Building Resilience in the Developing World

By Erik Berglöf
Special to The Times Kuwait

In its latest World Economic Outlook, the International Monetary Fund notes in passing that the economic impact of COVID-19 on emerging and developing economies has been much more severe than previously thought. While GDP growth rates in the developed world have returned to their pre-pandemic trends, those of developing countries are even lower.

The economic scars of COVID-19 across the developing world, particularly large debt overhangs and insufficient investment in future growth, will remain visible for decades. And as environmental disasters become increasingly frequent and more severe, the pandemic might be a harbinger of future shocks. COVID-19 is not the last or the most virulent virus the world will face.

After all, pandemics are far from the only environmental threat disproportionately affecting low-income countries. Climate change and biodiversity loss, together with antimicrobial resistance, air pollution, and lead poisoning, among others, all have the potential to act as significant drags on developing economies’ growth.

To be sure, emerging and developing economies are still growing faster than their more developed counterparts. Over the past three decades, developing countries’ share of global economic growth has nearly doubled to over 70 percent, but as extreme weather events, epidemics, and other natural disasters become more frequent, this may change. To prevent the gap between rich and poor countries from growing, we require a deeper understanding of developing economies’ unique vulnerabilities, as well as more effective strategies to build resilience.

COVID-19 is a case in point. Despite the massive death toll, developed countries have been able to leverage their substantial fiscal and monetary resources, along with their access to vaccines, to minimize the pandemic’s long-term economic impact. By contrast, the damage to emerging and developing countries has been more severe and is expected to last much longer than initially anticipated, reversing decades of progress and undermining their ability to achieve the United Nations Sustainable Development Goals (SDGs).

The financial risks associated with climate change can be both acute, triggered by extreme events such as storms and floods, and chronic, resulting from long-term shifts in weather patterns. Damage to physical assets, supply-chain disruptions, and reduced output pose significant threats to economic growth and development, especially in countries with mounting debt burdens and limited resources.

These risks inevitably affect the cost of capital. Ideally, capital should flow ‘downhill’ from capital-rich to capital-poor countries, where the potential social returns are higher. Since the 2008 global financial crisis, however, capital has tended to flow uphill, largely owing to perceived risks and weak institutions in emerging and developing countries, as well as developed economies’ monetary policies. The growing threat posed by pandemics and climate change are reinforcing these trends.

This is happening despite steady improvements in macroeconomic policies across the developing world. A recent paper by Piroska Nagy Mohácsi and others suggests that in terms of transparency and accountability, central banks in developing countries have even surpassed the US Federal Reserve and the European Central Bank. During the 2008 crisis, and again during the pandemic, developing countries’ central banks closely followed the policies of the Fed and ECB. But their post-pandemic inflation forecasts have been more accurate, enabling them to respond faster to price increases.

While these improvements have not significantly reduced the cost of capital, they may help address another, related problem. Most infrastructure investments needed to mitigate future pandemics and environmental shocks rely on technologies that are financed in dollars, yen, and euros but that generate revenues in local currencies. Improved macroeconomic management could make developing countries’ currencies more attractive, reducing currency mismatches.

Climate adaptation and resilience efforts are more difficult to finance than mitigation measures, as developing countries often lack the necessary revenue streams to secure contracts. The newly created Pandemic Fund could help bridge some financing gaps by facilitating investments in pandemic prevention, preparedness, and response. But the Fund is not large enough to support the necessary climate adaptation and biodiversity restoration projects, underscoring the need for additional financing mechanisms.

Collective investments in resilience are particularly crucial for poor people who cannot afford personal protective measures like generators, air purifiers, air conditioners, and floodwalls. Using the case of mangroves in Indonesia, a recent study by the Asian Infrastructure Investment Bank shows that these trees protect economically vulnerable communities from tidal waves. But poor people are more likely to deplete mangroves as they use them for firewood and building materials and live in areas where local authorities have less capacity to maintain these vital ecosystems.

To build resilience, emerging and developing economies must also attract private and institutional capital. This requires the creation of markets that can accurately assess the value of lower carbon footprints and the impact of climate change. Multilateral development banks, in particular, can play a vital role in certifying such assessments. They also help in managing risks, mobilizing private investment, stabilizing capital flows, and creating new tools for evaluating investments in adaptation and resilience.

Developing economies are already facing much tighter environmental constraints, with a limited global carbon budget and commitments to reverse biodiversity loss, than countries that achieved high-income status in the past. Strengthening resilience to future pandemics and environmental shocks will be crucial to preventing lower growth in emerging and developing economies, and thereby maintaining overall global growth.

Erik Berglöf
Chief Economist at the Asian Infrastructure Investment Bank.

Copyright: Project Syndicate, 2024.

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