EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL A World Bank Group TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) Flagship Report JANUARY 2019 Global Economic Prospects Darkening Skies EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) JANUARY 2019 EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) © 2019 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. 1 2 3 4 21 20 19 18 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) Summary of Contents Chapter 1 Darkening Skies .................................................................................................. 3 Chapter 2 Regional Outlooks ............................................................................................ 59 Chapter 3 Growing in the Shadow: Challenges of Informality ....................................... 141 Chapter 4 Two Topical Essays Debt in Low-Income Countries: Evolution, Implications, and Remedies ... 211 Poverty Impact of Food Price Shocks and Policies ...................................... 221 Boxes Box 1.1 e great disin ation in EMDEs ........................................................ 8 Box 1.2 Low-income countries: Recent developments and outlook................ 24 Box 1.3 Regional perspectives: Recent developments and outlook ................ 28 Box 2.1.1 Informality in East Asia and Paci c ................................................. 65 Box 2.2.1 Informality in Europe and Central Asia ............................................ 77 Box 2.3.1 Informality in Latin America and the Caribbean .............................. 89 Box 2.4.1 Informality in the Middle East and North Africa ............................ 101 Box 2.5.1 Informality in South Asia ............................................................... 112 Box 2.6.1 Informality in Sub-Saharan Africa .................................................. 123 Box 3.1 Linkages between formal and informal sectors ................................ 144 Box 3.2 Regional dimensions of informality: An overview ...........................152 Box 3.3 Casting a shadow: Productivity in formal and informal rms ........ 158 Box 3.4 Under the magnifying glass: How do policies affect informality? .... 167 III EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) Executive Summary e outlook for the global economy has darkened. International trade and investment have softened, trade tensions remain elevated, and some large emerging market and developing economies have experienced substantial nancial market pressures. Against this challenging backdrop, EMDE growth is expected to stall at 4.2 percent in 2019. Downside risks have become more acute and include the possibility of disorderly nancial market movements and an escalation of trade disputes. Debt vulnerabilities in emerging market and developing economies, particularly low-income countries, have increased. More frequent severe weather events would raise the possibility of large swings in international food prices, which could deepen poverty. In this di cult environment, it is of paramount importance for emerging market and developing economies to rebuild policy bu ers while laying a stronger foundation for future growth by boosting human capital, promoting trade integration, and addressing the challenges associated with informality. Global Outlook. Moderating activity and America and the Caribbean and Middle East and heightened risks are clouding global economic North Africa) is proceeding at a more moderate prospects. International trade and investment pace than previously anticipated, partly re ecting have softened, trade tensions remain elevated, and a substantial slowdown in some large economies, some large emerging market and developing and is expected to plateau towards the end of the economies (EMDEs) have experienced substantial forecast horizon. Growth in regions with large financial market pressures. Against this numbers of commodity importers (such as South challenging backdrop, EMDE growth is expected Asia and East Asia and the Paci c) is expected to stall at 4.2 percent in 2019, with a sharply remain solid at around 6-7 percent. For all weaker-than-expected recovery in commodity regions, risks to the outlook are increasingly tilted exporters accompanied by a deceleration in to the downside. commodity importers. Global growth is expected to slow to 2.9 percent in 2019, from 3.0 percent is edition of Global Economic Prospects includes in 2018. Downside risks have become more acute. a chapter on the challenges associated with the Disorderly financial market developments could presence of large informal sectors in EMDEs and disrupt activity in the affected economies and lead policy options to address informality; a box on the to contagion effects. Trade disputes could escalate remarkable decline in EMDE in ation over the or become more widespread, denting activity in past decades; and two essays, on rising debt the involved economies and leading to negative global spillovers. To confront this increasingly vulnerabilities in low-income countries (LICs) difficult environment, the immediate priority is and the implications of large food price spikes for for EMDE policymakers to prepare for possible poverty. bouts of financial market stress and rebuild macroeconomic policy buffers as appropriate. But Growing in the Shadow: Challenges of there remains the longer run need to foster Informality. e informal sector accounts for stronger potential growth by boosting human about a third of GDP and 70 percent of capital, removing barriers to investments, and employment (of which self-employment is more promoting trade integration. Such efforts would than a half) in EMDEs. Informality is more also help address the challenges associated with widespread in lower-income countries with a informality. large agricultural sector and a high share of unskilled workers. While o ering the advantage of Regional Perspectives. e cyclical upswing in exibility and employment in some economies, a regions with many commodity exporters (Latin larger informal sector is associated with lower V EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) productivity, reduced scal revenues, and greater in LICs have increased substantially in recent poverty and inequality. Overcoming the years. Since 2013, median government debt has challenges of informality requires a balanced mix risen by more than 17 percentage points of GDP of policies that carefully take into account and has shifted toward non-concessional and country-speci c drivers. A well-designed policy private sources. As a result, in most LICs interest framework should include measures aimed at payments are absorbing an increasing proportion reducing regulatory and tax burdens, expanding of government revenues. e majority of LICs access to nance, improving education and other would be hard hit by a sudden weakening in public services, and strengthening public revenue trade or global nancial conditions given high frameworks. levels of external debt, lack of scal space, low foreign currency reserves, and undiversi ed e Great Disin ation in EMDEs. EMDEs have exports. A proactive e ort to reduce debt-related achieved a remarkable decline in in ation, from vulnerabilities is a policy priority for many LICs, 17.3 percent in 1974 to about 3.5 percent in and focus needs to be placed on domestic 2018. is achievement coincided with an even resource mobilization, strengthening sharper decline in in ation in advanced management practices for debt and public economies. e great disin ation in EMDEs has investment, building more resilient macro- scal also been accompanied by growing in ation frameworks, and developing domestic nancial synchronization, as evidenced by the emergence systems. of a global in ation cycle. It has been supported by long-term trends such as the widespread Poverty Impact of Food Price Shocks and adoption of robust monetary policy frameworks Policies. In the event of large swings in world and strengthening of global trade and nancial food prices, governments sometimes intervene to integration. More recently, the disruptions caused soften the impact on domestic prices and to by the global nancial crisis also contributed to lessen the burden of adjustment for vulnerable the decline in in ation. However, a continuation groups. While individual countries can succeed at of low and stable EMDE in ation is by no means insulating their domestic markets from short- term uctuations in global food prices, the guaranteed. If the wave of structural and policy- collective intervention of many countries may related factors that have driven disin ation since exacerbate the volatility of world prices. Policies the 1970s loses momentum or is rolled back, introduced during the 2010-11 food price spike elevated in ation could re-emerge. If the global may have accounted for 40 percent of the in ation cycle turns up, EMDE policymakers increase in the world price of wheat and one- may nd that maintaining low in ation can be as quarter of the increase in the world price of a great a challenge as achieving it. maize. Combined with government policy responses, the 2010-11 food price spike tipped Debt in Low-Income Countries: Evolution, 8.3 million people (almost 1 percent of the Implications, and Remedies. Debt vulnerabilities world’s poor) into poverty. VI EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) Abbreviations ADB Asian Development Bank AE advanced economies CEMAC Central African Economic and Monetary Community CES constant elasticity of substitution CET constant elasticity of transformation CGE computable general equilibrium model CPI consumer price index DB Doing Business DGE Dynamic General Equilibrium DTF Distance to Frontier score EAP East Asia and Pacific ECA Europe and Central Asia ECM Error Correction Model EMDE emerging market and developing economies EU European Union FAO Food and Agriculture Organization of the United Nations FAOSTAT FAO Statistical Databases FCV fragility, conflict, and violence-affected economies FICCI Federation of Indian Chambers of Commerce Fewsnet Famine Early Warning Systems Network G4 Euro Area, Japan, the United Kingdom, and the United States GCC Gulf Cooperation Council GDP gross domestic product GEP Global Economic Prospects GIEWS Global Information and Early Warning System GNFS goods and nonfactor services GTAP Global Trade Analysis Project HRW Hard Red Wheat ICSE International Classification of Status in Employment ICT information and communication technology IEG Independent Evaluation Group ILO International Labor Organization IMF International Monetary Fund ISS International Sector Survey LAC Latin America and the Caribbean LES–CES linear expenditure system–constant elasticity of substitution LIC low-income country VII EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) MIC middle-income country MIMIC Multiple Indicators Multiple Causes model MMDA Metro Manila Developments Authority MENA Middle East and North Africa MSEs micro and small enterprises NBER National Bureau of Economic Research NEET Not in Employment, Education, or Training NPAs non-performing assets NRP Nominal Rate of Protection OECD Organisation for Economic Co-operation and Development OLS ordinary least squares PPP purchasing power parity RHS right-hand side (in figures) SAR South Asia Region SDGs Sustainable Development Goals SEMP self-employment rate SMEs small and medium-sized enterprises SSA Sub-Saharan Africa SSRN Social Science Research Network UNCTAD United Nations Conference on Trade and Development UNDP United Nations Development Programme UNICEF United Nations International Children’s Emergency Fund USDA United States Department of Agriculture VAT Value-added taxation WDI World Development Indicators WEF World Economic Forum WGI World Governance Indicators WVS World Value Survey WHO World Health Organization WTO World Trade Organization VIII EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) CHAPTER 1 GLOBAL OUTLOOK Darkening Skies EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 3 Moderating activity and heightened risks are clouding global economic prospects. International trade and investment have softened, trade tensions remain elevated, and some large emerging market and developing economies (EMDEs) have experienced substantial financial market pressures. Against this challenging backdrop, EMDE growth has stalled, with a sharply weaker-than-expected recovery in commodity exporters accompanied by a deceleration in commodity importers. Downside risks have become more acute. Disorderly financial market developments could disrupt activity in the affected economies and lead to contagion effects. Trade disputes could escalate or become more widespread, denting activity in the involved economies and leading to negative global spillovers. To confront this increasingly difficult environment, the immediate priority is for EMDE policymakers to prepare for possible bouts of financial market stress and rebuild macroeconomic policy buffers as appropriate. But there remains the longer run need to foster stronger potential growth by boosting human capital, removing barriers to investments, and promoting trade integration. Such efforts would also help address the challenges associated with informality. Summary advanced economies is estimated to have slightly decelerated to 2.2 percent last year, it is still above potential and in line with previous forecasts. Global growth is moderating, as the recovery in trade and manufacturing activity loses steam EMDE growth edged down to an estimated 4.2 (Figure 1.1). Despite ongoing negotiations, trade percent in 2018—0.3 percentage points slower tensions among major economies remain elevated than previously projected—as a number of and have been accompanied by heightened policy countries with elevated current account deficits uncertainty. Borrowing costs for emerging market experienced substantial financial market pressures and developing economies (EMDEs) have and appreciable slowdowns in activity. More increased, in part as major advanced-economy generally, as suggested by recent high-frequency central banks continue to withdraw policy indicators, the recovery among commodity accommodation in varying degrees. A exporters has lost momentum significantly, largely strengthening U.S. dollar, heightened financial owing to country-specific challenges within this market volatility, and rising risk premiums have group. Activity in commodity importers, while intensified capital outflow and currency pressures still robust, has slowed somewhat, reflecting in some large EMDEs, with some vulnerable capacity constraints and decelerating export countries experiencing substantial financial stress. growth. In low-income countries (LICs), growth is Energy prices have fluctuated markedly, mainly firming as infrastructure investment continues and due to supply factors, and other commodity easing drought conditions support a rebound in prices—particularly metals—have weakened, agricultural output. However, LIC metals posing renewed headwinds for commodity exporters are struggling partly reflecting softer exporters. metals prices. Central banks in many EMDEs have tightened policy to varying degrees to Economic activity in advanced economies has alleviate currency pressures and confront rising been diverging of late. Growth in the United inflation. States has remained solid, bolstered by fiscal stimulus. In contrast, activity in the Euro Area has In all, global growth is projected to moderate from been somewhat weaker than previously expected, a downwardly revised 3 percent in 2018 to 2.9 owing to slowing net exports. While growth in percent in 2019 and 2.8 percent in 2020-21, as economic slack dissipates, advanced-economy central banks continue to remove policy Note: This chapter was prepared by Carlos Arteta and Marc Stocker, with contributions from Patrick Kirby, Ekaterine accommodation, and global trade and investment Vashakmadze, and Collette M. Wheeler. Additional inputs were growth weaken further. Unlike other advanced provided by John Baffes, Alain Kabundi, Eung Ju Kim, Csilla Lakatos, Peter Nagle, Rudi Steinbach, and Shu Yu. Research economies, near-term growth in the United States assistance was provided by Liu Cui, Ishita Dugar, Brent Harrison, will be boosted temporarily by fiscal stimulus, Mengyi Li, Claudia Marchini, Julia Roseman, and Jinxin Wu. which will likely lead to larger and more persistent EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 4 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 TABLE 1.1 Real GDP1 Percentage point differences (Percent change from previous year) from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f World 2.5 3.0 3.0 2.9 2.8 2.8 -0.1 -0.1 -0.1 Advanced economies 1.7 2.3 2.2 2.0 1.6 1.5 0.0 0.0 -0.1 United States 1.6 2.2 2.9 2.5 1.7 1.6 0.2 0.0 -0.3 Euro Area 1.9 2.4 1.9 1.6 1.5 1.3 -0.2 -0.1 0.0 Japan 1.0 1.7 0.9 0.9 0.5 0.7 -0.1 0.1 0.0 Emerging market and developing economies 3.7 4.3 4.2 4.2 4.5 4.6 -0.3 -0.5 -0.2 (EMDEs) Commodity-exporting EMDEs 0.8 1.7 1.7 2.3 2.9 2.9 -0.8 -0.7 -0.1 Other EMDEs 5.9 6.1 5.8 5.5 5.6 5.6 0.0 -0.3 -0.1 Other EMDEs excluding China 4.9 5.2 5.0 4.7 4.9 5.1 -0.1 -0.4 -0.2 East Asia and Pacific 6.3 6.6 6.3 6.0 6.0 5.8 0.0 -0.1 0.0 China 6.7 6.9 6.5 6.2 6.2 6.0 0.0 -0.1 0.0 Indonesia 5.0 5.1 5.2 5.2 5.3 5.3 0.0 -0.1 -0.1 Thailand 3.3 3.9 4.1 3.8 3.9 3.9 0.0 0.0 0.1 Europe and Central Asia 1.7 4.0 3.1 2.3 2.7 2.9 -0.1 -0.8 -0.3 Russia -0.2 1.5 1.6 1.5 1.8 1.8 0.1 -0.3 0.0 Turkey 3.2 7.4 3.6 1.6 3.0 4.2 -0.9 -2.4 -1.0 Poland 3.0 4.6 4.7 3.9 3.6 3.3 0.5 0.2 0.1 Latin America and the Caribbean -1.5 0.8 0.7 1.8 2.4 2.5 -1.0 -0.5 -0.1 Brazil -3.3 1.1 1.2 2.2 2.4 2.4 -1.2 -0.3 0.0 Mexico 2.9 2.0 2.2 2.2 2.4 2.4 -0.1 -0.3 -0.3 Argentina -1.8 2.9 -2.8 -1.7 2.7 3.1 -4.5 -3.5 -0.1 Middle East and North Africa 5.1 1.2 1.7 1.9 2.7 2.7 -1.3 -1.4 -0.5 Saudi Arabia 1.7 -0.9 2.0 2.1 2.2 2.2 0.2 0.0 -0.1 Iran 13.4 3.8 -1.5 -3.6 1.1 1.1 -5.6 -7.7 -3.1 Egypt2 4.3 4.2 5.3 5.6 5.8 6.0 0.3 0.1 0.0 South Asia 7.5 6.2 6.9 7.1 7.1 7.1 0.0 0.0 -0.1 India3 7.1 6.7 7.3 7.5 7.5 7.5 0.0 0.0 0.0 Pakistan2 4.6 5.4 5.8 3.7 4.2 4.8 0.0 -1.3 -1.2 Bangladesh2 7.1 7.3 7.9 7.0 6.8 6.8 1.4 0.3 -0.2 Sub-Saharan Africa 1.3 2.6 2.7 3.4 3.6 3.7 -0.4 -0.1 -0.1 Nigeria -1.6 0.8 1.9 2.2 2.4 2.4 -0.2 0.0 0.0 South Africa 0.6 1.3 0.8 1.3 1.7 1.7 -0.6 -0.5 -0.2 Angola -2.6 -0.1 -1.8 2.9 2.6 2.8 -3.5 0.7 0.2 Memorandum items: Real GDP1 High-income countries 1.7 2.2 2.2 2.0 1.7 1.6 0.0 0.0 -0.1 Developing countries 4.0 4.6 4.4 4.4 4.7 4.8 -0.3 -0.4 -0.1 Low-income countries 4.8 5.6 5.7 5.9 6.3 6.3 0.0 0.0 0.1 BRICS 4.4 5.2 5.3 5.2 5.3 5.3 -0.1 -0.2 -0.1 World (2010 PPP weights) 3.3 3.7 3.6 3.5 3.6 3.6 -0.2 -0.3 -0.1 World trade volume4 2.6 5.4 3.8 3.6 3.5 3.4 -0.5 -0.6 -0.5 Commodity prices5 Oil price -15.6 23.3 31.6 -1.4 0.1 0.1 -1.0 0.0 0.0 Non-energy commodity price index -2.8 5.3 1.7 1.0 1.2 1.2 -3.4 0.8 0.7 Source: World Bank. Notes: PPP = purchasing power parity; e = estimate; f = forecast. World Bank forecasts are frequently updated based on new information. Consequently, projections presented here may differ from those contained in other World Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. Country classifications and lists of emerging market and developing economies (EMDEs) are presented in Table 1.2. BRICS include: Brazil, Russia, India, China, and South Africa. 1. Aggregate growth rates calculated using constant 2010 U.S. dollar GDP weights. 2. GDP growth values are on a fiscal year basis. Aggregates that include these countries are calculated using data compiled on a calendar year basis. Pakistan's growth rates are based on GDP at factor cost. The column labeled 2017 refers to FY2016/17. 3. The column labeled 2016 refers to FY2016/17. 4. World trade volume of goods and non-factor services. 5. Oil is the simple average of Brent, Dubai, and West Texas Intermediate. The non-energy index is comprised of the weighted average of 39 commodities (7 metals, 5 fertilizers, 27 agricultural commodities). For additional details, please see http://www.worldbank.org/en/research/commodity-markets. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 5 fiscal deficits. Advanced-economy growth will FIGURE 1.1 Summary – Global prospects gradually decelerate toward potential, falling to Global growth is moderating, as industrial activity and trade decelerate. 1.5 percent by the end of the forecast horizon, as Recovery in EMDEs has lost momentum owing to softening external monetary policy is normalized and capacity demand, weakness in some commodity prices, and tightening external financing conditions. Many EMDE central banks have raised interest rates constraints become increasingly binding. to fend off currency pressures. Per capita growth will remain anemic in several EMDE regions—most notably, in those with a large number of Moderating advanced-economy growth, softening commodity exporters. global trade and investment, tightening financing A. Global growth B. Global industrial production and conditions, and heightened trade tensions will new export orders result in a more challenging environment for EMDE economic activity. EMDE growth is expected to stall at 4.2 percent in 2019—0.5 percentage point below previous forecasts, partly reflecting the lingering effects of recent financial stress in some large economies (e.g., Argentina, Turkey), with a sharply weaker-than-expected pickup in commodity exporters accompanied by a deceleration in commodity importers. EMDE growth is projected to plateau at an average of 4.6 C. Change in commodity prices, 2018 D. Growth in EMDEs percent in 2020-21, as the recovery in commodity exporters levels off. Per capita growth will remain anemic in several EMDE regions—most notably, in those with a large number of commodity exporters—likely impeding further poverty alleviation. Risks to global economic prospects are on the downside (Figure 1.2). A sharper-than-expected tightening of global financing conditions, or a E. EMDE policy interest rates, by F. Per capita growth, by region extent of currency depreciation renewed rapid appreciation of the U.S. dollar, against the U.S. dollar could exert further downward pressure on activity in EMDEs, including in those with large current account deficits financed by portfolio and bank flows. Government and/or private sector debt has also risen in a majority of EMDEs over the last few years, including in many LICs, reducing the fiscal room to respond to shocks and heightening the exposure to shifts in market sentiment and rising borrowing costs. Sources: Bloomberg, Haver Analytics, International Monetary Fund, Organisation for Economic Co- operation and Development, World Bank. Escalating trade tensions are another major Note: EMDEs = emerging market and developing economies. A.D.F. Shaded areas indicate forecasts. Data for 2018 are estimates. Aggregate growth rates downside risk to the global outlook. If all tariffs calculated using constant 2010 U.S. dollar GDP weights. B. New export orders measured by Purchasing Managers’ Index (PMI). PMI readings above 50 currently under consideration were implemented, indicate expansion in economic activity; readings below 50 indicate contraction. Last observation is they would affect about 5 percent of global trade October 2018 for new export orders and September 2018 for industrial production. C. Cumulative change for periods January 1 to June 14 and June 15 to November 29. June 15 flows and could dampen growth in the involved indicates the date on which the United States announced tariffs on $34 billion of China’s goods. D. Data for 2015-17 are simple averages. Green diamonds denote forecasts in the June 2018 edition economies, leading to negative global spillovers. of the Global Economic Prospects report. While some countries could benefit from trade E. The aggregate policy interest rates are calculated using constant 2010 U.S. dollar GDP weights. The above average and below average currency depreciation groups are defined by countries above diversion in the short run, rising trade or below the sample average of the year-to-date percent change in the bilateral exchange rate against the U.S. dollar. The sample average is -9.3 percent and includes 27 EMDEs, of which 11 are protectionism would stifle investment and severely above and 16 are below average. Last observation is October 2018. F. EAP = East Asia and Pacific, ECA = Europe and Central Asia, LAC = Latin America and the disrupt global value chains, contributing to higher Caribbean, MNA = Middle East and North Africa, SAR = South Asia, and SSA = Sub-Saharan Africa. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 6 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.2 Global risks and policy challenges prices and lower productivity. Other downside risks—such as heightened political uncertainty, Downside risks predominate, with the possibility of financial stress leading to further deterioration in activity in EMDEs. Escalating trade tensions escalating geopolitical tensions, and conflict— involving major economies could spread globally. A simultaneous sharp further cloud the outlook. slowdown in both the United States and China could have severe effects on the global outlook. Fiscal space is particularly limited in countries with high foreign-currency-denominated debt. Informality remains widespread Even though the probability of a recession in the in EMDEs and is associated with large productivity gaps between formal United States is still low, and the slowdown in and informal firms. China is projected to be gradual, markedly weaker A. Probability of 2019 global growth B. Growth forecast revisions and -than-expected activity in the world’s two largest being 1-percentage-point below/above current account position, 2019 economies could have a severe impact on global baseline economic prospects. Stimulus measures have bolstered the near-term outlook in these two countries but could result in a more abrupt downturn later on. A simultaneous occurrence of a U.S. recession and a sharper-than-expected deceleration in China would significantly increase the probability of an abrupt global slowdown and thus negatively impact the outlook of other EMDEs through trade, financial, and commodity C. Imports affected by new tariffs D. Impact on global growth of 1- percentage-point growth slowdowns market channels. A global downturn would be in the United States and China particularly detrimental for those EMDEs with reduced policy space to respond to shocks. The softening outlook and heightened downside risks exacerbate various challenges faced by policymakers around the world. Advanced economies should use this period of above- potential growth to rebuild macroeconomic policy buffers and lay the foundation for stronger growth E. Fiscal sustainability gaps in F. Average productivity in formal and with reforms that bolster potential output. Care EMDEs, by extent of reliance on informal firms foreign-currency-denominated debt should be taken to avoid shifts in trade and immigration policies that could negatively affect longer-term growth prospects, both domestically and abroad. EMDEs policymakers need to bolster the capacity to cope with possible bouts of financial market volatility, including sharp exchange rate movements—while undertaking measures to Sources: Bank for International Settlements, Bloomberg, Freund et al. (2018), International Monetary sustain the ongoing period of historically stable Fund, Kose et al. (2017), Peterson Institute for International Economics, United Nations, World Bank. inflation (Box 1.1). This will require from central A. Probabilities are computed from the distribution of 12-month-ahead oil price futures, S&P 500 equity price futures, and term spread forecasts. Each of the risk factor weights are derived from the banks a credible commitment to price stability model described in Ohnsorge, Stocker, and Some (2016). Last observation is November 7, 2018. B. Forecast revisions for GDP growth in 2019 relative to June 2018. Sample includes 23 EMDEs. underpinned by strong institutional Current account position net of foreign direct investment in 2018. C. Import tariffs implemented in the United States and the rest of the world in 2018, as well as those independence, as well as efforts by regulators and under consideration, as a percent of global goods imports. prudential authorities to reduce persistent D. Blue and red bars show scenarios assuming a 1-percentage-point growth shock in China, in the United States, and the combination of the two. Shocks are applied in the second half of 2019. Based financial fragilities. EMDEs also face substantial on the vector autoregression model presented in World Bank (2016). Deviations from baseline are all significantly different from zero. fiscal challenges and the risk of worsening debt E. FC debt = foreign-currency-denominated debt. A negative sustainability gap indicates government debt is rising along an accelerated trajectory. The sample includes 27 EMDEs. The above (below) dynamics as global financing conditions tighten. average foreign-currency denominated debt groups are defined by countries above (below) the For many EMDEs, it will be imperative to restore sample average of external debt in foreign currency as a share of total external debt in 2017. F. Blue bars represent estimates and orange vertical lines indicate two standard deviation error fiscal space given cyclical conditions, as well as bands. World Bank’s Enterprise Survey data for 135 countries (2008-18). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 7 address the vulnerabilities associated with elevated FIGURE 1.3 Advanced economics foreign-currency-denominated debt. Activity has softened but still points to above-potential growth in major advanced economies. Growth is expected to continue to moderate over Equally critically, amid a projected deceleration in the forecast period. Fiscal policy will boost U.S. activity in 2019 but will become a drag thereafter. potential growth, EMDEs face the substantial longer-term challenge of ensuring sustained improvements in living standards. This will A. GDP and demand component B. Growth growth require investments in human capital and skills development to raise productivity and take full advantage of technological changes—and, in a context of limited fiscal space, prioritize effective public spending and increase public sector efficiency. Facilitating the expansion of small- and medium-sized enterprises, including by improving their access to international markets and finance, would also spur productivity and stimulate growth Sources: Haver Analytics, World Bank. -enhancing investments. For many EMDEs, there A.B Green diamonds correspond with the June 2018 edition of the Global Economic Prospects is scope to further liberalize trade and improve the report. Shaded areas indicate forecasts. Data for 2018 are estimates. A. Aggregate growth rates and components calculated using constant 2010 U.S. dollar GDP weights. extent to which they are integrated into global value chains, which would foster a more efficient allocation of resources, job creation, and export diversification. Policies that help improve investment and the eventual shift of U.S. fiscal outcomes in these areas would also contribute to policy from stimulative to contractionary address the challenges associated with informality, (Figure 1.3). thus reinforcing the basis for future productivity growth. United States Major economies: Recent U.S. growth in 2018 is estimated to have picked up to 2.9 percent, up 0.2 percentage point from developments and outlook previous projections mostly reflecting stronger- than-expected private consumption. Activity is Growth has moderated in most advanced economies, being bolstered by procyclical fiscal stimulus and with the notable exception of the United States, still-accommodative monetary policy, while where fiscal stimulus is boosting activity. Over the domestic demand remains solid (Figure 1.4). forecast horizon, growth in all major advanced economies is projected to slow toward potential as The labor market remains robust, bolstering capacity constraints become increasingly binding and consumption. The unemployment rate has fallen monetary accommodation is withdrawn. In China, to an almost 50-year low, despite an influx of new activity remains robust, but headwinds are increasing workers—about three-quarters of the in a context of heightened trade tensions. approximately 200,000 jobs being added every month are being filled by new entrants. Labor Incoming data in advanced economies have productivity is showing signs of picking up. softened but still point to above-potential growth. Although nominal wages have begun to accelerate, Unemployment rates have continued to decline, they have so far been largely overtaken by an and for many countries are below levels prior energy-driven rise in prices, leaving real wages to the global financial crisis. After slightly stagnant. Long-term inflation expectations are decelerating from 2.3 percent in 2017 to an edging up but still remain contained. estimated 2.2 percent last year, advanced-economy growth is expected to continue slowing over During 2018, the U.S. administration raised the forecast period, with a notable slowdown in tariffs on about $300 billion worth of imports, EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 8 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 1.1 The great disinflation in emerging market and developing economies “ e greatest threat to today’s low in ation, of Emerging market and developing economies (EMDEs) have achieved a remarkable decline course, would be a reversal in in ation, from 17.3 percent in 1974 to about 3.5 percent in 2018. is achievement of the modern trend has coincided with an even sharper decline in in ation in advanced economies. e great towards enhanced central disin ation in EMDEs has also been accompanied by growing in ation synchronization as bank independence, evidenced by the emergence of a global in ation cycle. It has been supported by long-term particularly if trend trends such as the widespread adoption of robust monetary policy frameworks and economic growth were to strengthening of global trade and nancial integration. More recently, the disruptions slow, owing, say, to a caused by the global nancial crisis also contributed to the decline in in ation. However, a retreat in globalization continuation of low and stable EMDE in ation is by no means guaranteed. If the wave of and economic structural and policy-related factors that have driven disin ation since the 1970s loses momentum or is rolled back, elevated in ation could re-emerge. If the global in ation liberalization.” cycle turns up, EMDE policymakers may nd that maintaining low in ation can be as a Kenneth Rogo (2003) great a challenge as achieving it. Emerging market and developing economies (EMDEs) • What are the benefits of low inflation for growth and have achieved a remarkable decline in inflation from a development outcomes? peak in the mid-1970s (Ha, Kose, and Ohnsorge 2019).1 Median annual national consumer price inflation in • Can EMDEs sustain the era of low inflation? EMDEs fell from stubbornly persistent double-digits Evolution of EMDE inflation: A remarkable during the 1970s to about 3.5 percent in 2018 (Figure conquest 1.1.1). By 2017, inflation was within or below central bank target ranges in three-quarters of the EMDEs that Disinflation. EMDEs have achieved a remarkable decline had adopted inflation targeting. Inflation has also fallen in inflation since the early 1970s, with median annual around the world, a peak of nearly 17 percent in 1974 to national consumer price inflation down from a peak of less than 2.5 percent in 2018. The decline in inflation 17.3 percent in 1974 to about 3.5 percent in 2018. began in the mid-1980s in advanced economies and in the Disinflation over recent decades has been broad-based mid-1990s in EMDEs. By 2000, global inflation had across regions and country groups.2 For example, stabilized at historically low levels. disinflation occurred across all EMDE regions, including Low and stable inflation has historically been associated those with a history of persistently high inflation, such as with greater output stability, higher growth and better Latin America and Sub-Saharan Africa (Figure 1.1.2).3 development outcomes. EMDEs can continue enjoying Even among low-income countries (LICs), inflation fell by the benefits of low inflation, but only if the confluence of two-thirds between the mid-1970s and 2017, to 5 percent. structural and policy related factors that have fostered EMDE disinflation was set against the backdrop of sharper global disinflation over the past decades is sustained. In the disinflation among advanced economies, where median near term, the global cyclical pressures that have depressed inflation dropped from its highest (15 percent in 1974) to EMDE and global inflation over the past decade appear to its lowest level (0.3 percent in 2015) in more than 60 be fading. This would likely test the resolve of EMDE years. Since then, it has risen somewhat to 1.5 percent in policymakers to prolong the era of low inflation. 2018Q2 but remains below the median inflation target of Against this backdrop, this box addresses the following advanced-economy central banks. After 2008, below-target questions: inflation and, in some cases, deflation became pervasive across advanced economies: for example, in 2015, inflation • How has EMDE inflation evolved? was negative in more than half of advanced economies. • How important is global inflation in explaining Some advanced-economy central banks have struggled to national inflation in EMDEs? 2 Disinflation is a decline in inflation rates, regardless of inflation being Note: This box was prepared by Jongrim Ha, M. Ayhan Kose, and Franziska Ohnsorge. negative (deflation) or positive. 3 However, inflation remains in double-digits in some relatively large 1 The “near-universal” character of the decline in inflation since the mid-1970s was recognized at an early stage by Rogoff (2003). EMDEs, in part reflecting currency depreciations. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 9 BOX 1.1 The great disinflation in emerging market and developing economies (continued) lift inflation back to their inflation targets over the past decade. FIGURE 1.1.1 Global inflation Drivers of low inflation. While the global financial crisis EMDE inflation remains near historic lows despite a recent normalization of inflation in advanced economies. played a major role in pushing inflation down around the Inflation is now consistent with inflation targets or target world over the past decade, the longer-term trend of ranges in the majority of EMDEs. disinflation has been supported by a wide range of structural changes. The most significant of these have been A. Median CPI inflation, by country group the wide-spread adoption of more effective and more transparent monetary, exchange rate, and fiscal policy frameworks as well as globalization.4 • Macroeconomic policies. In the second half of the 1980s and during the 1990s, many EMDEs implemented macroeconomic stabilization programs and structural reforms, and gave their central banks clear mandates to control inflation. The adoption of resilient policy frameworks has facilitated more effective control of inflation (Taylor 2014; Fischer 2015). Twenty-four EMDEs have introduced inflation targeting monetary policy frameworks since the late 1990s and, in the median EMDE, the index of central bank independence and transparency rose more than one-and-a-half-fold between 1990 and B. Share of advanced economies and EMDEs with inflation below or within target range 2014. Inflation tends to be lower in countries that employ an inflation targeting framework and that have more independent and transparent central banks (Ha et al. 2019). Changes in fiscal policy frameworks have also contributed: fiscal rules have been adopted in 88 countries, including 49 EMDEs; and EMDE government debt has fallen considerably from its peak in the early 1990s. Other reforms, including labor market and product market liberalization, and the removal or easing of foreign exchange market controls, also assisted the disinflation process. • Trade and financial integration. Trade integration has contributed to lower prices, as higher shares of imports in consumption and production result in Sources: Bloomberg, Consensus Economics, Haver Analytics, World Bank. A. Median year-on-year consumer price inflation for 29 advanced competitive pressures from foreign producers (Figure economies and 123 EMDEs (including 28 LICs). 1.1.4). Financial integration has helped discipline B. All inflation rates refer to year-on-year inflation. Share of 11 advanced economies and 24 EMDEs with consumer price inflation below-target or macroeconomic policies since more financially within target range. Horizontal line indicates 50 percent. integrated economies are more likely to implement monetary policies targeting low and stable inflation (Kose et al. 2010). In the median EMDE, as in the median advanced economy, the ratio of trade to GDP increased by half between 1970 and 2017, to 75 percent of GDP, and international assets and liabilities tripled (although they remain only half the 4 Other structural changes have also been important (Ha et al. 2019). level of advanced economies). Inflation tends to be For example, technological advances, including the digitalization of lower in economies that are more open to trade and services and automation of manufacturing have also transformed production processes, attenuating inflation pressures. Population aging financial flows (Ha et al. 2019). may also have contributed. