The first part of the Report shows how the recovery of global economic activity after its sharp decline in 2001 has been much slower and more erratic than expected. It traces this back to the pattern of global trade and financial flows in the 1990s, leading up to an increased dependence on the US economy as the main source of global growth. This in turn is fundamentally related to the changes that occurred in the underlying economic policy regimes, particularly across the developing world. Thus, in part II, the Report analyses why the market-led economic policy reforms adopted in many developing countries subsequent to the debt crisis of the early 1980s have not improved their growth and industrial performance, or strengthened their ability to withstand external shocks. The Report provides explanations that challenge conventional points of view and raises concerns about the current direction of global economic policymaking dogmatically driven by proponents of the neo-liberal economic paradigm.

The State of the World Economy
TDR 2003 makes revealing assessments of the state of the global economy and the problems of the prevailing economic policymaking. It presents the grim prospect that the imbalances and excesses created during the high-tech boom of the 1990s could result in a long period of erratic and sluggish growth, with occasional surges and dips accompanied by price deflation.

When the high-tech stock market boom in the US ended in the first half of 2000, there were widespread expectations of a short and sharp recession. Contrary to such expectations, the US economy entered a more persistent but less severe slowdown. Growth in Europe and Japan, on the other hand, instead of accelerating to offset the slowdown in the US, actually fell in 2002.

The Report attributes the delay in vigorous recovery in the US economy primarily to the failure of investment spending to recover, because of continued excess capacity remaining from the end-nineties' boom in the information and telecommunications sectors. Against this failure of an expected strong recovery in the US, preserving the growth of global income and international trade would require a rapid shift in the policies in the rest of the industrialized world. However, measures to stimulate domestic demand from the major countries in Europe and Japan have been short in coming. This has made the global recovery process more difficult.

A major factor behind the failure of Europe's recovery has been the increasing difficulty of implementing a counter-cyclical economic policy within the rigid monetary and fiscal constraints set for the Euro area. The increased interdependence of EU activity with that in the US, arising from the large number of mergers and acquisitions between European and US firms in the 1990s, has also contributed to the difficulties in stimulating European recovery. In Japan, on the other hand, despite the Bank of Japan's policy of zero interest rates, deflation continued unabated. As a result, the financial sector continued to reflect weaknesses, and the Japanese economy too started to contract again in the first quarter of 2003, pulling back global recovery.

The consequences of the global economic slowdown in 2002 inevitably affected the developing world, even though there were significant variations both between and within regions. In general, the latter can be linked to the differences in the policy choices made by them.

The East Asian region as a whole proved less susceptible than anticipated to the effects of the weaknesses in the industrialized world in 2002. However, with a sharp drop in growth or outright recession in most of the major economies in the region, output declined in Latin America in 2002, for the first time since the 1980s. On the other hand, performance in Africa was largely independent of the impact of the US downturn in 2001 and more closely linked to demand conditions in Europe. Thus, the region benefited little from the upswing in 2002, and climatic and political conditions continued to have a major impact on economic performance. The transition economies were also less affected by the global slowdown, inspite of the fact that many of these economies belonging to the Eastern Europe and the Commonwealth of Independent States (CIS) have high dependence on trade with Western Europe.

Capital Accumulation, Economic Growth and Structural Change- The Debate on Development Strategies
Given the increased diversity in economic performance among developing countries in the current global economic downturn, TDR opens afresh the debate on latecomer industrialisation and growth strategies facing developing countries. Given that the most notable success stories in catching-up industrialisation since the Second World War have been in East Asia, the discussion inevitably centres on the growth experiences of the first-tier and second-tier newly industrialising economies (NIEs) of the region and looks at the policy lessons they have to offer vis-à-vis the Latin American economies. As always, the analysis brought out by TDR makes a departure from the other main publication from the UNCTAD secretariat, the World Investment Report.

It is known that during the entire period 1960-1990, the countries in East Asia had enjoyed rapid, uninterrupted and stable growth, which was also remarkably stable. Growth slowed down and instability increased only during the 1990s and clearly reflected the boom-bust cycles associated with unstable capital flows. While this culminated in the 1997-98 crisis, most of these countries have managed a fairly rapid turnaround subsequently.

