Opinion – Martin Wolf: The threat of a lost decade in development

The shocks of the last three years hit all countries, but mainly emerging and developing countries. As a result, according to the Global Economic Outlook 2023, recently released by the World Bank, the convergence of average incomes between poor and rich countries has stagnated. Worse still, it may not return anytime soon, given the damage it has already done and is likely to persist for years to come.

By the end of 2024, GDP (Gross Domestic Product) levels in emerging and developing economies are expected to be 6% below what was expected before the pandemic. The cumulative loss of GDP for these countries between 2020 and 2024 is forecast at 30% of 2019 GDP.

In fragile and conflict-affected areas, it is estimated that real per capita income will have fallen completely by 2024. If the global economy slows down more than anticipated today, as a result of tight monetary policy and perhaps other shocks, these results could easily be worse.

These losses, with all they mean for the situation of the world’s most vulnerable populations, show the impact of the pandemic, the war in Ukraine, rising energy and food prices, rising inflation and the sharp tightening of monetary policy. in high-income countries, mainly in the United States, and consequent appreciation of the dollar.

An obvious danger now is waves of defaults in over-indebted developing countries. Together, these shocks will have lasting effects, perhaps lost decades, in many vulnerable places.

This has happened before. Indeed, this is what happened in Latin America after the 1982 debt crisis. This crisis, it should be remembered, also followed a surge in private lending to developing countries, then called “recycling” of export surpluses. oil.

Unfortunately, this increase in debt was followed by Iraq’s invasion of Iran, the second “oil shock” (the first in 1973), rising inflation, a sharp tightening of US monetary policy, and a stronger dollar. Disaster followed — a decade-long debt crisis.

Disturbingly, the recent tightening of monetary policy by the central banks of major economies, the Group of 7, has been more like that of the 1970s and early 1980s than anything since, both in speed and size. According to current market implicit interest forecasts, the cumulative increase will be close to 400 basis points over 17 months. The May 1979 increase turned out to be bigger, but it also took longer.

It is true that the rates start from a much lower level this time around. But maybe it doesn’t make much difference if people trust those low rates. In addition, the appreciation of the US dollar has been particularly strong. For countries that have substantial external debt denominated in US currency, this will also sharply increase debt service costs.

It’s good that this time the loans weren’t so much from banks at variable rates, but from bonds, which have longer maturities and fixed rates. However, a sudden cut in the flow of credit will create an unrelenting squeeze.

The World Bank shows a 17 percentage point increase in foreign currency sovereign loan spreads for commodity-importing countries with poor credit ratings in 2022. In effect, these countries are excluded from markets.

In addition, sub-Saharan Africa’s external debt is also high, at over 40% of GDP. Not surprisingly, there has been a large decline in government and corporate bond issuance in emerging and developing countries since February 2022 compared to the previous year.

Inevitably, heavily indebted countries that have already suffered the shock of Covid and a sharp deterioration in their terms of trade as food and energy prices soar will now face even more serious and lasting problems. This will also include a large number of low-income countries, where the livelihoods of many are already on the fringes of survival.

According to the bank, the number of people suffering from “food insecurity” (that is, they are on the verge of starvation) in low-income countries jumped from 56 million in 2019 to 105 million in 2022. When can this be reversed?

We also know that many children lost their parents during the pandemic and that their education was seriously damaged. In addition, physical investment has dropped dramatically. Thus, for emerging and developing countries as a whole, the bank predicts that aggregate investment in 2024 will be 8% lower than expected in 2020.

If we add the likelihood of lasting debt problems and therefore the interruption of capital flows, the possibility of a lost decade to convergence certainly becomes highly likely for many countries. Needless to say, in this environment, too, not much progress will be made on the energy transition in many places.

Covid was not the fault of these countries. The lack of global cooperation to deal with it was not their fault. The lack of adequate external official funding was not their fault. Global inflation was not their fault. The war is not their fault. But if high-income countries fail to provide the help they now clearly need, the blame will rest squarely with them.

High-income democracies want to embark on a values ​​war with China. Well, here’s a battle. It is necessary to find a way to solve the debt problems that are now emerging effectively and not, as happened in Latin America, after almost a decade of pretending. A way needs to be found to escape the vicious circle where poor credit quality generates unpayable spreads, which generate debt crises and then even lower credit quality.

This is not just of interest to poor countries. It also interests the rich. The problems of fragile and impoverished countries will also become theirs. It’s time to do things differently. Next week I plan to consider how.

Translated by Luiz Roberto M. Gonçalves