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 10 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 1.1 The great disinflation in emerging market and developing economies (continued) FIGURE 1.1.2 Evolution of inflation EMDE inflation has declined in all EMDE regions and low-income countries. In most EMDEs, inflation is now below 5 percent. A. Median CPI inflation, by region B. Inflation in low-income countries C. Distribution of inflation in EMDEs Sources: Haver Analytics, IMF International Financial Statistics and World Economic Outlook databases, OECDstat, World Bank. A. All inflation rates refer to year-on-year inflation. Horizontal lines reflect median inflation across all EMDEs during 1970-97 and 1998-2017. EAP = East Asia and the Pacific, ECA = Eastern Europe and Central Asia, LAC = Latin America and the Caribbean, MNA = Middle East and North Africa, SAR = South Asia, and SSA = Sub- Saharan Africa. B. Solid line shows median year-on-year headline inflation and dotted lines refer to interquartile range, based on 28 LICs. C. Inflation refers to quarter-on-quarter annualized inflation. Sample includes 50 EMDEs. FIGURE 1.1.3 Factors associated with disinflation Inflation tends to be lower in countries that employ an inflation targeting framework and that have more independent and transparent central banks. Lower inflation is also associated with greater trade and financial openness. A. Inflation, by trade and financial B. Inflation, by index of central bank C. Inflation, by monetary policy regime openness independence and transparency Source: World Bank; Ha, Kose, and Ohnsorge (2019). Note: Median headline CPI (consumer price index) inflation of 29 advanced economies and 123 EMDEs. A. Columns indicate median inflation in countries high trade-to-GDP ratios (“Trade”) or financial assets and liabilities relative to GDP (“Finance”) in the top quartile (“high openness”) of 175 economies during 1970-2017. Horizontal bars indicate countries in the bottom quartile (“low openness”). Differences are statistically significant at the 5 percent level. B.C. Columns indicate median inflation in country-year pairs with a central bank independence and transparency index in the top quartile of the sample (B) or with inflation targeting monetary policy regimes (C). Horizontal bars denote medians in the bottom quartile (B) or with monetary policy regimes that are not inflation targeting (C). Differences are statistically significant at the 5 percent level. Global inflation cycle: Getting stronger analyze its importance, a dynamic factor model is estimated for annual consumer price inflation rates in 25 A critical feature of the international inflation experience advanced economies and 74 EMDEs during 1970-2017 of the past five decades has been the emergence of a (Ha et al. 2019). The model includes a common global “global inflation cycle” (Ciccarelli and Mojon 2010). This factor as well as group factors specific to advanced is reflected in a growing contribution of a common global economies and EMDEs. The presence of group factors factor to the variation in country-level inflation rates. To allows the model to account for the large differences in EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 11 BOX 1.1 The great disinflation in emerging market and developing economies (continued) FIGURE 1.1.4 Inflation and macroeconomic outcomes Low and stable inflation has been associated with higher and more stable output growth, and higher investment and savings. Poorer households spend a larger share of their consumption expenditures on food. A. Growth, by inflation level and volatility B. Savings and investment, by inflation C. EMDEs: Share of food consumption, volatility by household income bracket Sources: World Bank; Ha, Kose and Ohnsorge (2019). A. Average real GDP growth from 1980 to 2016 for countries with average inflation (left column and bar) or standard deviation of inflation (right column and bar) in the top quartile and average inflation in the bottom quartile. B. Average savings and investment from 1980 to 2016 for countries with a standard deviation of inflation in the top quartile and standard deviation of inflation in the bottom quartile. C. Based on 100 EMDEs, including 24 low-income countries. country characteristics between advanced economies and to inflation variation was largest for import prices (54 EMDEs. percent in the median country) and smallest for core CPI inflation (5 percent). Between these two extremes, the Global inflation factor. Inflation has become increasingly global factor’s contribution to variation in PPI inflation globally synchronized (Figure 1.1.5). The contribution of was 42 percent and that for GDP deflator growth was 13 the global factor to inflation variation has grown over percent and comparable to that for headline CPI inflation. time: since 2001, it has almost doubled, and now accounts for 22 percent of inflation variation (Ha et al. 2019a). It Low inflation: Good for growth and has explained about one-fifth and one-quarter of EMDE development and advanced economy inflation variation, respectively, since 2001. Over the past four decades, an EMDE-specific Inflation can erode growth, which remains the main factor has also become more prominent. The rising source of poverty reduction, by sapping investor importance of these global and group-specific factors confidence and weakening incentives to save. The damage indicates that inflation synchronization has become more of high inflation often falls disproportionately on the poor, broad-based over time. since poorer households are more reliant than higher- income households on sources of income and forms of Global inflation versus global business cycle. Inflation savings that do not keep pace with inflation. synchronization is sizable by comparison with global business cycle synchronization. The international business Inflation and output growth. Historically, low and stable cycle literature has established the presence of a well- inflation, combined with well-anchored inflation defined global business cycle (Kose, Otrok, and Prasad expectations, has been associated with greater short-term 2012). In the sample used here, the global business cycle, stability of output and employment and higher long-term as captured by a common global factor in output growth, growth. Lower inflation has tended to be accompanied by has accounted for 5 percent of national output growth lower inflation volatility and higher output growth. Lower fluctuations since 1970—less than half the degree of inflation volatility, in turn, has typically been accompanied inflation synchronization. by lower output growth volatility, higher investment, and Tradables versus non-tradables. The role of the global savings (Figure 1.1.4). Several channels account for the factor has been more prominent in price baskets with a beneficial effects of low and stable inflation on economic larger tradables content. The global factor’s contribution activity. These include greater predictability for investors EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 12 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 1.1 The great disinflation in emerging market and developing economies (continued) FIGURE 1.1.5 Inflation synchronization Inflation has become increasingly globally synchronized. The global factor accounted for a greater share of the inflation variance in advanced economies than in EMDEs. The global factor was more important in explaining the variance of price indices with a greater tradable goods and services content. The synchronization of inflation has been stronger than the synchronization of output growth, especially in EMDEs. A. Contribution of global factor to B. Contribution of global factors to C. Contribution of global factors to inflation variation inflation variation, by inflation measure inflation and output growth variation Source: World Bank; Ha, Kose, and Ohnsorge (2019). A.C. The results are based on a two-factor dynamic factor model with inflation (A,C) or output growth (C) using a sample of 99 economies (25 advanced economies and 74 EMDEs) for 1970-2017. The model includes global and group inflation factors. All numbers refer to median variance shares of total inflation (A,C) or output growth (C) variance accounted for by the global factor. C. The global inflation factors are estimated with two-factor dynamic factor models for annual inflation for each measure in 38 countries (25 advanced economies and 13 EMDEs) for the period 1970-2016, the size of the sample being constrained by data availability. “IMP” = import price index, “PPI” = producer price index, “CPI” = headline consumer price index, “DEF” = GDP deflator, and “CORE” = core consumer price index. and households, higher transparency of relative price volatile rate of inflation than wealthier households, due to changes, and improved financial stability (Ha et al. differences in the composition of their consumption 2019a). baskets—for instance, poorer households may be relatively more exposed to food price volatility. Inflation and poverty. While the evidence of a positive correlation between inflation and inequality or poverty is Maintaining low inflation: A greater challenge mixed at the aggregate level, the linkages are more established at the household level (Ha et al. 2019). In The achievement of low inflation cannot be taken for general, the literature suggests higher inflation is associated granted (Rogoff 2014; Draghi 2016; Carstens 2018). Over with mildly lower inequality in countries where inflation is the next decade, both cyclical and structural forces are already low (typically advanced economies), but that high likely to become less disinflationary than they have been inflation is associated with higher inequality in countries over the past five decades. As global economic slack where inflation is already high (typically in EMDEs). The dissipates, inflation could rise globally. Through the evidence also suggests that achieving stable and low strengthening global inflation cycle, this may put upward inflation is associated with better outcomes for poverty, pressure on EMDE inflation. More importantly, structural with the benefits greatest among low-income, high- and policy related factors that have helped lower inflation inflation countries. over the past several decades may lose momentum or be rolled back amid mounting populist sentiment. Poorer households may suffer greater welfare losses from inflation than wealthier households. In general, poorer • Slowing globalization. The rising protectionist households tend to be less able to protect the real value of sentiment of recent years may slow or even reverse the their income and assets from the impact of inflation as pace of globalization. New tariffs and import they are more reliant on wage income, have less access to restrictions have been put in place in advanced interest-bearing and foreign currency-denominated economies and EMDEs since 2017. The possibility of accounts, and are more likely to hold the majority of their further escalation in trade restrictions involving major savings in cash. They may also face a higher or more economies remains elevated. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 13 BOX 1.1 The great disinflation in emerging market and developing economies (continued) FIGURE 1.1.6 Low inflation episodes Global inflation has been low and stable before: during the Bretton Woods fixed exchange rate system in the post-war period up to the early 1970s, and during the gold standard of the early 1900s. A. Global inflation B. Global inflation Source: World Bank; Ha, Kose and Ohnsorge (2019). A. Median of annual average inflation in a sample of 24 economies for which data are available across the full period. B. Cross-country average of annual average inflation. 1900-13 spans the gold standard, and 1944-71 the Bretton Woods system. • Weakening monetary policy frameworks. A shift from also increases the risk of policy errors when the appropriate a strong mandate of inflation control, to objectives response differs depending on the origin of the underlying related to the financing of government, would inflation shock (IMF 2018).5 EMDE central banks may undermine the credibility of monetary policy struggle to contain inflationary pressures and may not frameworks and raise inflation expectations. Among receive adequate support from fiscal policy in stabilizing EMDEs, a decline in central bank independence and the business cycle. For some EMDEs, a significant increase transparency has been associated with significantly less in inflation could set back poverty reduction efforts. well-anchored inflation expectations and greater pass- through of exchange rate movements to inflation. The demise of previous periods of sustained low inflation is a reminder that low EMDE inflation is by no means • Weakening fiscal policy frameworks. Growing guaranteed. Inflation has been low and stable before: populist sentiment could lead to a move away from during the Bretton Woods fixed exchange rate system of rule-based fiscal policies. Fiscal rules can become the post-war period up to 1971 and during the gold ineffective once commitment to them falters standard of the early 1900s (Figure 1.1.6). Yet directly (Wyplosz 2012). Mounting public and private debt in following the low inflation period that ended in the early EMDEs could also weaken commitment to strong 1970s, the sharp increase in oil prices in 1973-74 led to a fiscal and monetary policy frameworks. Government rapid acceleration in global inflation and sharp declines in and/or private sector debt has risen in more than half growth in many countries (Kose and Terrones 2015). of EMDEs since 2012, including in many LICs Global inflationary pressures also led to a significant (World Bank 2018). EMDE sovereign credit ratings increase in domestic inflation in developing economies, have continued to deteriorate, with some falling below including those that experienced relatively low and stable investment grade, reflecting concerns about rising inflation in the late 1960s and early 1970s (Cline 1981). All three episodes of sustained low inflation are debt and deteriorating growth prospects. characterized by inflation below 5 percent for an extended If unwanted inflation makes a comeback, policy period. It is notable, however, that the two earlier episodes frameworks may be tested in EMDEs: their inflation expectations are less well-anchored, and the absence of 5 Major advanced-economy central banks have also strong monetary policy frameworks in many of these economies means that inflation is sensitive to exchange acknowledged the need to consider the global environment in setting monetary policy in light of the highly synchronized nature rate movements (Kose et al. 2019; Ha, Stocker and of global inflation (Bernanke 2007; Draghi 2015; Carney 2015). Yilmazkuday 2019). Growing inflation synchronization EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 14 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 1.1 The great disinflation in emerging market and developing economies (continued) were followed by sharply rising inflation. This illustrates characteristics. However, the observations here imply that that maintaining low inflation can be as great a challenge low inflation in EMDEs in the past is no guarantee of low as achieving low inflation. inflation in the future. EMDE policymakers need to recognize the increasing role of the global inflation cycle in These observations do not constitute a blanket driving domestic inflation. Options to help insulate endorsement for the deployment of tighter monetary economies from the impact of global shocks include policy in EMDEs to get ahead of potential inflationary strengthening institutions, including central bank pressures. The stance of monetary policy depends on, independence, and establishing fiscal frameworks that can among other factors, the cyclical position of an economy, both assure long-run debt sustainability and provide room financial stability considerations, and country-specific for effective counter-cyclical policies. FIGURE 1.4 United States mostly from China; other countries have retaliated with tariffs on about $150 billion worth of U.S. The U.S. economy is experiencing robust growth, with strength in investment. There are signs that productivity and labor participation are exports. In all, new tariffs have been imposed on increasing. While nominal wages are rising, they have been matched by about 12 percent of U.S. goods imports and may rising inflation, resulting in stagnant real wages so far. Fiscal and monetary policies will stimulate activity in the near term but are likely to become a expand further, resulting in higher prices and drag by 2020. elevated policy uncertainty (Lindé and Pescatori 2017; Kutlina-Dimitrova and Lakatos 2017). A. Domestic demand and investment B. Additions to labor force and growth productivity growth During the forecast horizon, growth is expected to decelerate as monetary policy continues to tighten, and as fiscal stimulus fades and subsequently begins to drag on growth. Higher trade tariffs are expected to further weigh on activity, especially exports and investment. In all, U.S. growth is projected to slow to 2.5 percent in 2019 and to an average of 1.7 in 2020-21—roughly consistent with potential. C. Real and nominal wage growth D. Stance of fiscal and monetary policy Euro Area Euro Area growth slowed notably in 2018 to an estimated 1.9 percent, 0.2 percentage point below previous projections. In particular, net exports have softened, reflecting the earlier appreciation of the euro and slowing external demand (Figure 1.5). While unemployment has declined, inflation Sources: Bureau of Economic Analysis; Bureau of Labor Statistics; Federal Reserve Bank of St. Louis; Haver Analytics; Holston, Laubach, and Williams (2016); International Monetary Fund; World remains stubbornly low. Headline inflation has Bank. A. Investment is measured using gross fixed capital formation. Total domestic demand is GDP less risen to target, but largely due to a temporary net exports of goods and services. Last observation is 2018Q3. acceleration in energy prices. Core inflation is still B. Last observation is October 2018 for labor force data and 2018Q3 for productivity. C. Wage growth is the average hourly earnings of private, non-farm production, and nonsupervisory only about 1 percent, while long-term inflation employees. Last observation is October 2018. D. Policy rate is the mid-range of the federal funds target rates. Forecast for the policy rate and expectations continue to hover around 1.7 inflation are market expectations. The neutral rate is the nominal short-term interest rate consistent percent, as in the past three years. The European with the economy operating at its full potential once transitory shocks have abated, and is estimated according to Holston, Laubach, and Williams (2016). The neutral rate is assumed to remain Central Bank stopped adding to its balance sheet unchanged at its latest value (September 21, 2018) until 2020. Shaded area indicates forecasts. in 2018, although it is expected to maintain its negative interest rate policy until at least mid- EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 15 2019. Financial system lending and profitability FIGURE 1.5 Euro Area have continued to increase, though some A slowdown in exports has been the primary driver of cooling Euro Area European banks may be exposed to financial stress activity. While headline inflation has risen to target, it is largely due to a in some EMDEs. temporary acceleration in energy prices. Across the Euro Area, the stance of fiscal policy is A. Export contribution to growth B. Inflation expected to be mildly expansionary, primarily because of increased German expenditures leading to smaller surpluses. Disagreements between the European authorities and the Italian government about its draft budget and resulting deficits have pushed up yields on Italy’s government debt. In all, Euro Area growth is projected to further decelerate toward potential over the forecast horizon, to 1.6 percent in 2019 and an average of Sources: Bloomberg, European Central Bank (ECB), Eurostat, Haver Analytics, World Bank. A. Last observation is 2018Q3 for GDP growth and 2018Q2 for exports. 1.4 percent in 2020-21, as monetary stimulus is B. Inflation expectations are derived from 5-year over 5-year forward inflation-linked swap rates, withdrawn and global trade growth moderates. averaged over the quarter. Horizontal line represents 1.9 percent, consistent with the ECB's inflation target of close to, but below, 2 percent. Last observation is October 2018. Japan FIGURE 1.6 Japan Japanese growth slowed to an estimated 0.9 percent in 2018, reflecting contractions in the first The economy is still growing above potential, as solid growth in employment offsets subdued productivity. The Bank of Japan is providing and third quarters due to bad weather and natural exceptionally supportive monetary policy by keeping long-term rates near disasters. Nevertheless, the labor market has been zero and expanding its balance sheet, while the fiscal deficit is narrowing. robust, with the unemployment rate at 2.3 percent, rising earnings, and the participation rate A. Employment and productivity B. Gross government debt and long- standing at 79 percent—up more than a growth term bond yields percentage point since the beginning of last year. Rising labor force inputs, however, have been offset by weak productivity (Figure 1.6). The Bank of Japan continues to provide stimulus by keeping long-term rates near zero and adding to its balance sheet. It now holds about 40 percent of government debt. The government continues to run a primary deficit, which is expected to Sources: Bank of Japan (BoJ); Cabinet Office of Japan; Haver Analytics; Japan Ministry of Finance; Japan Ministry of Health, Labor, and Welfare. gradually narrow over the projection horizon. A. Last observation is 2018Q3. B. Bond yield is the quarterly average. Yellow horizontal line indicates the origin x-axis line Growth is expected to remain at 0.9 percent in corresponding to the right-hand scale (RHS). Last observation is 2018Q3. 2019, as recovery from last year’s temporary disruptions is offset by fiscal consolidation and a slowdown in employment growth. The planned infrastructure and other state spending. However, hike in the VAT rate is forecast to reduce growth industrial production and export growth have to 0.5 percent in 2020, followed by a rebound to decelerated, reflecting easing global manufacturing 0.7 percent in 2021. activity. Import growth continued to outpace export growth, contributing to a shrinking current China account surplus. Net capital outflows have Growth is estimated to have slowed to a still resumed, and international reserves have been robust 6.5 percent in 2018, supported by resilient edging down. Stock prices and the renminbi have consumption (Figure 1.7). A rebound in private been experiencing continued downward pressures, fixed investment helped offset a decline in public and sovereign bond spreads have risen in a context EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 16 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.7 China Tier 1 cities following several years of correction. Consumer price inflation has moved up since mid- Growth in China remains robust, in part reflecting resilient consumption. However, industrial production and new export orders have moderated, 2018 partly reflecting currency depreciation and asset prices have experienced downward pressures, and sovereign bond higher energy and food prices in most of last year, spreads have risen amid trade tensions. Prices of newly constructed residential buildings have rebounded, including in Tier 1 cities following but it is still below target. several years of correction. Growth is projected to decelerate to 6.2 percent in 2019, slightly below previous projections as a A. Contribution to GDP growth B. Industrial production and new export orders result of weaker exports, and to further moderate to 6 percent by the end of the forecast horizon, broadly in line with its potential pace. Domestic demand is projected to remain robust aided by policies to boost consumption. Supportive fiscal and monetary policies undertaken so far are expected to largely offset the negative impact of higher tariffs; however, additional stimulus may have the undesirable effect of slowing the deleveraging and de-risking process (World Bank C. Bond spreads and equity prices D. Housing price growth 2018a). Global trends In 2018, global trade slowed more rapidly than expected alongside softening industrial activity. Trade policy uncertainty remains elevated, dampening global investment and trade. Borrowing costs have generally tightened in EMDEs following a broad- Sources: National Bureau of Statistics of China, Haver Analytics, J.P. Morgan, World Bank. based appreciation of the U.S. dollar, bouts of A. Investment refers to gross capital formation, which includes the change in inventories. investor risk aversion, and increased focus on Consumption refers to total consumption, which includes public consumption and private consumption. Data for 2018 are estimates. country-specific vulnerabilities. External financing B. New export orders measured by Purchasing Managers’ Index (PMI). PMI readings above 50 indicate expansion in economic activity; readings below 50 indicate contraction. Last observation is conditions are expected to continue deteriorating in October 2018. C. Bond spread measures the average spread of China’s sovereign debt (as measured by J.P. 2019, as monetary policy accommodation in Morgan’s Emerging Market Bond Index) over its equivalent maturity U.S. Treasury bond. Equity index advanced economies is unwound. Oil prices were is the Shanghai Stock Exchange (SSE) Composite. Last observation is November 27, 2018. D. Prices of newly constructed residential buildings. The National Bureau of Statistics of China markedly volatile in the second half of 2018, mainly surveys house prices in 70 cities and divides them into three tiers. The first tier includes Shanghai, Beijing, Guangzhou, and Shenzhen. The second tier includes 31 provincial capital and sub-provincial due to supply factors, and most other com- capital cities. The third tier includes 35 other cities. The green bars are the January 2010 to October 2018 average. Data for 2017 reflect the average of monthly growth rates. modity prices—particularly metals—weakened on heightened trade tensions. Global trade of ongoing trade tensions and concerns about the growth outlook. Following strong momentum in 2017, global goods trade growth markedly slowed during the New regulations on commercial bank exposures to first half of 2018 and has only partially recovered shadow financing, together with stricter provisions since then. The deceleration was more for off-budget borrowing by local governments, pronounced than previously expected, as reflected have slowed credit growth to the non-financial in decelerating export orders and global sector. However, in mid-2018 the State Council manufacturing activity (Figure 1.8). reiterated its intention to pursue looser macroeconomic policies to counter the potential In particular, global capital goods production, economic impact of trade disputes with the which is highly trade-intensive, has slowed notably United States. Prices of newly constructed in Europe and developing Asia, two tightly residential buildings have rebounded, including in interconnected global manufacturing hubs EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 17 (Raschen and Rehbock 2016). Nearly a third of FIGURE 1.8 Global trade European exports and more than half of German Global goods trade and industrial activity decelerated in 2018 amid trade exports to developing Asia are of machinery and tensions between major economies. A projected moderation of investment vehicles, while capital goods and electronics growth in China and major advanced economies is expected to lead to slower trade growth in coming years. Technological changes could account for a third of exports from developing continue to increase the share of services trade. Asia to Europe. A. Global industrial production and B. Capital goods production, G20 The softening of global goods trade comes against new export orders the backdrop of ongoing trade tensions involving major economies. New tariffs introduced since the beginning of last year have affected about 12 percent of U.S. goods imports, 6.5 percent of China’s goods imports, and about 2.5 percent of global goods trade. In the United States, tariff increases were implemented citing national security concerns and unfair trade practices. Import restrictions and tariff increases were also C. Share of goods imports affected by D. Global trade growth, volumes put in place in some EMDEs, as retaliatory actions new tariffs, 2018 or as measures aimed at reducing current account vulnerabilities in the face of intensifying capital outflow pressures (e.g. Arab Republic of Egypt, Kazakhstan, India, Indonesia, Islamic Republic of Iran, Pakistan, Sri Lanka, Turkey). Combined with the rising prevalence of temporary trade barriers (such as anti-dumping and countervailing duties and safeguards), recent protectionist measures have disproportionately E. Import demand growth, volumes F. Global services trade, shares affected trade in parts and components, with negative repercussions for international value chains (Bown 2018; Baldwin 2018; Johnson and Noguera 2017). Increased tariffs on certain goods, including on U.S. steel imports, is associated with an especially large negative effect on producers in poorer and smaller EMDEs (Bown, Jung, and Zhang 2018). In contrast, some EMDEs may be benefiting in the short term from trade diversion, Sources: Haver Analytics, World Bank, World Trade Organization (WTO). A. New export orders measured by Purchasing Managers’ Index (PMI). PMI readings above 50 as rising tariffs increase the cost of targeted goods indicate expansion in economic activity; readings below 50 indicate contraction. Last observation is in the United States and China. October 2018 for new export orders and September 2018 for industrial production. B. Industrial production indexes for capital goods weighted by gross value added at constant 2010 U.S. dollars. Sample includes G20 countries. Last observation is September 2018. The temporary pause in tariff hikes agreed by the C. Value of tariffs implemented as of November 7, 2018, as a share of total imports. D.E. Shaded areas indicate forecasts. Aggregate growth rates calculated using constant 2010 U.S. United States and China during the G20 meeting dollar GDP weights. Trade measured as the average of export and import volumes. in early December 2018, the successful F. Trade measured as the average of export and import values. Trade and GDP measured in current U.S. dollars. Data are 4-quarter moving averages. Last observation is 2018Q2. negotiations of the new United States-Mexico- Canada Agreement, and of the draft withdrawal treaty mapping the United Kingdom’s exit from the European Union (EU) have somewhat to invest, export, and engage in international value tempered trade policy uncertainties. However, the chains, with negative effects on the global trade possibility of escalating trade restrictions involving outlook (Osnago, Piermartini, and Rocha 2018; major economies remains elevated. This Feng, Li, and Swenson 2017; Handley and Limão uncertainty is likely to weigh on firms’ willingness 2015). In addition, rising interest rates in EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 18 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.9 Global finance advanced economies and economic rebalancing in China is expected to contribute to slower global An increase in U.S. long-term yields and a strengthening U.S. dollar have contributed to tighter external financing conditions for EMDEs. Capital investment and trade growth, with the latter outflows and currency pressures have intensified, disproportionately projected to decelerate from 3.8 percent last year affecting countries with current account deficits financed by volatile capital flows. Bond issuances slowed markedly in some regions, as yields on to 3.4 percent by the end of the forecast horizon foreign-denominated debt increased at their fastest pace since 2013. (Ahuja and Nabar 2012; Kose et al. 2017a). Global trade is still projected to grow somewhat A. Largest annual changes in U.S. B. U.S. dollar exchange rate and faster than global GDP, but at a much weaker bond yields since 2000 interest rate differential with the Euro Area pace than previously envisaged, reflecting a deterioration in growth prospects in several large EMDEs and in the Euro Area, as well as trade policy uncertainties. Structural factors continue to weigh on the medium-term outlook for global trade, including maturing international value chains (Constantinescu et al. 2018; ECB 2016; Hoekman 2015). However, technological change C. EMDE portfolio flows during recent D. Currency movements since April and progress in liberalization efforts under the stress episodes 2018, by current account balance ex. Trade in Services Agreement (TiSA) should FDI continue to increase the relative importance of services in global trade flows (Lodefalk 2014; Miroudot and Cadestin 2017). Financial markets Borrowing costs in advanced economies crept up during 2018, as inflation moved closer to central bank targets and monetary policy accommodation continued to be withdrawn. U.S. long-term yields E. EMDE new bond issuance, by F. Largest annual changes in EMDE reached 3.2 percent during the second half of region bond yields since 2000 2018—their highest level since mid-2011, up about 80 basis point from the start of the year, and the third largest increase since 2000 (Figure 1.9). Notwithstanding a scaling back of central bank asset purchases in the Euro Area and Japan, negative interest rate policies in these economies have continued to keep a lid on global bond yields, with nearly $8 trillion of outstanding debt still trading at negative interest rates (16 percent of Sources: Bank for International Settlements, Bloomberg, Dealogic, Haver Analytics, Institute of International Finance, International Monetary Fund, J.P. Morgan, World Bank. all bonds). A search for higher-yielding safe assets A. U.S. bond yields are the annual percentage-point difference in 10-year U.S. Treasury bonds. Last observation is November 29, 2018. continued to support strong demand for long- B. Trade-weighted exchange rate is the J.P. Morgan nominal effective exchange rate index. Interest rate spread is the yield spread between 5-year U.S. Treasury bonds and 5-year German government term U.S. Treasuries, further compressing the bonds. Last observation is November 29, 2018. U.S. yield curve despite rising inflation and B.C. The start dates for the stress episodes are: Taper Tantrum: May 23, 2013; China concerns: June 12, 2015; Latest episode: April 15, 2018. ballooning U.S. government deficits driven by C. Cumulative flows to major EMDEs, excluding China, for the 230 days following the start of the stress episode. Last observation is November 29, 2018. fiscal stimulus measures. Global equity markets D. FDI = foreign direct investment. Figure shows the median of cumulative changes in exchange dropped in the final quarter of 2018, reflecting rates since April 15, 2018. Orange lines indicate interquartile ranges. Last observation is November 29, 2018. concerns about softening growth prospects, rising E. EAP = East Asia and Pacific, ECA = Europe and Central Asia, LAC = Latin America and the Caribbean, MNA = Middle East and North Africa, SAR = South Asia, and SSA = Sub-Saharan Africa. borrowing costs, and trade tensions. Figure shows the total new bond issuance from January to November for each year. Last observation is November 2018. F. EMDE bond yields are calculated as the sum of the J.P. Morgan Emerging Market Bond Index Divergent monetary policy among major (EMBI) spread and the 10-year U.S. Treasury yield. Last observation is November 29, 2018. economies also contributed to a significant EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 19 appreciation of the U.S. dollar in 2018. This, In contrast to the slowdown in portfolio and bank together with increased investor risk aversion and flows, foreign direct investment (FDI) into renewed attention to external vulnerabilities EMDE is estimated to have increased modestly in contributed to significant depreciations and capital 2018, driven mainly by a rebound in flows to outflows in many EMDEs. Since the U.S. dollar China. Outward FDI from China remained started strengthening in April 2018, EMDE robust, boosted by the Belt and Road initiative. currencies fell by an average of about 11 percent— the most significant episode of sustained Looking forward, global interest rates are likely to depreciation over the past five years. Cumulative rise at a slightly slower pace than previously portfolio outflows from EMDEs also surpassed expected, reflecting increased headwinds to global those seen after the 2013 Taper Tantrum, growth. Nevertheless, external financing reflecting a broad-based sell-off in both equity and conditions are expected to tighten further in bond funds. EMDEs, and capital flows to moderate, particularly among more vulnerable economies. While financial market stress was most Commodities pronounced in Turkey and Argentina, many other EMDEs also suffered from deteriorating market Energy prices fluctuated markedly in the second sentiment. Countries with current account deficits half of 2018, mainly reflecting supply factors, and financed by volatile capital flows, as well as prices of most metals and, to a lesser extent, countries with high short-term external debt, were agricultural commodities weakened largely due to most severely impacted, pointing to heightened concerns about the effects of tariffs on global investor focus on external vulnerabilities. Elevated growth and trade. Prices of the three commodity domestic debt, above-target inflation, and groups are expected to generally stabilize in 2019 idiosyncratic factors such as policy uncertainty (Figure 1.10). played a role as well. As in previous episodes, EMDEs with more liquid currency and equity Oil prices averaged $69 per barrel (bbl) in 2018, a markets were disproportionately affected by touch lower than June forecasts but about 32 shifting market sentiment and contagion effects percent higher than in 2017. While robust global (Ahmed, Coulibaly, and Zlate 2015; Eichengreen oil consumption contributed to this increase, and Gupta 2014). supply-side factors were the main drivers of price movements through the year. Continuing declines Bond issuance has slowed markedly since mid- in production in Venezuela and market concern 2018, particularly in Latin America and the about the impact of U.S. sanctions on Iran Caribbean and Eastern Europe and Central Asia, contributed to rising Brent crude oil prices, which amid worsening external financing conditions. peaked at $86/bbl in early October. However, EMDE sovereign credit ratings have continued to prices fell sharply in November after the United deteriorate, with some falling below investment States announced temporary waivers to the grade, reflecting concerns about rising debt and sanctions on Iran for eight countries, including deteriorating growth prospects. Yields on foreign- China and India. The decline in prices also currency-denominated debt rose by 150 basis reflected continued rapid growth in oil production points in 2018—among the three largest increases in the United States, as well as a substantial over the last two decades. Demand for cross- increase in supply by the Organization of the border bank loans has also weakened, with the Petroleum Exporting Countries (OPEC) and the appreciation of the U.S. dollar putting upward Russian Federation. pressure on dollar funding costs. Various EMDE central banks have responded to currency and Oil prices are expected to remain at $69/bbl in capital outflow pressures with interest rate hikes, 2019 and 2020, unchanged from June projections, leading to tighter domestic borrowing conditions but uncertainty around the forecast is high. While and, in some cases, slower credit and domestic growth in oil demand is expected to remain robust demand growth. in 2019, the expected loss in momentum across EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 20 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.10 Commodity markets uncertainty remains about the full impact of Commodity prices are expected to generally stabilize in 2019, following Iranian sanctions once temporary waivers end, as sharp movements last year. Crude oil prices fluctuated in the second half well as the outlook for Venezuelan production. In of 2018 mainly due to supply factors. Trade tensions between the United contrast, increased supply from the United States States and China, including the imposition of tariffs on a range of products, has had varying effects on metal and agricultural commodities. In is expected to help meet the anticipated rise in particular, the impact has depended on whether tariffs were broad-based global demand, with capacity constraints likely to or commodity specific, such as in the case of steel and soybeans. ease in 2019 as new pipeline capacity comes onstream. A. Commodity price forecasts, B. Crude oil prices, nominal nominal Metals prices rose 6 percent on average, in 2018, less than previously expected. After a substantial increase in the first half of last year, prices fell sharply in the second half following the imposition of broad-based tariffs by the United States on China’s imports (World Bank 2018b). Heightened trade tensions involving these economies have raised market concerns about global trade and investment prospects; as a result, C. Change in oil supply in major D. Metals price indexes, nominal they have clouded the outlook for demand for oil-producing countries commodities. Industrial metals have been particularly responsive to these concerns given their many uses in the manufacture of tradable goods, with some metals such as nickel falling more than 20 percent. In contrast, the price of steel and aluminum in the United States rose following the announcement of specific tariffs on imports of those metals from a wide range of countries. U.S. steel prices have increased by E. Benchmark steel price indexes, F. Soybean spot prices around 25 percent more than UK steel prices since nominal the start of 2018. Metals prices are expected to stabilize in 2019 and 2020. While agricultural prices were roughly flat in 2018 as a whole, they declined appreciably in the second half of the year, with developments varying by commodity. Soybean prices in the United States fell substantially following the announcement of tariffs by China on imports of U.S. soybeans, Sources: Bloomberg, International Energy Agency, United States Department of Agriculture, World while prices rose in other countries, particularly in Bank. A. Nominal price indexes. Shaded area indicates forecast. Brazil. The imposition of tariffs has led to trade B. Last observation is November 29, 2018. diversion, with China’s imports of soybeans from C. Chart shows the change in oil production of five major oil-producing countries from January 2018 to October 2018. Blue bars indicate total oil production in January and October. Red bars indicate a the United States 25 percent lower in 2018 decline in a country's production over the period, and green bars indicate an increase in production. D.E. Indexes are based on nominal U.S. dollars. Last observation is November 29, 2018. relative to 2017, while those from Brazil have risen F. Last observation is November 29, 2018. 22 percent. In contrast, wheat prices were slightly higher as bad weather in Europe led to smaller harvests. Estimates for the 2018-19 crop forecast EMDEs could have a greater impact on oil have been revised up for most commodities, and demand than expected. The outlook for supply is high stock-to-use ratios for rice and wheat reduce unclear and depends to a large extent on the likelihood of a food price spike. In all, production decisions by OPEC and key non- agricultural prices are projected to remain broadly OPEC producers, chiefly Russia. Considerable stable in 2019 and 2020. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 21 FIGURE 1.11 Activity in EMDEs Emerging market and developing economies: EMDE activity has stalled, in part reflecting the effect of financial stress in some large economies with sizable current account deficits and high Recent developments exposure to volatile capital flows. Domestic demand across EMDEs has moderated, and trade flows have softened. High-frequency indicators and outlook suggest that the weakness continues, particularly in more vulnerable economies. EMDE growth is expected to stall at 4.2 percent in A. Growth B. Contribution to GDP growth 2019, markedly below previous expectations. The forecast reflects the lingering effects of recent financial market pressure in some large economies, with a substantially weaker-than-expected pickup in commodity exporters accompanied by a deceleration in commodity importers. Growth is projected to plateau at 4.6 percent toward the end of the forecast horizon, as the recovery in commodity exporters levels off. In about 35 percent of EMDEs, per capita growth will be too low to avoid widening income C. Import growth, volumes D. Manufacturing PMIs gaps with advanced economies. Recent developments The recovery in EMDE activity has stagnated. Aggregate growth in EMDEs edged down to an estimated 4.2 percent in 2018—0.3 percentage point below previous projections—against the backdrop of a substantial strengthening of the U.S. dollar, weakening capital flows, heightened Sources: Haver Analytics, International Monetary Fund, Organisation for Economic Co-operation and trade tensions, and moderating global Development, World Bank. A.-C. Aggregate growth rates calculated using constant 2010 U.S. dollar GDP weights. Data for 2018 manufacturing and trade. This more challenging are estimates. Data for 2015-16 are simple averages. international environment was accompanied by A.-D. High CA def. ex. FDI = high current account deficit excluding foreign direct investment, which refers to countries with zero or negative values of current account balances net of foreign direct renewed market attention to country-specific investment. Others refers to countries with positive values of current account balances net of foreign direct investment. vulnerabilities and financial stress in some large A. Yellow diamonds correspond with the June 2018 edition of the Global Economic Prospects report. economies with persistent macroeconomic B. Domestic demand includes government consumption, private consumption, and gross capital formation, which includes the change in inventories. Net exports are calculated as the volume of fragilities—most notably, Argentina and Turkey. exports minus imports. C. Figure shows imports of goods and services. More generally, the weakness in activity was most D. Figure shows average Purchasing Managers’ Index (PMI) for manufacturing output for country groups. Readings above 50 indicate expansion in economic activity; readings below 50 indicate pronounced in EMDEs that suffered financial contraction. Last observation is October 2018. market pressures in a context of elevated current account deficits and high exposure to portfolio and bank inflows (Figure 1.11). Many of these softened, partly due to sharp currency economies faced sizable currency depreciation, depreciations in some large economies, while equity market declines, or foreign reserve losses export growth has also moderated, reflecting (e.g., Angola, Argentina, Turkey, South Africa). weaker external demand—notably, moderating Domestic demand across EMDEs has moderated, global investment. Recent high-frequency reflecting tighter domestic borrowing conditions, indicators confirm the weakening momentum softer confidence, and policy tightening in some among EMDEs. For example, manufacturing large economies to ward off domestic price and Purchasing Managers’ Indexes for EMDEs have capital outflow pressures. A rebound in EMDE moderated, mainly reflecting substantially weaker gross capital formation that began in 2015 has activity in countries that have sizable current slowed, and investor sentiment has deteriorated. account deficits and rely heavily on portfolio and On the external front, import growth has bank flows. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 22 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 Commodity-exporting EMDEs Arab Emirates). Recoveries have also continued, to varying degrees, in several large energy exporters The pace of recovery in commodity exporters has where significant adjustments were introduced in weakened significantly, and activity across the response to the 2014-16 oil price plunge (e.g., group has become more heterogenous. Investor Azerbaijan, Colombia, Saudi Arabia; World Bank confidence has generally worsened, especially 2018c, 2018d). Despite recent declines in toward economies with external vulnerabilities and industrial metals prices, growth among some large fragile domestic conditions (e.g., Argentina, metals exporters has continued to show resilience Angola, Nigeria, South Africa). Recent declines in (e.g., Chile, Mongolia, Peru). In addition, activity oil and other commodity prices have posited in a number of countries has been supported by additional headwinds to activity. infrastructure spending and foreign direct Long-standing challenges in several large investment flows (e.g., Benin, Burkina Faso, Côte economies have resurfaced. In a number of d’Ivoire, Ethiopia, Kenya, Lao People’s countries, capital flows have softened, and asset Democratic Republic, Morocco, Senegal, Uganda; prices and currencies have come under significant World Bank 2018e). pressure, amid weaker global trade, rising trade Commodity-importing EMDEs restrictions, and renewed investor attention to country-specific factors including sizable current Growth in commodity importers has decelerated, account and fiscal deficits and elevated debt. As a reflecting capacity constraints, moderating export consequence, the rebound in domestic demand growth, and deteriorated conditions in some large has slowed and the recovery in investment has economies with elevated vulnerabilities and stalled (e.g., Argentina, Brazil, Iran, South Africa). heightened policy uncertainty. Inflation has Private consumption growth has also cooled generally moved up, partly in response to higher following several years of continued recovery, energy prices in most of 2018 and closed or partly reflecting the dampening impact of rising positive output gaps. Price pressures, widening inflation and tighter lending conditions. fiscal and current account deficits, or in some cases currency and financial market volatility have Among the largest commodity exporters, growth prompted a shift to less accommodative monetary in Argentina plummeted following acute financial policy in some countries in this group (e.g., India, market stress that resulted in sharp currency Mexico, Pakistan, the Philippines, Romania). depreciation and monetary policy tightening. In South Africa, activity contracted in the first half of The moderation in activity is most evident among 2018 and remains subdued, reflecting challenges commodity importers with increasing capacity in mining production, a sharp fall in agricultural constraint, rising inflation, high current account production, and policy uncertainty. Growth in deficits, or sizable public debt. The slowdown in Brazil was lackluster in 2018, reflecting a truckers’ Turkey—which faced a substantial deterioration strike mid-year and heightened policy uncertainty. in foreign investor confidence—has been In Russia, although growth has been resilient especially severe. Activity is also slowing, and supported by private consumption, momentum financial conditions have tightened, in a number has slowed reflecting policy uncertainty, recent oil of other commodity importers that have price declines, and renewed pressures on currency experienced financial market stress of continue to and asset prices. Output has contracted in a face widening fiscal and current account deficits number of other commodity exporters that suffer (e.g., Pakistan, the Philippines, Romania). from social tensions or security issues (e.g., Equatorial Guinea, Nicaragua), as well as other Slowing Euro Area growth has diminished the idiosyncratic factors (e.g., sanctions in Iran). positive trade and financial spillovers that had previously supported activity in several countries In contrast, activity has firmed further in several in Europe and Central Asia (e.g., Bulgaria, oil-exporting economies where oil production Croatia, Montenegro). However, in some rebounded in 2018 (e.g., Iraq, Kuwait, United economies, moderate inflation and low interest EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 23 rates have continued to push growth toward or previous projections. This reflects the lingering above trend (e.g., Hungary, Poland, Serbia). effects of recent financial market stress on several Growth in Mexico remains moderate, partly large economies, a lackluster and notably softer- owing to tighter financing conditions and than-envisioned cyclical recovery in commodity domestic policy-related uncertainty. exporters, and a further deceleration in commodity importers (Figure 1.12). Growth Although activity continues to be generally more across EMDEs in 2019 is expected to be close to solid in Asia, external headwinds have increased. the upper bound of estimates of its potential In India, growth has accelerated, driven by an pace—particularly among the commodity upswing in consumption, and investment growth importers, where slack has been exhausted. has firmed as the effects of temporary factors wane. However, rising interest rates and currency Growth in EMDEs is foreseen to reach an average volatility are weighing on activity (World Bank of 4.6 percent in 2020-21, as the recovery in 2018f). Other Asian economies (e.g., Bhutan, commodity exporters matures. Throughout the Cambodia, Vietnam) continue to benefit from forecast horizon, the international context is pan-Asian infrastructure investment projects, expected to be increasingly less favorable, in light including the China-led Belt and Road initiative of a projected slowdown in advanced-economy (World Bank 2018a). growth, weakening trade and investment, tighter financing conditions, trade policy uncertainty, and Low-income countries reduced appetite for EMDE assets. These factors Economic activity has continued to strengthen in will impede further acceleration in EMDE activity. most low-income countries (LICs; Box 1.2). Increased agricultural production in the wake of Growth in commodity exporters is projected to easing drought conditions is supporting robust pick up to 2.3 percent in 2019—sharply below growth in several non-resource-intensive countries previous expectations—and plateau at 2.9 percent (e.g., Rwanda, Uganda), as well as infrastructure in both 2020 and 2021. Some large economies investment related to reforms (e.g., Benin, that experienced sizable contractions in activity in Senegal). Among exporters of industrial 2018 are expected to gradually recover over the commodities, growth performances have varied. forecast horizon (e.g., Angola, Argentina, Iran). Chad emerged from two years of recession partly The outlook for commodity exporters is uneven, due to the recovery in oil prices from their 2016 however, owing to divergences in commodity trough, as well as increased oil production. price movements and renewed market attention to However, for metal exporters, growth was more country-specific vulnerabilities. subdued, reflecting weaker metals prices and external demand. Lower export growth, combined Projections for many commodity exporters have with higher fuel-related imports, has caused been downgraded. Downward revisions reflect, to current account deficits to widen in many LICs. varying degrees, more adverse financial conditions In addition, the less favorable external and the resulting policy adjustment, softening environment is making the financing of these confidence, lingering effects of strikes and political deficits more challenging. Moreover, government uncertainty, and softer metals prices and mining debt has continued to rise, as fiscal deficits remain bottlenecks. These downward revisions are also elevated due to commodity-related declines in reflected in forecasts for EMDE regions with a revenue, as well as governance challenges in some substantial number of commodity exporters (Box countries (Chapter 4). 1.3; Chapter 2). EMDE Outlook Growth in commodity importers is expected to moderate to 5.5 percent in 2019—broadly in line Growth outlook with its potential rate—and remain steady at 5.6 percent in both 2020 and 2021. A structural EMDE growth is expected to stall at 4.2 percent in 2019—down 0.5 percentage point relative to slowdown in China is expected to be partly offset by a moderate pickup in other large economies in EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 24 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 1.2 Low-income countries: Recent developments and outlook Growth in low-income countries increased only slightly in 2018, to 5.7 percent, but is expected to rise to 5.9 percent in 2019 and average about 6.3 in 2020-21. Oil producers are benefitting from higher oil prices and output, while softer metals prices are weighing on growth in the metals exporters. Higher agricultural production and continued infrastructure spending has supported growth in non-resource-intensive countries. However, progress on poverty reduction across all low-income countries will remain slow. Downside risks to the outlook include the possibility that commodity prices will soften as a result of trade disputes, that global financing conditions will tighten abruptly, that fiscal policies will slip, or that extreme weather-related or health crises will emerge. Recent developments The financing of current account deficits has become more challenging amid a less supportive external environment, Economic growth is gradually improving in most low- as foreign direct investment (FDI) inflows slowed in income countries (LICs), even though the external almost 40 percent of countries (e.g., Mozambique, environment is becoming less favorable (Figure 1.2.1). Tanzania, Zimbabwe; UNCTAD 2018). FDI inflows, in Robust growth in several non-resource-intensive countries particular to LICs, are more vulnerable to fluctuations in has been supported by agricultural production (e.g., international financial conditions (Burger and Rwanda, Uganda) and services (e.g., Nepal, Uganda) on Ianchovichina 2017). However, in some countries, the production side, and household consumption (e.g., reduced political uncertainty and improved investor Togo) and public investment (e.g., Benin, Burkina Faso, sentiment have supported stronger FDI inflows (e.g., The Gambia, Nepal, Tajikistan) on the demand side. In Benin, The Gambia). In addition, remittance flows have LICs in the West African Economic and Monetary Union recovered in several countries as growth in selected (WEAMU), growth exceeded 6 percent in Benin, Burkina advanced economies improved in recent years (e.g., Benin, Faso, and Senegal. Among exporters of industrial Guinea-Bissau, Haiti; World Bank 2018a). Nevertheless, commodities, Chad emerged from two years of recession for many LICs, the accumulation of sufficient partly due to the recovery in oil prices from their 2016 international reserves remains difficult, leaving them below trough, as well as increased oil production. However, the the three-months-of imports benchmark and highly growth performance of metals exporters was more vulnerable to negative shocks. subdued, reflecting weaker metals prices and external demand, as well as mine closures (e.g., Sierra Leone), and Fiscal deficits generally widened among the LICs, with the heightened political uncertainty (e.g., Democratic median deficit increasing from 3.3 percent of GDP in Republic of Congo). 2017 to an estimated 3.6 percent in 2018. The deterioration reflected rising fiscal deficits among several Progress on poverty reduction in LICs continues to be industrial-commodity-exporting LICs, where governments disappointing, with more than 40 per cent of the struggle to rein in spending (e.g., Mozambique), while population in these countries living in extreme poverty— moderating metals prices dampened revenues. However, in i.e., earning below $1.90 per day. And while this ratio has oil-exporting countries (e.g., Chad), higher oil revenues remained broadly unchanged in recent years, insufficient combined with improved non-oil revenue collection per capita GDP growth, especially in economies affected yielded a fiscal surplus, and in some non-resource- by fragility, conflict, and violence, means that the poverty intensive countries, fiscal consolidation delivered narrower headcount is rising. fiscal deficits (e.g., Benin, The Gambia). Current account deficits are estimated to have widened in Debt levels remain elevated in many countries and several countries in 2018. Among non-resource-intensive continue to rise. In Liberia and Sierra Leone, the debt-to- economies, as well as metals exporters, external balances GDP ratio has increased more than twofold over the last have deteriorated as exports declined in response to weaker five years, driven by continually weak revenue collection external demand and moderating metals prices and the (Liberia) and a depreciating exchange rate coupled with effect of rising fuel prices on import bills. In contrast, oil new borrowings (Sierra Leone). In addition to the rise in exporters, such as Chad, recorded smaller deficits, helped debt ratios, changes in the composition of debt have made by higher oil export earnings. some countries more vulnerable to shifts in international financing conditions (Chapter 4). As countries have gained access to international capital markets and non-resident Note: This box was prepared by Rudi Steinbach. Research assistance participation in domestic debt markets expanded, non- was provided by Hazel Macadangdang. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 25 BOX 1.2 Low-income countries: Recent developments and outlook (continued) FIGURE 1.2.1 Recent developments in low-income countries Growth in LICs is gradually improving. Metals exporters are struggling owing to softer metals prices, while growth in non- resource-intensive countries is supported by higher agricultural production and infrastructure spending. However, the poverty headcount is rising, especially in economies affected by fragility, conflict, and violence. Current account and fiscal deficits have been widening, especially in metals exporters. Increased reliance on non-concessional debt is making LICs more vulnerable to global financial conditions, and the number of countries in debt distress has continued to rise. A. Growth B. Poverty headcount C. Current account balance D. Fiscal balance E. Non-concessional debt F. Debt distress Sources: International Monetary Fund, World Bank. Notes: LICs = low-income countries. Industrial-commodity-exporting countries include energy- and metal- exporting economies, and the sample includes 8 countries. Non-resource-intensive countries include agricultural-exporting economies and commodity importers, and the sample includes 22 countries. Data for 2018 are estimates. A. Aggregate growth rates calculated using constant 2010 U.S. dollar GDP weights. B. The number of people living on or below the international poverty line of $1.90 per day. Data for 2016-18 are estimates and calculated using data from World Bank (2018h). FCV = fragility, conflict, and violence. Per capita GDP represents the average growth rate from 2016 to 2019. C.E. Median of country groups. F. Percent of LICs eligible to access the IMF’s concessional lending facilities that are either at high risk of, or in, debt distress. The sample includes 30 low-income countries. concessional debt has increased, reaching more than 30 Outlook percent of total public debt in several LICs (e.g., Chad, Senegal, Mozambique, Ethiopia) and over half of total Growth in LICs is expected to improve, rising to 5.9 public debt in Zimbabwe. percent in 2019 and an average of about 6.3 percent in 2020-21 (Figure 1.2.2). While the growth recovery among As a result, debt sustainability has deteriorated in several the metals exporters is expected to be sluggish, as lower LICs. At the end of 2017, Chad, Mozambique, Somalia, revenues constrain fiscal spending, growth among oil and Zimbabwe were classified as in debt distress under the exporters is expected to be spurred by higher oil IMF-World Bank debt sustainability framework. In production and improving domestic demand. Economic addition, The Gambia, and Ethiopia more recently, were activity is also expected to remain robust in non-resource- downgraded from moderate-risk to high-risk rating. intensive LICs. In fast-growing countries, such as Rwanda EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 26 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 1.2 Low-income countries: Recent developments and outlook and Tanzania, the expansion will be supported by public FIGURE 1.2.2 Outlook investment in infrastructure and strong agricultural growth. Similarly, infrastructure investment related to Growth among the LICs is expected to improve. In non- resource-intensive economies, growth will be supported structural reforms should sustain Senegal’s growth by stronger agriculture production and continued recovery. However, in Ethiopia—the largest LIC—growth infrastructure investment, while oil exporters should is expected to moderate somewhat, as the government benefit from higher oil production. However, weaker metals prices and subdued external demand imply a tightens its fiscal stance to stabilize public debt. sluggish recovery in metals exporters. Moreover, progress on poverty reduction in LICs is expected to be Per capita GDP growth in LICs is expected to increase slow, as per capita income growth still remains modest, only modestly from 3.0 percent in 2018 to 3.3 percent in especially among fragility, conflict, and violence- 2019, and to an average of 3.7 percent in 2020-21. affected economies. Moreover, among LICs affected by fragility, conflict, and violence, growth in per capita GDP is expected to be A. GDP growth forecasts significantly lower—increasing from 0.7 percent in 2018 to an average of 1.9 per cent in 2020-21. In all, these rates are not sufficient to generate a marked reduction in poverty rates, and the number of people in LICs living below the international poverty line of $1.90 per day is expected to remain elevated. Risks The outlook is dominated by downside risks. On the external front, slower-than-projected growth in major world economies—such as the United States, Euro Area, or China—would adversely affect export demand and investment in several LICs, specifically countries that are heavily dependent on these large economies for trade and investment flows. Moreover, escalating trade tensions B. Per capita GDP growth involving major economies (e.g., rising tariffs between the United States and China) would be detrimental to LICs that depend on extractive industries—specifically metals producers, as metals prices are likely to fall faster than other commodity prices in response (World Bank 2018b). Furthermore, an unexpected deterioration in international financial conditions could disrupt capital inflows (IMF 2018), fuel disorderly exchange rate depreciations, and raise financing costs, especially in LICs with weaker macroeconomic fundamentals or higher political risks. Sharp increases in debt-servicing costs, specifically foreign currency denominated debt, would undermine much- needed fiscal consolidation efforts and crowd out poverty- reducing expenditures. Source: World Bank. Risks to debt sustainability are high, as several countries Note: Shaded area indicates forecasts. Industrial commodity countries include energy- and metal- based economies, and the sample includes 8 are either already in debt distress or facing high risk countries. Non-resource intensive countries include agricultural exporters and commodity importers, and the sample includes 22 countries. thereof, according to the IMF-World Bank debt A. Aggregate growth rates calculated using constant 2010 U.S. dollar GDP sustainability framework for LICs (Chapter 4). The recent weights. B. FCV = fragility, conflict, and violence. Aggregate per capita growth rates increased reliance on foreign currency borrowing has calculated using the total GDP for each subgroup divided by its total increased the extent to which debt sustainability is population. Afghanistan, Liberia, and Tajikistan are excluded due to data limitations. vulnerable to sharp currency depreciations. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 27 BOX 1.2 Low-income countries: Recent developments and outlook (continued) TABLE 1.2.1 Low-income country forecastsa Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projectionsd 2016 2017 2018e 2019f 2020f 2021 2018e 2019f 2020f Low Income Country, GDPb 4.8 5.6 5.7 5.9 6.3 6.3 0.0 0.0 0.1 Afghanistan 2.4 2.7 2.4 2.7 3.2 3.2 0.2 0.2 -0.1 Benin 4.0 5.6 6.0 6.2 6.5 6.6 0.0 0.1 0.2 Burkina Faso 5.9 6.4 6.0 6.0 6.0 6.0 0.0 0.0 0.0 Burundi -0.6 0.5 1.9 2.3 2.5 2.8 0.0 0.0 0.0 Chad -6.3 -3.0 3.1 3.3 6.2 5.2 0.5 0.8 0.4 Comoros 2.2 2.7 2.7 3.1 3.1 3.1 -0.2 0.1 0.1 Congo, Dem. Rep. 2.4 3.4 4.1 4.6 5.5 5.9 0.3 0.5 1.1 Ethiopiac 7.6 10.3 9.1 9.1 9.0 9.0 -0.5 -0.6 -0.9 Gambia, The 0.4 4.6 5.3 5.4 5.2 5.2 -0.1 0.2 0.3 Guinea 10.5 8.2 5.9 5.9 6.0 6.0 -0.1 0.0 0.0 Guinea-Bissau 5.8 5.9 4.8 5.1 5.3 5.5 -0.3 -0.1 -0.1 Haitic 1.5 1.2 1.6 2.3 2.4 2.5 -0.2 -0.1 0.0 Liberia -1.6 2.5 3.2 4.5 4.8 4.8 0.0 -0.2 0.0 Madagascar 4.2 4.2 5.0 5.4 5.3 5.3 -0.1 -0.2 0.0 Malawi 2.5 4.0 3.5 4.3 5.3 5.5 -0.2 0.2 0.4 Mali 5.8 5.4 5.1 4.8 4.8 4.8 0.1 0.1 0.1 Mozambique 3.8 3.7 3.3 3.5 4.1 4.1 0.0 0.1 0.5 Nepalc 0.6 7.9 6.3 5.9 6.0 6.0 0.0 1.4 1.8 Niger 4.9 4.9 5.2 5.3 5.7 5.8 -0.1 -0.1 -0.1 Rwanda 6.0 6.1 7.2 7.8 8.0 8.0 0.4 0.7 0.5 Senegal 6.2 7.2 6.6 6.6 6.8 6.9 -0.2 -0.2 -0.2 Sierra Leone 6.3 3.7 3.7 5.1 6.3 6.3 -1.4 -0.6 -0.2 Tajikistan 6.9 7.1 6.1 6.0 6.0 6.0 0.0 0.0 0.0 Tanzania 7.0 7.1 6.6 6.8 7.0 7.0 0.0 0.0 0.0 Togo 5.1 4.4 4.5 4.8 5.1 5.1 -0.3 -0.2 0.1 Ugandac 4.6 3.9 6.1 6.0 6.4 6.5 0.6 0.0 -0.1 Zimbabwe 0.6 3.2 3.0 3.7 4.0 4.0 0.3 -0.1 0.0 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. a. Central African Republic, Democratic People’s Republic of Korea, Somalia, Syria, and Yemen are not forecast due to data limitations. b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. c. GDP growth based on fiscal year data. For Nepal, the year 2017 refers to FY2016/17. d. Due to changes in the official list of countries classified as low income by the World Bank, the sample of LICs in this table is not comparable to June 2018. However, an identical sample is used for the comparison of the aggregate LIC GDP projection. For additional information, please see www.worldbank.org/gep. Weather-related shocks, such as flooding or severe and (e.g., Chad, Sierra Leone), or is the prevailing source prolonged drought episodes remain an important risk for of employment (e.g., Burkina Faso, Burundi; Chapter 4). many LICs. A return of the drought conditions experienced in recent years would undermine the ongoing Health crises are a continuous concern. The recent Ebola recovery in agricultural production. In addition, lower outbreak in the Democratic Republic of Congo could have agricultural output, and the food price spikes that are a detrimental impact on economic activity in the country likely follow, could adversely affect poverty rates in many and the sub-region, if it were to spread to major urban LICs, especially countries where agricultural activity centers and to neighboring countries. accounts for a dominant share of domestic value added EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 28 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 1.3 Regional perspectives: Recent developments and outlook The cyclical upswing in regions with many commodity exporters (such as Latin America and the Caribbean and the Middle East and North Africa) is proceeding at a more moderate pace than previously anticipated, partly reflecting a substantial slowdown in some large economies, and is expected to plateau toward the end of the forecast horizon. Growth in regions with large numbers of commodity importers (such as South Asia and East Asia and the Pacific) is projected to remain solid at around 6-7 percent. For all regions, risks to the outlook are increasingly tilted to the downside. East Asia and Pacific. Growth is projected to moderate to risks dominate, including the possibility of an abrupt a still-robust pace of about 6 percent in 2019 and remain further tightening of external financial conditions, a near that level over the forecast period, broadly as further escalation of domestic or international trade policy previously expected. In China, policies aimed at uncertainty, adverse market responses to fiscal conditions, rebalancing the economy and countering the impact of and disruptions from natural disasters. higher U.S. tariffs will continue to tilt activity toward consumption and away from exports. Excluding China, Middle East and North Africa. Growth in the region is regional growth is expected to remain steady at 5.2 expected to pick up slightly in 2019 to 1.9 percent, but percent over the forecast horizon. Risks to regional growth prospects are uneven across countries. Accelerating activity are to the downside and have intensified. They include a in Saudi Arabia and Egypt is expected to be offset by sharp further escalation of trade restrictions and a faster-than- contraction in Iran following the imposition of U.S. expected tightening of global financing conditions. Highly sanctions. Rising oil production, high oil prices, and fiscal leveraged economies and countries with sizable external easing are supporting the recovery in some oil exporters, financing needs are particularly vulnerable to disruptions while oil importers continue to benefit from policy in real and financial activity. reforms. Regional growth is projected to rise to 2.7 percent in 2020-21, as domestic demand among both oil Europe and Central Asia: Growth is estimated to have importers and exporters shows a broad-based pickup, fallen to 3.1 percent in 2018, driven by a slowdown in supported by reforms and diversification policies. Key Turkey and in Central European economies. Turkish downside risks include the possibility of intensified growth for this year has been revised sharply down due to geopolitical tensions, renewed volatility in oil prices, rising substantial financial market stress and the associated global trade restrictions, an abrupt tightening of global economic effects, contributing to a deceleration in regional financing conditions, and delays in reform growth in 2019 to 2.3 percent. Growth in the region is implementation. expected to pick up to 2.7 percent in 2020, as a rebound in Turkey offsets a moderation in activity among other South Asia. Growth is projected to accelerate to 7.1 commodity importers. Risks are tilted to the downside and percent in 2019—mainly reflecting strengthening growing. They include the possibility of renewed stress in domestic demand in India, as the benefits of structural Turkey alongside larger-than-expected spillovers to the rest reforms such as GST harmonization and bank of the region, and unexpected shifts in policy. recapitalization take effect. Elsewhere in the region, the forecast is for a moderation in activity, notably in Latin America and the Caribbean. Growth stalled at 0.7 Bangladesh and the Maldives. Over the medium term, percent in 2018, held back by currency crisis and drought growth is expected to remain at 7.1 percent, reflecting in Argentina, a truckers’ strike in Brazil, and worsening robust domestic demand in the region. External conditions in Venezuela. Although regional growth is vulnerabilities are rising in the region, reflected in projected to strengthen over the forecast horizon, the mounting external debt, widening current account deficits, improvement will be weaker than previously expected, and eroding foreign reserves. Risks to the outlook are to partly owing to the effects of financial market tightening the downside. On the domestic front, vulnerabilities are and trade policy uncertainty. However, firming being exacerbated by fiscal slippages and rising inflation, momentum in Brazil and Colombia, together with gradual and there is a risk of delays in structural reforms to address improvements in Argentina, will push regional growth to balance sheet issues in the banking and non-financial 1.8 percent in 2019 and 2.4 percent in 2020. Downside corporate sectors. Key external risks are of a further deterioration in current accounts, higher global oil prices, and a faster-than-expected global financial tightening. Note: This box was prepared by Patrick Kirby with contributions from Yoki Okawa, Rudi Steinbach, Temel Taskin, Ekaterine Vashakmadze, Sub-Saharan Africa. Regional growth is estimated to have Dana Vorisek, and Lei Ye. Research assistance was provided by Hazel reached 2.7 percent in 2018—a downward revision from Macadangdang. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 29 BOX 1.3 Regional perspectives: Recent developments and outlook (continued) FIGURE 1.3.1 Regional growth The cyclical upswing in regions with many commodity exporters is proceeding at a more moderate pace than previously anticipated. Growth in regions with large numbers of commodity importers is projected to remain solid. A. Regional growth, weighted average B. Regional growth, unweighted average Source: World Bank. A.B. Average for 1990-2017 is constructed depending on data availability. For Europe and Central Asia, the long-term average uses data for 1995-2017 to exclude the immediate aftermath of the collapse of the Soviet Union. A. Bars denote the latest forecasts; diamonds correspond to June 2018 forecasts in the Global Economic Prospects report. Since the largest economies account for almost 50 percent of regional GDP in some regions, weighted averages predominantly reflect developments in the largest economies in each region. B. Unweighted average regional growth is used to ensure broad reflection of regional trends across all countries in the region. previous projections due to weaker-than-expected is expected to pick up, reaching 3.4 percent in 2019 and incoming data, lower prices of key commodities, financial an average of 3.7 in 2020-21, as investment and consumer market volatility, and stalled reform agendas. South Africa spending rebound. Downside risks include the possibility entered a recession in the first half of last year. In Nigeria, of further declines in commodity prices, a sharp tightening oil production declined due to pipeline closures, while of global financing conditions, fiscal slippage, stalled farmer-herdsmen conflicts disrupted agricultural output. structural reforms, and conflict. The region is also In Angola, oil production is falling, but it is projected to vulnerable to adverse weather shocks. recover as new oil fields come on stream. Regional growth this group. In commodity importers excluding lower revenues constraining fiscal spending. In China, a downgrade to growth projections of 0.4 contrast, oil exporters should benefit from higher percentage point this year partly reflects the oil production and improving domestic demand. worsened outlook for Turkey as a result of the Economic activity is expected to remain robust in effects of recent financial market stress, and, to a non-resource-intensive LICs. In the fast-growing lesser degree, in some other large economies (e.g., countries (e.g., Rwanda, Tanzania), the expansion Romania, Pakistan). will be supported by public investment in infrastructure and strong agricultural growth. Growth in LICs is expected to improve, rising to Similarly, infrastructure investment related to 5.9 percent in 2019 and 6.3 percent in 2020-21. structural reforms should sustain Senegal’s growth However, for the metals exporters, growth will be recovery. However, in Ethiopia—the largest more sluggish than previously envisioned, with LIC—growth is expected to moderate somewhat, EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 30 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.12 EMDE growth prospects accumulation and less favorable demographic trends (World Bank 2018g, Vorisek et al. EMDE growth is expected to remain at 4.2 percent in 2019, well below previous forecasts, partly reflecting the lingering effects of financial stress forthcoming). Potential growth in EMDEs is in some large economies. EMDE growth is subsequently projected to expected to further decline, as its fundamental plateau at 4.6 percent, as the recovery in commodity exporters levels off. Growth is close to upper estimates of potential in commodity importers, drivers continue to weaken. Moreover, tightening while slack remains in commodity exporters. A decreasing share of global financing conditions, higher borrowing EMDEs will see further acceleration in activity, in part reflecting a less costs, moderating capital flows, and lingering favorable external environment. Drivers of long-term growth suggest softening potential over the next decade. policy uncertainty are likely to hamper investment growth in the coming years, further constraining A. Growth B. Projected and potential growth in potential growth. 2019 Outlook for per capita income and poverty Per capita income growth in EMDEs is expected to pick up in 2019, but it will be insufficient to narrow income gaps with advanced economies in about 35 percent of countries (Figure 1.13). The share will be even greater among commodity exporters (42 percent); among LICs (close to 36 percent); and in countries affected by fragility, C. Number of EMDEs with increasing, D. Drivers of potential long-term unchanged, or decreasing growth growth conflict, and violence (nearly 60 percent). Although the extreme poverty rate—defined at a threshold of $1.90 per day—has fallen below 3 percent in more than half of the world’s economies in recent years, nearly a quarter of countries faced rates above 30 percent in 2015, with the average for LICs standing above 40 percent. Poverty rates remain the highest among Sources: International Monetary Fund, Organisation for Economic Co-operation and Development, LICs, but the majority of extreme poor currently World Bank. A.-D. Aggregate growth rates are calculated using constant 2010 U.S. dollar GDP weights. reside in large lower-middle-income countries, A.C.D. Shaded areas indicate forecasts. Data for 2018 are estimates. including India and Nigeria. Current growth B.D. Potential growth estimates based on eight different methodologies (production function approach; multivariate filter; three univariate filters, including Hodrick-Prescott filter, Christiano- projections suggest that the number of extreme Fitzgerald filter, and Butterworth filter; IMF World Economic Outlook estimates; and OECD Economic Outlook and Long-Term Baseline Projections estimates). For further details on potential growth poor should continue to fall rapidly in India, but estimates, refer to the January 2018 edition of the Global Economic Prospects report. A. Data for 2015-17 are simple averages. Green diamonds correspond with the June 2018 edition of remain broadly unchanged in some other the Global Economic Prospects report. countries, including Nigeria. While extreme B. Blue bars refer to average projected growth for 2019. Vertical orange lines show minimum- maximum range of potential growth. poverty has declined notably, progress in C. Sample includes 50 largest EMDEs. Increasing/decreasing growth are changes of at least 0.1 percentage point from the previous year. Countries with a slower pace of contraction from one year alleviating poverty at higher income levels has to the next are included in the increasing growth category. been slower, with nearly a quarter of the world’s D. TFP = total factor productivity. The sample includes 23 EMDEs (11 EMDE commodity exporters and 12 EMDE commodity importers). population still living with less than $3.20 per day. Worryingly, per capita income growth in Sub- Saharan Africa is expected to average only 0.9 as the government tightens its fiscal stance to percent in 2019-21—insufficient to drive stabilize public debt. significant progress toward poverty alleviation. In the longer run, the underlying potential growth Indeed, if recent growth trends persist, the fraction of EMDEs has fallen considerably over the past of the global poor residing in Sub-Saharan Africa decade reflecting softening productivity growth could be as large as 87 percent by 2030 (World and, to a lesser degree, slowing capital Bank 2018h). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 31 FIGURE 1.13 Poverty and per capita income growth Risks to the outlook Per capita income growth in the near term will be insufficient to restart the The balance of risks is more firmly on the downside. catch-up with advanced economies in more than one-third of EMDEs. Poverty is increasingly concentrated in a few large lower-middle-income The risk of disorderly financial market developments countries. Per capita GDP growth is expected to remain weak in EMDE has increased and could spread through EMDEs, regions with a large number of commodity exporters. amplified by elevated vulnerabilities in many countries. A marked intensification of trade A. Share of EMDEs with widening B. Poverty in EMDEs, in 2015 income per capita gaps with advanced restrictions remains possible, and its realization could economies be highly disruptive in the presence of complex value chains. Policy uncertainty and geopolitical risks remain elevated and could negatively impact confidence and investment both in the affected countries and globally. Although unlikely in the near term, the simultaneous occurrence of a U.S. recession and a sharper-than-expected deceleration in China would trigger a marked downturn in global activity. Global growth is projected to gradually slow over C. Poverty projections for India and D. Per capita growth, by region the forecast horizon as economic slack dissipates, Nigeria major central banks remove policy accommodation, and the recovery in commodity exporters matures. This moderation is somewhat more pronounced than previously expected, amid softer-than-expected global trade and industrial activity and heightened financial market pressures in some EMDEs. While an abrupt slowdown is only expected in countries that faced severe financial stress in 2018, the global outlook has Sources: United Nations, World Bank. become more uncertain, with downside risks Notes: EAP = East Asia and Pacific, ECA = Europe and Central Asia, LAC = Latin America and the Caribbean, MNA = Middle East and North Africa, SAR = South Asia, and SSA = Sub-Saharan Africa. becoming more predominant. A.D. Shaded areas indicate forecasts. Data for 2018 are estimates. A. EMDEs with per capita GDP growth of at least 0.1-percentage-point higher than advanced- economy per capita GDP growth are those counted as converging. Advanced-economy growth rates A faster-than-expected tightening of global calculated using constant 2010 U.S. dollar GDP weights. Sample includes 117 EMDEs. B. LICs = low-income countries, LMCs = lower-middle-income countries, and Other EMDEs = EMDEs financing conditions, or disorderly exchange rate not classified in LICs or LMCs. Aggregate poverty rates are weighted by total population. Data as of 2015, the latest available observation. movements, could have large adverse effects on C. The number of poor are people living on or below the international poverty line of $1.90 per day. Shaded area indicates forecasts. Data for 2016-18 are estimates and calculated using data from activity, particularly among more vulnerable World Bank (2018h). EMDEs. Escalating trade tensions represent D. Aggregate growth rates calculated using constant 2010 U.S. dollar GDP weights. another key risk to the global outlook, as they could significantly hamper cross-border trade and investment, with the impact amplified by complex envisioned. In particular, a simultaneous regional and global value chains. Loss of occurrence of a U.S. recession and a sharper-than- confidence in international trading rules could expected deceleration in China would significantly inflict long-lasting damage, lowering opportunities increase the likelihood of a global recession. Past for future growth in EMDEs. Rising political experience illustrates that global slowdowns and uncertainty and polarization, geopolitical risks, recessions often come unexpectedly after spells of and conflict could also depress sentiment and highly synchronized growth and of rapid debt investment in the affected countries and globally. build-ups (Figure 1.14; Kose and Terrones 2015). The materialization of one or several of these On the upside, a resolution of trade tensions downside risks would result in a more abrupt between major economies could lift sentiment and slowdown in global growth than currently support global investment and trade. Furthermore, EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 32 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.14 Risks: Tilted to the downside market conditions, the probability of global growth being more than 1 percentage point below Past global recessions often came unexpectedly following periods of highly synchronized growth. Downside risks to global growth have baseline in 2019 is estimated at 21 percent, while increased from a year ago amid trade tensions, rising borrowing costs, and that of growth being more than 1-percentage- deteriorating financial market sentiment. point above baseline is 17 percent. That range has widened and shifted further down from a year ago, A. Share of countries in recession B. Probability distribution around global growth forecasts reflecting increased uncertainty embedded in the distribution of key risk factors, including equity price futures. Disorderly financial market developments Risks of disorderly financial market developments have intensified substantially, reflecting the possibility of a faster-than-expected tightening of global financing conditions, sharp movements in major currencies, and contagion from financial C. Probability of 2019 global growth D. Volatility and skewness in equity stress in some EMDEs. being 1-percentage-point below/above price futures baseline Despite bouts of volatility in bond and equity markets, as well as ongoing uncertainty about growth and inflation prospects, U.S. term premiums are still negative, raising the risks of sharp upward adjustments (Crump, Eusepi, and Moench 2018; Kopp and Williams 2018). Investors also continue to foresee a shorter and shallower tightening cycle in U.S. policy interest rates than currently signaled by the Federal Sources: Bloomberg, Kose and Terrones (2015), World Bank. A. Recession is defined as a contraction in per capita GDP. Unbalanced sample includes 149 Reserve, implying risks of disorderly market countries. Aggregate share is calculated using constant 2010 U.S. dollar GDP weights. Red bars show the four global recessions in 1975, 1982, 1991, and 2009, and orange bars show the two global reassessments (FOMC 2018). In this context, a slowdowns in 1998 and 2001. B.C.D. The fan chart shows the forecast distribution of global growth using time-varying estimates of sharper-than-expected rise in U.S. borrowing costs the standard deviation and skewness extracted from the forecast distribution of three underlying risk remains possible, triggered for instance by factors (oil price futures, the S&P 500 equity price futures, and term spread forecasts). Each of the risk factor’s weight is derived from the model described in Ohnsorge, Stocker, and Some (2016). concerns about rising inflation, swelling fiscal Values for 2019 are computed from the forecast distribution of 12-month-ahead oil price futures, S&P 500 equity price futures, and term spread forecasts. Values for 2020 are based on 24-month-ahead deficits, or slowing foreign demand for U.S. forecast distributions. Last observation is November 7, 2018. C. Bars show the probability that global growth is 1-percentage-point above or below baseline government debt (Andolfatto and Spewak 2018; forecasts 12 months ahead. Kopp and Williams 2018). Following a decade of D. The implied volatility and skewness indexes refer to 12-month S&P 500 equity price futures. Last observation is November 29, 2018. exceptionally low U.S. interest rates and growing debt levels, the effects of a sudden rise in borrowing costs could be amplified by increased the ongoing cyclical recovery in global productivity growth could prove more durable investor risk aversion and sudden stops in capital flows to EMDEs (Arteta et al. 2015; Buttiglione et than expected, including if the pickup in al. 2014; Dobbs et al. 2015; Mai 2018). The intangible investments in recent years lead to a dampening effect could be particularly severe on broader diffusion of productivity-enhancing cross-border bank loans to EMDEs (Bräuning and technologies. If so, this would help counter the dampening effect of population aging on potential Ivashina 2018). growth in the longer term. A further appreciation of the U.S. dollar, possibly triggered by diverging monetary policy and A quantification of possible global growth growth prospects among major economies, could outcomes around the baseline provides additional also impact the outlook for EMDEs. Periods of evidence of elevated forecast uncertainty and the dollar strength have been associated in the past predominance of downside risks. At current with an increased frequency of disorderly currency EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 33 depreciations in EMDEs. If currency crises were to FIGURE 1.15 Financial stress materialize, they would be associated with slowing More than a third of currency crises in EMDEs are associated with growth or outright contractions. In the past, a negative growth in the same year. Currency crises are sometimes large proportion of crises were accompanied by a accompanied by banking crises, and their simultaneous occurrence can be particularly damaging. Financial stress can be amplified by persistent recession in the same year (Figure 1.15). When external vulnerabilities, potentially leading to further forecast downgrades currency crises are accompanied by banking crises, for more exposed countries. as is sometimes the case, the likelihood of large output losses rises substantially (Laeven and A. Currency crises and growth in B. EMDE banking and sovereign debt Valencia 2018). These “twin” crises can occur in EMDEs crises around currency crises the presence of elevated foreign-currency- denominated debt or on the back of an abrupt end to capital inflows and credit booms leading to rising corporate defaults and large asset price corrections (Caballero 2014; Bordo and Meissner 2016). Financial stress could spread through contagion effects. Excluding China and a few large regional C. Share of EMDEs with negative D. Growth forecast revisions and economies (e.g., Russia, Brazil), direct trade and growth around currency crises current account position, 2019 financial sector spillovers from most other EMDEs are limited (World Bank 2016). However, contagion across countries can result from heightened investor risk aversion and shifts in portfolio allocations between broad asset classes, amplifying the effects of shocks (Gelos 2012). Historically, the correlation across EMDE assets has been high and tends to increase during stress episodes (Park and Mercado 2013; Eichengreen Sources: Bloomberg, Institute of International Finance, Laeven and Valencia (2018), World Bank. and Gupta 2016). A. Currency crises with negative or positive GDP growth during the year of the crisis. Currency crises are defined as nominal depreciation of the currency vis-à-vis the U.S. dollar of at least 30 percent that is also at least 10-percentage-points higher than the rate of depreciation in the year before. Last These risks are particularly salient in the current observation is 2017. B. The percent of EMDE currency crisis episodes that were preceded by, coincided with, or followed context given persistent domestic and external by a banking or sovereign debt crisis, with t denoting the start of the currency crisis. Crises episodes vulnerabilities in EMDEs, as these can both are as defined in Laeven and Valencia (2018). C. Share of countries that experienced negative growth in the current or next year following a amplify the impact of financial shocks and limit currency crisis, a currency and banking crisis, or a currency, banking, and sovereign debt crisis. Last observation is 2017. policy options in response to financial stress. On D. Forecast revisions for GDP growth in 2019 relative to June 2018. Sample includes 23 EMDEs. Current account position net of foreign direct investment in 2018. the domestic front, many countries evidence sizable government debt and primary fiscal deficits, elevated or rising private debt, and high non-performing loans. Corporate borrowers have them exposed to shifts in external financing increasingly relied on bond markets to finance conditions, which could exert further downward rising debt levels, and now face significant pressure on activity. refinancing needs amid rising interest rates (Lund et al. 2018). This could result in sudden increases In low-income countries (LICs), public debt in corporate default rates and have a sustained burdens and vulnerabilities associated with a negative effect on investment and financial greater reliance on non-concessional financing are stability (Borensztein and Ye 2018). On the rising (Chapter 4). More than 40 percent of LICs external side, many EMDEs are faced with the are in debt distress or at high risk of debt challenge of financing large current account distress—more than twice the share in 2013 (IMF deficits and rely heavily on volatile capital inflows. 