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Investment slump clouds growth prospects

Franziska Ohnsorge's picture

Investment growth in emerging market and developing economies has tumbled from 10 percent in 2010 to 3.4 percent in 2015 and was below its long-term average in nearly 70 percent of emerging an developing economies in 2015. This slowing trend is expected to persist, and is occurring despite large unmet investment needs, including substantial gaps in infrastructure, education, and health systems.

Slowing foreign direct investment inflows and spillovers from soft activity in major economies was to blame for much of the slowdown in investment growth among commodity importing countries. Among  commodity exporters, the loss of export revenues as a result of falling commodity prices, which hit energy exporters particularly hard, and mounting private debt burdens were important culprits. Political and policy uncertainty further sapped investment in several economies.

A lingering legacy of the 2008-2009 financial crisis is that advanced economy growth has repeatedly fallen short of expectations. As growth and growth prospects have faltered in the advanced economies who trade and invest in emerging and developing markets, output growth in the emerging market and developing world has slowed as well. For every one percentage point that growth in the United States or Euro Area drops, emerging market and developing economy output growth falls by between 0.8 and 1.3 percentage points within a year. Investment is even more sensitive to major economy growth weakness: emerging and developing economy investment growth responds about twice as strongly to growth declines in U.S. and Euro Area as growth does.

Another factor behind investment weakness is the policy-driven slowdown in investment growth in China. Since China’s investment intensively uses imports, especially commodity imports, this has weighed on growth in other emerging and developing economies through inter-sectoral input-output links and, indirectly, via output growth spillovers.

Ironically, investment weakness comes during a time of exceptionally benign domestic (and global) financing conditions. Policy interest rates of advanced economy central banks are at or near record lows and, in several instances, negative. Private credit growth in about 30 emerging and developing economies was near or above levels associated with credit booms at some point during 2010-15. Historically, around 40 percent of credit booms have coincided with investment surges. However, similar credit booms since 2010 have brought rapidly rising consumption but not a surge in investment.

Weak investment growth is a serious concern because it undermines longer-term growth prospects and hampers efforts to alleviate poverty. By slowing capital accumulation and the technological progress embedded in investment, weak post-crisis investment growth has reduced potential output growth relative to pre-crisis rates.   

Policymakers can tackle the problem head on or through indirect measures. For example, public investment in infrastructure and human capital could help raise demand in the short-run, increase potential output in the long-run and improve the environment for private investment and trade. Public investment would also help close investment gaps targeted by the United Nations Sustainable Development Goals.

Fiscal and monetary stimulus can also promote private investment indirectly by strengthening output growth, especially in commodity-exporting emerging and developing economies. These policies may be less effective, however, if employed to mitigate the impact of a persistent terms of trade shock, or if there is limited fiscal space. To raise investment growth sustainably, such policies will need to be buttressed by structural reforms to encourage both domestic private and foreign direct investment. Although policy priorities depend on country circumstances, including the availability of policy space and economic slack, policymakers should be ready to employ the full range of cyclical and structural policies to accelerate investment growth.
 

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