago
Uruguay
Venezuela,
R. B. de826Isle of Man

2

9

Haiti
Nicaragua

733gep_app03.qxd 12/5/02 12:18 PM Page 217

R E G I O N A L

E C O N O M I C

P R O S P E C T SClassification of economies by income and region, July 2002 (continued)
Sub-Saharan Africa

Incomegroup

Highincome
countries

Total

Subgroup

East andSouthern
AfricaWest
AfricaEast Asia
and Pacific

South
Asia

OECD

Australia
Japan
Korea, Rep. of
New Zealand

Non-OECD

BruneiFrenchPolynesia
GuamHong Kong,
ChinacMacao,
ChinadNew
Caledonia
N. Mariana
Islands
Singapore
Taiwan,
China

209

25

Europe andCentral Asia

Asia

23

36

EasternEurope andCentral Asia

Middle Eastand North Africa

Rest ofEuropeMiddleEast

Americas

North
AfricaAustria
Belgium
Denmark
FinlandFranceb
Germany
GreeceIceland
Ireland
Italy
Luxembourg
Netherlands
NorwayPortugal
Spain
SwedenSwitzerland
UnitedKingdom
Slovenia

8

27

CanadaUnitedStatesAndorraChannelIslands
CyprusFaeroeIslands
Greenland
Liechtenstein
MonacoSan Marino

BahrainIsrael
Kuwait
Qatar
United ArabEmirates

28

14

Aruba
Bahamas,The
BermudaCaymanIslands
Netherlands
AntillesVirginIslands(U.S.)

741

a. Former Yugoslav Republic of Macedonia.
b. The French overseas departments French Guiana, Guadeloupe, Martinique, and Réunion are included in France.
c. On 1 July 1997 China resumed its exercise of sovereignty over Hong Kong.
d. On 20 December 1999 China resumed its exercise of sovereignty over Macao.
Source: World Bank data.

Definition of groups
For operational and analytical purposes, the World Bank’s
main criterion for classifying economies is gross national
income (GNI) per capita. Every economy is classified as
low income, middle income (subdivided into lower middle
and upper middle), or high income. Other analytical groups,
based on geographic regions and levels of external debt, arealso used.
Low-income and middle-income economies are sometimes
referred to as developing economies. The use of the term isconvenient; it is not intended to imply that all economies in

the group are experiencing similar development or that
other economies have reached a preferred or final stage ofdevelopment. Classification by income does not necessarilyreflect development status.
This table classifies all World Bank member economies,
and all other economies with populations of more than
30,000. Economies are divided among income groups according to 2001 GNI per capita, calculated using the World Bank
Atlas method. The groups are: low income, $745 or less;lower middle income, $746–$2,975; upper middle income,$2,976–$9,205; and high income, $9,206 or more.

217

gep_app03.qxd 12/5/02 12:18 PM Page 218

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 3

Classification of economies by income and indebtedness, July 2002
Incomegroup

Subgroup

Lowincomecountries

Severely indebted

Afghanistan
AngolaBenin
BurundiCameroon
Central African
Republic
Chad
Comoros
Congo, Dem.
Rep. ofCongo, Rep. ofCôte d’Ivoire
Ethiopia
GuineaGuinea-Bissau
Indonesia
KyrgyzRepublic
Lao PDR

Middle- Lower Cuba
incomeEcuadorcountries
GuyanaIraq
JordanPeru
Syrian Arab
Republic

Upper

218

Argentina
BrazilGabon

Liberia
Madagascar
Malawi
Mauritania
MyanmarNicaragua
Niger
Nigeria
Pakistan
RwandaSão Toméand Principe
Sierra Leone
Somalia
Sudan
Tajikistan
Tanzania
ZambiaModerately indebted

Less indebted

Burkina Faso
Cambodia
Gambia, The
Ghana
Haiti
Kenya
Mali
Moldova
Mongolia
MozambiquePapua New
GuineaSenegalTogo
UgandaUzbekistan
Yemen, Rep. of
Zimbabwe

Armenia
Azerbaijan
Bangladesh
BhutanEquatorial
GuineaEritreaGeorgia
India
Korea,
Dem. Rep. of
Lesotho
Nepal
SolomonIslands
UkraineVietnam