2018a; World Bank 2018e). Most LICs also suffer Coupled with high levels of short-term external from a lack of transparency in public sector debt and low foreign currency reserves, this leaves accounts, further exacerbating vulnerabilities. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 34 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.16 Trade protectionism trade restrictions. These, along with previous measures, would affect close to all goods trade If all new tariffs currently under consideration were to be implemented, more than 5 percent of global goods trade would be affected, and average between the two countries. Additional tariffs on U.S. tariff rates would increase to levels not seen since the late 1960s. The U.S. imports of motor vehicles and parts are also dampening impact of escalating trade tensions involving major economies could be amplified by adverse confidence effects. The cost of under consideration, which could cause serious protectionism can be multiplied through global value linkages, particularly adverse effects given tightly integrated global in EMDEs. automotive value chains. A. Imports affected by new tariffs B. Average import tariffs in the United If all proposed tariffs increases were to be States implemented, the average U.S. tariff rate would more than quadruple, rising to levels not seen since the late 1960s. These new tariffs, and the associated retaliatory actions, could substantially depress bilateral U.S.-China trade, increase demand for costlier substitutes, and lead to lower growth in both the United States and China. It is also likely to affect investment strategies by multinational companies and lead to changes in C. Impact on nominal GDP of tariff D. Magnification of tariffs due to some value chains. While some countries could hikes on all U.S.-China trade flows vertical specialization benefit from trade diversion in the short run, including those with comparative advantages in close substitutes to the goods subject to U.S. or China tariffs, adverse effects from weakening growth and rising policy uncertainty involving the world’s two largest economies would have predominantly negative repercussions. In this context, a further escalation of trade frictions between the United States and China, coupled with possible negative effects on confidence, has Sources: Freund et al. (2018), Peterson Institute for International Economics, United States International Trade Commission, World Bank. been estimated to reduce global exports by up to 3 A. Import tariffs implemented in the United States and the rest of the world in 2018, as well as those under consideration, as a percent of global goods imports. percent and global income by 1.7 percent over the B. Ratio of duties collected to the total value of imports. Data for 2018-20 are forecast from tariffs under consideration, excluding car imports from Canada and Mexico, as of November 30, 2018. medium term (Freund et al. 2018). C. Blue bars depict the impact of a 25-percentage-point increase of the tariff surcharge on all bilateral U.S.-China trade flows. Red bars depict the additional impact from adverse investor confidence. The additional confidence shock assumes a decline of the investment-to-GDP ratio of 0.5 percentage More generally, a proliferation of trade barriers point, similar to that observed during the global slowdown in 2001. The percent deviations from CGE simulations are applied to GDP in current U.S. dollars. across both advanced economies and EMDEs D. The magnification ratio of vertical specialization is estimated by comparing a country’s standard could inflict lasting damage to the global tariff on exports and the gross effective tariff rate faced in export markets. A country’s standard tariff on exports is defined as the trade-weighted tariff rate applied by a country’s trading partners economy. In particular, if all WTO members were (in ad-valorem equivalent). The gross effective tariff rate is defined as the standard tariff rate divided by the domestic content share and weighted by trade. Higher magnification ratios in EMDEs to increase tariffs up to legally-allowed bound are partly driven by their lower domestic value-added share. rates, this could translate into a decline in global trade flows of about 9 percent, similar to the Escalating trade restrictions drop seen during the global financial crisis in 2008-09 (Kutlina-Dimitrova and Lakatos 2017). The risk of rising trade protectionism remains In the presence of regional and global value high. U.S. tariffs and the retaliatory response of chains, costs associated with increasing tariffs or trading partners now affect close to $430 billion of other barriers to trade would cumulate through global imports—around 2.5 percent of global different stages of production (Koopman, Wang, goods trade (Figure 1.16). Despite a temporary and Wei 2014; World Bank et al. 2017). This pause in tariff hikes agreed by the United States amplification effect of vertical specialization would and China in early December, unsuccessful be particularly important for EMDEs, as the share negotiations could lead to a renewed escalation in of domestic value added in manufactured exports EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 35 is usually lower and trade costs higher than in FIGURE 1.17 Policy uncertainty and other downside advanced economies. In the automotive sector, risks participation of EMDEs in global value chains has Policy and geopolitical uncertainties remain above historical norms, which proliferated in the past decade, intensifying risks could eventually lead to an increase in financial market volatility from in the case of sudden pullbacks (Van Biesebroeck current low levels. More frequent armed conflicts and extreme weather patterns can significantly dampen prospects in the affected countries and and Sturgeon 2011). globally. Intensifying trade disputes could eventually A. Global policy uncertainty, B. Long-term bond yield spread threaten the stability of the rules-based global geopolitical risks, and financial between Italy and Germany market volatility, 2018 trading system and undo the beneficial effects of trade liberalization and global integration achieved during decades of multilateral cooperation. Uncertainty about future trade rules could compound the negative effect of trade barriers on investment and activity (IMF 2018b; Kose et al. 2017a). Policy uncertainty and geopolitical tensions C. Number of armed conflicts D. Number of extreme weather events Global policy uncertainty has increased since mid-2018, reflecting heightened trade tensions and geopolitical risks, as well as idiosyncratic developments in a number of large advanced economies and EMDEs. Elevated policy uncertainty tends to encourage investors to require higher risk premiums to hedge against negative outcomes. Financial market volatility remained exceptionally low in 2018, implying the risk of disorderly repricing of policy-related risks (Figure Sources: Baker, Bloom, and Davis (2016); Bloomberg; Caldara and Iacoviello (2017); Centre for the Study of Civil War at the Peace Research Institute Oslo (PRIO); EM-DAT, The CRED/OFDA 1.17). A further escalation of policy uncertainty International Disaster Database; Uppsala University in Sweden; World Bank. A. Z-scores computed as the index value minus the sample mean divided by the sample standard could lead companies to delay or reconsider capital deviation. The global policy uncertainty index is computed by Baker, Bloom, and Davis (2016) and is based on the frequency of words in domestic newspapers mentioning economic policy uncertainty. spending, contributing to a more rapid The geopolitical risk index is computed by Caldara and Iacoviello (2017) and is based on the frequency of words in domestic newspapers mentioning geopolitical tensions, including military, deceleration of global growth than currently nuclear, war, and terrorism. Financial market volatility is measured by the Chicago Board Options projected. Exchange (CBOE) VIX implied volatility index of option prices on the U.S. S&P 500 index. Last observation is November 2018 for geopolitical risk and volatility, and October 2018 for policy uncertainty. B. Bond yield spread is the difference between 10-year government bond yields in Italy and Germany. Political uncertainty is generally associated with Last observation is November 29, 2018. lower growth in both advanced economies and C. Conflicts are defined as when the use of armed force between two parties, of which at least one is the government of a state, results in at least 25 battle-related deaths in one calendar year. EMDEs (Aisen and Veiga 2013). It has increased D. Decadal simple averages. or remained elevated in a number of European countries—including in the United Kingdom as it transitions out of the EU, and in Italy where fiscal Geopolitical risks intensified again in the Middle slippages have led to a market reassessment of East, and persist in Central Asia, East Asia, and country risk. Electoral outcomes in a number of Africa. An intensification of these risks could EMDEs and advanced economies could result in impact growth the affected regions, and their main further polarization and political fragmentation, trading partners. In the case of the Middle East, making it harder to govern and formulate policies. disruptions to global oil supplies could result in A backlash against trade and immigration could higher-than-expected oil prices, with negative also spur more inward-looking and populist impacts on aggregate demand and trade balances policies (Aksoy, Guriev, and Treisman 2018; in major oil importers (Baffes et al. 2015; Stocker Moriconi, Peri, and Turati 2018). et al. 2018). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 36 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 The number of armed conflicts also remains above progress in disaster risk finance has created historical averages. In particular, security opportunities for preventive actions (Végh et al. conditions remain challenging in many countries 2018). in Sub-Sahara Africa, the Middle East, and North Simultaneous slowdown in the two largest Africa. In the past, countries in conflict or in fragile situations suffered from below average economies growth in income per capita, delaying or derailing Fiscal measures undertaken in the United States their catchup with advanced economy levels (UN and China are supporting their near-term growth and World Bank 2018). Beyond adverse short- prospects; however, they could exacerbate term effects on growth, conflict can also imbalances and amplify risks of a more abrupt substantially set back efforts to reduce poverty and downturn later on. A sharper-than-expected and child mortality, and can hamper access to simultaneous slowdown in these two economies education, implying longer lasting negative could have severe consequences for the global repercussions on development (Gates et al. 2012). economy. Region-specific downside risks The policy mix in the United States will shift from expansionary to contractionary during the forecast These global risks are compounded by multiple horizon, with monetary, fiscal, and trade policies region-specific risks (Box 1.2; Chapter 2). Most all expected to become a drag on activity within regions are vulnerable to sudden shifts in policy, the next couple of years. In this context, relatively which could result in fiscal slippage, reduced small negative shocks have the potential to investment due to policy uncertainty, and weaker abruptly end the current expansion, which is on potential growth resulting from insufficient track to be the longest in more than century structural reforms. Security-related risks remain (Figure 1.18). Although the probability of a U.S. present, in varying degrees, in Europe and Central recession in the short term is still low, at about Asia, the Middle East and North Africa, South half its level prior to previous recessions, it has Asia, and East Asia, and could rise in the face of increased throughout 2018. renewed geopolitical tensions. A flare-up in violence would disrupt activity in various ways, Economic expansions do not end, and give way to weigh on potential output, and drive up refugee recessions, only because they have lasted long flows. A fall in the price of specific commodities (Castro 2013; Diebold and Rudebusch 1999; could disrupt activity in large regional commodity Rudebusch 2016). Instead, they tend to end as a exporters, with possible broader spillovers. reflection of corrections from imbalances accumulated over the business cycle. In particular, Severe weather events appear to be becoming more recessions often follow periods of rapid increase in frequent, with particularly serious consequences debt levels and excessive asset price valuations for vulnerable countries, such as island nations in (Mendoza and Terrones 2012; Claessens, Kose, the Caribbean and East Asia and the Pacific. and Terrones 2012). These imbalances tend to Adverse weather patterns are also problematic for suddenly unwind, often during or shortly after the countries with large agricultural sectors dependent end of a monetary policy tightening cycle on rainfall, including many in Sub-Saharan Africa (Bernanke and Gertler 1995; Sims and Tao 2006). and South Asia. In those countries, large food In the United States, three of the last four price increases could severely impact poverty tightening cycles were indeed followed by a (Chapter 4). For instance, the spike in food prices recession within a year and a half, with the most in 2007-08 is estimated to have placed around 140 severe contractions following unsustainable million to 155 million people below the extreme housing market booms (Gelain, Lansing, and poverty line. Other natural disasters, such as Natvik 2018; Mian and Sufi 2009; Berkovec, earthquakes and hurricanes, can inflict severe Chang, and McManus 2012). The only exception damage in the affected countries. These events are was the productivity-driven growth revival around unpredictable and often force countries to overly mid-1990, which continued uninterrupted despite rely on aid for reconstruction, even though recent interest rate hikes in 1994-95. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 37 At the present juncture, the rise in U.S. private FIGURE 1.18 Simultaneous slowdown in the two largest debt is smaller than prior to past recessions, mostly economies because of household and bank deleveraging since The U.S. expansion is on track to be the longest in more than a century. the global financial crisis. U.S. corporate debt is The probability of a U.S. recession in the short term is still low, but has starting to accumulate, however, raising the risk increased, and corporate debt vulnerabilities are growing. Private debt in China exceeds levels that gave rise to significant adjustments in other that corporate bond defaults could amplify the EMDEs in the past. A simultaneous sharp slowdown in both the United next downturn. On balance, the U.S. economy States and China could bring the global economy closer to a global has some of the characteristics that have preceded recession. relatively mild recessions, but some corporate and A. Duration of U.S. expansions B. Probability of U.S. recession non-bank financial sector risks are a source of concern (IMF 2018c). In China, risks to the outlook are increasingly tilted to the downside. Fiscal and monetary policy stimulus measures could offset the adverse effect of trade tensions with the United States but may delay efforts to contain credit growth and limit the buildup of balance sheet vulnerabilities of corporates, local governments, and financial C. Private sector debt in the United D. Private sector debt in China institutions (IMF 2017; World Bank 2018g, States compared with previous peaks in other EMDEs World Bank 2018i). Both the level and pace of increase in the stock of private debt are well above those observed during previous credit booms in other EMDEs—two thirds of which ended in significant growth slowdowns and more than a third in financial crises (Acharya et al. 2015; Alter and Elekdag 2016). In the case of China, risks are somewhat tempered by still low central government debt, extensive capital controls, large foreign reserves, and a low reliance on external E. Share of EMDEs with growth F. Global per capita growth scenarios: Impact of growth slowdowns in the financing. That said, if financial stress were to slowdowns or crises after reaching debt peaks United States and China materialize, it would likely translate into a significantly sharper-than-expected slowdown in activity (Bernadini and Forni 2017; Beltran, Garud, and Rosenblum 2017; Maliszewski et al. 2016). The simultaneous occurrence of a recession in the United States and a sharper-than-expected slowdown in China, although still unlikely in the near term, would substantially increase the risk of Sources: Bank for International Settlements, Federal Reserve Bank of New York, Haver Analytics, Institute of International Finance, Kose and Terrones (2015), Laeven and Valencia (2018), National an abrupt global downturn, or even a global Bureau of Economic Research, World Bank. A. Shaded area indicates the number of months from January 2019 to December 2019. recession. These two economies are, together with B. Probability of a recession in 12 months derived from the U.S. yield curve model of the Federal Reserve Bank of New York. Last observation is October 2018. the Euro Area, the most important source of C. Shaded areas indicate recessions, as identified by the National Bureau of Economic Research global spillovers, and can impact the outlook for (NBER). Last observation is 2018Q2. D. Debt peaks are defined as the highest value of the private non-financial credit to GDP ratio over EMDEs through trade, confidence, financial- the period 1960Q1 to 2018Q1. Sample includes 15 EMDEs. For China, values are the last observations in 2018Q1. market, and commodity-market channels (World E. Countries must have experienced a currency, systemic banking, or sovereign debt crisis within two years after reaching the peak debt-to-GDP ratio. A slowdown is defined as a 1-percentage-point or Bank 2016). more drop in GDP growth between the two years before and the two years after peak debt-to-GDP ratio. Sample includes 15 EMDEs. F. Blue and red bars show scenarios assuming a 1-percentage-point growth shock in China, in the In all, a 1-percentage-point decline in U.S. growth United States, and the combination of the two. Shocks are applied in the second half of 2019. Based is estimated to translate after one year into a on the vector autoregression model presented in World Bank (2016). Deviations from baseline are all significantly different from zero. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 38 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.19 Productivity revival systemically large economies decelerate (Kose and A sustained revival in productivity growth following cyclical improvements Terrones 2015). For instance, a recession in the in 2017-18 could lead to stronger-than-expected global activity. A United States increases the probability of a global significant productivity gap between leading and lagging firms suggests an untapped potential for existing technologies. recession from 7 percent on an average year to 50 percent. The risk of a global downturn or recession could be magnified as policymakers’ A. Global productivity growth B. Productivity growth in frontier and non-frontier firms ability to respond is constrained by a lack of fiscal and monetary space and by a reduced appetite for coordinated policy responses among major economies. High levels of private and public debt also make EMDEs particularly vulnerable to adverse shocks (World Bank 2018g). The materialization of a global downturn could set back efforts to alleviate extreme poverty— including in Sub-Saharan Africa, where progress Sources: Conference Board, Organisation for Economic Co-Operation and Development, World has been slow in recent years. Bank. A. Labor productivity per person employed. B. Productivity growth for frontier and non-frontier firms of the period 2001-16. The global frontier is Possible productivity revival defined as the top 5 percent of firms in terms of labor productivity levels within each two-digit industry at the start of the period, while non-frontier firms refer to all other firms. Aggregate productivity is calculated as the unweighted average of log labor productivity across firms, which the initial year, Although global downside risks predominate, a 2001, is indexed to 0 and separately for the manufacturing and services sectors. sustained revival in productivity growth following cyclical improvements in 2017-18 could lead to decline in other advanced economy and EMDE stronger-than-expected global activity in coming growth of 0.6 percentage point for both groups. years (Figure 1.19). An acceleration in patent The impact of slower growth in China is around applications and growing investments in half that of a U.S. slowdown for other advanced intangible assets could be tentative signs of such a economies (-0.3 percentage point), but it is revival. Greater connectivity, falling computing comparable for other EMDEs (-0.6 percentage costs, and open software architectures could also point)—and, among them, significantly larger for facilitate the adoption of digital technologies and commodity exporters (-1.2 percentage points). enable less productive firms to catch up with the Slower growth in China tends to dampen technological frontier (Andrews, Criscuolo, and commodity prices, as this country is a primary Gal 2016; OECD 2018). Over the medium term, driver of global demand for industrial breakthroughs in data processing, artificial commodities, especially of metals (World Bank intelligence, and manufacturing could drive 2018b). Critically, a combined 1-percent negative additional productivity-enhancing innovations growth shock in China and the United States (Diamandis and Kotler 2012; Brynjolfsson and would have severe consequences for global growth, McAfee 2014). reducing it by almost 1 percentage point after one year. Should such a risk materialize in the second Economies experiencing faster productivity half of 2019, global per capita growth would drop growth would benefit from additional policy to around 1 percent in 2020, bringing the global room, as the recovery could continue without economy perilously closer to a global recession.1 generating overheating pressures. This could allow for a more gradual pace of monetary policy The probability of a global recession tends to tightening than currently envisioned and facilitate increase noticeably when one or several the necessary restoration of fiscal buffers given higher revenues. A sustained pickup in 1 Global recessions are defined as a decline in world real GDP per productivity could also spur additional capita accompanied by a synchronized deceleration in multiple measures of global activity, including industrial production, trade, investments and trigger virtuous cycle between capital flows, employment, and energy consumption (Kose and capital deepening and growth. Terrones 2015). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 39 FIGURE 1.20 Monetary and fiscal policy in advanced Policy challenges economies Challenges in advanced economies The U.S. policy rate is approaching the point where it may no longer be providing stimulus and is expected to peak at a lower level than in previous tightening cycles, with significantly less room to cut rates. Government Advanced economy monetary policy is expected to debt has become the largest component of debt for advanced economies, gradually become less stimulative, especially in the which can lead to less effective fiscal stimulus during an economic slowdown. United States, where tightening is proceeding more A. U.S. federal funds rate B. Peak and trough of Federal quickly than elsewhere partly in response to pro- Reserve policy rates in previous cyclical fiscal easing. Advanced economies should use cycles this period of above-potential growth to create the room to respond to future cyclical shocks. Longer-term prospects remain subdued and could be further eroded by major shifts in trade and immigration policies. Monetary and nancial policies The U.S. Federal Reserve is gradually removing C. Debt in advanced economies D. Fiscal multiplier, by level of fiscal stimulus in response to low unemployment and space near-target inflation amid pro-cyclical fiscal stimulus. In contrast, the European Central Bank and the Bank of Japan have signaled that they will be holding policy rates at current levels in the near term. For the first time since the financial crisis, the main U.S. policy rate is approaching its neutral level (Figure 1.20). However, the policy rate is Sources: Federal Reserve Bank of St. Louis; Board of Governors of the Federal Reserve System; expected to peak at about 3 percent, meaning the Haver Analytics; Holston, Laubach, and Williams (2016); Huidrom et al. (2016); Institute of International Finance; National Bureau of Economic Research; World Bank. Federal Reserve has significantly less room to cut A. The effective rate is the mid-range of the federal funds target rates. The long-run estimate is the rates before reaching the zero lower bound should federal funds rate that would be expected to prevail in the absence of shocks to the economy, as assessed by members of the Federal Open Market Committee. The neutral rate is the nominal short- a new downturn occur—in the last three term interest rate consistent with the economy operating at its full potential once transitory shocks have abated, and is estimated according to Holston, Laubach, and Williams (2016). Shaded area downturns, the Federal Reserve cut its policy rate indicates forecasts. Last observation is 2018Q3 for the effective rate and long-run estimate, and 2018Q2 for the neutral rate. by about 5 percentage points. B. Bars represent the peak policy rates in the four months prior the official recession dates of the National Bureau of Economic Research, and the trough policy rate in the subsequent expansion. C. Aggregates calculated using current U.S. dollar GDP weights. Sample includes: Australia, Canada, To varying degrees, central banks in other Denmark, Finland, the Euro Area, Japan, New Zealand, Norway, Sweden, Switzerland, the United States, and the United Kingdom. Last observation is 2018Q2. advanced economies currently have even less D. Figure shows fiscal multipliers 1 year on at different levels of fiscal space. These are based on estimates from the IPVAR model of Huidrom et al. (2016). A country is considered to have “wide” policy space. While unconventional monetary fiscal space if it is in the lowest quartile of advanced economies for government debt, and to have policies could again be deployed, their “narrow” fiscal space if it is in the highest quartile. Orange lines represent the 16-84 percent confidence bands. effectiveness in returning inflation to target and supporting growth is subject to debate (Bernanke 2017a; Engen, Laubach, and Reifschneider 2015; Fiscal policy Greenlaw et al. 2018). This lack of monetary In many advanced economies, government debt- space highlights the importance of avoiding a to-GDP ratios have reached unprecedented levels, policy-driven downturn in activity, combined becoming the largest component of debt. This with research into alternative methods of limits the capacity of countries to provide counter- providing monetary policy stimulus (Bernanke cyclical fiscal stimulus in response to economic 2017b, Williams 2017). slowdowns (Huidrom et al. 2016). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 40 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.21 Structural policies in advanced economies could also worsen fiscal positions, by dampening growth and the net contribution that immigrants Potential growth is expected to decelerate in advanced economies, partly due to demographic factors. This deceleration is likely to be more severe if typically provide to the government budget government policies lead to heightened restrictions on immigration, as (Clements et al. 2015). immigrants tend to be younger than the native population. Recent trade disputes represent a critical headwind A. Potential growth in advanced B. Immigrant versus native population to longer-term prospects. Rising tariffs may economies age distribution to OECD destinations already be contributing to weaker productivity by increasing costs, disrupting global supply chains, stranding productive assets, and relocating activity away from the most efficient locations (Melitz 2003). Lack of policy clarity also risks causing firms to delay investment because of uncertainty over market access. This highlights the importance of a continued commitment to a rules-based international trading system. Sources: Organisation for Economic Co-operation and Development, World Bank. A. TFP = total factor productivity growth. Figure shows potential growth estimates based on the Increasing restrictions to trade and immigration production function approach. For further details on potential growth estimates, refer to the January 2018 edition of the Global Economic Prospects report. Aggregates calculated using constant 2010 could therefore result in weaker growth and lower U.S. dollar GDP weights. Sample includes 30 advanced economies. B. "Working age" includes population aged 25-64 years, "dependents" includes population aged productivity. While international trade and 0-24 and above 65 years. Country-level age proportions are weighted by size of the immigrant population. Data are from the 2010-11 OECD Database on Immigrants in OECD and Non-OECD immigration can impose costs on some sectors of countries (DIOC-E). the economy or vulnerable groups of workers, a better course is to adopt policies that mitigate these costs and redistribute more equitably the The significant U.S. fiscal stimulus has been benefits of globalization. enacted when the economy is already at or above full employment and is expected to result in Challenges in emerging market and persistent deficits equivalent to about 5 percent for developing economies most of the next decade (CBO 2018). In these circumstances, the consequence of pro-cyclical Recent financial market stress in some EMDEs stimulus is likely to be inflation pressures, higher highlights the need to strengthen buffers against the domestic interest rates, a crowding out of private risk of less favorable global financial conditions. sector activity, and a widening of the U.S. current Fiscal positions remain fragile, underscoring the account deficit. urgency to improve domestic revenue mobilization and to commit to or deepen fiscal reforms aimed at Structural policies controlling expenditures. In the longer-term, steps to enhance human capital, encourage regional economic Potential growth remains subdued in advanced integration, and lower barriers to investment for economies and is likely to slow further in coming small- and medium-sized enterprises would boost years, partly due to aging populations and potential growth and help tackle challenges associated declining birth rates (Figure 1.21; World Bank with high informality. China’s key policy challenge is 2018g). An increasing number of countries are to foster the transition to more sustainable growth raising barriers to immigration, which might while dealing with trade-related headwinds without hasten this deceleration. Immigration is an overstimulating the economy and delaying the important reason for rising labor forces in many deleveraging process. advanced economies and may also contribute to productivity growth; immigrants skew younger Policy challenges in China than host populations, and younger populations have been associated with faster labor productivity Authorities in China have shifted to looser growth for various industries and occupations monetary and fiscal policies in response to a more (World Bank 2018j; Maestas, Mullen, and Powell challenging external environment, including 2016). Heightened restrictions on immigration heightened trade tensions. They have cut reserve EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 41 requirements, introduced new tax breaks for FIGURE 1.22 EMDE monetary policy financial institutions lending to small firms, and Monetary and financial policy challenges have been compounded by encouraged banks to buy more local government recent financial market pressures. Policy interest rates and inflation ticked bonds. They have also reduced taxes and fees, up in EMDEs facing above-average currency depreciation against the U.S. dollar in 2018. The share of EMDEs hiking policy rates during U.S. increased export tax rebates, and accelerated tightening cycles is markedly higher than the share of EMDEs cutting rates issuance of special purpose local government during U.S. easing periods, suggesting that ongoing U.S. normalization bonds to bolster infrastructure spending. In may constrain the room of maneuvering of many EMDE central banks. Higher borrowing costs contributed to an increase in sovereign bond addition, the authorities have stepped up their spreads, especially in EMDEs with large current account deficits. structural reform efforts to improve the business environment, including for foreign firms, and A. Policy interest rates, by extent of B. Inflation, by extent of currency have lowered tariffs on imports—with the critical currency depreciation against the U.S. depreciation against the U.S. dollar dollar exception of tariffs on U.S. imports in retaliation to U.S. tariffs on China’s goods. The trade disputes with the United States, and the ongoing moderation of global trade, highlight China’s key economic policy challenge—namely, how to confront trade-related headwinds with supportive policy actions that avoid overstimulating the economy and delaying the deleveraging process, while fostering the transition C. Share of policy interest rate D. Change in sovereign bond spreads, to more sustainable growth (World Bank 2018a). changes following U.S. policy rate by extent of current account deficit in This will require continued reforms to reduce hikes or cuts 2018 financial vulnerabilities, including those associated with the accumulation of non-financial enterprise debt. Additional efforts to enhance market competition, encourage a shift of capital and labor toward more productive firms and sectors, and bolster household consumption would also be needed (World Bank 2018k). Advancing reforms that boost innovation, including through stronger intellectual property rights, would also help Sources: Haver Analytics, International Monetary Fund, J.P. Morgan, Shambaugh (2004), World Bank. alleviate trade frictions while enhancing China’s A.B. The above average and below average currency depreciation groups are defined by countries above or below the sample average of the year-to-date percent change in the bilateral exchange rate competitiveness in the medium term. In addition, against the U.S. dollar. The sample average is -9.3 percent and includes 27 EMDEs, of which 11 are productivity-enhancing investments in health, above and 16 are below average. Last observation is October 2018. A. The aggregate policy interest rates are calculated using constant 2010 U.S. dollar GDP weights. education, and research and development would B. Median consumer price inflation for each group. C. Pegged exchange rates are defined, based on a de facto classification, as exchange rates encourage a shift from growth that is dependent fluctuating within a +/-2 percent band or, at most, a one-time devaluation over the preceding 11- month period relative to a country-specific reference currency. Refer to Shambaugh (2004) for details. on physical capital and help offset the impact of Unbalanced sample includes 108 non-LIC EMDEs and considers policy rate actions from 1970 adverse demographic trends. onwards. Last observation is October 2018. D. The above average and below average current account deficit groups are defined by countries above or below the 2018 sample average of the current account balance. The sample average is -1.6 EMDE monetary and nancial policies percent of GDP. The sovereign bond spread is measured by J.P. Morgan Emerging Market Bond Index (EMBI). Sample includes 38 EMDEs. Last observation is November 2018. Policy challenges across many EMDEs have been compounded by recent financial market pressures generally, monetary policy became less that have been associated with sizable currency accommodative in EMDEs that faced above- depreciations and capital outflows. Among some average currency depreciation, or that used up key EMDEs, currency and financial market reserves to stem it (Figure 1.22). pressures were substantial (e.g. Argentina, Turkey), leading to significant policy tightening Weaker exchange rates have pushed up inflation and markedly clouding the near-term across many EMDEs, particularly in some key macroeconomic and financial outlook. More commodity exporters, highlighting the role of the EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 42 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 exchange rate pass-through to domestic prices (e.g. exposures to foreign currency borrowing and Argentina, Brazil, Chile, South Africa; World currency mismatches, as appropriate, can help Bank 2018l). Among commodity importers, price contain the financial system’s vulnerability to pressures also reflect their cyclical positions, as dislocating exchange rate movements (Ahnert suggested by their positive output gaps. Higher et al. 2018). For EMDEs that have made progress energy prices in most of 2018 also pushed up on macroprudential reforms, enhancing financial inflation in a number of net oil importers (e.g., deepening and improving governance could Kenya, Mexico). further boost resilience to shocks (Sahay et al. 2015). The ongoing normalization of advanced-economy monetary policy will continue to pose challenges EMDE policymakers also need to uphold a for EMDEs (Arteta et al. 2015; Obstfeld 2015; credible commitment to medium-term price Sobrun and Turner 2015). In particular, U.S. stability, which can be supported by tightening cycles spillover to EMDEs mainly macroeconomic frameworks that set attainable through the availability of foreign credit, especially inflation targets where appropriate, as well as through portfolio bond flows (Bräuning and maintain strong institutional independence and Ivashina 2018; Koepke 2018). Moreover, the transparency. This will be especially critical if the share of EMDEs hiking policy rates during U.S. ongoing period of low and stable global inflation tightening cycles is markedly higher than the share came to an end, perhaps driven by a slowdown or of EMDEs cutting rates during U.S. easing rollback of the structural factors that have held periods, suggesting that ongoing U.S. inflation at bay in recent decades—in particular, normalization may constrain the room of trade and financial integration—or an erosion of maneuvering of a large number of EMDE central central bank independence. The reversals of these banks. These challenges will be greater for those long-term trends could coincide with cyclical countries with large external vulnerabilities, such upward pressures on prices in EMDEs, reigniting as sizable current account imbalances, weak inflation (Box 1.1). foreign reserves, and high inflation or external debt (Iacoviello and Navarro 2018). In addition, EMDE scal policy higher borrowing costs may cause balance sheet, Government finances in many EMDEs are in a debt service, and rollover difficulties for some fragile position, with deteriorating debt dynamics EMDE sovereigns and corporates, which could and limited fiscal space. In some cases, much undermine financial stability (Borensztein and Ye needed reforms to improve fiscal space have either 2018; World Bank 2018i). These may be stalled or not been fully implemented, while particularly acute in economies facing currency funding new or increasing liabilities, such as mismatches on corporate and household balance public wage bills, have put further strain on sheets (Davies et al. 2014). domestic revenues (e.g., Brazil, South Africa). To confront these challenges, EMDE authorities Oil exporters continue to face fiscal sustainability need to address persistent vulnerabilities that challenges, with recent oil price volatility render their countries more susceptible to tighter highlighting the need for these countries to financing conditions, capital flow reversals, and continue to reduce their reliance on oil revenues financial market shocks. This includes shoring up by deepening reforms that bolster the non- the financing of current account deficits to reduce resource budget (e.g., Ecuador, Russia; IMF the effects of net portfolio flow reversals, 2018d). In metals and agricultural producers, improving public and corporate balance sheet weaker-than-envisaged commodity prices could management, and implementing macroprudential put further pressure on already fragile public frameworks that bolster banking and corporate finances (e.g., South Africa, Zambia). Among sector resilience, such as countercyclical capital commodity importers, for the first time since the buffers and stricter reserve ratio or leverage ratio oil price collapse that began in 2014, fiscal deficits requirements (Cerutti, Claessens, and Laeven are projected to be larger as a share of GDP than 2015; Forbes 2018). In addition, reducing those in commodity exporters, as waning revenue EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 43 growth continues to be accompanied by strong FIGURE 1.23 EMDE fiscal policy expenditure growth (Figure 1.23). For the first time in several years, fiscal deficits are projected to be wider in commodity importers than in commodity exporters. Government debt is Across EMDEs, rising global interest rates will rising among EMDEs with high foreign-currency-denominated debt or make financing fiscal deficits through sovereign persistent current account deficits. In low-income countries, the cost of debt issuance more costly, underscoring the need servicing debt has risen as the composition has moved from concessionary to market financing. Greater government effectiveness is to realign government spending with revenue and associated with stronger tax revenue collection. to manage the composition of debt, particularly in countries with elevated foreign-denominated debt A. Fiscal deficits B. Fiscal sustainability gaps, by or persistent current account deficits (Du and extent of reliance on foreign- currency-denominated debt Schreger 2016). In a rising global interest-rate environment, employing expansionary fiscal policy with narrow fiscal space can amplify vulnerabilities by increasing market perceptions of sovereign credit risk, which may lead to higher sovereign bond yields and borrowing costs (Corsetti et al. 2013; Bi, Shen, and Yang 2014). LICs are more vulnerable to rising global financial costs than in the past, as LIC debt has increasingly shifted from concessionary to market financing (Chapter 4; C. Interest rate payments on debt in D. Tax revenues, by extent of LICs government effectiveness World Bank 2018i). More generally, EMDE governments with high private-sector debt are exposed to contingent liabilities if banking sector stress materializes in a rising interest rate environment (World Bank 2018g). Regaining policy buffers should be a key priority to be able to use countercyclical fiscal policy to stabilize growth (World Bank 2015). Efforts to build fiscal space could include implementing Sources: Haver Analytics, International Monetary Fund, Kose et al. (2017), World Bank. credible medium-term expenditure or deficit A.C.D. Figures show medians across groups. A. Shaded area indicates forecasts. Sample includes 155 EMDEs. targets, better managing contingent liabilities to B. FC debt = foreign-currency-denominated debt. The sustainability gap is measured as the contain fiscal risks, stabilizing debt, and reforming difference between the primary balance and the debt-stabilizing primary balance, assuming historical median (1990-2016) interest rates and growth rates. A negative gap indicates government debt is the tax system to improve domestic resource rising along an accelerated trajectory. The aggregates are calculated using constant 2010 U.S. dollar GDP weights. The sample includes 27 EMDEs. The above average and below average foreign- mobilization and the investment climate—e.g., currency denominated debt groups are defined by countries above or below the sample average of external debt in foreign currency as a share of total external debt in 2017. The sample average is adjusting statutory rates, broadening bases, 86.9 percent of GDP. C. Interest rate payments include those made on government debt to domestic and foreign residents. eliminating loopholes and exemptions, and Solid line represents median and area between the dashed lines represents the interquartile range. improving tax administration and compliance. The sample includes 30 low-income countries and excludes Somalia, South Sudan, and Syria due to data restrictions. Managing the composition of debt can also help D. Government effectiveness measured by the Worldwide Governance Indicators. Higher government effectiveness are EMDEs with 2000-17 averages above 0 (stronger governance); lower address public-sector balance sheet are EMDEs with 2000-17 average government effectiveness below 0 (weaker governance). Unbalanced sample includes 150 EMDEs. vulnerabilities—for EMDEs with elevated foreign- currency debt, bolstering domestic-currency bond markets, if feasible, could help stem rollover and spending on quality investment and safeguarding currency risks. poverty-reducing social transfers, while reining in To complement these efforts, improving programs that are unproductive or inefficient government effectiveness and strengthening (World Bank 2018g; World Bank 2018m). institutions would support tax revenue collection EMDE fiscal policymakers also need to confront (Ajaz and Ahmad 2010; Prichard 2010). If fiscal the longer-term challenges posed by high adjustment remains necessary to ensure long-term informality, as its prevalence in some regions fiscal sustainability, policymakers need to evaluate reduces government revenues through tax base the efficacy of public expenditures, prioritizing erosion (Chapter 3). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 44 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 1.24 EMDE structural policies EMDE structural policies Learning-adjusted years of schooling are a good predictor of growth EMDEs also face substantial longer-term performance in EMDEs. Greater trade integration, as well as lower barriers to investment in small- and medium-sized enterprises, could help boost challenges to ensure sustained improvements in productivity in EMDEs. Informality remains prevalent in EMDEs and is incomes and living standards amid rapid generally associated with large productivity gaps between formal and technological and demographic changes. Meeting informal sectors. these challenges will require, among other actions, A. Link between education measures B. Average productivity growth since effective investments in human capital, efforts to in 2000 and GDP growth in 2000-16 2000, by gross exports to GDP ratio accelerate regional and global integration, and measures to free up a large untapped potential for growth and productivity gains among small- and medium-sized enterprises. Progress in these areas would also help bring people and companies out of informality. Improving human capital Under-investment in human capital has left large C. Productivity level by firm size D. Share of fixed capital spending parts of the workforce in EMDEs unprepared for financed by retained earnings rapid technological changes and future skill requirements (Flabbi and Gatti 2018). This represents a significant bottleneck to growth in many countries. Moreover, continued divergences in the demand for high- and low-skilled labor could exacerbate income inequality over time. How education systems adapt to skills needs will be a key determinant of the productivity and distributional effects of technological change E. Share of informal activity F. Average productivity in formal and (Barro and Lee 2015). informal firms Improving student learning is particularly important, starting with an effective measurement of the performance of education systems. Measures that capture both the quantity and quality of learning, such as learning-adjusted years of schooling, reflect relevant dimensions of success and are better predictors of subsequent growth across EMDEs (Figure 1.24; Filmer et al. 2018). A Sources: Ayyagari, Demiguc-Kunt, and Maksimovic (2017); Borensztein and Ye (2018); Filmer et al. focus on both schooling participation and learning (2018); International Monetary Fund; Organisation for Economic Co-Operation and Development; United Nations; World Bank. results can more properly inform policy actions A. LAYS = learning-adjusted years of schooling. Figure shows regression of three measures of education in 2000—LAYS, average years of schooling, and average test score—on average GDP and support effective investments in human growth over the period 2000-16 across EMDEs. Test scores are from the mathematics assessment of the 1999 Trends in International Mathematics and Science Study (TIMSS) and 2000 Program for capital (World Bank forthcoming). International Student Assessment (PISA). Regression conditioned on original GDP per capita levels. B. Above average and below average indicate above and below average changes in gross exports to Beyond a heightened focus on learning outcomes, GDP ratios over the period 2000-14. C. Productivity is defined as the value-added per person employed, measured in thousands of U.S. a comprehensive approach to human capital dollars in current PPP terms. Data as of 2015, or latest available year. Advanced economies include Austria, Denmark, Finland, France, Germany, Italy, Netherlands, Spain, Sweden, United Kingdom. improvements in EMDEs should also address EMDEs include Brazil, Hungary, Mexico, Poland, and Turkey. D. Proportion of the purchase of fixed assets financed by internal funds or retained earnings. other dimensions, including malnutrition and E. Unweighted averages, in percent of official GDP. Estimates of informal output derived from a health throughout the life cycle. In this context, a deterministic dynamic general equilibrium model, as described in Chapter 3. F. Blue bars represent estimates and orange vertical lines indicate two standard deviation error human capital index has recently been developed bands. World Bank’s Enterprise Survey data for 135 countries (2008-18). Labor productivity is proxied by annual sales per worker. to assess productivity gains that could be achieved by matching education and health outcomes to best practices (Kraay 2018). This benchmarking EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 45 exercise helps to identify areas of intervention to conducive to greater GVC integration. Although improve public spending and governance in their participation has nearly doubled during the education and health systems—and to raise last two decades, LICs still have little presence in awareness of the costs of inaction (World Bank GVCs, accounting for about 11 percent of the 2018n). world total. Participation is hindered by domestic capacity constraints and restrictive trade and The urgency to bolster human capital comes in a investment regimes. Tariffs and other barriers to period of constrained public-sector resources and trade increase costs for firms, reduce their ability elevated debt levels, creating a notable policy to access foreign inputs, and can impede the challenge. Accordingly, more effective spending in development of downstream industries (Miroudot, education and health will need to be accompanied Rouzet, and Spinelli 2013). Reducing these by renewed efforts to priorities government barriers remains a key priority to support GVC spending, improve efficiency of public participation, and to increase trade gains for many administrations and revenue mobilization, and EMDEs (Kowalski at al. 2015). Closer physical encourage private sector participation. integration of transport networks and other Boosting regional and international integration regional infrastructures can also help reduce the cost of trade and support increased openness If faced with growing protectionist measures, (Donaldson 2018). policymakers in EMDEs may be tempted to resort to retaliatory action or unilateral increases in That said, increased international integration and barriers to trade. While such measures could help participation in GVCs does not guarantee positive recapture some of their terms-of-trade losses, an and sustainable development outcomes for increase in trade barriers would likely lead to EMDEs. Targeted policies that encourage the significant distortionary effects and efficiency upgrading of domestic production are crucial in losses for EMDEs (Devarajan et al. 2018). Instead, ensuring that the social and development impacts continued commitment to regional and of GVC activities are optimized (Taglioni and international integration through trade Winkler 2016; Fessehaie and Morris 2018). liberalization, properly designed free trade Untapping SMEs growth potential agreements, and participation in global value chains (GVCs) within an open and rules-based Supported with appropriate frameworks, small- multilateral trading system could yield significant, and medium-sized enterprises (SMEs) can be key previously untapped benefits for EMDEs. The call drivers of growth and job creation in EMDEs of G20 members to consider additional reform of (Ayyagari, Demirgüç-Kunt, and Maksimovic the World Trade Organization could be a chance 2017). They can play a central role in industrial to maximize development opportunities for development and restructuring, support larger EMDEs. firms with inputs and services, and allow increased sectoral specialization. However, their growth International integration enables firms of all sizes potential continues to be hindered by many to increase their participation in international factors, including insufficient access to finance; tax trade. In particular, participation in GVCs helps and regulatory burdens; skills mismatch; limited companies specialize in tasks closely aligned with access to infrastructure, particularly electricity; and their comparative advantage and can contribute to corruption (Wang 2016). Alleviating those a more efficient allocation of resources, job obstacles could lead to significant growth windfalls creation, and export diversification. In turn, for EMDEs, given that SMEs have the largest increased trade openness and GVC integration untapped potential for productivity catch-up with boost productivity growth and helps the diffusion advanced economies (Cusolito, Safadi, and of technologies (Elms and Low 2013; Criscuolo, Taglioni 2017). Supporting SMEs development Timmis, and Johnstone 2016). could also help reduce high informality in some Many EMDEs and LICs, however, still face regions, which is most prevalent among micro- important challenges in fostering an environment enterprises. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 46 C H A P TE R 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 Limited access to finance is most often cited as a developed regions, with South Asia and Sub- key obstacle to SMEs’ growth in EMDEs, forcing Saharan Africa accounting for nearly 60 percent of these companies to rely on retained earnings to all informal workers in EMDEs. It is also elevated fund investment. This leads to sub-optimal capital in regions with weak institutions and high levels of spending and an unrealized potential for taxation and regulation, such as Latin America and expansion and job creation. Key obstacles include the Caribbean and Europe and Central Asia. the lack of reliable credit information, the absence While the informal economy provides an of suitable collateral, or weak legal institutions. Increasing SMEs’ access to finance could help important safety net to workers, particularly during downturns, it can dampen growth by boost their average size and support innovation and job creation (Ayyagari, Demirgüç-Kunt, and weighing on physical and human capital Maksimovic 2017; Ayyagari et al. 2016). formation (Oviedo et al. 2009; 2011; Docquier et al. 2017). In particular, firms operating in the Improved access to finance for women entrepreneurs could also lead to more investment, informal economy tend to limit their size to avoid detection and use less advanced production while access to savings account for female-headed households could result in additional spending on technologies (Dabla-Norris et al. 2018). Their education (Sahay and Cihak 2018; Demirgüç- lack of compliance with regulations and taxes may help them stay in business despite low Kunt et al. 2018). Bankruptcy protection laws also lag international best practices in many EMDEs. productivity (Schneider and Enste 2000; La Porta and Shleifer 2014; Box 3.4). Historical experience suggests that strengthening bankruptcy protection can boost investment High informality can also limit fiscal revenues and activity and facilitate responsible corporate risk- thus can constrain the government’s ability to taking, helping to relieve the costs of debt provide public services, conduct countercyclical overhang (Gopalan, Mukherjee, and Singh 2016; policies, and implement effective redistributive World Bank 2014). measures (Box 3.5; Ordóñez 2014; Besley and Beyond basic education, technological know-how, Persson 2014). Both government revenues and expenditures are lower in EMDEs where managerial capabilities, and tolerance for risk are also key factors underlying successful informality is widespread. High informality is entrepreneurship and vibrant firm dynamics often associated with lack of development, limited access to finance, low human capital, poor (Cusolito and Maloney 2018). Framework conditions that encourage experimentation and do governance, and heavy regulatory burdens. If properly designed, policies that help improve not penalize failure are crucial to support the upgrading firm capabilities and diffusion of outcomes in those areas would contribute to technological progress. Tax, registration, and other bolster growth prospects and encourage workers to participate in the formal economy, thus helping administrative simplifications can also be successful tools to facilitate SME’s creation and reduce informality and its associated challenges. expansion (Bruhn 2011). Finally, restrained access Policies that are implemented with other purposes to infrastructure, particularly electricity, is often in mind also need to take into consideration the mentioned as a major barrier to the development unintended consequences on informality. For of SMEs and start-up companies in many example, changes in labor market regulation EMDEs, especially in Sub-Saharan Africa. accompanying the decentralization of minimum Improvements in both traditional power line wages or the liberalization of trade have resulted in supplies and off-grid solutions such as solar energy higher informality in some countries (Goldberg and micro grids need to be achieved in tandem, and Pavcnik 2003; Attanasio, Goldberg and supported by proper policy incentives and effective Pavcnik 2004, Chapter 3, Box 3.4). These regulations (World Bank 2017). experiences are a reminder of the need to design comprehensive reform packages that are calibrated Growing out of informality to country circumstances. Informality remains widespread in many EMDEs (Chapter 3). It is particularly prevalent in less EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 47 TABLE 1.2 List of emerging market and developing economies1 Commodity exporters2 Commodity importers3 Albania* Madagascar Afghanistan Panama Algeria* Malawi Antigua and Barbuda Philippines Angola* Malaysia* Bahamas, The Poland Argentina Mali Bangladesh Romania Armenia Mauritania Barbados Samoa Azerbaijan* Mongolia Belarus Serbia Bahrain* Morocco Bhutan Seychelles Belize Mozambique Bosnia and Herzegovina Solomon Islands Benin Myanmar* Bulgaria Sri Lanka Bolivia* Namibia Cabo Verde St. Kitts and Nevis Botswana Nicaragua Cambodia St. Lucia Brazil Niger China St. Vincent and the Grenadines Burkina Faso Nigeria* Comoros Thailand Burundi Oman* Croatia Tunisia Cameroon* Papua New Guinea Djibouti Turkey Chad* Paraguay Dominica Tuvalu Chile Peru Dominican Republic Vanuatu Colombia* Qatar* Egypt Vietnam Congo, Dem. Rep. Russia* El Salvador Congo, Rep.* Rwanda Eritrea Costa Rica Saudi Arabia* Eswatini Côte d’Ivoire Senegal Fiji Ecuador* Sierra Leone Georgia Equatorial Guinea* South Africa Grenada Ethiopia Sudan* Haiti Gabon* Suriname Hungary Gambia, The Tajikistan India Ghana* Tanzania Jamaica Guatemala Timor-Leste* Jordan Guinea Togo Kiribati Guinea-Bissau Tonga Lebanon Guyana Trinidad and Tobago* Lesotho Honduras Turkmenistan* Macedonia, FYR Indonesia* Uganda Maldives Iran* Ukraine Marshall Islands Iraq* United Arab Emirates* Mauritius Kazakhstan* Uruguay Mexico Kenya Uzbekistan Micronesia, Fed. Sts. Kosovo Venezuela* Moldova, Rep. Kuwait* West Bank and Gaza Montenegro Kyrgyz Republic Zambia Nepal Lao PDR Zimbabwe Pakistan Liberia Palau * Energy exporters. 1 Emerging market and developing economies (EMDEs) include all those that are not classified as advanced economies. Dependent territories are excluded. Advanced economies include Australia; Austria; Belgium; Canada; Cyprus; the Czech Republic; Denmark; Estonia; Finland; France; Germany; Greece; Hong Kong SAR, China; Iceland; Ireland; Israel; Italy; Japan; the Republic of Korea; Latvia; Lithuania; Luxembourg; Malta; Netherlands; New Zealand; Norway; Portugal; Singapore; the Slovak Republic; Slovenia; Spain; Sweden; Switzerland; the United Kingdom; and the United States. 2 An economy is defined as commodity exporter when, on average in 2012-14, either (i) total commodities exports accounted for 30 percent or more of total goods exports or (ii) exports of any single commodity accounted for 20 percent or more of total goods exports. Economies for which these thresholds were met as a result of re-exports were excluded. When data were not available, judgment was used. 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Interview with Börsen-Zeitung, Report 2018: Piecing Together the Poverty Puzzle. May 22, 2018. Washington, DC: World Bank. Cecchetti, S. G., and S. Krause. 2002. “Central Bank World Bank. 2018i. Global Economic Prospects: e Structure, Policy E ciency, and Macroeconomic Turning of the Tide? June. Washington, DC: World Performance: Exploring Empirical Relationships.” Bank. Federal Reserve Bank of St. Louis Review 84 (4): 47-60. World Bank. 2018j. Moving for Prosperity: Global Ciccarelli, M., and B. Mojon. 2010. “Global Migration and Labor Markets. Policy Research Report. In ation.” e Review of Economics and Statistics 92 (3): Washington, DC: World Bank. 524-535. Cline, W. R. 1981. World In ation and the Developing World Bank. 2018k. China – Systematic Country Countries. Washington, DC: Brookings Institution. Diagnostic: Towards a More Inclusive and Sustainable Development. Washington, DC: World Bank. Dincer, N., and B. Eichengreen. 2014. “Central Bank Transparency and Independence: Updates and New World Bank. 2018l. In ation in Emerging and Measures.” International Journal of Central Banking 10 Developing Economies: Evolution, Drivers and Policies. (1): 189-259. Washington, DC: World Bank. Draghi, M. 2015. “Global and Domestic In ation.” World Bank. 2018m. Fiscal Adjustment in Latin Speech at the Economic Club of New York, December America and the Caribbean: Short-Run Pain, Long-Run 4. Gain? Washington, DC: World Bank. Fischer, S. 2015. “Global and Domestic In ation.” World Bank. 2018n. e Human Capital Project. Speech at Crockett Governors’ Roundtable 2015 for Washington, DC: World Bank. African Central Bankers, University of Oxford, Oxford. World Bank. 2019. Forthcoming. World Development Ha, J., A. Ivanova, F. Ohnsorge, F. Unsal. 2019a. Report 2019: e Changing Nature of Work. “In ation: Concepts, Evolution and Correlates.” In Ha, Washington, DC: World Bank.\ J., M. A. Kose, and F. Ohnsorge (eds). 2019 In ation in Emerging and Developing Economies: Evolution, Box 1.1 references Drivers and Policies. Washington, DC: World Bank. Arteta, C., M. A. Kose, F. Ohnsorge, and M. Stocker. Ha, J., M. A. Kose, and F. Ohnsorge. 2019. In ation in 2015. “ e Coming U.S. Interest Rate Tightening Emerging and Developing Economies: Evolution, Drivers Cycle: Smooth Sailing or Stormy Waters?” Policy and Policies. Washington, DC: World Bank. Research Note 2, World Bank, Washington, DC. Ha, J., M. A. Kose, F. Ohnsorge, H. Yilmazkuday. 2019. “Understanding Global In ation Baldwin, R. 2018. “Trump Can’t Fix a 21st Century Synchronization.” In Ha, J., M. A. Kose, and F. Problem with 20th Century inking”, VoxEU.org, Ohnsorge (eds). 2019. In ation in Emerging and CEPR Policy Portal, 27 September 2018. Developing Economies: Evolution, Drivers and Policies. Bernanke, B. S. 2007. “Globalization and Monetary Washington, DC: World Bank. Policy,” Speech at the Fourth Economic Summit, Ha, J., M. Stocker, and H. Yilmazkuday. 2019. Stanford Institute for Economic Policy Research, “In ation and Exchange Rate Pass- rough.” In Ha, J., Stanford, CA. M. A. Kose, and F. Ohnsorge. 2019. In ation in Emerging and Developing Economies: Evolution, Drivers Bordo, M. D., and A. Orphanides. 2013. e Great and Policies. Washington, DC: World Bank. In ation: e Rebirth of Modern Central Banking. Chicago: University of Chicago Press. IMF (International Monetary Fund). 2018. “Challenges for Monetary Policy in Emerging Markets Bown, C. 2018. “Protectionism Was reatening as Global Financial Conditions Normalize.” Chapter in Global Supply Chains Before Trump.” VoxEU.org, World Economic Outlook. Washington, DC: CEPR Policy Portal, October 30 2018. International Monetary Fund. Carney, M. 2015. “In ation in a Globalised World.” Johnson, R., and G. Noguera. 2017. “A Portrait of Remarks at the Economic Policy Symposium, Federal Trade in Value Added over Four Decades.” Review of Reserve Bank of Kansas City, Jackson Hole, August 29. Economics and Statistics 99 (5): 896-911. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 1 55 Kose, H. Matsuoka, U. Panizza, and D. Vorisek. 2019. World Bank. 2018. Global Economic Prospects: e “In ation Expectations: Review and Evidence.” In Ha, Turning of the Tide? June. Washington, DC: World J., M. A. Kose, and F. Ohnsorge (eds). 2019 In ation Bank. in Emerging and Developing Economies: Evolution, Wyplosz, C., 2012. Fiscal rules: eoretical issues and Drivers and Policies. Washington, DC: World Bank. historical experiences. In Fiscal Policy after the Financial Kose, M. A., and M. Terrones. 2015. Collapse and Crisis (pp. 495-525). University of Chicago Press. Revival: Understanding Global Recessions and Recoveries. Washington, DC: International Monetary Fund. Box 1.2 references Kose, M. A., C. Otrok, and E. Prasad. 2012. “Global Burger, M. J., and E. I. Ianchovichina. 2017. “Surges Business Cycles: Convergence or Decoupling?” and Stops in Green eld and M&A FDI Flows to International Economic Review 53 (2): 511-538. Developing Countries: Analysis by Mode of Entry.” Review of World Economics 153 (2): 411-432. Kose, M. A., E. Prasad, K. Rogo and S.-J. Wei. 2010. “Financial Globalization and Economic Policies.” In IMF (International Monetary Fund). 2018. “Capital Rodrik, D. and M. Rosenzweig (eds). 2010. Handbook Flows to Sub-Saharan Africa: Causes and of Development Economics, 5: 4283-4362, e Consequences.” In Sub-Saharan Africa Regional Netherlands: North-Holland. Economic Outlook: Capital Flows and the Future of Work. Washington, DC: International Monetary Fund. Rogo , K. 2003. “Globalization and Global Disin ation.” Federal Reserve Bank of Kansas City UNCTAD (United Nations Conference on Trade and Economic Review 88 (4): 45-78. Development). 2018. World Investment Report – Investment and New Industrial Policies. Geneva, Rogo , K. 2014. “ e Exaggerated Death of In ation.” Switzerland: UNCTAD. Project Syndicate, September 2. World Bank. 2018a. “Migration and Remittances: Shambaugh, J. C. 2004. " e E ect of Fixed Exchange Developments and Outlook.” In Migration and Rates on Monetary Policy." e Quarterly Journal of Development Brief. Washington, DC: World Bank. Economics 119 (1): 301-352. World Bank. 2018b. “ e Implications of Tari s for Taylor, J. B. 2014. “In ation Targeting in Emerging Commodity Markets.” In Commodity Markets Outlook. Markets: e Global Experience.” Speech at the e Changing of the Guard: Shifts in Industrial Conference on Fourteen Years of In ation Targeting in Commodity Demand. October. Washington, DC: South Africa and the Challenge of a Changing World Bank. Mandate, South African Reserve Bank, Pretoria. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) CHAPTER 2 REGIONAL OUTLOOKS EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) Growth in the East Asia and Pacific region is expected to moderate to a still-robust 6 percent in 2019 and 2020. In China, policies aimed at rebalancing and countering external headwinds will continue to tilt activity toward domestic demand and away from exports. Risks to regional growth are to the downside and have intensified, including the possibility of further escalation of trade restrictions and faster-than-expected tightening of global financing conditions. Countries most vulnerable to disruptions in global trade and financial market activity are those with high debt, elevated current account deficits and high exposure to portfolio and bank inflows, and significant reliance on exports. Recent developments but less than during the last two financial stress episodes and less than the EMDE average, Growth in the East Asia and Pacific (EAP) region reflecting continued strong investor confidence is estimated to have slowed to 6.3 percent and toward these economies. momentum has weakened in 2018, reflecting China has been implementing measured monetary diminishing support from exports partly offset by and fiscal easing policies in anticipation of slowing robust domestic demand (Figure 2.1.1; Table export growth amid trade tensions, while at the 2.1.1). External conditions have deteriorated, same time making progress at reducing growth in reflecting moderating global demand, escalating non-bank financing. In contrast, several countries, trade tensions, and a substantial tightening of such as Indonesia and the Philippines, have financing conditions. This less favorable stemmed capital outflows by tightening monetary international environment has been accompanied policy. Most EAP countries have taken advantage by financial stress in some large emerging market of flexible exchange rates, which has allowed their and developing economies (EMDEs). currencies to act as shock absorbers during times Several large economies in the region have faced of stress. Indonesia has also implemented measures some combination of capital outflows, currency to curb imports while taking steps to increase coal depreciations, equity market corrections, and exports, in an effort to reduce the current account foreign reserve losses (e.g., China, Indonesia, deficit and relieve pressure on the rupiah (World Malaysia, the Philippines, Thailand). In addition Bank 2018a). to country specific factors, the countries most Growth in China is estimated to have slowed to a affected are those with sizable or widening current still robust 6.5 percent in 2018, with resilient account deficits and dependence on volatile domestic demand helping to offset a deceleration portfolio flows, those with relatively high asset of exports (Figure 2.1.2). Consumption has valuations, or those with exposure to trade remained strong and private investment is disputes involving major economies (e.g., China, recovering, partly reflecting the simplification of Indonesia, Myanmar, the Philippines). Bond the approval process for investment projects. In spreads in these countries have generally widened general, policies in China have become more supportive of growth, as authorities attempt to offset the effects of new trade restrictions with the Note: e author of this section is Ekaterine Vashakmadze. Research assistance was provided by Liu Cui. United States. Price growth of newly constructed EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 60 C H A P TE R 2. 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 2.1.1 Recent developments residential buildings, most notably in Tier 1 cities, Growth in EAP slowed to 6.3 percent in 2018, with robust domestic have rebounded following several years of demand but softening export growth. Inflation has been trending up but is correction, and the services sector has continued to generally in below targets. EAP economies have faced some combination outperform. of capital outflows, currency depreciations, equity market corrections, and foreign reserve losses during the 2018 financial market stress episode. Regional bond spreads have generally widened but less than during the On the external front, China’s current account last two financial stress episodes and less than the EMDE average. surplus has dissipated as import growth outpaced export growth. Export growth is estimated to have A. Growth B. Export growth dropped from about 9 percent in 2017 to around 4-5 percent in 2018, reflecting the dampening effects of weaker global demand and new U.S. tariffs. Since the beginning of 2018, substantial new tariffs have been introduced on bilateral trade between China and the United States accounting for about 11.4 percent of China’s goods exports and about 6.5 percent of imports. Capital outflows have resumed, and equities and the renminbi have been under pressure, reflecting the C. Inflation D. Balance of payments EAP ex. China escalating trade tensions and the diverging direction of monetary policy between the PBoC and the U.S. Federal Reserve. Growth in commodity-importing economies excluding China is moderating. In the Philippines, activity has slowed as surging inflation, capacity constraints, and currency pressures have prompted authorities to hike policy rates. Growth in E. Exchange rate and equity prices F. Emerging Market Bond spreads Vietnam remains robust helped by booming exports, but authorities have tightened fiscal policy as part of their commitment to reduce the economic role of the state. In Thailand, a cyclical recovery continues, but its pace is moderating in response to tighter fiscal policies and the effects of softening global demand on export growth. In commodity-exporting EAP economies, the Sources: Bloomberg, Haver Analytics, World Bank. investment-led cyclical recovery is maturing, and E. F. Taper T. 2013 refers to mid-2013 global financial market stress episode; China SM 2015 refers the pace and composition of growth continues to to mid-2015 China stock market turbulence; Episode 2018 refers to mid-2018 financial market volatility episode. The start dates for the stress episodes are: Taper Tantrum: May 23, 2013; China reflect country-specific factors. In Indonesia, SM 2015: June 12, 2015; Episode 2018: April 15, 2018. A. Aggregate growth rates are based on constant 2010 U.S. dollar GDP-weights and include growth last year was led by rising investment on Indonesia, Malaysia, Philippines, Thailand, and Vietnam. B. Data include only goods. 12-month moving average. Aggregate growth rate excludes Cambodia, the back of accelerated infrastructure spending. In Fiji, Lao PDR, Mongolia, Myanmar, Solomon Islands, Papua New Guinea, Timor-Leste, Vanuatu, and Malaysia, lower public investment is weighing on Vietnam due to data limitations. Last observation is September 2018. C. Average year-on-year growth. The mid-points of targeted ranges in 2018 in Indonesia (2.5-4.5 growth, reflecting the completion of several percent), Philippines (2-4), Vietnam (4), China (3), and Thailand (1-4). For Malaysia, the mid-point of Bank Negara’s 2018 forecast of 2-3 percent. Last observation is October 2018. infrastructure projects and a more prudent D. Current account balance is based on seasonally adjusted data. Net capital flows and change in reserves are estimates. Last observation is Q2 2018. approach towards new ones. In contrast to the E. Percent change of exchange rates (US dollar vs. local currency) and equity prices in local currency regional trend, import growth in Malaysia has over 226 days since the start dates of respective stress episodes. EAP aggregate exchange rate includes China, Indonesia, Malaysia, Mongolia, Philippine, Thailand and Vietnam. EAP aggregate been weak, with the continued construction in equity price includes China, Indonesia, Malaysia, Philippine, Thailand and Vietnam. Orange lines denote minimum-maximum ranges. Green diamonds denote emerging market and developing public investment dampening demand for capital economy (EMDE) averages. F. The change of bond spread over 226 days since the start dates of respective stress episodes. The goods imports combined with lower imports of average spread of country’s sovereign debt (as measured by J.P. Morgan’s Emerging Markets Bond Index) over their equivalent maturity U.S. Treasury bond. EAP aggregate bond spread includes intermediate goods. China, Indonesia, Malaysia, Philippine and Vietnam. Orange lines denote minimum-maximum ranges. Red diamonds denote emerging market and developing economy (EMDE) averages. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E A S T A S I A A N D P A C IF I C 61 Despite the slowdown, EAP remains one of the FIGURE 2.1.2 China world’s fastest-growing regions and has been In China, growth is slowing but remains robust amid resilient consumption. relatively resilient to recent bouts of financial China’s current account surplus has dissipated as import growth outpaced export growth. Equities and the renminbi have been under pressure market volatility (Figure 2.1.3). This is the case throughout 2018. Bond spreads, which widened in late-2017-early-2018 on for several reasons. Most of the EAP countries trade concerns, have been stable since mid-2018, reflecting continued (with the exception of the Pacific Islands) strong investor confidence. The authorities have been easing monetary policy, but keeping credit growth in check, by reducing shadow financing. continue to experience above the EMDE average Prices of newly constructed residential buildings, most notably in Tier 1 growth and maintain positive current account cities, have rebounded following several years of correction. balances net of foreign direct investment (e.g., China, Malaysia, Thailand, the Philippines, and A. Contributions to growth B. Balance of payments Vietnam). Policy frameworks across EAP region have improved over time with the shift to floating exchange rates, economic diversification, and solid buffers. That said, many countries have pockets of vulnerabilities, including as a result of elevated levels of public and private debt (e.g., China, Lao PDR, Malaysia, Mongolia, Vietnam), external C. Exchange rate and equity prices D. Emerging Market Bond Index debt (e.g., Malaysia, Mongolia, Lao PDR, Papua spreads New Guinea), foreign participation in local- currency sovereign bond markets (e.g., Indonesia, Malaysia), fiscal deficits (e.g., Cambodia, Indonesia, Lao PDR, Mongolia, Vietnam), and current account deficits and high reliance on volatile capital flows (e.g., Cambodia, Indonesia, Mongolia). In addition, deep regional and global integration makes the region vulnerable to trade shocks (see more detailed discussion on the risk section below). E. Total loan growth F. Housing prices Outlook Regional growth is expected to moderate from 6.3 percent in 2018 to 6 percent in 2019 and stay at that pace in 2020—broadly unchanged from June forecasts (Tables 2.1.1 and 2.1.2; Figure 2.1.3). The outlook is predicated on stable energy prices Sources: Bloomberg, Haver Analytics, World Bank. in the next two years, a moderation in global C. D. Taper T. 2013 refers to mid-2013 global financial market stress episode; China SM 2015 refers demand and trade, and a gradual tightening of to mid-2015 China stock market turbulence; Episode 2018 refers to mid-2018 financial market volatility episode. The start dates for the stress episodes are: Taper Tantrum: May 23, 2013; China global financing conditions. stock market turbulence: June 12, 2015; Episode 2018: April 15, 2018. A. Investment refers to gross capital formation, which includes change in inventories. Data for 2018 are estimates. Last observation is 2018Q3. The structural slowdown in China is expected to B. Current account balance is based on seasonally adjusted data. Net capital flows and change in reserves are estimates. Data for 2018 are estimates. Last observation is 2018Q3. continue. Growth is projected to slow from 6.5 C. Figure shows the percent changes of exchange rates (US dollar vs. Chinese yuan) and equity prices in Chinese yuan over 226 days since the start dates of respective events. Orange lines denote percent in 2018 to 6.2 percent on average in 2019 EAP minimum-maximum ranges. Green diamonds denote the emerging market and developing economy (EMDE) averages. -20, and domestic and external rebalancing are D. Figure shows the change of bond spread over 226 days since the start dates of respective events. expected to continue. Authorities in China have Bond spread measures the average spread of a country’s sovereign debt (as measured by J.P. Morgan’s Emerging Markets Bond Index) over their equivalent maturity U.S. Treasury bond. Orange shifted to looser monetary and fiscal policies in lines denote the EAP minimum-maximum ranges. Red diamonds denote the emerging market and developing economy (EMDE) averages. response to a more challenging external E. Domestic and overseas loans. Last observation is 2018 Q3 for nominal GDP. F. The National Bureau of Statistics of China surveys house prices in 70 cities and divides them into environment, including escalating trade tensions. three tiers. The first tier includes Shanghai, Beijing, Guangzhou, and Shenzhen. The second tier includes 31 provincial capital and sub-provincial capital cities. The third tier includes 35 other cities. Dotted lines indicate February 2011-September 2018 averages. Last observation is October 2018. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 62 C H A P TE R 2. 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 2.1.3 Outlook and risks They have cut reserve requirements, reduced taxes EAP growth is projected to gradually decelerate reflecting a structural and fees, increased export tax rebates, and slowdown in China. Growth in the rest of the region is expected to remain accelerated issuance of special purpose local stable in 2019-20. The region is characterized by deep regional and global government bonds to bolster infrastructure integration, which makes it vulnerable to external shocks. Domestic and external vulnerabilities would amplify the impact of external shocks, spending. In addition, the authorities have stepped especially where policy buffers are limited. up their structural reform efforts to improve the business environment, including for foreign firms, A. Growth B. Global exposure by type of foreign and have lowered tariffs on imports—with the inflows, 2013-17 critical exception of tariffs on U.S. imports in retaliation to U.S. tariffs on Chinese goods. These policy steps are expected to largely offset the direct negative impact of higher tariffs on China’s exports, which would otherwise lower growth by about 0.1-0.3 percentage point in 2019. However, the measures may also run counter to the needed deleveraging and de-risking process if the authorities were to pursue a stronger fiscal and C. Impact of 1 percentage point D. Change in growth and current monetary stimulus effort in the future (Chapter 1; decline in China’s growth on EAP account balance net of FDI, 2010-18 World Bank 2018a). Growth in the rest of the region is projected to remain broadly unchanged at around 5.2 percent on average in 2019-20. Resilient domestic demand is expected to offset the negative impact of slowing exports. Growth among commodity importers is projected to moderate in 2019 as it converges with its potential rate. Among commodity importers E. External debt F. Fiscal balance and public debt excluding China, a slight downgrade to growth projections in 2018 reflects a downward revision to the Philippines due to a moderation in private consumption amid rising inflation. Growth in commodity exporters is expected to remain broadly unchanged at about 5.1 percent in 2019, in line with potential, with significant cross -country differences. This forecast is slightly below Sources: Haver Analytics, International Monetary Fund, World Bank. that of June, reflecting a number of downward A. Commodity importers ex. China include Cambodia, Philippines, Solomon Islands, Thailand, revisions (e.g., Malaysia, Myanmar). Output gaps Vietnam, and Vanuatu. Commodity exporters include Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, Papua New Guinea and Timor-Leste. Yellow diamonds denote growth projections in most commodity exporting economies are published in the June 2018 edition of the Global Economic Prospects report. Aggregates growth rates are calculated using 2010 U.S. dollar GDP-weights. Data in shaded areas are forecasts. expected to close over the forecast horizon, as B. The linkages presented in this chart only present direct channels. Spillovers may propagate via indirect channels such as global and regional value chains. Diamond denotes direct exposure to countries complete their adjustment to earlier China. Hyphen denotes share of commodity exports as share of GDP. EA stands for East Asia. PI stands for Pacific Islands. EA1 includes Brunei Darussalam, Cambodia, Malaysia, Mongolia, Thailand commodity price declines, investment growth and Vietnam; EA2 includes Indonesia, Lao PDR, Myanmar and Philippines. PI1 includes Kiribati, stabilizes, and trade flows decelerate. For both Marshall Islands, Micronesia, Timor-Leste, Tonga and Tuvalu; PI2 includes Palau and Vanuatu; PI3 includes Fiji, Papua New Guinea, Samoa and Solomon Islands. commodity exporters and importers, inflation C. Median of posterior distribution. Estimates based on a Bayesian SVAR, using quarterly data for 1998Q1-2018Q1. The spillovers include the effects through indirect channels, including confidence pressures are expected to intensify over the forecast and global and regional value chains. Cumulative impact on growth after two years. GDP weighted. D. CAB ex. FDI = Current Account Balance excluding Foreign Direct Investment. Orange hyphen horizon, in part reflecting exchange rate pass denotes GDP growth in 2010; green hyphen—CAB ex. FDI in 2010. Data for 2018 are estimates. through as well as domestic demand pressures. E. External debt stock is defined as debt owed to nonresidents repayable in foreign currency, goods or services. It is the sum of public, publicly guaranteed and private nonguaranteed debt. Data are in current U.S. dollars. Short-term debt includes all debt having an original maturity of one year or less Despite the projected robust activity in the region and interest in arrears on long-term debt. Interest Diamond denotes short-term external debt as share of GDP in 2018; hyphen—total external debt as share of GDP in 2010. in the near term, underlying potential growth— F. Diamond denotes estimated fiscal balance as share of GDP in 2018; hyphen denotes public debt as share of GDP in 2010. The general government debt data for Mongolia is based on the World which has fallen considerably over the past Bank staff estimates. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E A S T A S I A A N D P A C IF I C 63 decade—is likely to decline further over the investment, have been estimated to reduce global long term. This reflects increasingly adverse exports by up to 3 percent and global income by demographic patterns and a projected slowdown 1.7 percent over the medium term with the in capital accumulation as credit growth is biggest, up to 3.5 percent decline in income reined in. recorded by China (Freund et al. 2018).1 A significant disruption to activity in China would Risks have large regional effects, propagating through Risks to the outlook remain tilted to the downside bilateral trade, regional supply chains, and and have intensified. Growing trade tensions financial linkages (Figure 2.1.3). A one-off, involving large economies continue to create unexpected 1 percentage-point drop in China’s uncertainty about the future of established trading GDP growth would lower growth in the rest of relationships. A potential disruption of trade the region by 0.5 percentage points after two years would disproportionately affect the more open (World Bank 2016a, World Bank 2018a). Growth economies in the region. The region is spillovers from China would be particularly large characterized by deep regional and global for Mongolia, due to its reliance on commodity integration, which makes it vulnerable to external exports to China, and for Cambodia and the shocks. The region relies significantly on foreign Pacific Islands which depend on China for income, mostly from exports but also from returns tourism and FDI. on foreign assets and direct investment. Total exports and gross capital inflows exceed 50 percent Risks of disorderly financial market developments of GDP in more than two-thirds of the regional have also intensified (Chapter 1). A further economies, and 100 percent in about one-third of tightening of global financial conditions could be countries (Figure 2.1.3). In many regional triggered by rising inflation, swelling fiscal deficits, economies, the cost of rising import tariffs may be or contagion from financial stress in other magnified by participation in complex global value EMDEs, and could place further pressure on chains (e.g., Indonesia, Malaysia, Thailand, the regional exchange rates and asset prices. High debt Philippines; Chapter 1, World Bank 2018a). levels and external vulnerabilities among some Furthermore, the impact of trade measures could EAP countries could amplify the impact of be amplified regionally if it also weights on external shocks such as a sudden stop in capital investor confidence and reduces foreign direct flows or a rise in borrowing costs. If a investment (World Bank 2018a, IMF 2018a). combination of downside risks were to materialize, it could trigger an even sharper-than-expected China’s baseline projections assume that the slowdown in regional growth. measured fiscal and monetary policy stimulus that is being introduced in response to rising U.S. tariffs is successful in offsetting the immediate economic impact of trade-related headwinds. However, if authorities opt for additional and stronger fiscal and monetary stimulus initiatives— particularly in the form of unfunded mandates for local governments to increase public investment— efforts to contain credit growth and limit risks to corporate and bank balance sheets could be undermined. A continued intensification of trade tensions, along with previous measures, would affect close to all goods trade between China and the United States. In the extreme case scenario, 1 is scenario assumes a 25 percent tari surcharge on all further escalation of trade tensions, coupled with products traded between China and the United States, combined with a decline in investor con dence, resulting in a 0.5 percentage possible negative effects on confidence and point drop in global investment to GDP (Freund et al. 2018). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 64 C H A P TE R 2. 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 TABLE 2.1.1 East Asia and Pacific forecast summary Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 20 2018e 2019f 2020f EMDE EAP, GDP 1 6.3 6.6 6.3 6.0 6.0 5.8 0.0 -0.1 0.0 (Average including countries with full national accounts and balance of payments data only)2 EMDE EAP, GDP2 6.3 6.6 6.3 6.0 6.0 5.8 0.0 -0.1 0.0 GDP per capita (U.S. dollars) 5.6 5.9 5.7 5.4 5.4 5.3 0.0 -0.1 -0.1 PPP GDP 6.3 6.5 6.3 5.9 5.9 5.8 0.1 -0.2 -0.1 Private consumption 6.8 6.5 7.7 7.4 7.1 7.2 0.7 0.6 0.1 Public consumption 9.3 8.5 7.6 7.3 7.1 7.1 0.0 -0.2 -0.3 Fixed investment 6.6 4.5 5.6 5.3 5.2 5.2 0.1 0.0 -0.3 Exports, GNFS3 3.3 9.4 4.8 4.7 4.4 4.3 -0.9 -1.3 -1.4 Imports, GNFS3 5.4 8.1 6.8 6.5 5.9 5.8 1.0 0.4 -0.5 Net exports, contribution to growth -0.6 0.4 -0.6 -0.5 -0.5 -0.5 -0.6 -0.5 -0.3 Memo items: GDP East Asia excluding China 4.9 5.4 5.2 5.2 5.2 5.2 -0.2 -0.1 -0.1 China 6.7 6.9 6.5 6.2 6.2 6.0 0.0 -0.1 0.0 Indonesia 5.0 5.1 5.2 5.2 5.3 5.3 0.0 -0.1 -0.1 Thailand 3.3 3.9 4.1 3.8 3.9 3.9 0.0 0.0 0.1 Source: World Bank. Notes: e = estimate; f = forecast. EMDE = emerging market and developing economy. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Democratic People’s Republic of Korea and dependent territories. 2. Sub-region aggregate excludes Democratic People’s Republic of Korea, dependent territories, Fiji, Kiribati, the Marshall Islands, the Federated States of Micronesia, Myanmar, Nauru, Palau, Papua New Guinea, Samoa, Timor-Leste, Tonga, and Tuvalu, for which data limitations prevent the forecasting of GDP components. 3. Exports and imports of goods and non-factor services (GNFS). For additional information, please see www.worldbank.org/gep. TABLE 2.1.2 East Asia and Pacific country forecasts1 Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projections) 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f Cambodia 6.9 7.0 7.1 6.8 6.8 6.7 0.2 0.1 0.2 China 6.7 6.9 6.5 6.2 6.2 6.0 0.0 -0.1 0.0 Fiji 0.4 3.8 3.5 3.4 3.3 3.3 0.0 0.0 0.0 Indonesia 5.0 5.1 5.2 5.2 5.3 5.3 0.0 -0.1 -0.1 Lao PDR 7.0 6.9 6.7 6.9 6.9 6.7 0.1 0.0 0.0 Malaysia 4.2 5.9 4.7 4.7 4.6 4.6 -0.7 -0.4 -0.2 Mongolia 1.4 5.4 5.9 6.6 6.3 6.2 0.6 0.2 -0.2 Myanmar 5.9 6.8 6.2 6.5 6.6 6.8 -0.5 -0.4 -0.5 Papua New Guinea 2.6 2.8 0.3 5.1 3.1 3.4 2.0 1.1 0.1 Philippines 6.9 6.7 6.5 6.7 6.6 6.6 -0.2 0.0 0.0 Solomon Islands 3.5 3.5 3.4 2.9 2.8 2.7 0.4 0.0 0.0 Thailand 3.3 3.9 4.1 3.8 3.9 3.9 0.0 0.0 0.1 Timor-Leste2 5.3 -4.7 0.8 3.3 4.9 5.0 -1.4 -0.9 0.9 Vietnam 6.2 6.8 6.8 6.6 6.5 6.3 0.0 0.0 0.0 Source: World Bank. Notes: e = estimate; f = forecast. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. 2. Non-oil GDP. Timor-Leste’s total GDP, including the oil economy, is roughly four times its non-oil economy and is highly volatile as a result of sensitivity to changes in global oil prices and local production levels. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E A S T A S I A A N D P A C IF I C 65 BOX 2.1.1 Informality in East Asia and Pacific The share of informal output in East Asia and the Pacific (EAP) region is somewhat below the EMDE average while the share of informal employment is somewhat above-average. Within the region, informality is particularly high in lower-income countries, which are also characterized by a lack of diversification, large rural sectors, and weak institutions. Nonetheless, even higher- income economies within the region have urban informality. This diversity within the region argues for tailored policy approaches to address challenges associated with informality. Higher-income countries can prioritize urban planning and providing essential social protection to informal workers. Lower-income countries can focus on policies that increase productivity, lower costs and increase the potential benefits of regulatory compliance. Introduction Informality in the EAP region has declined over the past two decades (Chapter 3, Schneider, Buehn, and The share of informal output in East Asia and the Pacific Montenegro 2010). The share of informal output declined (EAP) is below the EMDE average.1 Nevertheless, despite from 35 percent of official GDP to 27 percent between a downward trend over the past 30 years, informality 1990-2000 and 2010-16—the fastest decline among remains high in the lower-middle-income economies, EMDE regions. Survey-based measures of informality also including Lao PDR, Myanmar, Cambodia. Higher- suggest a moderate decline in acceptance and perception of income countries in the region have made considerable informality. progress in integrating rural migrants into urban labor markets, but face challenges related to urban informality, The decline in informality has been accompanied by in particular in providing access to public services and sustained growth, rapid industrialization, urbanization, essential social protection. and improvements in institutional quality (World Bank Against this backdrop, this Box examines the following 2015). A large number of informal, mainly agricultural, questions: workers in China have been successfully integrated into the formal labor force mainly by absorbing migrants into • How has informality evolved in East Asia and the the urban labor market (World Bank 2014a). Total Pacific? employment in China rose by about 250 million during 1990–2014, amid large-scale rural-to-urban migrant flows • What have been the macroeconomic and social (Lam, Liu, and Schipke 2015). Between 1990-2000 and implications of informality? 2010-16, the share of informal output declined • What policy options are available to address particularly rapidly in the fastest-growing countries, in part challenges associated with informality? reflecting the effect of comprehensive reforms (Cambodia, Myanmar, and Lao PDR). For example, the informal share Evolution of informality of output has fallen by 33 percentage points in Myanmar (to below 30 percent in 2010-16) following broad-based In the EAP region, informal output accounted for about liberalization measures. 30 percent of GDP on average in 2010-2016, slightly below the EMDE median (Figure 2.1.1). However, at 48 The region is characterized by significant cross-country percent of total employment, informal employment in heterogeneity in terms of institutional and socio-economic EAP was above the EMDE average during the same indicators (Figure 2.1.1). Per capita GDP levels vary period.2 About 75 percent of the labor force in EAP lacked widely across EAP, and those economies with higher per basic pension coverage during 2000-10. capita GDP generally have lower levels of informality (ILO 2018a; Loayza and Rigolini 2006). The share of Note: This Box was prepared by Ekaterine Vashakmadze and Jinxin informal output in higher income countries is about [30] Wu. percentage points less than in lower-middle income 1 Informality is often defined as market-based legal production of countries (e.g. Lao PDR and Myanmar). The share of goods and services that are hidden from public authorities for monetary, informal employment is also about one-quarter of that in regulatory, and institutional reasons (Schneider, Buehn, and Montenegro 2010). Informal output is measured as a percent of informal output in official GDP. In this box, informality is estimated based on the Dynamic General Equilibrium (DGE) model used in Elgin and Oztunali (2012) (for more detailed discussion see Chapter 3 and Annex 3.1). employed workers are those workers who, working on their own account, 2 The most frequently used informal employment measure is the share with one or a few partners, or in a cooperative, hold the type of jobs of self-employment in total employment, which represents a lower bound defined as "self-employment jobs" (for more detailed discussion see of informal employment (e.g., La Porta and Shleifer 2014). Self- Chapter 3 and Annex 3.1). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 66 C H A P TE R 2. 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.1.1 Informality in East Asia and Pacific (continued) FIGURE 2.1.1 Informality in East Asia and the Pacific Compared with other EMDE regions, East Asia and the Pacific (EAP)’s share of informal output is moderate whereas its share of informal employment is above-average. Informality is particularly high in lower income countries, which are also characterized by stringent labor regulations and lack of enforcement. A. DGE and MIMIC based informal B. Labor force without pension and C. Perceived informal activities and atti- activities self-employment tudes towards informality D. Informality by different measures E. Cross country difference in informality F. Institutional Factors Sources: World Development Indicators, Organization for Economic Co-operation and Development (OECD), country’s national statistical bureaus and offices, Inter- American Development Bank, Eurostat, Haver, World Economic Forum, World Value Survey, World Bank Doing Business. Notes: Blue bars show simple averages of the informal economy of the region. Red makers show the median average of all EMDEs and the vertical lines denote interquartile range of all EMDEs. A. The Dynamic General Equilibrium (DGE) model is a model to estimate the size of the informal sector, used in Elgin and Oztunali (2012). DGE estimates the informal output in percent of official GDP. The Multiple Indicators Multiple Causes model (MIMIC) is a structural equations model which considers multiple causes of informal activity and captures multiple outcome indicators of informal activity, used in Schneider et (2010). MIMIC estimates the informal output in percent of official GDP. B. Labor force without pension is the fraction of the labor force that doesn’t contribute to a retirement pension scheme. Self-employed is the share of self-employment in total employment. C. WEF is a World Economic Forum survey which ask the question “In your country, how much economic activity do you estimate to be undeclared or unregistered? (1=Most economic activity is undeclared or unregistered; 7 = Most economic activity is declared or registered).” The average responses constitute a series of informality measures, named as WEF. The indices are flipped in the figure so that a higher average at the country level indicates a larger informal economy. The responses range from 1 (never justifiable) to 10 (always justifiable). WVS is World Value Survey which asks whether respondents can justify cheating on taxes. A higher average implies that people find cheating on taxes more justifiable, which is associated with a higher level of informality. D. Diamonds represent the average level of EAP region; bars denote the range of EAP countries in each measure. E. The upper bound of bar indicates the share of informal employment in total employment. The lower bound indicates the share of informal output in official GDP based on the Dynamic General Equilibrium (DGE) model. For Malaysia, the level of informal output is higher than the level of informal employment. F. All measures are taken from the latest year available. The first three institutional measures are taken from World Bank’s World Governance Indicators (2017), with a higher value indicating better institutional quality in year 2016. The “Ease of doing business” (DB 2018) and “Ease of paying taxes” (DB 2017) are taken from World Bank’s Doing Business database and measured as “Distance to Frontier”, with a higher value indicating an easier environment for businesses. An economy’s distance to frontier is reflected on a scale from 0 to 100, where 0 represents the lowest performance and 100 represents the frontier. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E A S T A S I A A N D P A C IF I C 67 BOX 2.1.1 Informality in East Asia and Pacific (continued) lower-middle income economies.3 Informality is most Underinvestment in human capital. In EAP, investment pervasive in Lao PDR and Myanmar, at around 60-80 in human capital and higher levels of educational percent of total employment. Indonesia, Mongolia, and attainment have increased labor productivity and have Vietnam have below average informal output shares, but been closely associated with a smaller share of the informal their informal employment shares are above the EAP economy (Figure 2.1.2; ILO 2018, Moscoso-Boedo and average (ADB 2010, Handavani 2016). D’Erasmo 2012). Workers with higher education levels are also more likely to be formally employed. This is also Drivers and implications of informality evident in cross-country comparisons. For example, in Informality has been attributed to several drivers. These Indonesia, the results of the 2009 Informal Sector Survey included large agricultural sectors, rapid urbanization, low (ISS) in Yogyakarta and Banten suggest that persons who human capital, and overly burdensome regulations. are informally employed tended to have lower levels of education than those with formal jobs (ADB 2010, World Size of agricultural sectors. People living in rural areas are Bank 2017). Malaysia is among the countries with the almost twice as likely to be in informal employment as highest educational attainment and the lowest share of those in urban areas, and agriculture is the sector with the informal employment (25 percent). In contrast, Lao PDR, highest share of informal employment (ILO 2018). The Myanmar and Cambodia are characterized by low agricultural sector still accounts for about 30 percent of educational outcomes and high informality. employment in EAP on average, and these shares are particularly high in Lao PDR, Myanmar, and Vietnam Enterprise sector characteristics. In China and Vietnam, (ADB 2010; Figure 2.1.2). Informal workers constitute informal economies arose amidst economic reforms that the vast majority of employment in the agriculture sector began in the 1970s and allowed the emergence of a private in Cambodia and Thailand, in part because high economy in the form of unregulated micro-enterprises, compliance costs discourage formal-sector activity of family enterprises, and individual entrepreneurs (Park, agricultural small enterprises (ILO 2018). Wu, and Du 2012). The informal economy comprises more than 90 percent of micro and small enterprises Urbanization. Rapid urbanization in EAP has supported (MSEs) worldwide (ILO 2018). In EAP, informal workers large-scale rural-to-urban migration, stimulated growth, tend to be employed in small, low-productivity firms. For productivity, and formal and informal job creation (Ghani example, in Indonesia, most informal firms are very small and Kanbur 2013). The urbanization process has (micro) firms with less than five employees. These firms coincided with the rapid structural transformation of tend to be less productive than larger firms and pay lower China and other fast-growing East Asian economies and wages. Their operations tend to be local, predominantly the shift of activity from agriculture to manufacturing and supplying local markets, with little desire for expansion services (McMillan, Rodrik, and Sepulveda 2017, Rodrik (Rothenberg et al, 2015). 2015). In general, a larger non-agricultural sector is associated with a smaller informal sector size and Taxes and labor regulations. Informality is also a informality in manufacturing is also significantly lower consequence of higher tax burdens, stringent labor than in services (Atesagaoglu, Bayram, and Elgin 2017). regulations, limited enforcement capacity, and poor Although the growth of urban areas provides opportunities governance (World Bank 2014b). In EAP, informality is for many, urban expansion, if not well planned, can also higher in lower-income countries with markedly weaker contribute to rising urban informality and policy institutional quality, cumbersome rules and procedures, challenges. In China, for example, unequal access to public and pervasive lack of awareness or adequate enforcement services between citizens with urban household (Lao PDR, Myanmar; Figure 2.1.2). Within Malaysia, the registrations (hukou) and those without, although Philippines, Thailand, and Vietnam, informality has been diminishing, has led to unregistered urban households that associated with more rigid business regulations and lack essential social protection (Park, Wu, and Du 2012, ineffective law enforcement (Loayza and Rigolini 2006). World Bank 2014a). Informality has been associated with a number of adverse economic outcomes. These include urban poverty, household vulnerability and lower productivity. 3 Although the commonly observed link between income growth and Urban poverty and income inequality. EAP is the world’s informality generally holds in EAP region, informality is nevertheless most rapidly urbanizing region, with an average annual relatively high in Thailand despite its higher income status (Schneider 1999). urbanization rate of 3 percent (World Bank 2017). The EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 68 C H A P TE R 2. 1 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.1.1 Informality in East Asia and Pacific (continued) FIGURE 2.1.2 Drivers and implications of informality Better institutions and business environments, industrialization, and rapid urbanization are associated with low informality in higher-income economies. Countries with a high share of informality have higher income inequality and lower levels of educational attainment. A. Informality and institutions B. Institutional factors in countries with C. Employment in agriculture high and low informality D. Urban population as percent of total E. Year of total schooling F. Human capital index population Sources: World Development Indicators, Organization for Economic Co-operation and Development (OECD), World Bank Doing Business A. Higher MICs include Malaysia, China and Thailand; Middle MICs includes Philippines, Indonesia and Mongolia’ Lower MICs include Myanmar, Laos PDR, Cambodia and Vietnam. The grouping of countries is based on GDP per capita. B. All measures are taken from the latest year available. The first three institutional measures are taken from World Bank’s World Governance Indicators (2017), with a higher value indicating better institutional quality in year 2016. Error bars reflect all EAP countries. C. The vertical and horizonal lines denote EMDE averages. D. Latest data available is 2014. E. Data are from Barro-Lee. Average years of total schooling, 15+, total is the average years of education completed among people over age 15. F. The HCI calculates the contributions of health and education to worker productivity. The final index score ranges from zero to one and measures the productivity as a future worker of child born today relative to the benchmark of full health and complete education. The vertical and horizonal lines denote EMDE averages. rapid growth of cities has created challenges that include Papua New Guinea and Vanuatu, and in Indonesia and the lack of affordable housing, resulting in increasing Lao PDR (World Bank 2017).4 slums, poor provision of basic services, and widening inequality for urban dwellers. EAP host the world’s largest In China, the exceptional scale of rural to urban migration slum population, many of them informally employed: amplifies the challenges from informality. Many of these around 35 percent of urban population (250 million workers—approximately 120-150 million— are migrant people) live in slums. In Indonesia, 27 percent of the workers who are not registered to work in cities, and urban population do not have access to improved therefore lack a number of formal protections (Jutting and sanitation facilities (UNICEF-WHO 2015), followed by Xenogiani 2009, Huang 2009). These urban migrants gain a large wage premium by migrating; yet both rural and 21 percent in the Philippines (PSA and ICF 2018). The cities with the highest numbers of urban poor are in China, Indonesia, and the Philippines, while the highest 4 Approximately 75 million people in EAP region live below the urban poverty rates are in the Pacific Island countries of US$3.10/day poverty line. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E A S T A S I A A N D P A C IF I C 69 BOX 2.1.1 Informality in East Asia and Pacific (continued) urban migrants tend to work in informal jobs and lack prioritize providing essential social protection to informal adequate social protection (Gagnon, Xenogiani and Xing workers; lower-income countries could focus on reforms to 2012). In Thailand, informally employed workers increase firm and worker productivity. systematically present lower earnings at all earnings levels, and the difference increases with level of earnings (ILO Essential social protection. In higher-income countries, 2015). essential social protection coverage can be expanded to shield informal workers from adverse shocks (Olivier, Household vulnerability to shocks. Informality may Masabo, and Kalula 2012). This would imply higher impose significant economic risk and result in public expenditure on social protection to extend at least underinvestment in human capital of current and future basic social protection coverage to all (ILO 2017). generations (Oviedo 2009). It is characterized by a lack of adequate social protection coverage, which increases Reforms to improve urban planning. Urban planning can household vulnerability to shocks. For middle and lower increase efforts to match physical expansion with access to income countries in EAP region, pension coverage is jobs, affordable housing, commercial services, public extremely low (Figure 2.1.2). In China, compared with transportation, and health and education services to ensure formal employees and business owners, casual workers equal opportunity for disadvantaged communities (World report the lowest monetary and subjective well-being Bank 2015). Examples of effective metropolitan (Liang, Appleton, and Song 2016). governance include Beijing, Jakarta, Kuala Lumpur, Metro Manila Developments Authority (MMDA) and Shanghai Low productivity. Countries characterized by larger (World Bank and DRCSC 2014, World Bank 2015). informal sectors are associated with lower shares of skilled workers and weaker measured total factor productivity. At Reforms to increase firm productivity. Agglomeration the firm level, entering and operating in the formal sector benefits can lower the unit costs of public service is costly, but provides firms with a better access to provision, enabling governments to extend access to basic technologies, skilled and competitive workers, and access services to more people (World Bank 2014, World to capital (Figure 2.1.2; D’Erasmo et al. 2014). There Development Indicators 2016, Ghani and Kanbur 2013). exists a sharp productivity difference between firms of the Policies to support small agricultural enterprises, which same size in the formal and informal sector when engage a large share of EAP’s workforce, and other micro, measured in terms of value added per employee, with small- or medium-sized enterprises include improving formal firms being, on average, 30 percent more access to services, decreasing red tape and corruption, productive (Monteiro and Assuncao, 2012; Fajnzylber et facilitating access to financial services, and offering better al., 2011; La Porta and Shleifer 2014). Despite a well- education and training (OECD 2009, World Bank documented gap between the performance of formal and 2018b). informal firms, less is known about how the allocation of low-productivity firms in the informal sector affects Remove disincentives to formal employment. Removing productivity over time. If by operating informally firms are disincentives to formal employment could encourage a able to cut costs and stay more productive, then a shift shift of informal workers into formal employment. Reform from the informal to the formal sector will not necessarily options include lower registration costs; shorter lead to an increase in productivity. Some recent studies registration procedures; streamlined registration services, indeed find some evidence that a shift into the formal for example, through information and communication sector does not necessarily lead to an increase in technologies; lower compliance costs by introducing productivity for firms (Demenet et al. 2016; McKenzie simplified tax assessment and payment regimes; improved and Sakho 2010; De Mel et al. 2013). Overall, while access to financial services; and improved access to individual motivations to become or stay informal may training, skills development and business development differ, the aggregate outcome of prevalence of informal services (ILO 2016). As small firms have different sector is low scale and low productivity. motivations to stay small and informal, measures to lower cost and increase the potential benefits of regulatory Policy challenges compliance (such as reducing barriers) can be combined A tailored approach can help address the challenges with a more effective enforcement regime. associated with informality. Higher-income countries can EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) Growth in the region is estimated to have decelerated to 3.1 percent in 2018 and is projected to further slow to 2.3 percent this year, mainly because of weakness in Turkey. Regional growth is expected to pick up modestly in 2020-21, as a gradual recovery in Turkey offsets moderating activity in Central Europe. The main risks to the region are weaker-than-expected investment due to heightened policy uncertainty, and a renewal of financial pressure in Turkey combined with possible contagion to the rest of the region. Recent developments Growth among the Central European economies slowed in 2018. Softening exports and labor Activity in the Europe and Central Asia (ECA) shortages restrained growth in Bulgaria, Croatia, region is estimated to have slowed to 3.1 percent Hungary, and Romania. By contrast, despite labor in 2018 from 4 percent in 2017, reflecting the shortages, growth in Poland accelerated slightly marked weakness in activity in Turkey in the because of fiscal support and strong consumption. second half of the year. Excluding Turkey, Robust domestic demand supported activity in the regional growth remained unchanged at an Western Balkans, except for Montenegro. In the estimated 2.9 percent in 2018, as slowing activity Former Yugoslav Republic of Macedonia, growth in countries in the western part of the region, such rebounded in 2018 as the formation of a new as Hungary and Romania, offset an acceleration in government ended a prolonged political crisis and the eastern part of the region that benefitted from improved investor sentiment (World Bank higher oil prices (Figure 2.2.1). 2018a). In Turkey, the lira declined more than 30 percent Russia and other oil exporters in Central Asia in 2018 reflecting capital outflows in response to maintained steady growth in 2018, supported by a accelerating inflation, a perceived delay in rise in oil prices. Despite a tightening of economic monetary tightening, and rising private sector sanctions by the United States, the Russian debt. The country faces sizable current account economy increased oil production, inflation deficit and a large foreign-currency denominated remained low and relatively stable, and domestic debt load, leaving it vulnerable to shifting investor activity was robust (World Bank 2018b). Higher- sentiment and currency depreciation. Output than-expected production in the Kashagan oil field shrank [X percent, data released Dec10] percent in and strong domestic demand supported growth in 18Q3, as consumer confidence plummeted, and Kazakhstan. A stabilization in the financial sector capital outflows and monetary policy tightening and higher oil prices contributed to a slow led to credit scarcity. Despite this contraction, recovery of growth in Azerbaijan in 2018. strong growth in the first half of the year will The stance of fiscal policy in the region varies. bring Turkish growth to an estimated 3.6 percent Turkey has committed to tight fiscal policy to help for 2018. curb high inflation and currency depreciation. Romania’s fiscal stance is mixed, with income tax reductions and increased public sector benefits Note: This section was prepared by Yoki Okawa. Research offset by an increase in social contribution assistance was provided by Zhuo Chen and Mengyi Li . revenue. Fiscal policy has become more procyclical EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 72 C H A P TE R 2. 2 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 2.2.1 ECA: Recent developments support the economy. Regional growth is estimated to have slowed in 2018 reflecting financial stress in Turkey and weak regional trade. Financial stress in Turkey, which For the majority of ECA countries, monetary experienced a sharp depreciation and an increase in bond spreads, does policy is either stable or loosening. In the second not appear to have spilled over to other countries in the region. Slowing half of 2018, nine countries lowered policy rates inflation in eastern ECA region led to loosening in monetary policy, while a pickup in inflation in the western ECA has not yet led to monetary compared to a year ago, while three countries have tightening. The fiscal stance in the region is mixed. higher policy rates (Romania, Ukraine, Turkey). Inflation reached 25 percent in Turkey in A. Growth B. Trade October, significantly above the 5 percent target amid an overheating economy in the first half of 2018 and currency depreciation in the second. To ward off inflationary and currency pressures, Turkey’s central bank increased the average cost of funding more than 10 percentage points over the course of 2018. In Central Europe, tightening labor markets and increasing energy prices have pushed inflation up toward target, with monetary policy remaining stable in most countries—except C. Currency movements in Turkey D. EMBI spreads Romania, where robust domestic demand pushed inflation above the upper bound of the target band, prompting monetary policy tightening. Gradually accelerating inflation has also led to policy tightening in Ukraine. In the Western Balkans, Albania, FYR Macedonia, and Serbia have lowered policy rates amid stable and below- target inflation. For oil exporters such as Azerbaijan and Kazakhstan,, the ongoing recovery E. Inflation F. Monetary and fiscal policy from the 2014-16 oil price plunge has resulted in lower inflation and looser monetary policy. In Russia, monetary policy was tightened in late 2018 amid pressures on the currency. Outlook The lingering effects of financial stress in Turkey are expected to be reflected in a further slowing of Sources: Haver Analytics, World Bank. regional growth in 2019, to 2.3 percent, before E. Year-on-year inflation in September for each year. recovering to 2.7 percent in 2020 (Figure 2.2.2). F. Number of countries. Monetary policy tightening/loosening is defined as increase/decrease of the central bank’s policy rate between January and November 2018. Fiscal policy tightening/loosening is Excluding Turkey, regional growth is expected to defined as increase/decrease of primary balance in estimated 2018 values compared to 2017. average 2.5 percent during the forecast horizon from 2.9 percent in 2018, with a gradual deceleration in Central Europe. This outlook is in Croatia and Poland. In the eastern part of the predicated on an orderly tightening of global region, the Russian government has implemented financial conditions, the oil price averaging $69 in a new fiscal rule and is estimated to have recorded 2019-2021, a gradual slowdown in the Euro Area, last year its first surplus since 2012. As fiscal and the absence of heightened geopolitical stimulus measures phased out, Kazakhstan has tensions. started to tighten the fiscal stance, resulting improvement of non-oil fiscal balance, while While the outlook for Turkey is subject to Azerbaijan continues to rely on fiscal measures to considerable uncertainty, the country is expected EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E U R OP E A N D CE N T R A L A S I A 73 to suffer continued weak activity as high inflation, FIGURE 2.2.2 ECA: Outlook and risks high interest rates, and low confidence dampen Regional growth is expected to slow notably in 2019 and gradually consumption and investment. Turkish growth is accelerate in 2020-21, partly reflecting a sharp decline and subsequent expected to slow to 1.6 percent in 2019 and begin recovery in Turkish growth. A number of countries in the region appear vulnerable to shifts in investor sentiment, as reflected by their high current to recover by 2020 through a gradual account deficits and corporate debt. improvement in domestic demand and continued strength in net exports. However, this outlook A. Actual and potential growth B. Growth forecast assumes that fiscal and monetary policy successfully avert further sharp falls in the lira and corporate debt restructurings help avert serious damage to the financial system. A comprehensive stabilization package with consistent policy framework, clear milestones, and effective communication would help reduce risks and support recovery. Spillovers from Turkey to the rest of the region are C. Trade openness D. Current account expected to remain modest, as trade and financial linkages are relatively limited. On the trade side, Azerbaijan has the largest exposure, as 9 percent of its exports are directed to Turkey. Financial linkages are also small—only Georgia receives meaningful amounts of FDI from Turkey, while foreign bank ownership of Turkish assets is limited in scale. E. Corporate debt F. Exchange rate risk in debt Growth in western ECA, excluding Turkey, is projected to gradually slow toward potential, driven by a slowdown in Central European economies. Domestic demand in this sub-region will be constrained by tight labor markets, while a continued slowdown in Euro Area growth will limit export growth. Poland is expected to slow from 4.7 percent in 2018 to 3.9 percent in 2019, as fiscal policy becomes less supportive. Sources: Haver Analytics, Institute of International Finance, International Monetary Fund, World Bank. Growth in eastern ECA is forecast to slow in A. Blue bars refer to GDP-weighted average actual growth and vertical orange line show minimum- maximum range of potential growth estimates based of five different methodologies (production 2019, as the Russian economy decelerates. The function approach, multivariate filter, IMF World Economic Outlook five-year-ahead forecast, Consensus Forecasts, and potential growth estimates in OECD Economic Outlook and OECD Long- country’s VAT is scheduled to be increased from Term Baseline Projections). C. Share of exports as a percentage of GDP in 2016. 18 to 20 percent in 2019, which will temporarily D. Current account balance as a percentage of GDP. drag on Russian growth. Kazakhstan’s economy is E-F. The data used are IIF end-of-period estimates of non-financial corporate debt as a percentage of GDP. also expected to decelerate as oil production growth levels off and fiscal consolidation efforts continue (World Bank 2018c). risks is increasingly tilted down. The most important downside risk is the possibility that the Risks recent financial stress in Turkey worsens and triggers widespread bank failures. Turkish Despite some upside risks—mainly, that stronger- corporations carry significant debt, much of which than-expected energy prices support activity in is denominated in or linked to foreign currencies. Russia and other oil exporters—the balance of Although many corporations are hedged against EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 74 C H A P TE R 2. 2 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 forex risks and corporate debt restructuring is which remains high despite recent declines, and under way, falling domestic demand and forex private borrowing in foreign currencies makes exposure of non-tradable sector pose risks. Central European countries such as Croatia, Currency depreciation and high interest rates Hungary, and Poland vulnerable to financial could push corporate borrowers into bankruptcy pressure. Public debt has also been trending up in and depleting banks’ capital buffers. Renewed Central Asia and the Western Balkans. pressure in currency markets and increased uncertainty about the policy framework would The region is subject to the risks of heightened increase the probability of deepening crisis, policy uncertainty and rising geopolitical tensions. implying a longer and more severe slowdown than A slowdown or reversal of ongoing structural currently forecast for Turkey (World Bank reforms remains a risk in many countries in the 2018d). While direct linkages between Turkey region, especially in Armenia, Azerbaijan, Belarus, and the rest of the region are small, an Ukraine, and Turkey. A deterioration in intensification of financial stress in Turkey or confidence stemming from unexpected policy other EMDEs could also lead investors to shifts could negatively affect activity in the reevaluate their exposure in the region, which in region—for example, tension concerning Syria or turn could lead to capital outflows, currency Ukraine could trigger new sanctions, or policy depreciations, and rising borrowing costs for disagreements between the European Union and vulnerable countries. some Central European countries could deter international investors and reduce fiscal transfers. The potential for financial stress is more elevated An escalation of trade restrictions between the for countries with domestic vulnerabilities like United States and the Euro Area could have a Romania and Belarus, which have large and/or negative impact on western ECA countries, as the widening current account deficits. Public debt, Euro Area is the largest trading partner for all countries in the sub-region. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E U R OP E A N D CE N T R A L A S I A 75 TABLE 2.2.1 Europe and Central Asia forecast summary Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f EMDE ECA, GDP 1 1.7 4.0 3.1 2.3 2.7 2.9 -0.1 -0.8 -0.3 EMDE ECA, GDP excl. Turkey 1.2 2.9 2.9 2.5 2.7 2.5 0.1 -0.3 0.0 (Average including countries with full national accounts and balance of payments data only) 2 EMDE ECA, GDP2 1.6 4.0 3.0 2.3 2.7 2.9 -0.2 -0.8 -0.3 GDP per capita (U.S. dollars) 1.2 3.6 2.7 2.0 2.5 2.7 -0.1 -0.8 -0.2 PPP GDP 1.6 3.9 3.0 2.3 2.7 2.9 -0.2 -0.8 -0.3 Private consumption 1.2 4.8 3.0 2.4 3.2 2.9 -0.1 -0.8 0.1 Public consumption 2.9 2.1 1.9 2.5 2.2 2.1 0.4 1.1 0.9 Fixed investment -0.1 6.2 0.2 2.2 4.6 4.8 -5.0 -2.6 -0.1 Exports, GNFS3 3.4 6.9 5.5 5.3 4.3 4.5 0.7 0.6 -0.4 Imports, GNFS 3 3.2 10.4 2.8 5.1 5.8 5.8 -2.7 -0.4 0.6 Net exports, contribution to growth 0.2 -0.7 1.1 0.3 -0.2 -0.2 1.1 0.3 -0.2 Memo items: GDP Commodity exporters4 0.3 2.0 2.1 2.0 2.3 2.3 0.1 -0.3 0.0 Commodity importers5 3.1 5.9 4.0 2.6 3.2 3.6 -0.3 -1.2 -0.5 Central Europe6 3.3 4.8 4.4 3.6 3.3 3.0 0.2 -0.1 -0.2 Western Balkans7 3.0 2.5 3.5 3.5 3.8 3.8 0.3 0.1 0.0 Eastern Europe 8 0.8 2.6 3.6 2.7 3.1 3.4 0.3 -0.9 -0.4 South Caucasus9 -1.6 2.0 2.5 4.0 3.8 3.4 -0.1 0.0 0.1 Central Asia 10 3.3 4.8 4.4 4.2 4.0 4.1 0.0 0.0 0.0 Russia -0.2 1.5 1.6 1.5 1.8 1.8 0.1 -0.3 0.0 Turkey 3.2 7.4 3.6 1.6 3.0 4.2 -0.9 -2.4 -1.0 Poland 3.0 4.6 4.7 3.9 3.6 3.3 0.5 0.2 0.1 Source: World Bank. Notes: e = estimate; f = forecast. EMDE = emerging market and developing economy. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. 2. Sub-region aggregate excludes Bosnia and Herzegovina, Kosovo, Montenegro, Serbia, Tajikistan, and Turkmenistan, for which data limitations prevent the forecasting of GDP components. 3. Exports and imports of goods and non-factor services (GNFS). 4. Includes Albania, Armenia, Azerbaijan, Kazakhstan, the Kyrgyz Republic, Kosovo, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. 5. Includes Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Georgia, Hungary, FYR Macedonia, Moldova, Montenegro, Poland, Romania, Serbia, and Turkey. 6. Includes Bulgaria, Croatia, Hungary, Poland, and Romania. 7. Includes Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. 8. Includes Belarus, Moldova, and Ukraine. 9. Includes Armenia, Azerbaijan, and Georgia. 10. Includes Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 76 C H A P TE R 2. 2 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 TABLE 2.2.2 Europe and Central Asia country forecasts1 (Real GDP growth at market prices in percent, unless indicated otherwise) Percentage point differences from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f Albania 3.4 3.8 4.0 3.6 3.5 3.5 0.4 0.1 0.0 Armenia 0.2 7.5 5.3 4.3 4.6 4.6 1.2 0.3 0.6 Azerbaijan -3.1 0.1 1.1 3.6 3.3 2.7 -0.7 -0.2 0.1 Belarus -2.5 2.4 3.8 2.0 2.5 2.5 0.9 -0.7 0.0 Bosnia and Herzegovina2 3.1 3.0 3.2 3.4 3.9 4.0 0.0 0.0 -0.1 Bulgaria 3.9 3.8 3.3 3.1 3.0 2.8 -0.5 -0.5 -0.6 Croatia 3.5 2.9 2.7 2.8 2.8 2.6 0.1 0.1 0.0 Georgia 2.8 5.0 5.3 5.0 5.0 5.0 0.8 0.2 0.0 Hungary 2.2 4.0 4.6 3.2 2.8 2.4 0.5 0.0 -0.2 Kazakhstan 1.1 4.1 3.8 3.5 3.2 3.2 0.1 0.2 0.4 Kosovo 4.1 4.2 4.2 4.5 4.5 4.5 -0.6 -0.3 -0.3 Kyrgyz Republic 4.3 4.6 3.1 3.4 3.9 4.0 -1.1 -1.4 -1.1 Macedonia, FYR 2.9 0.0 2.5 2.9 3.2 3.3 0.2 0.2 0.2 Moldova 4.5 4.5 4.8 3.8 3.5 3.2 1.0 0.1 0.0 Montenegro 2.9 4.4 3.8 2.8 2.5 2.5 1.0 0.3 0.4 Poland 3.0 4.6 4.7 3.9 3.6 3.3 0.5 0.2 0.1 Romania 4.8 6.9 4.1 3.5 3.1 2.8 -1.0 -1.0 -1.0 Russia -0.2 1.5 1.6 1.5 1.8 1.8 0.1 -0.3 0.0 Serbia 2.8 1.9 3.5 3.5 4.0 4.0 0.5 0.0 0.0 Tajikistan 6.9 7.1 6.1 6.0 6.0 6.0 0.0 0.0 0.0 Turkey 3.2 7.4 3.6 1.6 3.0 4.2 -0.9 -2.4 -1.0 Turkmenistan 6.2 6.5 6.2 5.6 5.1 4.9 -0.1 -0.7 -1.2 Ukraine 2.3 2.5 3.5 2.9 3.4 3.8 0.0 -1.1 -0.6 Uzbekistan 7.8 5.3 5.0 5.1 5.5 6.0 0.0 0.0 0.0 Source: World Bank. Notes: e = estimate; f = forecast. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars, unless indicated otherwise. 2. GDP growth rate at constant prices is based on production approach. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E U R OP E A N D CE N T R A L A S I A 77 BOX 2.2.1 Informality in Europe and Central Asia The share of informal output in Europe and Central Asia (ECA) is larger than the EMDE average, even after a decline from elevated 1995 levels, but informality in the labor market is below average and there is wide heterogeneity within the region. Informality in ECA has been associated with weak institutions, sizeable agricultural sectors, and large-scale migration as well as low productivity, fiscal revenue losses, and poor job prospects for youth. In some countries in the region, declines in informality have accompanied the simplification of tax systems and labor market regulations, as well as reforms to reduce corruption. Introduction Central Europe accounted for 10 percentage points of GDP more than in the more advanced EU19 economies Informal output accounts for a larger share of official GDP in 1999-2007 (Fialová 2011).3 In the eastern part of the (36 percent) in Europe and Central Asia (ECA) than in region, the decline in informality has been considerably the average EMDE (Figure 2.2.1.1).1 However, despite a less pronounced, in part reflecting slower implementation widely shared history of transition from centrally planned of market liberalizing and other reforms, as well as to market economies, there is significant variation in persistently higher levels of corruption (Kaufmann and informality within the region, ranging from 22 percent to Kaliberda 1996). 56 percent. Drivers of informality. Informality in ECA economies has Against this backdrop, this Box examines the following typically been attributed to three factors: questions. • Agriculture. Higher labor market informality has been • How has informality evolved in Europe and Central associated with a larger share of workers in the Asia? agricultural sector as they tend to be self-employed • What have been the macroeconomic and social (Figure 2.2.1.2; Rutkowski 2006; World Bank 2011). correlates of informality? A larger agricultural sector has also been correlated with greater informality in non-agricultural sectors • What policy options are available to address (Atesagaoglu, Bayram, and Elgin 2017). challenges associated with informality? • Remittances. In countries with large diasporas, Evolution and drivers of informality informal activity has been higher among workers in households that receive sizeable remittances Evolution of informality. With the collapse of centrally (Chatterjee and Turnovsky 2018; Shapiro and planned economies in the late 1980s, many firms chose to Mandelman 2016). In Kazakhstan, FYR Macedonia, operate in the informal sector to avoid burdensome Moldova, Serbia, Tajikistan, and Ukraine, remittances regulations, taxation, or corruption. Estimates based on provided the capital to establish small businesses, electricity consumption suggest that the average size of the which tend to be informal, and the income support informal economy more than doubled during 1989-95 needed to accept less secure but often more lucrative (Johnson, Kaufmann, and Shleifer 1997). While informal work (Ivlevs 2016). informality declined in most countries once an economic recovery got underway, there was considerable • Institutions. Institutional quality varies widely within heterogeneity across countries. In the western part of the the region. The east has considerably weaker region, where institutions were stronger, informality indicators than the west, which implemented declined steeply.2 Notwithstanding this decline, one in ten substantial reforms in the context of the EU accession formal employees in Central Europe still received process (Figure 2.2.1.2; Kaufmann and Kaliberda “envelope wages” in 2006, and the informal economy in 1996).4 In general, a favorable business environment encourages firms to do business in the formal sector (Chapter 3). However, the transition from economies 1The methodology of informality estimates is discussed in Chapter 3. dominated by large-state owned enterprises to more 2The western part of the region includes Central Europe (Bulgaria, Croatia, Hungary, Poland and Romania) and the Western Balkans 3 “Envelope wages” refers to the practice of paying a portion of wages (Albania, Bosnia and Herzegovina, Kosovo, the Former Yugoslav Republic of Macedonia, Montenegro, and Serbia), and Turkey. The in undeclared cash to avoid tax and social contributions (see, for example, eastern part of the region comprises Eastern Europe (Belarus, Moldova, Horodnic 2016, and Williams and Padmore 2013). and Ukraine), South Caucasus (Armenia, Azerbaijan and Georgia), 4 Institutional indicators include the World Bank’s Doing Business Central Asia (Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, Indicators and World Governance Indicators of government effectiveness, and Uzbekistan) and Russia. control of corruption, or rule of law. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 78 C H A P TE R 2. 