How To Reignite Growth in Emerging Market and Developing Economies

IMF Blog, October 9, 2019

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Emerging markets and developing economies have enjoyed good growth over the past two decades but many countries are still not catching up with the living standards of advanced economies.
At current growth rates:
- it would take more than 50 years for a typical emerging market economy to close half of its current income gap in living standards,
- and 90 years for a typical developing economy.
Chapter 3 of the October 2019 World Economic Outlook finds that implementing major reforms in six key areas at the same time—domestic finance, external finance, trade, labor markets, product markets, and governance—can double the speed of income convergence of the average emerging market and developing economy to the living standards of advanced economies and could raise output levels by more than 7 percent over a six-year period.

The IMF developed a comprehensive dataset covering structural regulations in domestic and external finance, trade, and labor and product markets.
Dataset coverage and composition:
- covers a large sample of 90 advanced and developing economies during the past four decades.
- To the five indicators, the authors added the quality of governance (for example, how countries control corruption) from the World Governance Indicators.
Historical patterns:
- After the major wave of reforms in the late 1980s and—most importantly—the 1990s, the pace slowed in emerging market and developing economies during the 2000s, especially in low-income developing countries.
- There remains ample room for a renewed reform push, particularly in developing economies—notably, across sub-Saharan Africa and, to a lesser extent, in the Middle East and North Africa and the Asia-Pacific region.

Sample for empirical analysis:
- reforms in 48 current and former emerging markets and 20 developing economies.
Measured impacts (typical effect about six years after implementation):
- domestic finance reform of the size that took place in Egypt in 1992 leads to an increase in output of about 2 percent, on average, six years after implementation.
- anti-corruption measures: effects are sizable in the short run and stabilize at around 2 percent in the medium term.
- in the other four reform areas—external finance, trade, product markets, and labor markets—the gains are about 1 percent six years after the reform.
Aggregate implication:
- For the average emerging market and developing economy, major simultaneous reforms across all six areas can raise output by more than 7 percent over a six-year period.
- This would increase annual per capita GDP growth by about 1 percentage point, doubling the average speed of income convergence to advanced-country levels.
Model-based (longer-term) analysis:
- Model-based analysis—which captures the longer-term effect of reforms and provides insights on the channels through which they affect economic activity—points to output gains about twice as large as the empirical model over the longer term (beyond 6 years).

One channel through which reforms increase output is by reducing informality.
Mechanism:
- lowering barriers to businesses’ entry in the formal sector encourages some informal companies to become formal.
- formalization boosts output by increasing companies’ productivity and capital investment.
Implication:
- the payoff from reforms tends to be larger where informality is pervasive.

Timing considerations:
- Some reforms work best when the economy is strong (for example, reducing layoff costs encourages hiring in good times but can amplify downturns in bad times).
- Increasing competition in the financial sector at a time of weak credit demand may push certain financial intermediaries out of business, further weakening the economy.
Prioritization in weak economies:
- governments may prioritize reforms—such as strengthening product market competition—that pay off regardless of economic conditions.
- design other reforms to alleviate short-term costs—such as enacting job protection reforms now with a provision that they will take effect later.
- these reforms can also be accompanied with monetary or fiscal policy support where possible.
Sequencing and packaging:
- reforms work best if properly packaged and sequenced.
- reforms typically deliver larger gains in countries where governance is stronger.
- strengthening governance can support economic growth and income convergence directly and indirectly by magnifying the payoff from reforms in other areas.

Ensure reforms are:
- timely and sequenced to minimize short-term costs and avoid amplifying downturns;
- properly packaged with complementary monetary or fiscal support where possible;
- accompanied by governance strengthening to magnify payoffs.
Redistributive measures:
- to fulfill their promise of improving living standards, reforms must be supported by redistributive policies that spread the gains widely across the population—such as strong social safety nets and programs that help workers move across jobs.
- for reforms to be sustainable and effective, they need to benefit not just some, but all.

Source: How To Reignite Growth in Emerging Market and Developing Economies (October 9, 2019), Romain Duval, Davide Furceri.