21 694 DEVELOPMENT BRIEF Number 53 The World Bank May 1995 Reverse Ili n kages to industrial countries from integra- Reverse linkages tion with developing countries will be greater than those from further everybody wins trade integration among them- selves. Growth in developing economies and their increasing Because of technology improve- ments, trade in long-distance ser- integration into world trade and finance benefit, rather vices is also increasing. This trade is than hurt, industrial countries likely to bring big gains to indus- trial countries because the cost of A s developing countries in- in world exports of manufactures providing services in developing creasingly become part of could increase from 17% to more countries is a fraction of that in in- the global economy, they than 22%. Developing countries dustrial countries. For example, the benefit not just themselves but also purchase roughly a quarter of in- gross dollar income of clerks in industrial countries. The gains to dustrial country exports and, on Bombay is one-fortieth that of industrial countries from reverse present trends, that could rise to clerks in Zurich. Little wonder that linkages are potentially huge. There more than a third by the end of the the Swiss national airline (Swissair) are, however, a couple of caveats.* next decade. now has a sizable part of its back Much depends on developing One indicator of the potential office in India. countries' continuing the policy im- gains from trade integration be- Big price differences and faster provements responsible for their tween industrial and developing growth of per capita income in rapid economic growth in recent counties is the price difference for some developing countries suggest years (see figure 1). Many face po- similar products in those coun- that the dynamic gains from trade litical and policy uncertainties, and tries-the greater the difference the with them will be large. Increased the path forward is unlikely to be bigger the possible gains through trade integration can increase the smooth. Witness Mexico's woes. trade. Cost-price differences be- rate of output growth in industrial Much also depends on the continu- tween developing and industrial countries. It can also mean higher ing liberalization of global trade- countries are on average about productivity growth. It can, for ex- and that cannot be taken for twice those between industrial ample, raise the incentive to invest granted, given the strong protec- countries. That suggests that (trade) in research and development be- tionist pressures in both industrial specialization and efficiency gains cause firms can spread the fixed and developing countries. The gains from reverse linkages Figure 1 Growth in industrial and developing countries come from increased trade integra- (percent) tion of developing and industrial 6 countries, increased integration through financial flows, and higher growth in developing countries. 4 Closer integration has some costs 3 for industrial countries, but these 2Industrial are far outweighed by the benefits. In 1994 developing countries' 1 share of world imports was 24%. 0 Actal.ikey.ten That could rise to 30% or so by Actual Likely trend 2010. At the same time, their share 1980 1984 1988 1992 1996 2000 2004 2008 'For more details, see World Bank, Global Economic Prospects Note: Excludes former Soviet Union and Eastern Europe and Central Asia. and the Developing Economies 1995, Washington, DC, 1995. Source: World Bank, Global Economic Prospects and the Developing Countries 1995, Washington, DC, 1995. costs of R&D over a bigger market, such an inflow without appreciat- Figure 2 Developing which in turn could mean faster in- ing substantially), the annual return countries' share of novation and technical progress. on the entire portfolio would rise by global output 2 percentage points without in- (percent) Financial forays creased risk. All the gains from trade integration will be reinforced by efficiency Global growth gains from increased globalization On current trends, developing 20 of industrial country production countries could account for 38% of and distribution through foreign the growth in world output in direct investment (FDI). Indeed, 1995-2010, compared with 22% in 10 FDI plays a vital role in generating the 1980s. Their share of world out- gains from trade integration; for ex- put would rise from 21% in 1994 to Actual Likely trer,d ample, more than 30% of trade be- 27% in 2010 (see figure 2). In terms o tween Mexico and the United States of purchasing power parity, more 1970 1978 1986 1994 2002 2010 is intracompany sales. than half of world output could Source: World Bank, Global Economic Prospects and In 1992-94 developing countries come from developing countries in the Developing Countries 1995, Washington, DC, 1995. received about 40% of global FDI the next decade, compared with inflows, compared with 23% in the 43% today. By 2010 they would ac- with developing countries contin- early 1980s. That share is likely to count for more than 55% of global ues to increase, some industries will rise further as more developing consumption and capital formation shrink, others will expand. Most af- countries open their markets and (again, in terms of purchasing fected will be labor-intensive and improve growth prospects. power parity). And three develop- low-skill industries. At the same Developing countries also offer ing countries-China, India, and time, those industries and services investors in industrial countries Indonesia-could be among the in which industrial countries retain pure financial gains from FDI. Over world's six biggest economies. comparative advantage will ex- the past three years the rate of re- Growth in developing countries pand. For industrial countries, the turn on FDI flows from the United stimulates demand for industrial challenge is to minimize the social States to the rest of the G-7 has av- country output in two ways. With costs of adjustment while reallocat- eraged around 8%, while returns growth in investment, it boosts the ing resources to those industries on FDI flows to the eight largest de- demand for capital goods and ser- that benefit from integration. veloping countries averaged about vices. And, as incomes rise, so too Flexibility in labor markets is cru- 21%. Of course, that difference re- does the demand for more (and in- cial. When these markets work flects the greater risk in the devel- creasingly sophisticated) imports of smoothly, any increase in unem- oping countries, but even the consumer goods. By 2010 more than ployment can be kept to a mini- risk-adjusted rates of return in one billion consumers in develop- mum. In the 1980s, for example, the those countries are substantially ing countries could have per capita United States was able to generate 6 higher than the returns in indus- incomes exceeding those of Greece million jobs in the retail, hotel, and trial countries. or Spain today. restaurant sectors, compared with Investments in shares traded on the loss of 400,000 jobs (in textiles, emerging stock markets also offer Future prospects leather, and apparel) that could be higher returns and help to diversify Has increasing integration hurt in- attributable to competition from risk. The typical pension fund in dustrial countries? Some, but not developing countries. the United States holds only 1-2% much. Certainly, it does not appear Inevitably, there will be calls for of its portfolio in emerging mar- to have been an important factor in more protectionism. Indeed, that is kets. Yet calculations for 1989-94 the decline in manufacturing in in- probably the biggest single threat to suggest that if industrial country dustrial economies over the past 20 this mutually beneficial integration, investors were to increase this to 30 years-nor in the rise in un- and it must be resisted. If not, bc th share to about 20% (assuming employment and wage inequality. developing and industrial countries emerging markets could absorb But what of the future? As trade will lose-and lose big. Development Briefs are issued by theWorld Bank to inform the media,business, academic, and govemment policy communities about development policy analyses and results from the Bank's research activities. They are drawn fromthework of individual Bank researchers and do not necessariy represent theviews of the World Bank and its membercountries-and should not therefore be attributed to the World Bank or its affiliates. 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