2 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.2.1 Informality in Europe and Central Asia (continued) FIGURE 2.2.1.1 Informality in Europe and Central Asia and other EMDE regions The share of informal output in the ECA region is higher than the EMDE median throughout the sample period, and it declined at the roughly same pace as in the other EMDE regions. However, employment informality is low, in part reflecting a low share of agriculture in some countries in the region. Institutional quality is on par with other regions, albeit with considerable hetero- geneity within the region. A. Share of informal economy in output B. Share of labor force without pension; share of self- employment C. Perceptions of informality and attitudes towards informality D. Institutional quality Sources: World Development Indicators, Organization for Economic Co-operation and Development (OECD), country’s national statistical bureaus and offices, Inter- American Development Bank, Eurostat, Haver, World Economic Forum, World Value Survey, World Bank Doing Business and World Governance Indicators, and Elgin et al. (2018a). Notes: Blue bars show simple averages of the informal economy of the region. Red markers show the median average of all EMDEs and the vertical lines denote interquartile range of all EMDEs. A. Both DGE and MIMIC estimates measure the informal output in percent of official GDP. B. Labor force without pension is the fraction of the labor force that doesn’t contribute to a retirement pension scheme, which is derived from the original data on pension coverage obtained from WDI. Self-employed is the share of self-employment in total employment. C. WEF index is the average responses at the country-year level to the following question (surveyed by World Economic Forum): “In your country, how much economic activity do you estimate to be undeclared or unregistered? (1=Most economic activity is undeclared or unregistered; 7 = Most economic activity is declared or registered).” WEF indices are re-ordered (i.e. 1= Most economic activity is declared or registered; 7= Most economic activity is undeclared or unregistered) so that a higher average at the country level indicates a larger informal economy. The index does not use data for year 2004-2005 due to inconsistency in survey methods. The World Value Survey asks whether respondents can justify cheating on taxes, with responses ranging from 1 (never justifiable) to 10 (always justifiable). The average responses at the country- year level are used as a measure for attitudes towards informality (or tax morality, Oveido et al. 2009), labeled as WVS. A higher average at the country level implies that people find cheating on taxes more justifiable. D. All measures are taken from the latest year available. The first three institutional measures are taken from World Bank’s World Governance Indicators (2017), with a higher value indicating better institutional quality in year 2016. The “Ease of doing business” (DB 2018) and “Ease of paying taxes” (DB 2017) are taken from World Bank’s Doing Business database and measured as “Distance to Frontier”, with a higher value indicating an easier environment for businesses. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E U R OP E A N D CE N T R A L A S I A 79 BOX 2.2.1 Informality in Europe and Central Asia (continued) private-business friendly economies sometimes created encourage skilled professionals to forgo migration more informal employment and larger informal sector opportunities in highly regulated economies with large (Earle and Sakova 2000). emigration, such as Tajikistan (Abdulloev, Gang, and Landon-Lane 2011). Correlates of informality Inequality. In some countries, the low wages paid to Firm productivity. Some country-specific studies suggest informal workers (the “wage penalty”) compared with that informal firms tend to be less productive than formal formal workers have contributed to inequality. In Serbia, firms. In Turkey, for example, after controlling for firm the wage penalty was found to contribute to rising characteristics, informal firms in the manufacturing sector inequality between 2002 and 2007 (Krstic and Sanfey and services sector had 16 percent and 38 percent lower 2010). Similar wage penalties in Turkey were found to total factor productivity than formal firms, respectively, lower incomes of less educated workers, for whom with the productivity gap attributed to restricted access to informal employment is more common (Taymaz 2009). public services and formal markets (Taymaz 2009). By However, in some cases informal workers have been found these estimates, shifting all informal firms in the Turkish to earn a wage premium, e.g., in Russia, Romania, manufacturing and services sectors into the formal sector Tajikistan, and Ukraine (Zahariev 2003; Staneva and could raise total output by 5 percent and 25 percent in Arabsheibani 2014; Shehu and Nilsson 2014; Lehmann manufacturing and services, respectively (Taymaz 2009). and Norberto 2018). In those countries, the informal wage In Kyrgyz Republic, productivity in the informal sector premium may compensate for the lack of social security has declined significantly since 2009, despite robust and lower job security (Marcouiller and Woodruff 1997; productivity growth in the formal sector (Sattar, Keller, Lehmann and Norberto 2018).6 and Baibagysh Uulu 2015). Fiscal revenues. Large informal sectors erode tax revenues Policy challenges and hamper governments’ ability to provide public goods. The impact of policies on informality can depend on However, the magnitude of foregone revenues due to country characteristics such as labor market flexibility, informality remains a matter of debate. One estimate efficiency of tax collection or control of corruption. This suggests that tax revenue losses from informality could underscores the importance of ensuring that reform efforts have been as high as 7 percent of GDP in Central Asia and are carefully tailored to country circumstances to avoid the Caucasus in 2004 (Grigorian and Davoodi 2007). unintended increases in informality. However, estimates based on micro survey data suggest only modest potential revenues gains (0.03-0.07 Labor market policies. The impact of labor market percentage points of GDP) from turning informal workers reforms on informality in ECA has been mixed, and into formal workers in a country such as Ukraine in 2009, appears to have depended on country characteristics. In a as newly formalized are mainly low-skilled worker subject cross-sectional study of ECA countries, more restrictive to low tax rates (World Bank 2011). employment protection legislation has been associated with a higher share of the informal economy (both in Labor market prospects. Informal employment is more terms of GDP and labor force; Fialová 2011; Lehmann common among young, low-skilled, and female workers, and Muravyev 2009). In contrast, there was no robust and some studies suggest that informal employment can association of informality with more generous damage prospects to improve long-term careers and unemployment benefits or higher minimum wages entrenches income differentials (World Bank 2007; Taymaz 2009; World Bank 2011). However, informal (Fialová 2011; Lehmann and Muravyev 2009). employment can also be an income source when formal Fiscal policy. Several countries have changed tax rates or employment opportunities are scarce and can provide an tax enforcement, but the impact on informality has been opportunity to develop human capital towards eventual varied. That said, reducing the tax compliance burden and formal employment or self-employment, as has been found for Russia and Turkey (Guariglia and Kim 2006; World Bank 2009).5 Better-paid informal activity may also 6 Controlling for worker characteristics and selection bias, the absence of male-female wage differentials in the informal economy—in the 5 This is consistent with the finding that informally employed youth presence of large differentials in the formal economy—has been have lower job satisfaction relative to their peers with formal jobs (Shehu interpreted as sign of lesser gender discrimination in the informal and Nilsson 2014). economy than in the formal economy in Turkey (Tansel 2000). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 80 C H A P TE R 2. 2 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.2.1 Informality in Europe and Central Asia (continued) FIGURE 2.2.1.2 Correlates of informality in Europe and Central Asia Informality as a percentage of GDP in the eastern part of the region is higher than the western part of the region, in part reflecting differences in institutional quality. Employment informality tends to be higher in countries with larger agricultural sectors. A. Informality in output B. Institutional quality C. Informality in labor market D. Labor market informality and agricultural employment Sources: European Bank of Reconstruction and Development, World Bank, and World Governance Indicators. Notes: A-E. Data are from the latest year available, usually 2016. A.B. C. E. The western part of the region includes Central Europe (Bulgaria, Croatia, Hungary, Poland and Romania) and the Western Balkans (Albania, Bosnia and Herzegovina, Kosovo, the Former Yugoslav Republic of Macedonia, Montenegro, and Serbia), and Turkey. The eastern part of the region comprises Eastern Europe (Belarus, Moldova, and Ukraine), South Caucasus (Armenia, Azerbaijan and Georgia), Central Asia (Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan) and Russia. A. B. E. Orange diamonds indicate subsample average and blue bars indicate one standard deviation range. A. DGE estimate of informal output in percent of official GDP. B. Share of self-employment. C. Average percentile rank among 214 sample countries. Higher value means better quality. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 E U R OP E A N D CE N T R A L A S I A 81 BOX 2.2.1 Informality in Europe and Central Asia (continued) subsidizing a transition to the formal sectors have typically into the preferential status and may encourage firms been accompanied by declines in informality.7 to remain small (Packard et al. 2014). • Flat tax. One form of tax simplification that has been • Shift from labor to other taxation. Shifting from labor used in the region is the introduction of a flat labor income taxes, which constitute a wedge between income tax rate (e.g., Bulgaria, Poland, Russia, and informal and formal employment, to less distorting Romania). The flat tax reform in Russia was followed and more easily enforced taxes, such as value-added by a decline in informal employment and informal taxes and progressive real estate taxes, can shrink the activity, especially in the top income bracket informal economy (Packard et al. 2014). (Slonimczyk 2012). A simulation suggests that the Polish flat tax reform in 2004 could have led to a 48 • Subsidies. A formal employment subsidy, such as the percent increase in reported business income and 25 one introduced in Turkey, can increase the number of percent higher tax revenue, despite a lower average registered jobs by encouraging informal workers to marginal tax rate (Kopczuk 2012). However, flat tax transition to formal employment as well as provide structures can be regressive and need to be balanced better social protection (Betcherman, Daysal, Pages with poverty fighting initiatives. 2010). • Preferential tax schemes. Another form of tax Control of corruption. Better governance and more simplification that has been used has been the effective tax authorities can reduce the size of the informal introduction of indirect assessments of tax liabilities economy and increase tax revenue. Bureaucratic for the self-employed and small firms. Such measures corruption has been associated with greater informal can encourage entrepreneurship, help revenue activity in Poland, Romania, and Slovakia (Johnson et al. collection from hard-to-tax sectors, and ease the 2000). Conversely, better control of corruption has transition from informal to formal work. However, reduced the extent of informal activities in the countries these preferential schemes for small firms can also that joined the European Union in the mid-2000s (Fialová encourage formal workers to avoid taxes by shifting 2011). 7 On the one hand, higher labor tax rates encourage a move of labor into untaxed informal employment, especially for low-wage earners (Koettl and Weber 2012). On the other hand, higher labor tax rates have in some cases been associated with a lower share of informal employment, because higher revenue allow governments to provide better public goods that can only be accessed in formal employment (Fialova 2011, Freedman, Johnson and Kaufmann 2000). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) Growth in Latin America and the Caribbean was disappointingly weak in 2018, at an estimated 0.7 percent, and notably lower than previously expected. This reflected the impact of Argentina’s recent currency crisis, a truckers’ strike and policy uncertainty in Brazil, and worsening conditions in Venezuela. Growth is expected to pick up in 2019, to 1.8 percent, as growth accelerates in Brazil and the recession in Argentina begins to fade. Per capita growth in LAC is projected to pick up moderately, and to outpace that in advanced economies starting in 2020, after six years of stalled convergence. Downside risks continue to dominate. Key external risks include the possibility of an abrupt further tightening of external financial conditions and a further escalation of international trade policy uncertainty. The region also faces intraregional and domestic risks, such as spillovers from larger-than-expected growth contractions in Argentina and Venezuela and the persistent threat of natural disasters and extreme weather. Recent developments impact on ongoing hyperinflationary dynamics. Growth in Latin America and the Caribbean Commodity price developments are also affecting stalled at a subdued 0.7 percent in 2018, LAC economies. The decline in copper prices in substantially weaker than previously projected. the second half of 2018 contributed to slowing The disappointing growth outcome reflected growth momentum in Chile and Peru, after a softening global trade growth and tighter external strong performance in the first half. Rising oil financing conditions. Developments in Brazil, prices underpinned accelerating growth in oil- Argentina, and Venezuela hindered regional producing Colombia. In oil-importing Central growth, despite a solid pickup in several mid-size America, higher oil prices were one factor that economies (e.g., Chile, Colombia, Peru). Growth inhibited growth in 2018, despite the decline in moderated in Central America, reflecting a variety prices at the end of the year. The sub-region was of factors, while it strengthened in almost all also affected by weak confidence in Costa Rica Caribbean economies as the subregion began to and Panama, political uncertainty in Guatemala, recover from a severe 2017 hurricane season. and social unrest in Nicaragua. In Brazil, growth bounced back in the second half A long-awaited rebound in regional fixed of 2018, following a strike-induced dip around investment that began in 2017 was significantly mid-year, but remains subdued. In Argentina, the weaker in 2018 than previously expected, after recent currency crisis and associated sharp losing momentum in the first half of the year tightening of monetary and fiscal policies, together (Figure 2.3.1). Export growth in the region was with the effect of a severe drought on the also lower than expected, owing to the drought in agriculture sector, resulted in a sharp contraction Argentina and slowing global trade growth. in activity. Venezuela’s economic collapse has deepened, and there is no indication that the latest Nearly all LAC economies with floating exchange redenomination of the currency has had a major rates have experienced nominal depreciation against the U.S. dollar, particularly Argentina, Brazil, Chile, Colombia, and Uruguay. The Note: This section was prepared by Dana Vorisek. Brent Harrison provided research assistance. adjustment in effective terms has been more EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 84 C H A P TE R 2. 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 2.3.1 LAC: Recent developments through to domestic inflation, despite falling pass- Investment and export momentum in LAC have slowed. Rising U.S. interest through ratios observed over the long term (Ha, rates and weakening investor sentiment toward EMDEs has translated into Stocker, and Yilmazkuday 2019). Central banks in diminished capital inflows and rising bond spreads and credit default swap several countries have intervened in foreign spreads in LAC, while a strengthening U.S. dollar is putting upward pressure on inflation. Fiscal deficits narrowed in most LAC countries in exchange markets using derivative instruments to 2018, mainly reflecting higher revenues, but debt continues to build. reduce currency volatility (e.g., Brazil, Uruguay) or to build reserves (e.g., Colombia). A. Investment and export growth B. Exchange rates against the U.S. dollar External financing conditions have tightened. Against the backdrop of rising U.S. interest rates, U.S. dollar appreciation, and weaker investor sentiment toward EMDEs, the region has experienced a generalized rise in bond and credit default swap spreads and a fall in equity indexes. Capital inflows, particularly bond flows, steadily diminished through the third quarter of 2018. Current account deficits have widened in most C. Inflation D. Bond spreads commodity-exporting and commodity-importing economies. Several Caribbean economies that were not significantly damaged by hurricanes in 2017, however, registered narrowing deficits or widening surpluses as a share of GDP in 2018 on strong tourism inflows and rising oil prices (e.g., The Bahamas, Belize, St. Vincent and the Grenadines, and Trinidad and Tobago). E. Gross capital inflows F. Fiscal balances and government Fiscal conditions across the region remain fragile, debt and government debt continues to build. Fiscal deficits narrowed slightly in most countries in 2018, however. The improvement mainly reflected higher revenues, in part stemming from rising prices of key commodities. The recently undertaken austerity program in Argentina will be challenging to implement but should improve long-term fiscal sustainability. In Chile, a proposed tax reform would integrate and Source: Bloomberg, CPB Netherlands Bureau for Economic Policy Analysis, Haver Analytics, International Monetary Fund, World Bank. streamline the tax system. A proposed tax reform A. Investment growth is the GDP-weighted average of 12 economies that represent 91 percent of regional GDP. Last observation is 2018Q3 for investment and 2018Q3 for exports. in Colombia would boost revenues in order to B. Last observation is November 26, 2018. comply with fiscal targets. C. Above average and below average groups are delineated according to depreciation is measured against the U.S. dollar between January 1, 2018 and October 1, 2018. Average depreciation in the region, not including Argentina, is 4.3 percent. Sample includes 17 economies and excludes those with conventional currency pegs and currency boards and those using the U.S. dollar as their official currency. Last inflation observation is October 2018. Outlook D. Last observation is November 19, 2018. E. LAC line shows median of 15 countries: Argentina, Belize, Brazil, Chile, Colombia, Dominican Republic, Ecuador, Jamaica, Mexico, Panama, Peru, El Salvador, Trinidad and Tobago, Uruguay, Regional growth is projected to advance to a still and Venezuela. F. Sample includes 32 economies. modest 1.8 percent in 2019, lower than previously projected, and build to 2.5 percent in 2021 (Figure 2.3.2). The pickup will be supported modest. In most of these economies, especially mainly by private consumption. Investment Argentina, depreciation is contributing to a rise in growth will accelerate, though at a slower pace this inflation. Recent interest-rate hikes (e.g., in Chile) year than previously expected, in view of tight were made partly reaction to exchange rate pass- financing conditions and planned public spending EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 L A T I N AM E RI C A A N D T H E C A R I B B E A N 85 reductions in a number of countries. Decelerating FIGURE 2.3.2 LAC: Outlook and risks global trade will limit export growth during the Growth in LAC is projected to accelerate only moderately through 2021, forecast period. and at a slower pace than previously expected. Risks to the regional outlook are predominantly to the downside. Further tightening of global financing conditions and escalation of trade tensions among major Although the prices of key non-oil commodities economies are key external risks. The region also faces intraregional and such as soybeans and copper are projected to domestic risks, such as spillovers from a larger-than-expected growth contraction in Argentina or Venezuela and unexpected disruptions from continue rising through the forecast period, natural disasters and extreme weather. copper prices will increase at a much slower pace through 2021 than in 2017 and 2018. Oil prices A. Growth B. Commodity prices are projected to be flat, on average, during 2019- 20, at $69 per barrel, potentially limiting fiscal and export revenue increases in oil-producing economies. In Brazil, momentum is expected to steadily build in 2019, from a weak base. The growth forecast of 2.2 percent for this year assumes that fiscal reforms are implemented expeditiously under the incoming administration, and that a recovery of C. Debt D. Current account deficit less FDI consumption and investment, resulting from improving confidence and investor sentiment, will outweigh the negative growth effect of reduced government spending. In Mexico, policy uncertainty is expected to keep growth at a moderate 2.2 percent in 2019, despite the decrease in trade-related uncertainty following the announcement of the United States-Mexico- Canada Agreement. Argentina’s economy is E. Exposure to Argentina, 2017 F. Elections expected to continue contracting in 2019 as deep fiscal consolidation results in a loss of employment and reduction in consumption and investment, and as high interest rates place corporate balance sheets under stress and dampen private investment. By 2020, a strengthening recovery in Brazil, modestly accelerating growth in Mexico, and solid performance in Chile, Colombia, and Peru, are Sources: Bank for International Settlements, Comtrade, Haver Analytics, International Monetary Fund, World Bank. expected to push regional growth to 2.4 percent, B. Change in nominal prices. C. Bars show data for 2007Q4, 2012Q4, and 2018Q1. consistent with potential. Per capita GDP growth F. Chart shows economies holding presidential or parliamentary elections in a given year as a share in the region is also expected to accelerate of regional GDP. A single economy is counted only once when both types of elections occur in a single year. moderately, and to outpace per capita growth in advanced economies starting in 2020, after five years of stalled convergence. Achieving sustained improvements in potential inflexibility, deepen trade integration, and address growth in the region over the medium term will the negative economic and social outcomes of require implementing reforms in several areas. informality, among other challenges (World Bank There is need to improve infrastructure and 2018; Chapter 3; Box 2.3). education attainment, reduce labor market EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 86 C H A P TE R 2. 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 the medium and long term, inward migration to Risks Colombia could result in a growth boost as a Risks to the regional outlook remain tilted to the result of a larger labor supply and higher downside. The experience of Argentina in 2018 is consumption and investment. a stark reminder of the risk of sudden and widespread shifts of investor sentiment toward Poor fiscal conditions and slow adjustment of EMDEs. Tightening global financing conditions fiscal imbalances are another downside risk, and are a particular concern for countries with large may have negative repercussions for debt current account deficits or reliance on volatile sustainability and market confidence. In capital inflows (e.g., Argentina, Bolivia, and Argentina, for instance, adherence to the fiscal several Caribbean countries), with high external consolidation plan is key to a quick emergence debt loads (e.g., Jamaica, Nicaragua, Venezuela), from the recent currency crisis. Plans to reduce or with sizable foreign-currency-denominated debt public spending in other countries (e.g., Ecuador) as a share of GDP (e.g., Costa Rica, Honduras, need to be carried out to retain investor Nicaragua). confidence. In Brazil, the new administration needs to urgently make plans to reduce fiscal Trade tensions are another key external risk. vulnerabilities arising from an unsustainable Although trade diversion in response to rising pension system. trade restrictions in the United States and Canada may benefit some LAC economies in the short Election-related risks, which generated term, continued trade tensions may dampen considerable uncertainty in countries such as regional growth in the medium term through Brazil and Mexico in 2018, are expected to recede, export, confidence, and commodity market given that the elections scheduled in the next two channels. years are in economies representing a much lower share of regional GDP. However, it will be LAC economies also face intraregional and incumbent on some new governments to domestic sources of risk. Thus far, the recession in implement challenging policy reforms. Argentina has had limited spillovers on the rest of the region. But a larger-than-expected contraction Unexpected disruptions related to natural disasters in Argentina could spill over to the rest of the and extreme weather represent a significant region through trade and financial flows. Paraguay ongoing risk. Hurricanes, floods, droughts, and and Bolivia are most reliant on Argentina as a earthquakes have long had detrimental impacts on destination for goods exports and a source of growth in several economies in the region in remittance inflows. Although Uruguay has recent years. The region remains highly vulnerable diversified its trading partners in recent years, it to such events, underscoring the need to use risk remains reliant on Argentina for services export instruments such as catastrophe bonds and revenues through tourism. Cross-border bank domestic and multi-country catastrophe risk lending data for Latin American economies is insurance funds (Végh et al. forthcoming). patchy but suggests that Panama is most exposed, although with bank claims on Argentina still limited at approximately 0.6 percent of domestic GDP. Continued outward migration from Venezuela stands to have negative spillovers elsewhere in the region. In Colombia, the cost of providing basic public services to migrants and Colombian returnees at levels similar to those delivered to the 1 Calculations of the cost of public services in World Bank (2018) local population is an estimated 0.2–0.4 percent of are made using the number of migrants and returnees in Colombia as GDP per year (World Bank 2018b).1 However, in of September 2018. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 L A T I N AM E RI C A A N D T H E C A R I B B E A N 87 TABLE 2.3.1 Latin America and Caribbean forecast summary (Real GDP growth at market prices in percent, unless indicated otherwise) Percentage point differences from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f EMDE LAC, GDP1 -1.5 0.8 0.7 1.8 2.4 2.5 -1.0 -0.5 -0.1 (Average including countries with full national accounts and balance of payments data only) 2 EMDE LAC, GDP2 -1.4 0.8 0.7 1.8 2.4 2.5 -1.0 -0.5 -0.1 GDP per capita (U.S. dollars) -2.5 -0.2 -0.4 0.8 1.4 1.5 -1.1 -0.5 -0.1 PPP GDP -0.8 1.1 0.9 1.9 2.5 2.6 -1.0 -0.5 -0.1 Private consumption -1.6 1.6 0.5 1.8 2.7 2.7 -1.6 -0.7 0.0 Public consumption 0.1 -0.7 0.2 -0.1 0.2 0.4 0.4 -0.3 -0.5 Fixed investment -6.8 -0.7 1.3 2.2 4.9 4.7 -2.4 -1.8 0.3 Exports, GNFS3 1.2 2.4 3.9 4.0 3.6 3.7 0.7 0.3 -0.3 Imports, GNFS3 -3.2 5.2 3.1 3.7 4.8 4.9 -1.2 -0.4 0.2 Net exports, contribution to growth 0.9 -0.6 0.2 0.1 -0.2 -0.3 0.4 0.2 0.0 Memo items: GDP South America4 -3.1 0.3 0.0 1.5 2.3 2.4 -1.3 -0.6 0.0 Central America5 3.9 3.8 2.7 3.2 3.6 3.5 -1.0 -0.7 -0.3 Caribbean6 2.5 2.3 3.7 3.6 4.1 3.9 0.2 0.1 0.3 Brazil -3.3 1.1 1.2 2.2 2.4 2.4 -1.2 -0.3 0.0 Mexico 2.9 2.0 2.2 2.2 2.4 2.4 -0.1 -0.3 -0.3 Argentina -1.8 2.9 -2.8 -1.7 2.7 3.1 -4.5 -3.5 -0.1 Source: World Bank. Notes: e = estimate; f = forecast. EMDE = emerging market and developing economy. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. 2. Aggregate includes all countries in Table 2.3.2 except Dominica, Grenada, Guyana, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago, for which data limitations prevent the forecasting of demand-side GDP components. 3. Exports and imports of goods and non-factor services (GNFS). 4. Includes Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Paraguay, Peru, Uruguay, and Venezuela. 5. Includes Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and Panama. 6. Includes Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Dominican Republic, Grenada, Guyana, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 88 C H A P TE R 2. 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 TABLE 2.3.2 Latin America Caribbean country forecasts1 (Real GDP growth at market prices in percent, unless indicated otherwise) Percentage point differences from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f Argentina -1.8 2.9 -2.8 -1.7 2.7 3.1 -4.5 -3.5 -0.1 Belize -0.5 0.9 1.5 1.9 1.7 1.7 -0.5 0.0 0.0 Bolivia 4.3 4.2 4.5 4.3 3.8 3.4 0.6 0.7 0.4 Brazil -3.3 1.1 1.2 2.2 2.4 2.4 -1.2 -0.3 0.0 Chile 1.3 1.5 4.0 3.5 3.3 3.2 0.7 0.1 -0.2 Colombia 2.0 1.8 2.7 3.3 3.7 3.6 0.0 0.0 0.1 Costa Rica 4.2 3.3 2.7 2.6 2.5 2.5 -0.7 -1.0 -1.1 Dominican Republic 6.6 4.6 5.8 5.1 5.0 4.8 0.8 0.4 0.4 Ecuador -1.2 2.4 1.5 1.6 1.6 1.9 -0.7 0.1 0.7 El Salvador 2.6 2.3 2.8 2.5 2.4 2.4 0.5 0.3 0.2 Grenada 3.7 5.1 5.2 4.2 2.8 2.8 1.9 1.4 0.0 Guatemala 3.1 2.8 2.7 2.9 3.0 3.1 -0.4 -0.4 -0.3 Guyana 3.4 2.1 3.4 4.6 30.0 24.8 -0.4 0.8 1.0 Haiti2 1.5 1.2 1.6 2.3 2.4 2.5 -0.2 -0.1 0.0 Honduras 3.8 4.8 3.6 3.8 3.8 3.7 0.1 0.2 0.0 Jamaica 1.4 0.5 1.7 1.8 2.0 2.0 0.0 -0.1 0.0 Mexico 2.9 2.0 2.2 2.2 2.4 2.4 -0.1 -0.3 -0.3 Nicaragua 4.7 4.9 -3.8 -0.5 2.6 3.6 -8.5 -5.0 -1.8 Panama 5.0 5.4 4.0 5.0 6.2 5.2 -1.6 -0.6 0.6 Paraguay 4.3 4.8 4.0 3.9 4.0 4.0 -0.3 -0.3 -0.2 Peru 4.0 2.5 3.9 3.8 3.8 3.7 0.4 0.0 0.0 St. Lucia 3.4 3.8 1.5 2.7 2.8 2.3 -1.3 0.4 0.5 St. Vincent and the Grenadines 1.3 0.5 1.2 1.6 1.6 2.0 -0.9 -0.9 -1.1 Suriname -5.1 -2.1 1.4 1.6 1.8 1.9 0.3 -0.1 -0.3 Trinidad and Tobago -6.0 -2.3 0.7 0.9 1.2 1.2 -0.9 -1.0 0.0 Uruguay 1.7 2.7 2.1 2.1 2.3 2.5 -1.2 -1.0 -0.6 Venezuela -16.5 -14.5 -18.0 -8.0 -5.0 -4.0 -3.7 -1.0 -1.0 Source: World Bank. Notes: e = estimate; f = forecast. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. 2. GDP is based on fiscal year, which runs from October to September of next year. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 L A T I N AM E RI C A A N D T H E C A R I B B E A N 89 BOX 2.3.1 Informality in Latin America and the Caribbean Informal sector output in Latin America and the Caribbean, equivalent to about one-third of GDP, is slightly higher than in the median EMDE, despite a steady decline during recent decades. Roughly four out of ten of those employed in the region are employed informally. Informality has been associated with lower growth, weaker productivity, and higher levels of inequality. Policies to reduce payroll taxes and increase labor inspections have been found to reduce informality. Introduction very low: 12 percent in Suriname (2014), 14 percent in The Bahamas (2011), and 17 percent in Barbados (2013). Informality in Latin America and the Caribbean (LAC) Again, Bolivia appears at the top end of the spectrum, with during the past decade was slightly higher than in the self-employment equivalent to 64 percent of formal median emerging and developing economy (EMDE), employment in 2015. In most countries, labor informality whether measured in terms of informal output or the share is higher than output informality, although Brazil, of self-employment (Figure 2.3.1.1, Box 3.2). Yet there is Guatemala, and several Caribbean countries are substantial heterogeneity in the incidence informality exceptions. within the region. Informality tends to be higher in countries with poorer institutional environments. Trend decline in output informality. Output informality in the region has steadily declined since the early 2000s Against this backdrop, this box addresses the following (Figure 2.3.1.2). Several of the countries with the highest questions: incidence of output informality (Bolivia, Panama, Peru) have also experienced some of the largest declines during • How has informality evolved in Latin America and the past two decades, in part due to rapid formal job the Caribbean? creation in the context of strong output growth. Yet even where labor informality has fallen, the decline did not • What have been the macroeconomic and social necessarily affect all workers equally. In Brazil and correlates of informality? Argentina, two of the largest economies in LAC, middle- • What policy options are available to address aged men, the highly skilled, and those working full time challenges associated with informality? were the most likely to shift out of informal into formal employment during the 2000s (Maurizio 2015). Evolution and drivers of informality Moreover, the decline in output informality has not always been accompanied by a similar decline in labor Moderate informality. On average, the informal economy informality, which has been persistently high in countries in LAC was equivalent to 34 percent of official GDP in such as Bolivia, Colombia, Honduras, Jamaica, Nicaragua, 2016, slightly above the median EMDE.1 Informal and Peru. employment averaged 62 percent of employment in 2016 (slightly below-median), while 38 percent of those Correlates of informality employed were self-employed. Within the region, informality varies considerably. Informality has been associated with weak institutions and business climates as well as poor macroeconomic, Regional heterogeneity. Output informality ranged from microeconomic, and social outcomes in LAC. These 16 percent of GDP in Chile, in line with rates observed in include lower output and productivity growth, weaker advanced economies, to 56 percent in Bolivia. Haiti also financial resilience of households, and greater poverty. has very high informality, at 61 percent of GDP.2 Survey- based measures of labor informality show a similarly wide Weak governance and business climates. Most of the range. For Caribbean countries with available data, self- institutional factors associated with informality are at or employment as a share of formal employment tends to be slightly above the EMDE average in LAC. However, LAC economies with below-average institutional quality have also tended to be those with high informality. For Note: This box was prepared by Dana Vorisek. Brent Harrison and instance, higher labor informality in Peru than in Chile Jinxin Wu provided research assistance. has been shown to be mostly explained by poor 1 Output informality based on DGE estimates of Elgin and Oztunali governance (Loayza and Wada 2010). One of the most (2014), unless otherwise specified. 2 For lack of data on DGE estimates, this figure refers to MIMIC 3 Loayza (1997); Vuletin (2008); Loayza, Servén, and Sugawara estimates (Chapter 3). DGE and MIMIC estimates are similar at the (2010); Estevão and de Carvalho (2012); Dougherty and Escobar (2013). country level. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 90 C H A P TE R 2. 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.3.1 Informality in Latin America and the Caribbean (continued) FIGURE 2.3.1.1 Informality in LAC Output-based informality in LAC has fallen since the 1990s, on average, yet remains above the median in EMDEs. Employ- ment-based informality in the region has risen slightly, to about the EMDE median. The key institutional factors that are often associated with informality, other than the difficulty of paying taxes, are slightly better in LAC than in all EMDEs. A. DGE- and MIMIC-based informal activity B. Labor force without pension and self-employed C. Perceived informal activity and attitude toward informality D. Institutional quality Sources: Elgin et al. (2018); Eurostat; Haver Analytics; Inter-American Development Bank; national statistical bureaus and offices; Organisation for Economic Co- operation and Development; World Bank Doing Business, World Development Indicators (WDI), and World Governance Indicators; World Values Survey. A. -D. Blue bars show simple averages of the informal economy of the region. Red markers show the median of all EMDEs. Vertical lines denote interquartile range of all EMDEs. A. DGE = dynamic general equilibrium model. MIMIC = multiple indicators multiple causes model. DGE sample includes 26 LAC economies and 122 EMDE; MIMIC sample includes 25 LAC economies and 124 EMDEs. B. Labor force without pension is the share of the labor force that does not contribute to a retirement pension scheme, derived from data on pension coverage obtained from WDI. Self-employed is the share of self-employment in total employment. Labor force without pension sample includes 20 LAC economies and 103 EMDEs; self- employed sample includes 32 LAC economies and 134 EMDEs. C. WEF = World Economic Forum. WVS = World Values Survey. WEF index is the average response at the country-year level to the question: “In your country, how much economic activity do you estimate to be undeclared or unregistered? (1 = Most economic activity is undeclared or unregistered; 7 = Most economic activity is declared or registered).” WEF index is inverted; a higher average at the country level indicates a larger informal economy. The index does not use data for 2004–05 due to inconsistency in survey methods. The WVS asks whether respondents can justify cheating on taxes (1 = never justifiable; 10 = always justifiable). The average responses at the country-year level are used as a measure of attitude toward informality (or tax morality; Oviedo, Thomas, and Karakurum-Ozdemir 2009). WEF sample includes 25 LAC economies and 114 EMDEs; WVS sample includes 13 LAC economies and 66 EMDEs. D. All measures are taken from the latest year available. The first three institutional measures are taken from World Bank’s World Governance Indicators (2017), with a higher value indicating better institutional quality in 2016. The “ease of doing business” and “ease of paying taxes” are taken from World Bank’s Doing Business database and measured as distance to frontier, with a higher value indicating a more favorable business environment. Sample includes 32 LAC economies and 149 EMDEs. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 L A T I N AM E RI C A A N D T H E C A R I B B E A N 91 BOX 2.3.1 Informality in Latin America and the Caribbean (continued) FIGURE 2.3.1.2 Evolution and causes of informality in LAC Although output-based informality in LAC has fallen, the incidence of informality still varies considerably within the region. In LAC economies where corruption and the burden of paying taxes is high, output-based informality tends to be high. Self- employment tends to be high where labor market efficiency is low. Both corporate and personal income tax rates are higher in LAC than in all EMDEs. A. DGE-based informal activity B. DGE-based informal activity, by C. DGE-based informal activity country D. DGE-based informal activity E. Self-employment F. Average tax rates Sources: Elgin et al. (2018); Haver Analytics; Inter-American Development Bank; national statistical bureaus and offices; OECD; Végh and Vuletin (2015); World Bank Doing Business, World Development Indicators, and World Governance Indicators; World Economic Forum. A. Sample includes 23 economies. The median of the MIMIC-based estimate of informality shows a similar downward trend. B. CHL = Chile, ARG= Argentina, CRI= Costa Rica, BRB = Barbados, BHS = The Bahamas, ECU = Ecuador, MEX = Mexico, DOM = Dominican Republic, COL = Colombia, JAM = Jamaica, SUR = Suriname, BRA = Brazil, PRY = Paraguay, NIC = Nicaragua, SLV = El Salvador, BLZ = Belize, URY = Uruguay, HND = Honduras, PER = Peru, GTM = Guatemala, PAN = Panama, BOL = Bolivia. C. Bars show medians. Sample includes 21 LAC economies. D. Bars show medians. Sample includes 20 LAC economies. Tax burden is measured as the ease of paying taxes in the World Bank’s Doing Business indicators. E. Bars show medians. Sample includes 16 LAC economies. F. Corporate tax rate sample includes 17 LAC economies and 49 EMDEs; personal tax rate sample includes 17 LAC economies and 47 EMDEs. common explanations for informality in LAC countries Trade liberalization amid inflexible labor markets. Some has been restrictive business and labor regulations, which instances of trade liberalization have also been associated discourage firms from entering the formal sector.3 with rising informality in LAC. The reduction of trade barriers in the 1980s and 1990s led to fears that domestic High tax burdens. High tax rates or burdensome tax firms in the formal sector would be rendered regulations have also encouraged informality in the region uncompetitive and shift to the informal sector. In Brazil, (Loayza 1997; Vuletin 2008; Ordóñez 2014). Both the association between trade liberalization and informality corporate and personal income tax rates tend to be higher was ambiguous in the early literature (Goldberg and in LAC than in the average EMDE—indeed, LAC is the Pavcnik 2003; Menezes-Filho and Muendler 2011; Bosch, only EMDE region where the average personal income tax Goñi-Pacchioni, and Maloney 2012). However, recent rate has risen since the early 2000s. research has established that trade liberalization was followed by increased informality in Brazil, though only in EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 92 C H A P TE R 2. 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.3.1 Informality in Latin America and the Caribbean (continued) the long run (Dix-Carneiro and Kovak 2017; Dix- productivity and profitability in informal firms compared Carneiro et al. 2018). In Colombia, trade liberalization to formal firms was due in part to worse access to credit was associated with slightly higher informality, yet only (Medvedev and Oviedo 2013). Across the region, rising prior to a subsequent reform that increased labor market informality has been associated with lower pension flexibility (Goldberg and Pavcnik 2003). contributions (Vuletin 2008). Sectoral and worker characteristics. Informality has been Higher poverty and inequality. Informality in LAC has shown to be higher in the presence of large agricultural also been associated with inequality and poverty, in part sectors. Other structural factors, such as poor education reflecting the wage gap between the informal and formal and skills, have also been identified as underlying reasons sectors. In Argentina, past poverty has been associated with for labor informality (Fernandez and Villar 2016). In some current informal employment, and past informality has LAC countries, a considerable share of people working been associated with current poverty (Devincienti, informally entered the informal sector voluntarily. Groisman, and Poggi 2015). The process of increasing Switching between the formal and informal sectors has formal-sector employment contributed significantly to the been common in the largest economies in the region decline in inequality in Argentina and Uruguay during the (Perry et al. 2007; Fiess, Fugazza, and Maloney 2008; 2000s (Beccaria, Maurizio, and Vazquez 2015; Aramante, Bosch and Maloney 2010). This has been suggested to Arim, and Yapor 2016). In Colombia, informal workers reflect a high regard for self-employment in LAC relative received lower wages than formal workers due not only to to other regions, or a response to adverse employment and lower returns to their education, but also to educational income shocks in the formal sector. mismatches (Herrera-Idárraga, López-Bazo, and Motellón 2015). Lower output growth. In studies of a large number of LAC economies, informality has been negatively associated Policy options with growth, even after controlling for country characteristics (Loayza 1997; Loayza, Servén, and Designing policies to address informality requires an Sugawara 2010). However, studies at the country level are understanding of its causes and characteristics. These vary less conclusive. In Mexico, for instance, informality has considerably, even within individual countries in LAC been accompanied by slowing growth, yet in Brazil, falling (Perry et al. 2007; Alcarez et al. 2012; Garcia 2014; informality has not necessarily been associated with higher Fernandez and Villar 2016). GDP (Levy 2008; Ulyssea 2018). Tax system. Making tax policy less restrictive, by lowering Lower productivity growth. The informality literature on tax rates or simplifying tax systems, could incentivize firms LAC has established a link between informality and to become formal and increase demand for formal workers. aggregate productivity (Loayza et al. 2009). Linkages Indeed, a large reduction in payroll tax rates in Colombia between informality and productivity have also been in 2012 reduced labor informality in the main identified at the firm level. Informal firms in Brazil, for metropolitan areas by about 7 percentages points instance, have been less productive than formal firms (de (Fernandez and Villar 2016). e results of Brazil’s Paula and Scheinkman 2011). In Paraguay, not only are reduction and simpli cation of business taxes in Brazil in informal firms less productive, but their low productivity 1996 have been more ambiguous. Early studies found that has had negative spillovers to formal firms (Vargas 2015). the reform was associated with a signi cant increase in the incidence of formal rms, and that newly formalized rms Lower savings and access to finance for households and achieved higher revenue and pro ts than those operating firms. For workers and firms, there are negative financial informally, although the impact of the reform on implications of informality. Informal workers in Chile, for informality varied across economic sectors (Fajnzylber, instance, have not been able to save as much as formal Maloney, and Montes-Rojas 2011; Monteiro and workers, and have had more less access to finance than Assuncão 2012). Recent studies have found no evidence of formal firms (Schlcarek and Caggia 2015). In Brazil, poor increased formalization as a result of the reform (e.g., Piza access to finance was the key reason for informal firms 2016). being small and unproductive: their cost of capital was at least 1.3 times that of formal firms (de Paula and Labor market regulation. Tighter labor inspections have Scheinkman 2011). Similarly, in Ecuador, lower been effective in reducing informality in the region, EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 L A T I N AM E RI C A A N D T H E C A R I B B E A N 93 BOX 2.3.1 Informality in Latin America and the Caribbean (continued) through a variety of mechanisms. In Brazil, tighter for informality. A reform that simplified the process of enforcement of labor market regulations raised wages and opening a business in Mexico was successful in increasing output by improving the allocation of workers between the the number of registered businesses (Bruhn 2011; Kaplan, formal and informal sectors (Meghir, Narita, and Robin Piedra, and Seira 2011). However, the reform had no 2015). More frequent labor inspections in Brazil also impact on informality: the owners of the new businesses induced some informal workers to become formal, albeit were former employees of formal firms, rather than due to wage rigidity in the formal sector (Almeida and informal workers. Financial deepening contributed to a Carneiro 2012). Inspections were also more effective than reduction in informality in Uruguay, particularly for incentives in convincing firms in Brazil to operate in the women and older workers (Gandelman and Rasteletti formal sector (De Andrade, Bruhn, and McKenzie 2013). 