By contrast, the growth performance of the Latin American region, whose growth rates and per capita income levels were similar to that of the East Asian region between 1960 and 1973, diverged sharply and became increasingly unstable after that. In fact, subsequent to the adoption of the economic reforms, most of these countries experienced slower and less stable growth during 1980-2000 than in the previous two decades. Further, at present, Latin American countries have appreciating currencies just when there is a global economic slowdown in output and trade, and are faced with a shift to short-term capital flows once again. Against the backdrop of the instability of such short-term capital inflows, the recovery in Latin America in 2003 is thus also likely to be weak and fragile.

TDR highlights how the neoliberal reforms adopted in the Latin American economies subsequent to the debt crisis (collectively referred to as the "Washington Consensus") were aimed at removing structural and institutional impediments to growth and imcreasing allocative efficiency, and thus improve productive capacity and trade performance. The argument of the proponents of these reforms has been that the removal of domestic price distortions and the freeing of market forces would generate rapid increases in private investment. Specifically, increasing investment was to be achieved through the mobilization of domestic savings through deregulation, liberalization of the financial sector, and attraction of foreign direct investment (FDI). This was expected to put an end to the stop-go development cycles associated with excessive indebtedness and periodic BOP crises, and usher in an era of sustained growth and poverty reduction. But, the Latin American growth experience and their increased vulnerability to BOP crises as seen in the last two decades, discredit any claims of the neoliberal growth paradigm in meeting these professed objectives.

Although the ultimate aim of the macroeconomic and other measures implemented in the countries that experienced the debt crisis was to prepare the ground for private investment-led recoveries, a rapid and sustained recovery in capital accumulation and growth has proved elusive for most of the countries undergoing rapid market reforms, in both Latin America and Africa. In fact, the "investment pause" that followed the debt crisis of the early 1980s has become a much more permanent feature of the economic scene of many developing countries.

Industrial progress has also halted in much of the developing world; only eight of 26 selected countries succeeded in raising the share of manufacturing value added in GDP between 1980 and the 1990s. In particular, almost all Latin American countries saw significant declines in the share of manufacturing value added in GDP following the introduction (or intensification) of market-based economic reforms since the 1970s and 1980s. By contrast, policy continuity in East Asia after the debt crisis produced a strong investment performance, and has lead to an increase in manufacturing value added, employment and exports.

Given that after so many years of reform and adjustment, there is little sign of creative forces initiating a new virtuous process of accumulation, growth and structural change, the deindustrialisation process associated with the shift in development paradigm in Latin America and sub-Saharan Africa surely calls for a serious rethinking of the development strategies adopted by developing countries. The TDR thus goes into the reasons of why leaving enterprise to the invisible hand of global market forces, as propounded by the prevailing paradigm, has failed in the rapid reformers.

It argues that capital accumulation holds the central place in the mutually reinforcing interplay of linkages among capital accumulation, technological progress and structural change, which constitute the basis for rapid and sustained productivity growth and thus make up a virtuous growth regime. Thus, identification of the factors that govern investment decisions is the key to understanding the varying economic performance of developing countries.

Industrialisation, Trade and Structural Change
Drawing attention to the contrasts between the Asian and Latin American investment regimes, the Report points out how a strong relationship between a rising ratio of investment to GDP constitutes an integral part of a virtuous investment dynamic in most East Asian countries. On the contrary, weak recoveries in Latin America is observed to have often been associated with stronger performances in less productive categories such as housing construction, along with a sharp decline in public investment in infrastructure. This also gets reflected in the fact that for most Latin American countries, there has been no improvement in the level or composition of investment, even when FDI increased. In Asia, by contrast, recent surges in FDI inflows have been associated with a rising share of investment in GDP and increased investment in machinery and equipment. Thus, varying investment performance is a major reason for the differences in the ability of developing countries to establish and sustain a strong development path.