Algeria
BelizeBolivia
Bosnia andHerzegovina
Bulgaria
Colombia
Honduras
Jamaica
Philippines
RussianFederation
Samoa
St. Vincent and
the Grenadines
ThailandTunisia
TurkeyTurkmenistan

Albania
BelarusCape Verde
China
Djibouti
Dominican
Republic
Egypt, Arab
Rep. ofEl Salvador
Fiji
GuatemalaIran, Islamic
Rep. of
Kazakhstan
Kiribati
Macedonia,
FYRa
Maldives

Chile
Croatia
Estonia
Hungary
Lebanon
Malaysia
Mauritius
PanamaUruguay
Venezuela, R. B. de

Antigua andBarbudaBarbados
Botswana
Costa Rica
Czech
Republic
Dominica
GrenadaLatviaLibya
Lithuania
Malta

Not classified
by indebtedness

Timor-Leste

MoroccoNamibiaParaguay
RomaniaSouth Africa
Sri Lanka
Suriname
Swaziland
Tonga
Vanuatu
Yugoslavia,
Fed. Rep. of

MexicoOman
PolandSaudi Arabia
Seychelles
SlovakRepublic
St. Kitts andNevis
St. Lucia
Trinidad andTobagoMarshall Islands
Micronesia, Fed. Sts.
West Bank and Gaza

American Samoa
Isle of Man
MayottePalau
Puerto Rico

gep_app03.qxd 12/5/02 12:18 PM Page 219

R E G I O N A L

E C O N O M I C

P R O S P E C T SClassification of economies by income and indebtedness, July 2002 (continued)
Incomegroup

Subgroup

Severely indebted

Moderately indebted

Less indebted

HighOECD
incomecountries

NonOECD

Total

209

44

43

Not classified
by indebtedness

Australia
Austria
Belgium
CanadaDenmark
FinlandFranceb
Germany
GreeceIceland
Ireland
Italy
Japan

Korea, Rep. of
Luxembourg
Netherlands
New Zealand
NorwayPortugal
Spain
SwedenSwitzerland
UnitedKingdom
United States

AndorraAruba
Bahamas,The
BahrainBermudaBruneiCaymanIslands
ChannelIslands
CyprusFaeroeIslands
FrenchPolynesia
Greenland
Guam
Hong Kong,
ChinadIsrael
KuwaitLiechtenstein
Macao,
ChinacMonacoNetherlands
Antilles
New Caledonia
N. Mariana
Islands
Qatar
San Marino
Singapore
Slovenia
Taiwan, China
United ArabEmirates
VirginIslands (U.S.)

60

62

a. Former Yugoslav Republic of Macedonia.
b. The French overseas departments French Guiana, Guadeloupe, Martinique, and Réunion are included in France.
c. On 20 December 1999 China resumed its exercise of sovereignty over Macao.
d. On 1 July 1997 China resumed its exercise of sovereignty over Hong Kong.
Source: World Bank data.

Definitions of groups
This table classifies all World Bank member economies, andall other economies with populations of more than 30,000.
Economies are divided among income groups according to2001 GNI per capita, calculated using the World Bank Atlas
method. The groups are: low income, $745 or less; lower
middle income, $746–$2,975; upper middle income,$2,976–$9,205; and high income, $9,206 or more.
Standard World Bank definitions of severe and moderateindebtedness are used to classify economies in this table.
Severely indebted means either: present value of debt service
to GNI exceeds 80 percent or present value of debt service
to exports exceeds 220 percent. Moderately indebted means

either of the two key ratios exceeds 60 percent of, but does
not reach, the critical levels. For economies that do not reportdetailed debt statistics to the World Bank Debtor Reporting
System (DRS), present-value calculation is not possible.
Instead, the following methodology is used to classify the
non-DRS economies. Severely indebted means three offour key ratios (averaged over 1998–2000) are above
critical levels: debt to GNI (50 percent); debt to exports(275 percent); debt service to exports (30 percent); andinterest to exports (20 percent). Moderately indebted means
three of the four key ratios exceed 60 percent of, but do
not reach, the critical levels. All other classified low- andmiddle-income economies are listed as less indebted.

219