Speech

Speech: Small Middle Income Countries: Raising the Bar by IMF Deputy Managing Director Min Zhu

January 29, 2016

As prepared for delivery

On behalf of the International Monetary Fund, I would like to welcome you all to the 2016 High Level Conference for Small Middle Income Countries in sub-Saharan African, Raising the Bar.

This conference also coincides with the launch of the book “Africa on the move: Unlocking the potential of small middle-income states,” the result of a collaboration between IMF staff and officials from member countries.

I wish to express my gratitude to the Government of Botswana for its warm hospitality and to the Bank of Botswana for co-hosting this conference. I am looking forward to interesting discussions from today’s panelists and all of you on how this group of middle-income countries can overcome current challenges and move to the next stage of development.

Today I would like to talk about three issues:

• The changing global economic landscape
• The successes and challenges for small middle-income countries
• How countries could rethink their growth strategies, and the possible policies that could help them graduate to the next stage of development and avoid the so-called middle-income trap.

Together, these issues form the nucleus that will shape how small middle-income countries graduate to their next level of development. Let me start with the global picture.

The changing global economic landscape

The global economic crisis left us with a bigger scar than initially anticipated that we are still struggling to overcome: lower output and potential output, investment, and trade. Going forward, potential global growth has also moderated, including in emerging markets.

In addition, commodity prices have declined in what could be a protracted period of depressed prices. This puts pressure on those countries whose exports are mainly commodities, worsening their balance of payments and fiscal positions. The effect of the decline in export prices on the terms of trade has been at least partly compensated by lower fuel import prices.

All this is taking place as U.S. interest rates begin to rise and financial markets are experiencing heightened volatility. The increase in financing costs and volatility raises the issue of fiscal sustainability. Setbacks in domestic economic management can deteriorate both access to and pricing of external funding, yielding a potentially significant adverse shock to fiscal and external positions, and to debt dynamics. This suggests that some of the factors that supported high growth in the region—strong external demand and high commodity prices, coupled with low cost access to financing—are no longer as conducive.

Let me now turn to three megatrends that affect us all: climate change, technology, and demographics.

Climate change, while a global phenomenon, will affect countries in a variety of ways. Countries in sub-Saharan Africa are among the most vulnerable to climate change. It increases the uncertainty associated with natural disasters as the incidence of droughts, floods and cyclones is likely to increase. Mauritius is among the most vulnerable countries in the world to cyclones. All islands are vulnerable to rising sea levels. Swaziland is vulnerable to droughts. The poor are most at risk from climate change, including disruptions to the supply of food. This highlights the importance of economic resilience and measures to fight against the impact of climate change.

Innovations and changes in technology impact all aspects of our lives. Countries will have to change the way they have traditionally done things. This forces them to integrate differently into the “global village”. The impact will be both creative and destructive. For example, financial technology will affect payments, deposits and lending, financial markets, investment management, and capital raising and insurance.

Demographics potentially are on Africa’s side. While the rest of the world is aging, Sub-Saharan Africa could become the main source of growth for the global labor force. This will provide both challenges and opportunities. Sub-Saharan Africa’s population, slightly over 800 million in 2010, is projected to more than quadruple to 3.7 billion by 2100. The region is expected to account for most of the projected 2 billion increase in the global labor force this century. This requires special emphasis on building human capital and support for job creation to mitigate the social risks associated with high unemployment. By putting in place many of the reforms we are discussing today, countries can be well placed to benefit from a “demographic dividend.”

Small middle-income countries have a much narrower window of opportunity since they are at a somewhat more advanced stage of their demographic and income transitions. Mauritius and the Seychelles are even facing an aging population and need to prepare for the associated growth and fiscal challenges. If countries are able to harness the demographic dividend, small middle-income countries will have new markets next door, with trade reducing the constraints associated with smallness and location.

Successes and challenges

Small middle-income countries represent a successful group that have experienced solid growth over the past 20 years and sustained increases in per capita GDP. Their incomes have converged to advanced and emerging economy levels, but have not progressed as quickly as desired, reflecting a moderation of growth in some cases.

Growth has moderated in a few countries in 2014-15; some of it can be attributed to global conditions, but domestic constraints may also be playing a role.

We see the following main challenges countries face at home: how to diversify economies; job creation; infrastructure; developing the human resources necessary for economies to grow; and making growth inclusive.