TDR 2003 then goes on to show how the close correlation between high investment rates, rising shares of manufacturing in GDP and strong export performance is underpinned by a rapid growth in productivity. Foreign trade also exerts an important influence on the evolution of economic structure, in so far as it can help to overcome domestic supply-side and demand-side constraints on industrialisation and growth. However, as with investment, the extent to which trade feeds into a more or less dynamic and virtuous industrialisation process owes a good deal to policy choices and interventions.

This is because the links between investment on the one hand, and productivity growth and trade performance on the other are not automatic. The pace of productivity growth in developing countries and the speed with which the productivity gap with developed countries can be reduced are affected by: the nature of their participation in international production networks (IPNs); technology and capital goods imports; and the process of learning and adaptation fundamental to technological progress. Thus, targeted technology policies also have a direct bearing on the outcome.

This is why while many developing countries are becoming increasingly similar to developed countries in the structure of their manufactured exports; this does not necessarily imply a corresponding similarity in their pattern of manufacturing value added. This disparity between the growth rates of manufacturing value added and exports is due to the weak growth in domestic value added and to strong growth in imports associated with participation in IPNs. Participation in IPNs is often advocated as a possible basis for technological leapfrogging and rapid acceleration of productivity growth. However, it has been established that the technology transfer and learning processes in such networks are increasingly circumscribed by the global strategies of TNCs, rather than by the national development strategies of the host countries, as has been argued by the proponents pushing for domestic economic policy and institutional reforms. This is what leads to weak backward and forward linkages, which reduces the scope for expansion in domestic value added.

Thus, it is rightly emphasised that the pace and pattern of industrialisation are greatly influenced both by the pace and pattern of capital accumulation and the nature of participation of countries in international trade. The mutually reinforcing dynamic interactions between capital accumulation and exports are believed to lead to successful industrialisation in developing countries.

Analysing the processes of accumulation, industrialisation, trade and structural change, the Report comes out with a classification of five broad categories of developing countries:

1. The first group consists of first-tier NIEs, notably the Republic of Korea and Taiwan Province of China, which have already achieved a considerable degree of industrial maturity through a rapid accumulation of capital, and growth in industrial employment, productivity, output, as well as in manufactured exports. In both economies, the share of industrial output is well above the levels of advanced industrial countries, but the pace of expansion of production capacity and output in the industrial sector has slowed down compared to the previous decades.

2. The second group consists of countries that are progressing rapidly in industrialisation. They are increasing the share of manufacturing sector in total employment, output and exports as well as upgrading from resource-based and labour-intensive products to medium- and high-tech products in both output and trade. These include the dynamic second-tier NIEs, notably Malaysia and Thailand. China and to a lesser extent, India could also be considered in this group, even though they are earlier stages of industrialisation compared to the former.

3. The third group comprises countries that have rapidly integrated into IPNs by focusing on simple assembly operations in labour-intensive manufactures. They have seen a sharp rise in industrial employment and manufactured exports, but their performance in terms of investment, manufacturing value added and productivity growth, as well as overall economic growth has been poor. Two countries that stand out in this group are Mexico and the Philippines.

4. The fourth group comprises countries that have reached a certain level of industrialisation, but have been unable to sustain a dynamic process of industrial deepening in the context of rapid growth. These include Brazil and Argentina, where investment performance has been poor, industry has been losing its relative importance in total employment and value added, productivity growth has been due to labour shedding rather than faster accumulation and technical progress, industrial upgrading has been limited, and exports have continued to be dominated by primary products and low value-added manufactures. In these countries, although progress has been achieved in certain industries such as aerospace and automobiles, it has not gone deep enough to establish a dynamic momentum in the industries. The African countries, at a much lower level of industrial development, can also be included in this group, in terms of sluggish progress in their industrialisation and structural change.

5. A final category consists of countries that have achieved sustained and strong growth by intensifying exploitation of their rich natural resources through a rapid pace of capital accumulation. However, their industrial performance has been weak both in terms of manufacturing value added and exports, and prospects for further structural change and productivity growth appear to be limited. The most outstanding example is Chile.

