South Korea is an economy that has successfully adapted to evolving growth challenges, a new study says (photo: Jodi Cobb/National Geographic Society/Corbis)
Staff Discussion Note
Such a strategy would allow them to further narrow the gap in living standards with the advanced economies, a new IMF study says.
Despite clear progress in recent years, income levels of emerging market and developing economies are still far behind those of advanced economies, note the authors of Anchoring Growth: The Importance of Productivity-Enhancing Reforms in Emerging Market and Developing Economies. With a less favorable external environment and growing demographic challenges, continued strong economic performance in these countries will hinge on how well policymakers are able to unlock productivity growth by improving economic efficiency and a better allocation of resources in the economy.
Exactly how countries go about doing so will depend on their overall policy, business, and institutional environment, the study says, noting that the reform strategy will also depend on the economy’s stage of development, since reforms that generate gains in productivity at earlier stages of development may have a smaller payoff in the later stages.
“The scope for structural reforms remains considerable in most emerging market and developing countries, and recommendations tailored to where the country is located along the development path can help focus attention where potential productivity payoffs are likely to be larger,” the study says.
Recent gains
In many emerging market and developing economies, real GDP growth per capita picked up in the second half of the 1990s, and, since the mid-2000s, they—as a group—have been growing faster than advanced economies.
Growth over the past two decades was supported by a range of external factors—expansion of cross-country production chains, declines in transportation and communication costs, buoyed global trade, and easy financing conditions. However, domestic factors—such as structural reforms that gave greater play to market forces, better policymaking, and greater trade and financial openness—have also played an important role.
There are significant differences in the sources of growth across countries, the study notes. In some countries (for example, in Latin America), growth has been driven by increases in labor utilization. In others it is attributable to increases in labor productivity brought about by the accumulation of capital (such as in developing Asia) or improvements in total factor productivity (for example, in Central and Eastern Europe).
While productivity gains can arise from the adoption of advanced countries’ technologies or better use of resources within sectors of the economy, they often also reflect structural change—reallocation of resources from less productive sectors (such as agriculture) into higher-productivity ones (such as industry and services) or new activities. These changes that push up economy-wide productivity are the same channels through which advanced economies have increased their income in the past.
Varying reform priorities
Emerging market and developing countries have made significant progress, building stronger institutions and achieving greater and more durable economic stability. But as economies develop and external conditions change, new constraints emerge and policymakers need to adapt their reform priorities, the study observes.
The study notes that in low-income countries, there is room to raise productivity in agriculture while pursuing a shift toward higher-productivity industry and services. In emerging economies, where many structural changes have already taken place, productivity growth will depend more on climbing the technology ladder—that is, diversifying the economy toward higher value-added production and modern services.
The set of required policies varies given the vast differences among emerging market and developing countries. As countries get closer to the global technology frontier, payoffs from simply adopting technology diminish and innovation becomes more important. Reform measures that are effective in generating productivity payoffs for countries at earlier stages of development are thus often not appropriate for the ones that are more developed, the authors emphasize.
Policy advice
While stressing that reforms must be tailored to individual country circumstances, the study makes a series of recommendations for countries at three different stages of development:
• In low-income countries, policymakers could further reduce trade barriers, roll back distortionary agricultural subsidies and price controls, and reform the banking sector. Improving basic education and the institutions needed for market-based economic activity will also continue to be important.
• In lower-middle income countries, maintaining productivity growth would require continued reforms in banking and agricultural sectors, reducing barriers to foreign investment, as well as increasing competition in product markets, improving the quality of secondary and tertiary education, and alleviating infrastructure bottlenecks.
• In upper-middle income countries, productivity enhancements would come from deepening capital markets, developing more competitive and flexible product and labor markets, fostering a more skilled labor force, and investing in research and development and new technologies.