First, countries need to accelerate their progress in diversifying exports and put in place policies to ensure that growth is broad-based. There inevitably are more risks when you have all your eggs in one basket. An economy is more resilient if the growth comes from a variety of economic drivers and the quality of growth is higher. In small middle-income countries, the service sectors have grown fast, but the main economic driver in most countries has been government expansion.

The second key challenge is job creation. Unemployment is high in several countries and the recent rise in youth unemployment is a big concern. There is also the issue of under-employment arising from large informal sectors with low productivity levels.

What are the causes of unemployment? In some cases they are structural and are caused by a lack of diversification and a country’s inability to move up the global value chain. Also a mismatch of skills―between those available and those the economy needs―can prevail, which is often caused by a lack of education and job training.

The difficulties in dealing with the problem and the political and social pressures it creates often lead to short-term solutions that are unsustainable or undesirable in the longer term. Unemployment exacerbates pressure on governments as an “employer of last resort.” This inflates the public sector wage bill and crowds out other priority spending.

The third challenge is the infrastructure gap, which is a major issue throughout Sub-Saharan Africa. Infrastructure gaps affect countries’ connections to the rest of the world, and limits their competitiveness. Countries should add infrastructure, but also make better use of what is available. There is also significant scope to improve the efficiency of investment, as higher levels of spending do not necessarily translate into improved public infrastructure. The slowdown in public investment in most small middle-income countries contributes to stagnant or declining capital stocks in several cases.

With many countries facing binding budget constraints and significant investment needs, the importance of increasing the efficiency of existing infrastructure is more important than ever. This requires well-prioritized projects, with sound cost-benefit analysis and carefully weighted financing options, including public-private partnerships.

Fourth, while various dimensions of human development indices have shown improvements over the years, challenges remain in many of your countries. Life expectancy has been converging to advanced and emerging market levels in several countries, thanks to better health care, but further progress is needed in others. While primary education is near 100 percent in most countries, in most cases there is room for progress in secondary and university education.

We see similar patterns when we look at the evolution of other human development indicators. So there is plenty of room left to build human capital, especially considering its importance in helping to deal with high levels of youth unemployment in many countries.

Fifth is inclusive growth, which is one of the key challenges many nations face in the 21st century. While poverty rates have fallen over time among small middle-income countries in Sub-Saharan Africa, efforts are still needed to ensure convergence in this area. Also, inequality remains unacceptably high in several countries. If unchanged, this will lead to social pressures and hurt growth.

Policies for growth and development: the next level

I now want to turn to how countries can best deal with all these domestic and external challenges, adapt to the new global environment and move to the next level of development.

Reform needs vary according to the stage of economic development: what got you from low-income to middle-income will not necessarily take you to the next level.

Countries that have graduated from middle-income status to advanced economy status have some features in common:

• More effective governments, which is not necessarily positively correlated with government size
• Private sector participation, facilitated by the right policies, including investor protection and adequate credit availability
• More inclusive growth that leads to lower poverty and unemployment.

The earlier growth model for small middle-income countries based on factor accumulation that allowed them to graduate from low- to middle-income status may no longer be well suited, especially considering the megatrends I mentioned earlier. To deal with these headwinds and recapture the earlier growth momentum over the medium-term will require governments to rethink the possible sources of growth, along with new policies. Crucially, countries need to implement previously delayed structural reforms to enhance their competitiveness and resilience.

Reforms

In many cases, the reform priorities are country-specific and consistent with their stage of development. We have identified five areas of common interest: policies to reduce government debt and deficits; private sector development; inclusive growth; job creation; and strengthening pubic financial management.

Given multiple reform needs, countries need to prioritize and sequence reforms to maximize pay-offs. The pace of reform appears to matter for productivity growth as much as the type of reform. Similarly, there appear to be benefits in implementing certain reforms simultaneously or in “waves.” For instance, there are synergies between labor market and product market reforms.

Also, governments need to diversify growth from government-led to private sector-led. This requires addressing the high cost of doing business and creating an enabling environment for the private sector.

I want to leave you with the sense that progress and advancement are within reach. This will require policymakers to adapt and change to new circumstances while also sticking to their goals. And it will be a lot of work.

In the face of a changing and uncertain world, small middle-income countries have to carve out their own path to take their development to the next level, and the IMF will be there to assist our member countries achieve this goal.

Thank you.