Such evidence examined in Part II of the Report clearly shows that the neoliberal reforms have failed in exactly the same areas in which previous policies of import substitution had also failed. Unlike the advanced industrial economies and the East Asian NIEs, the deindustrialisation trend in many developing countries in Latin America and sub-Saharan Africa has not been a benign product of differential productivity growth and structural change in the context of steady economic expansion. Rather, it has coincided with a widespread slowdown in growth.

Thus, it is clear that the support and protection given during the import-substituting industrialisation of the 1960s and 1970s had undoubtedly allowed industry in Latin America and to a lesser extent in Africa, to expand considerably faster than would have been possible under competitive conditions. Unlike in East Asia, however, which also made extensive use of industrial policies, these strategies in Latin America and Africa were not always able to promote viable industries. Consequently, with big-bang liberalisation and the withdrawal of support and protection, confronted with stiff competition, industries in these regions were forced to downsize, rationalise or perish.
However, with the failure of the first generation of reforms to deliver on its promises, as TDR discusses, attention has turned to "getting the investment climate right". This would be achieved by combining macroeconomic stability with better business organization, improved 'governance', and measures to boost competition for ensuring the 'quality' of investment.

This reintroduction of investment into the mainstream does not however imply a fundamental departure from the earlier focus on market-driven efficiency. Rather, strong emphasis has been placed on the role of competition in promoting investment and economic growth, and this is to be attained not only through further deregulation of domestic market, but through even greater openness to international trade and investment. But, TDR is unequivocal in its assertion that no unconditional link has been established between greater openness and economic growth, either theoretically or empirically.

Overall, the TDR is unambiguous in its preference for the strategy followed by East Asian countries whose integration occurred from a position of strength and was characterised by a continuous and purposeful strategy of gradual opening up. A wide range of macroeconomic, financial and trade policies were used in East Asia to stimulate investment, target industrial upgrading and encourage exporting. By contrast, the shift in development strategies that occurred in Latin America and Africa occurred in a period of weakness in the aftermath of the debt crisis. The big-bang liberalization they had to adopt has led to inconsistencies among macroeconomic, trade, FDI and financial policies, which have skewed structural changes and stunted technological progress.

Thus, East Asia's better performance is attributed to the better flexibility and resilience of their productive structures, institutions and government policies to respond to external shocks with effectiveness and vigour than by Latin American countries. This has enabled most of the East Asian economies, when exposed to external shocks, to adjust and continue, after a brief pause, on their high growth paths. The importance of developing a broad domestic industrial base to respond to development challenges derives from its potential for strong productivity and income growth.

In fact, in 2002, the East Asian region as a whole proved less susceptible than anticipated to the effects of the weaknesses in the industrialized world. The Report attributes this to their low dependence on short-term capital inflows, which has allowed them greater leeway for counter-cyclical economic policy. However, this explanation seems problematic, as the reduced short-term capital inflows to the region has largely not been the outcome of deliberate policy decisions by the governments concerned in terms of reducing their reliance on external capital. Rather, East Asia's recent lesser reliance on short-term capital flows has been a reflection of the fact that foreign portfolio investors have not returned en masse to the region in the aftermath of the crisis. For some of these countries, reduced net capital inflows has also been due to the repayments on the multilateral loans taken by these countries subsequent to the financial crisis.

Growth in private consumption expenditure has been seen to be a more important factor in explaining the region's recent growth. What is not highlighted is the fact that the expansion in domestic demand, even in the countries that took IMF loans in the aftermath of the crisis, was brought about with non-orthodox expansionary policies, instead of following the IMF's restrictive policy prescriptions. This recovery of domestic demand growth also enabled expansion of the capacities bought over by foreign direct investors through M&As, in both productive and financial sectors of the crisis-ridden economies. This together with the expansion of intraregional trade, especially with a surge in China's imports from the region appear to be behind the recovery process, in spite of the slow down in the US, which is the most important market for the region. However, the vulnerability of the continued heavy dependence of these economies on externally-driven growth is reflected in the fact that in 2003, East Asian output growth is expected to be weaker than in 2002 (though faster than in Latin America), with the SARS outbreak having an impact on earnings from trade and services.

In general, the findings on varying success in industrial catching-up paths followed by the different developing countries have lead the TDR to seriously question the strategies adopted by a range of developing countries, which attempt to activate a dynamic process of capital accumulation and growth through a combination of increased FDI and reduced public investment and policy intervention.

The Report underscores the crucial role played by domestic entrepreneurs in the process of capital accumulation in a late industrialising developing country. This is based on the evidence that after the initial stages of industrialisation, capital accumulation is financed primarily by profits in the form of corporate retention, rather than household savings. While the role played a domestic entrepreneur base is clearly crucial to a sustainable industrialisation strategy, the explanation in the Report citing the linkage between domestic capital formation and corporate profits fails to consider the capital accumulation process in many large emerging market economies, where household savings continue to play a prominent role.

Whatever the source of capital accumulation, what is important to note is that in the countries that were able to generate sizeable resources for investment, market forces alone were not left to dictate either its pace or direction. TDR disputes the claims for the virtues of unlimited competition in relation to economic development. The East Asian NIEs did not have the maximum competition in product, capital or labour markets (which the neoliberal paradigm propounds as basic to achieving efficient growth), rather, they strived to achieve an optimal degree of cooperation and competition. The defining features of successful development strategies followed particularly by the first-tier NIEs were the following: a low-interest-rate policy; using trade, financial and industrial policies to coordinate investment decisions to prevent "investment races"; and long-term ties between banks and large corporations.

It is known how many of these same institutional features which were recognised to have contributed to the "Asian Miracle" came under misguided criticism as the factors responsible for the financial crisis during 1997-98. On the contrary, studies have clearly shown that a major reason for the deterioration in the performance of such institutional arrangements in East Asia, which had served them well until the phase of full-fledged financial liberalization, was precisely the dismantling of the checks and balances that had been part of the earlier system under the onslaught of rapid integration into the world economy. In particular, this occurred in two crucial areas: control over external borrowing; and state guidance of private investment. TDR 2003 is therefore justifiably doubtful that a "second generation" of neoliberal reforms will start to put things back on track.

The Way Forward
In making these gloomy assessments about the prospects for a strong economic recovery, the Report takes into account the prospects for acceleration in financial flows and trade to developing countries, as well as the potential for international currency realignments. The Report emphasises that sustainable expansion of trade and capital flows now depends on a rapid recovery of the world economy, rather than the other way around as the proponents of further trade and financial liberalisation argue.
It is observed that while economic recovery in the developed countries has failed to pick up strongly, growth in international trade, which had decelerated subsequent to the IT bubble burst and the global economic slowdown since 2000, registered only a modest recovery in 2002. While factors such as greater trade liberalisation, deeper vertical integration (through increased spread of international production networks) and increased capital inflows can once again enable international trade to expand faster than global production and income, all these factors are currently operating under strict limits due to sluggish growth and rising unemployment globally.

Net private capital flows to developing countries also rebound in 2002, reversing the steady decline since 1996. However, given that the surge in financial flows in the 1990s was also largely due to one-off policy changes related to the deregulation of national financial markets and liberalisation of international financial flows, the Report cautions against excessive optimism for an increase in capital flows to the levels seen in the nineties. Further, with the evidence showing that most greenfield FDI is also attracted by growth and not vice versa, it is anticipated that the partial recovery in flows seen last year is unlikely to herald a stronger upturn in inflows.

According to the TDR, the exchange rate adjustments that are now occurring are also unlikely to reduce global trade imbalances and therefore, unlikely to support global recovery. This is because, since a large proportion of the US trade deficit is with the East Asian countries, a correction of these imbalances would require the dollar to depreciate against the East Asian currencies, including the yen. But, there are varying pressures acting upon the latter nations, which may make this difficult to materialize. These include Japan's reliance on export growth as the only source of demand expansion and the intense export competition among the East Asian developing countries.

In the absence of effective currency alignments and rapid growth in Europe and Japan, the external adjustment required to break this global deadlock, this then calls for a faster price deflation in the US than in the former economies. Thus, the Report argues that global growth will continue to depend heavily on the performance of the US economy and its policy choices. But, based on the US economy's performance during the past three years, decisive action would be needed in order to avert the danger of a prolonged deflation in the US. While the US monetary authorities have shown readiness to fight deflation by injecting money into the economy in order to induce price rises, much of the task, according to the TDR, will fall on fiscal policy. This calls for a reorientation of US public spending in order to increase investments in areas such as public infrastructure, health and environment.

However, given that there is a global deflationary situation, the Report calls for bold Keynesian type of globally coordinated expansionary action, so as to stabilize the international monetary and financial system. Only coordinated monetary policies can help in bringing about stability to capital flows, and an orderly realignment of exchange rates. However, clearly, given that there is now a real danger of the emergence of a "liquidity trap" in economies that are considered to be engines of growth, monetary policy might become ineffective in checking and reversing the falls in output and employment, unless it is combined with coordinated fiscal expansion to expand liquidity and effective demand, both at the national and global levels.

In the case of developing countries too, TDR makes bold suggestions as to how to escape from the vicious circle of low and unstable growth, high interest rates and rising indebtedness. For example, the Report emphasizes less dependence on foreign capital and greater efforts to build stronger investment-export linkages to ease the BOP constraint. It also suggests that ways must be found to improve the contribution of FDI to these goals. Further, it calls for more strategic policies to support higher investment and upgrading, and active policies in the areas of industrial support, technological progress and public infrastructure.

But, it is by now well acknowledged that several agreements under the WTO combined together taken in letter and spirit, as well as the several conditionalities attached to various debt relief and financial assistance programmes from international financial institutions (IFIs) and donor countries mean that developing countries have very little policy space in effect. But, very often, official publications from international organisations fail to discuss the actual policy flexibility which remains for various countries, for pursuing the kind of interventionist development policies which they advocate.

The TDR has also been disappointing in this regard. The Report makes a passing mention of the failure of Cancun and of the WTO to deliver on its development promises, the lack of progress of international financial reform and in developing countries' participation in decision-making in the Bretton Woods institutions and the WTO. But, it totally ignores a discussion of how the policies suggested by them can be practised. The Report fails to acknowledge just how difficult it is for late industrialisers today to adopt some of the most important policy tools that were so crucial to the industrial development strategies of earlier generation industrializers in achieving the above goals.

Several prominent works from the UN organisations themselves have lucidly established the glaring problems faced by developing countries in the context of WTO agreements and implementation. There is a need to incorporate the essence of these works into official publications, for the maximisation of the existing provisions in the WTO for policy flexibility for developing countries, and to call for reformulations wherever necessary, in order to make the global system more fair, and thus, more sustainable for both developing and the developed countries. Probably, the next natural step for TDR should be to plunge deeper into the implications of the trade agreements that have been carried out at various levels by developing countries. There is also a critical need for incorporating indepth analysis of service sector industries as well into analyses of capital accumulation and structural change.

Further, the focus of TDR 2003 appears to be on export-led growth as the single most important development strategy choice facing developing countries. Given the fact that this has only led to increased dependence of their economies on external demand and external capital and consequent cycles of boom and bust (as the Report itself shows so decisively), it would have added further value if the Report had explored beyond the framework of export-led growth to the need for varying development strategies based on the relevance of the domestic economy in the context of the distinctions between small and large economies, and the need for domestically-pegged growth even in the context of export-oriented growth strategies.

Overall, TDR 2003 has definitely added weight to the growing volume of dissenting analyses on market-driven globalisation. Unfortunately, the tragedy of the times is that such incisive assessments and analyses brought forth by the UNCTAD, however, fails to instigate similar soul-searching by developed country policy makers, IFIs, and other multilateral organisations such as the WTO. Even in the face of mounting evidence suggesting severe lacunae in their prescriptions, the latter continue to seek refuge behind ideological fixations and a plethora of yet more development-friendly phrases and policy papers.

December 23, 2003.