2016). Finally, the emerging “gig” economy presents unique policy challenges that may require regulatory Other regulations. Policy reforms intended to ease barriers changes to smooth economic risks for “gig” workers to entering the formal sector have had diverse outcomes (World Bank 2014, 2016, and 2018b). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) Growth in the region is expected to follow a recovery in 2018 and rise slightly to 1.9 percent in 2019, supported by improvements in both oil exporters and oil importers. Rising investment and easing fiscal consolidation are supporting the recovery of some oil exporters, while oil importers continue to benefit from policy reforms. Regional growth is projected to reach 2.7 percent in 2020, as domestic demand remains resilient. Risks are tilted to the downside, including the possibility that activity will be constrained by intensified geopolitical tensions, stronger external trade headwinds, abrupt tightening of global financing conditions, and slower-than- expected reform pace. production and oil prices have eased the pressure Recent developments for fiscal consolidation, enabled higher public spending, and supported higher current account Growth in the Middle East and North Africa balances. Non-oil sector activity in the GCC has (MENA) region is estimated to have improved to largely been stable. Among non-GCC oil 1.7 percent in 2018, rebounding from a sharp exporters, the contraction in Iran, where activity deceleration a year earlier driven by oil production has been severely affected by U.S. sanctions, has cuts in oil exporters and fiscal tightening (Figure been a significant drag on oil exporters’ and 2.4.1).1 Growth among oil importers in the region regional growth. Growth in other non-GCC oil has been picking up in the past two years and exporters has been supported by public spending continues to garner positive momentum. and investment. Although positive spillovers to the region via external demand are softening amid weaker global Among oil importers, growth has been boosted by economic prospects, domestic factors continue to broad-based improvements in domestic demand; support growth. These include resilient domestic especially in Egypt, the largest country in this demand and policy reforms that are helping the group. Egypt’s tourism and natural gas activity region’s transition away from dependence on have continued to show strength, its commodity exports and the public sector. unemployment rate has generally fallen, and policy reforms have contributed to an upgrade of Growth in oil exporters is estimated to have its sovereign rating in August 2018. Fiscal recovered further in 2018. In the Gulf adjustments in Egypt have also been steadily Cooperation Council (GCC), increased oil progressing. More generally, robust agricultural production and tourism have helped support Note: This section is prepared by Lei Sandy Ye. Research growth of the oil importers in the region, assistance is provided by Mengyi Li. especially Morocco and Tunisia. However, while 1 The World Bank’s Middle East and North Africa aggregate includes 16 economies and is grouped into three subregions. Bahrain, international reserves have strengthened in Egypt, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates they have declined in other oil importers amid comprise the Gulf Cooperation Council (GCC); all are oil exporters. higher external vulnerabilities. Policy reforms in Other oil exporters in the region are Algeria, the Islamic Republic of Iran, and Iraq. Oil importers in the region are Djibouti, the Arab oil importers have helped enhance capacity of Republic of Egypt, Jordan, Lebanon, Morocco, Tunisia, and West innovation among firms, but scope for Bank and Gaza. Syrian Arab Republic, the Republic of Yemen, and improvement remains large, given fundamental Libya are excluded from regional growth aggregates due to data limitations. challenges like the quality of electricity supply that EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 96 C H A P TE R 2. 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 2.4.1 MENA: Recent developments youth unemployment (Purfield et al. 2018; Growth in the MENA region is estimated to have improved to 1.7 percent in Schiffbauer et al. 2015). 2018, supported by increased oil production in the GCC and higher oil prices. Growth among oil importers has been supported by policy reforms, Headline inflation in Egypt remains near its end- contributing to greater capacity to innovate. The region continues to tackle long-term challenges, such as high youth unemployment and electricity 2018 target level of 13 percent, despite edging up access, through structural adjustment programs. Inflation has been volatile recently. Core inflation has been contained and in Egypt and Iran, but remains generally stable in the region. High public the central bank has conducted two policy rate debt is a significant headwind to growth for oil importers. cuts in 2018, despite tighter external financing conditions. In Iran, inflation rose sharply in the A. Growth B. Oil production: GCC second half of 2018, partly reflecting the depreciation of the rial in the parallel market relative to early 2018. Inflation is generally contained across the rest of the MENA region, averaging less than 3 percent in the GCC, and rising moderately in smaller oil importers. Bond issuance across the region, particularly in the GCC, was robust at the start of 2018, but slowed C. Innovation capacity and electricity D. Youth unemployment: non-GCC around mid-year amid tighter external financing access: Oil importers conditions and rising investor risk aversion. Although international financing conditions have become less favorable, investor confidence in the region were supported by efforts by GCC countries to diversify their economies as well as the inclusion of Saudi Arabia and Kuwait in the MSCI emerging market index in 2018. These developments kept the region somewhat insulated from the turmoil affecting many emerging markets E. Inflation F. Public debt positions and developing economies (EMDEs) in the second half of 2018. Outlook GDP growth is projected to rise slightly to 1.9 percent in 2019 and pick up to 2.7 percent later in the forecast horizon. Both oil exporters and oil importers will show steady growth improvement Sources: Bank for International Settlements, Haver Analytics, International Energy Agency, over the forecast period. Despite the headwinds International Monetary Fund, World Bank, World Economic Forum. A. Weighted average growth rates of real GDP. Gray denotes forecasts. B. Sum of production in from a less favorable international economic Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE. Oil price denotes average of Brent, Dubai, and WTI. C. Based on World Economic Forum surveys. “Capacity for Innovation” denotes environment, which is expected to be marked by response to the question: “In your country, to what extent do companies have the capacity to innovate? [1 = not at all; 7 = to a great extent].” “Quality of Electricity Supply” denotes response to the slower trade growth and tighter external financing question “In your country, how reliable is the electricity supply (lack of interruptions and lack of voltage fluctuations)? [1 = extremely unreliable; 7 = extremely reliable].” D. Youth unemployment as a conditions, domestic factors—in particular, policy percent of youth labor force (age 15-24). Includes 10 MENA economies. Based on 2017 data. E. reforms—continue to bolster growth in the Monthly year-on-year growth rates of CPI inflation. Last observation is Sept 2018. F. General government debt as a ratio to GDP. 2018 data are estimates. Includes 6 GCC economies, 3 non- region. GCC oil exporters, and 6 oil importers. Among oil exporters, growth in 2019 is expected to improve slightly, supported by continued hinder the potential for private sector dynamism strengthening in the GCC that is partly offset by (Arezki et al. 2018). These reforms also address weakness among the large non-GCC oil exporters. challenges in the labor market, including high Infrastructure investment and improved regulatory EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 M I D D LE E AS T A N D N O RT H A F R IC A 97 environment are expected to support higher FIGURE 2.4.2 MENA: Outlook and risks growth in GCC economies. Over the medium Heightened geopolitical tensions have been associated with volatile term, growth among the GCC economies will sovereign default spreads and may amplify fragile economies’ significant remain steady, underpinned by planned income losses. Trade disputes involving major economies may weigh on external demand of both oil exporters and importers, while a more abrupt- diversification programs, infrastructure projects, than-expected increase of global interest rates may raise external debt and medium-term reform plans (World Bank vulnerabilities, especially if accompanied by sharp dollar appreciation. 2018a). Outside of the GCC, activity in Iran is expected to contract as U.S. sanctions kick in. A. Sovereign default spreads B. Per capita income: fragile economies Algeria’s growth is projected to moderate after its budgeted strong increase in government spending in 2018 tapers. Among oil importers, growth is forecast to rise further, led by improvements among the larger economies. Investment will be further supported by reforms that strengthen the business climate and a pickup in domestic demand (World Bank 2018b). Tourism is envisioned to continue C. Export exposure D. External debt: oil importers support activity in Egypt, Morocco, and Tunisia. Positive spillovers via external demand in the Euro Area are likely to taper somewhat amid the area’s weaker growth prospects. While smaller oil importers’ growth is envisioned to pick up slightly, these economies continue to grapple with elevated public debt, and in some cases, the challenges associated with the ongoing refugee crisis. Medium-term growth forecasts for the MENA Sources: Haver Analytics, International Monetary Fund, World Bank. A. Denotes 5 Year USD Credit Default Swap Par Mid Rate. Oil importers include four economies. Oil region are predicated on the assumption that there exporters include six economies. Three month-rolling averages. UAE denotes average of Abu Dhabi and Dubai. will not be a significant escalation of geopolitical B. Estimated per capita income in thousands of USD. Data not available for Syria. conflicts and that there will be limited regional C. Share of goods exports to respective economies denoted as a ratio to each country group’s total exports. Denotes latest available data in 2017. spillovers from conflict-ridden economies. D. Unweighted averages. Includes 5 oil importers. Continued IMF and World Bank programs in many economies (e.g., Egypt, Morocco) are expected to provide a basis for needed structural Risks adjustments (e.g., stronger fiscal management frameworks, higher public infrastructure quality), Risks are tilted to the downside. A diverse range of as well as steps to address the vulnerabilities geopolitical risks have been associated with volatile associated with the informal sector (Chapter 3, sovereign default spreads in both oil exporters and Box 2.4.1). Financial reforms—such as newly importers (Figure 2.4.2) New conflicts in fragile approved bankruptcy laws in Saudi Arabia, Egypt, economies illustrate the potential for an escalation and the United Arab Emirates—should help of military conflicts to inflict even greater damage relieve financial constraints in the corporate sector to incomes and economic activity (Devarajan and and support investor confidence (World Bank Mottaghi 2017). These conflicts may also 2014a). Multilateral efforts to promote rural diminish access to health and water services in transportation, electricity access, and private sector fragile economies, in turn encouraging associated financing (e.g., Gaza Solar Fund, Compact with diseases (e.g., cholera outbreaks in the Republic of Africa) are likely to enhance the business climate. Yemen). Although reconstruction is now Collectively, policy reforms across the region are underway in Iraq (e.g., World Bank Iraq Social expected to improve growth potential in the Fund for Development), these efforts could be medium term (World Bank 2018c). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 98 C H A P TE R 2. 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 derailed by a resumption of conflict. A substantial However, a more abrupt tightening of advanced further escalation of U.S.-Iran tensions could have economy monetary policy could weigh on capital adverse spillovers to the rest of the region.2 flows to the region and dampen foreign investor Geopolitical factors, combined with uncertainty in confidence in large GCC economies, which had oil production in response to these factors, also recently relaxed foreign investment restrictions could trigger volatility in oil prices, all of which (World Bank 2018c). High external debt could further complicate or stall fiscal and current denominated in foreign currency in some oil account adjustments in both oil exporters and importers implies that they are also vulnerable to importers. unexpected sharp appreciation of the U.S. dollar. Escalating global trade tensions may negatively Post-election political uncertainty in some impact the MENA region. Although direct trade economies has led to delays in the formation of with the United States is low, the region is tightly new governments, which may in turn delay policy interconnected to the European Union and, to a reforms. Several oil importers depend critically on lesser degree, China. A further rise of trade IMF/WB multi-year fiscal adjustments programs, tensions could weigh heavily on the demand for which hinge on progress in the pace of reforms. exports from the MENA region (World Bank Higher-than-expected oil prices may further 2016). This risk may be slightly mitigated by challenge oil importers’ subsidies reforms and deeper trade integration across regional neighbors other fiscal adjustment programs. Among GCC (e.g. Djibouti-Ethiopia). economies, these risks may be reflected in fiscal reform slippages due to high oil prices or Rising interest rates in advanced economies may inefficient management of contingent liabilities affect both oil exporters and importers. Interest and large investment projects. rates in GCC economies have moved broadly in tandem with advanced economies’ policy rates, On the upside, rising reconstruction spending in especially that of the U.S., and their net external conflict affected economies (e.g., Iraq) may have assets positions are strong. Combined with the positive spillovers to neighboring economies, gradual nature of advanced economy monetary supporting higher investment in physical policy normalization, the dampening effect on infrastructure as well as soft infrastructure (e.g., borrowing costs and non-oil activity associated broadband internet, mobile telephony) (Arezki et with higher interest rates have so far been modest. al. 2018). 2 The current sanctions feature waivers from eight economies that import oil from Iran, as well as proposed Special Purpose Vehicles designed by the EU to facilitate transactions with Iran. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 M I D D LE E AS T A N D N O RT H A F R IC A 99 TABLE 2.4.1 Middle East and North Africa forecast Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f EMDE MENA, GDP1 5.1 1.2 1.7 1.9 2.7 2.7 -1.3 -1.4 -0.5 (Average including countries with full national accounts and balance of payments data only)2 EMDE MENA, GDP2 4.8 1.4 1.7 1.6 2.7 2.7 -1.3 -1.7 -0.6 GDP per capita (U.S. dollars) 3.0 -0.3 0.1 0.1 1.3 1.4 -1.3 -1.7 -0.6 PPP GDP 5.1 1.7 1.8 1.6 2.8 2.8 -1.4 -1.8 -0.7 Private consumption 2.8 2.2 1.5 1.6 2.3 2.3 -1.9 -1.9 -1.2 Public consumption -6.3 2.3 3.4 1.1 1.9 1.9 2.1 -0.3 0.3 Fixed investment -2.0 1.0 2.8 3.6 4.7 4.8 -2.3 0.0 -0.1 Exports, GNFS3 8.5 2.9 1.9 1.8 3.4 3.4 -1.8 -2.3 -0.6 Imports, GNFS3 -1.2 5.1 1.3 1.9 3.1 3.1 -2.4 -1.2 -0.3 Net exports, contribution to growth 4.2 -0.4 0.5 0.2 0.5 0.5 0.0 -0.7 -0.3 Memo items: GDP Oil exporters 4 5.6 0.6 1.2 1.4 2.3 2.3 -1.5 -1.7 -0.6 GCC countries 5 2.4 -0.3 2.0 2.6 2.7 2.7 -0.1 -0.1 0.0 Saudi Arabia 1.7 -0.9 2.0 2.1 2.2 2.2 0.2 0.0 -0.1 Iran 13.4 3.8 -1.5 -3.6 1.1 1.1 -5.6 -7.7 -3.1 Oil importers 6 2.9 3.9 4.1 4.2 4.6 4.7 0.1 -0.2 0.0 Egypt 4.3 4.7 5.5 5.7 5.9 6.0 0.2 0.0 0.1 Fiscal year basis 7 4.3 4.2 5.3 5.6 5.8 6.0 0.3 0.1 0.0 Source: World Bank. Notes: e = estimate; f = forecast. EMDE = emerging market and developing economy. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Libya, Syria, and Yemen due to data limitations. 2. Aggregate includes all countries in notes 4 and 6 except Djibouti, Iraq, Qatar, and West Bank and Gaza, for which data limitations prevent the forecasting of GDP components. 3. Exports and imports of goods and non-factor services (GNFS). 4. Oil exporters include Algeria, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. 5. The Gulf Cooperation Council (GCC) includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. 6. Oil importers include Djibouti, Egypt, Jordan, Lebanon, Morocco, Tunisia, and West Bank and Gaza. 7. The fiscal year runs from July 1 to June 30 in Egypt; the column labeled 2017 reflects the fiscal year ended June 30, 2017. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 100 C H A P TE R 2. 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 TABLE 2.4.2 Middle East and North Africa economy forecasts1 (Real GDP growth at market prices in percent, unless indicated otherwise) Percentage point differences from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f Algeria 3.2 1.4 2.5 2.3 1.8 1.8 -1.0 0.3 0.5 Bahrain 3.2 3.9 3.2 2.6 2.8 2.8 1.5 0.5 0.7 Djibouti 8.6 5.7 6.7 7.3 7.5 7.5 0.2 0.9 1.2 Egypt 4.3 4.7 5.5 5.7 5.9 6.0 0.2 0.0 0.1 Fiscal year basis 2 4.3 4.2 5.3 5.6 5.8 6.0 0.3 0.1 0.0 Iran 13.4 3.8 -1.5 -3.6 1.1 1.1 -5.6 -7.7 -3.1 Iraq 13.0 -2.1 1.9 6.2 2.9 2.8 -0.6 2.1 1.0 Jordan 2.0 2.0 2.1 2.3 2.4 2.7 -0.1 -0.1 0.0 Kuwait 2.9 -3.5 1.7 3.6 3.6 3.6 -0.2 0.1 0.6 Lebanon 1.7 1.5 1.0 1.3 1.5 1.5 -1.0 -0.7 -0.5 Morocco 1.1 4.1 3.2 2.9 3.5 3.5 0.2 -0.6 -0.2 Oman 5.0 -0.9 1.9 3.4 2.8 2.8 -0.4 0.9 -0.1 Qatar 2.1 1.6 2.3 2.7 3.0 3.0 -0.5 -0.5 0.2 Saudi Arabia 1.7 -0.9 2.0 2.1 2.2 2.2 0.2 0.0 -0.1 Tunisia 1.1 2.0 2.6 2.9 3.4 3.6 0.2 0.0 0.0 United Arab Emirates 3.0 0.8 2.0 3.0 3.2 3.2 -0.5 -0.2 -0.1 West Bank and Gaza 4.7 3.1 1.7 1.9 1.9 1.9 -0.8 -0.4 -0.4 Source: World Bank. Notes: e = estimate; f = forecast. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of economies’ prospects do not significantly differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Libya, Syria, and Yemen due to data limitations. 2. The fiscal year runs from July 1 to June 30 in Egypt; the column labeled 2017 reflects the fiscal year ended June 30, 2017. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 M I D D LE E AS T A N D N O RT H A F R IC A 101 BOX 2.4.1 Informality in the Middle East and North Africa Middle East and North Africa’s (MENA’s) informal sector output, on average, amounts to nearly one quarter of official GDP. However, there is wide heterogeneity across the region. Informality is high among non-GCC economies, the young population, as well as the agricultural workforce. Levels of informality in the region are closely linked to its low private sector vibrancy, limited economic diversification, and sizeable agricultural sectors. Policy options that reduce regulatory barriers, streamline public sector efficiency, and enhance workforce skills can help improve access to the formal sector and unlock the potential from a relatively young informal workforce. Introduction exporters, limited private sector, low labor mobility, and lack of economic diversification. The extent of informal output in the Middle East and Africa region amounts to nearly one quarter of official Regional heterogeneity. The moderate average level of GDP during 2008-16, lower than in other EMDE regions. informality masks disparate trends within the region. The However, there is considerable heterogeneity within the share of informal output in GCC economies is about 8 region, with higher informality among non-Gulf percentage points less than in non-GCC economies (18 Cooperation Council (GCC) economies. Moreover, percent and 26 percent, respectively), and the share of self- although the share of informal activity in MENA has been employment to total employment in non-GCC economies steady over the past two decades, perceptions of is about 10 times that of the GCC. informality in the MENA region have risen. Employment informality is concentrated among agricultural workers Correlates of informality and the young, which poses important challenges for Informality in MENA has reflected a number of economic MENA’s ongoing transition to a more diversified and development challenges. These ranged from limited economic structure and jobs-oriented growth. private sector activity to conflict situations. Large informal Against this backdrop, this Box examines the following sectors have been associated with lower productivity, low questions: wages, and less inclusive growth. Although informality can provide helpful employment opportunities where the • How has informality evolved in the Middle East and formal sector features distortions and governance is poor, North Africa? the structural, policy and institutional features that foster informality in MENA poses challenges for the region’s • What are the macroeconomic and social correlates of efforts to diversify and reduce its reliance on commodities informality? production and the public sector. • What policy options are available to address Economic structure. Low informality in the GCC reflects challenges associated with informality? high reliance on expatriate workers and high public employment for nationals (World Bank 2018a). In the Evolution of informality non-GCC economies, informal workers constitute the vast On average during 2008-2016, informal sector output in majority of the employed in the agriculture and mining MENA amounted to about one quarter of official GDP, sectors. Across countries, a higher share of agricultural lower than other EMDE regions (Figure 2.4.1.1, Chapter employment had been associated with higher informality 3). During the same period, about 24 percent of the labor (ADB 2016, World Bank 2004 and 2014b, Elshamy force are reported to be self-employed. 2015, UN 2013). Urban workers were also 5-12 percent less likely to be informally employed than rural workers Broadly stable over time. The extent of informality in (Angel-Urdinola and Tanabe 2012), altogether consistent MENA appears to have remained roughly unchanged over with the negative correlation between stage of the past two decades, although survey-based measures of development and informality. informality suggest that perceived informality may have increased. The persistence of informality is linked to the Governance and business climates. Informality in MENA long-standing economic structure of MENA economies, is closely linked to governance quality, which has been including dependence on commodities production in oil negatively correlated with informality (Elbadawi and Loayza 2008). In non-GCC economies, where informality is higher, institutional quality indicators also tend to be Note: This section is prepared by Lei Sandy Ye. Research assistance is markedly lower than in the GCC. This issue is further provided by Mengyi Li and Jinxin Wu. compounded by poor public services and burdensome EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 102 C H A P TE R 2. 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.4.1 Informality in the Middle East and North Africa (continued) FIGURE 2.4.1.1 Informality in MENA MENA’s informal sector output comprises nearly one quarter of official GDP, lower than other EMDE regions. However, per- ceptions of informality in MENA has risen somewhat while they have declined in the median EMDE region. Institutional quality is generally lower in non-GCC MENA economies, where informality is higher. A. DGE and MIMIC based informal activities B. Self-employment C. Perceived informal activities and attitudes towards D. Institutional quality: MENA informality Sources: World Development Indicators, Organization for Economic Co-operation and Development (OECD), country’s national statistical bureaus and offices, Inter- American Development Bank, Eurostat, Haver, World Economic Forum, World Bank Doing Business and World Governance Indicators. Notes: Blue bars show simple averages of the informal economy of the region. Red markers show the median average of all EMDEs and the vertical lines denote interquartile range of all EMDEs. GCC denotes Gulf Cooperation Council. A. Both DGE and MIMIC estimates measure the informal output in percent of official GDP. Includes 6 GCC economies and 9 non-GCC economies. B. Self-employed is the share of self-employment in total employment. Includes 6 GCC economies and 11 non-GCC economies. C. WEF index is the average responses at the country-year level to the following question (surveyed by World Economic Forum): “In your country, how much economic activity do you estimate to be undeclared or unregistered? (1=Most economic activity is undeclared or unregistered; 7 = Most economic activity is declared or registered).” WEF indices are re-ordered (i.e. 1= Most economic activity is declared or registered; 7= Most economic activity is undeclared or unregistered) so that a higher average at the country level indicates a larger informal economy. The index does not use data for year 2004-2005 due to inconsistency in survey methods. Includes 6 GCC economies and 8 non-GCC economies. D. All measures are unweighted averages and are taken from the latest year available. The first three institutional measures are taken from World Bank’s World Governance Indicators (2017) , with a higher value indicating better institutional quality in year 2016. The “Ease of doing business ” (DB 2018) and “Ease of paying taxes ” (DB 2017) are taken from World Bank’s Doing Business database and measured as “Distance to Frontier”, with a higher value indicating an easier environment for businesses. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 M I D D LE E AS T A N D N O RT H A F R IC A 103 BOX 2.4.1 Informality in the Middle East and North Africa (continued) FIGURE 2.4.1.2 Informality in MENA Informal activity is higher among non-GCC economies in the MENA region and competition from the informal sector presents a major obstacle to businesses in several large economies. Low wages for informal sector women workers have been associated with particularly low female labor force participation rates in the region. Informality is also high among the youth in MENA, a group that often has insufficient access to education and training programs. A. Informality in regional subgroups B. Firms citing informal sector competitor business practices as biggest obstacle C. Female labor force participation D. Youth unemployed or not in education Sources: World Bank, Organization for Economic Co-operation and Development (OECD), country’s national statistical bureaus and offices, Eurostat, Haver Analytics, Inter-American Development Bank. A. Based on DGE estimates of informal output in percent of official GDP (chapter 3). 2008-16 averages. EMDE medians denote the median across averages of each EMDE region during the same period. B. Columns denote the percent of firms citing “informal business practices” as the biggest obstacle to their business. Based on the latest available World Bank Enterprise Survey year since 2013 for each economy denoted. C. Workforce as a percent of female population ages 15-64. Based on 2017 data. Unweighted average of 6 GCC economies, 3 Non-GCC oil exporters, and 7 oil importers. D. Denotes share of youth (aged 15-24 years) not in education, employment or training in percent of youth population. Based on latest available data since 2010 for each country. regulatory environment, which raise the costs of operating the number of public sector jobs, which also caused in the formal sector (World Bank 2016). workers to shift into the informal sector for lack of alternatives (Devarajan and Mottaghi 2017, Ianchovichina Conflict. In a number of countries (e.g. Syrian Arab and Ivanic 2014). In neighboring countries of fragile and Republic), wars and violent conflicts have severely limited war-torn economies (e.g., Jordan, Lebanon), the massive EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 104 C H A P TE R 2. 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.4.1 Informality in the Middle East and North Africa (continued) FIGURE 2.4.1.3 Policy challenges In non-GCC economies, where informality is more pervasive, policies that improve access to finance and public-sector effectiveness can help increase mobility from the informal to the formal sector. A. Firms citing access to finance as a major constraint B. Public sector effectiveness: non-GCC Source: World Bank. A. Percent of firm citing access to finance as a major constraint to business, based on World Bank enterprise surveys (surveys in the MENA region only include non-GCC economies). Based on latest survey year since 2010 for each country. Includes 9 MENA economies. B. Based on the Worldwide Governance Indicators of regulatory quality and government effectiveness, in which a lower index denotes weaker regulatory quality and weaker effectiveness. Index ranges from -2.5 to 2.5. “EMDEs” denotes unweighted average in 2016. influx of refugees—many of whom are unregistered—has Restricted market access. Informal workers in the region boosted the informal sector, where jobs tend to be labor tend to be concentrated in small and medium-sized firms, intensive and low skilled. which constitute more than 90 percent of MENA’s enterprises (Purfield et al. 2018). Although these firms can Lower productivity. High informality has been associated include young start-ups with high entrepreneurial with lower labor productivity and more limited export potential, they have tended to be local market-oriented, potential, partly reflected in its relatively low informal with limited regional or global market access (World Bank share of output compared to that of employment (Box 2004, 2016). Among these enterprises, a 1 percentage 3.2., Gatti et al. 2014, Elbadawi and Loayza 2008). point increase in the share of informal workers was Hindrances in the formal sector, including regulatory associated with a 6-percentage-point lower output share barriers to entry and burdensome taxation, divert for non-local markets (Elbadawi and Loayza 2008). otherwise productive firms and workers to enter and remain in the informal sector where productivity is lower.1 Wage differentials. Informality presents a source of Moreover, based on enterprise survey data, a sizable employment but also income vulnerability among women portion of firms in oil importers (e.g., Tunisia, Morocco) and the youth, challenging efforts at poverty reduction. consider competitors’ practices in the informal sector as The wage gap between informal and formal workers (i.e., hindering their own business operations (Figure 2.4.1.2, formality premium) has been higher for women than men. World Bank 2004).2 For example, in Egypt, the formal wage premium was about 30 percent for males but more than 50 percent for females (Gatti et al. 2014). Informality has been higher 1 Within small and medium-sized enterprises in MENA, a 1 among the youth, in part reflecting the entrance of percentage point increase in the share of informal workers was associated workers into public sector jobs at a later age (Elbadawi and with 3 percentage point lower wages relative to average wages (Elbadawi Loayza 2008, Angel-Urdinola and Tanabe 2012). In and Loayza 2008). 2 Informal business operations may also imply lower contributions to Morocco, the formal wage premium among the youth was government revenues, while possibly adding to resource utilization on more than 50 percent (Gatti et al. 2014). Further, returns public services, such as infrastructure (Galal 2005). to education have been lower in the informal sector than EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 M I D D LE E AS T A N D N O RT H A F R IC A 105 BOX 2.4.1 Informality in the Middle East and North Africa (continued) the formal sector, which has discouraged skills acquisition Access to finance. Access to finance is a larger obstacle to (Angel-Urdinola and Tanabe 2012).3 doing business in MENA than in most other EMDE regions (Figure 2.4.1.3; Farazi 2014). Boosting access to Less inclusive growth. High informality in the region is finance, including through a stronger legal framework and associated with lower levels of educational attainment and improved credit protection regimes, can help promote enrollment, as a majority of informal workers are school private sector activity by increasing transparency of firms dropouts and have not received a secondary education to investors and facilitating investment (Straub 2005). A (Elshamy 2015). High informality is associated with number of economies in MENA have recently adopted limited access to health care and legal services, especially in policies in this area, such as new insolvency resolution laws fragile areas (Loayza and Wada 2010; Cho 2011). Workers in Egypt, Saudi Arabia, and the United Arab Emirates. in the informal sector have also reported harsher job The adoption of financial technologies (Fintech), such as conditions and poorer work safety, and among young innovations that automate financial transactions, can also informal workers, lower levels of job satisfaction (Gatti et facilitate financial services to informal unbanked al. 2014). These social disparities have the potential to individuals or SMEs (Arezki et al. 2018, Lukonga 2018). slow reform momentum in the region by constraining consensus-building. Regulatory effectiveness. Beyond its large size, public sector effectiveness and regulatory quality in non-GCC Policy challenges MENA countries have deteriorated in the last decade. Corruption is cited among the biggest hindrances to Informality in non-GCC MENA countries, where MENA firm operations and increases incentives for firms informality is widespread, reflects deep-rooted economic and workers to operate informally (World Bank 2016). structures. These economies have the highest youth Together with low regulatory efficiency, it reduces the unemployment rate and lowest female labor force effectiveness of labor market regulations and enforcement, participation rates among all EMDE regions. Public sector and allows firms to stay informal (Gatti et al 2014). employment constitutes more than 15 percent of total Policies that reduce regulatory costs help increase mobility employment, about twice the EMDE average (IMF 2018). of MENA firms between the informal and formal sector, Multi-pronged policies can aim to create a more vibrant while those that strengthen property rights may assist the private sector and strengthen human capital of workers, rural or agricultural-sector populations to access financing part of building a new social contract in the region (e.g., enabling collateralized loans). Policies to promote (Devarajan and Mottaghi 2015). Policies targeting specific entrepreneurial activities, such as easing of business vulnerable groups can lessen the negative externalities licensing requirements, can also facilitate entry of informal associated with informality. workers into more productive jobs in the formal sector. Fiscal reforms. Burdensome taxation has been one of the Education. Policies that encourage higher education and most important constraints to formal sector firms in expand job training can be especially relevant for younger MENA (Gatti et al. 2014). In non-GCC MENA workers, more than half of whom are informally economies where informality is more pervasive, reforms to employed, to facilitate their entry into more productive align tax systems with international best practices and formal jobs (Angel-Urdinola and Tanabe 2011). Training strengthen enforcement could further attract informal programs may be particularly effective if coupled with firms to productive formal activity while also raising mechanisms to increase women’s mobility, which is revenue collection. Such reforms may include reducing constrained in the region, and offer a combination of soft excessive corporate tax rate burden and enhancing revenue and hard skills. Training is also more effective if extended collection through harmonized electronic filing systems to areas (e.g., rural) where educational levels are lower, as (e.g., Morocco) or the introduction of a value-added tax MENA region’s training programs tended to serve higher (e.g. Egypt).4 income and more educated individuals (Angel-Urdinola, Semlali, and Brodmann 2010). A holistic approach that combines job training with job creation efforts, such as 3 Evidence from Egypt, for example, suggests that a worker in the through public-private sector programs, can also be formal sector who has completed 5 years of education earns comparable wages to those of an informal sector worker with 12-14 years of effective; given higher unemployment rates for university education (Angel-Urdinola and Tanabe 2012). graduates than low-skilled workers in the region (World 4 Evidence from Egypt suggests that lowering the corporate tax burden Bank 2018e). These programs may also help boost can be associated with higher revenues through a higher tax base (Gatti et earnings of informal workers (Steel and Snodgrass 2008). al. 2014). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) South Asia remains the world’s fastest growing region. India’s domestic demand is strengthening as the country reaps the benefits of structural reforms and of a revival of credit growth. Growth in the region is projected to accelerate to 7.1 percent in 2019 from 6.9 in the previous year. Over the medium term, robust domestic demand will continue to underpin growth, which is expected to average 7.1 percent. However, risks to the outlook are tilted down. On the domestic side, vulnerabilities are being exacerbated by fiscal slippages and rising inflation, and the possibility of delays in needed structural reforms to address weaknesses in balance sheets of banks and non-financial corporates. Key external risks include a further deterioration in current accounts and a faster-than-expected tightening of global financing conditions. Recent developments continued to strengthen amid GST harmonization and a rebound of credit growth, consumption Growth in South Asia accelerated to an estimated remained the major contributor to growth 6.9 percent in 2018 from 6.2 percent the previous (Ahmad et al. 2018). year, with domestic demand strengthening in Excluding India, regional growth moderated India as temporary disruptions fade and the slightly in 2018. Pakistan’s GDP (factor cost) is benefits from ongoing structural reforms start to estimated to have grown 5.8 percent in materialize (Figure 1A). The recovery was in line FY2017/18 (July 16 to July 15), with solid with expectations, and recent high frequency data contributions from consumption and investment. – including purchasing managers’ indices and Activity was supported by strengthening in the industrial production – have broadly remained agricultural and industrial sectors, and a sustained solid (Figure 1B and 1C). acceleration in services. Throughout the region, private consumption In Bangladesh, growth was broad-based, remained robust in 2018 while investment picked remaining strong at an estimated 7.9 percent in up. The recovery in investment was supported by FY2017/18 (July 1 to June 30). Private the fading of a number of temporary disruptions, a consumption was the main driver of growth, revival of credit growth, and ongoing supported by strong remittance inflows. Net infrastructure projects. Strong domestic demand exports turned negative because of rising food and boosted imports, while exports remained subdued capital machinery imports and weak exports amid weak global trade sentiment, causing current (World Bank 2018a). account deficits to widen. (World Bank 2018c). In Sri Lanka, activity accelerated to an estimated India’s growth accelerated to an estimated 7.3 3.9 percent in 2018 on the back of a recovery in percent in FY2018/19 (April to March) as the agriculture and services sectors. In Nepal, economic activity continued to recover with economic activity remained solid with a 6.3 strong domestic demand. While investment percent growth in FY2017/18 (April to March). Less favorable monsoons led to weakness in agricultural activity, but this was offset by Note: This section was prepared by Temel Taskin. Research assistance was provided by Ishita Dugar and Brent Harrison. recovered remittances and robust industrial sector EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 108 C H A P TE R 2. 5 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 2.2.1 SAR: Recent developments the Maldives. In Bhutan, hydropower and other South Asia remains the fastest growing EMDE region. High frequency infrastructure projects supported investment, and indicators of economic activity are mixed across the region but broadly GDP expanded by an estimated 4.6 percent in consistent with the recovery underway. Remittance inflows are an FY2017/18 (July 16 to July 15). Maldives’ GDP important source of income in the region. Inflation is below official target in general despite a recent acceleration in some countries. Sovereign credit accelerated to an estimated 8.0 percent in 2018, default spreads have been rising as Federal Reserve continues to tighten reflecting strength in tourism and construction. monetary policy and U.S. dollar appreciates. Growth in Afghanistan is estimated to have edged down to 2.4 percent. Although activity was A. Growth B. Purchasing Managers’ Indexes supported by agriculture and services, subdued business confidence and security challenges continued to weigh on growth. There were some signs of rising inflation pressure across the region, and both India and Pakistan raised rates in 2018 to counter the effects of currency depreciation, rising energy prices, and domestic capacity constraints (Figure 1E). C. Industrial production indexes D. Remittance inflows Sovereign bond yields surged in the region last year (Figure 1F). Fiscal consolidation stalled owing to elections in several countries, contributing further to the region’s high levels of government debt. In India, the government deficit was higher than planned, reflecting lower-than- expected revenues from telecom spectrum auctions and low dividends from public sector enterprises (World Bank 2018d). The central government is E. Inflation F. Sovereign credit default spreads budgeting a reduction in the fiscal deficit in next fiscal year. Pakistan’s fiscal deficit rose to 6.6 percent of GDP last year, well above the government’s target of 4.1 percent, as tax collection fell short of expectations. External vulnerabilities are also rising in the region. In Sri Lanka and to some extent in Pakistan, external debt is sizable and current Source: Haver Analytics, International Monetary Fund, World Bank. account deficits have deteriorated considerably. A. SAR stands for South Asia Region. Aggregate growth rates are calculated using constant 2010 U.S. dollar GDP-weights. Data for 2018 are estimates. Shaded areas indicate forecasts. Recent currency pressures have eroded Pakistan’s B. PMI readings above 50 indicate expansion in economic activity; readings below 50 show foreign exchange reserves significantly—they contraction. Last observation is September 2018. C. Last observation is September 2018. currently amount to only around two months of D. Data present the workers' remittances and compensation received by countries. Last observation is 2017. imports. E. Last observation is October 2018. F. Data present five-year U.S. dollar credit default swap par (mid-rate). Last observation is November 2018. Outlook The The outlook for South Asia is robust, despite growth, particularly for manufacturing activities the financial stress that has affected a number of (Figure 1D, World Bank 2018b). EMDEs and continued trade disputes. Regional growth is expected to accelerate in 2019, to 7.1 Investment and services remained the major percent (Figure 2A). Economic activity will be contributor to economic activity in Bhutan and underpinned by strengthening investment and EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S O U TH A S I A 109 robust consumption. While exports and imports FIGURE 2.2.2 SAR: Outlook and risks will be held back owing to slowing global trade, Economic activity is projected to remain strong. Possible fiscal slippages the region’s relatively low exposure to could further worsen already-high public debt positions. Non-performing international trade will mitigate the impact of this assets remain high despite recent efforts to improve balance sheet quality of financial sector. External imbalances pose a risk on the outlook. Major slowdown on the regional outlook. economies in the region have tightened their monetary stance to stabilize inflation and mitigate external risks. India’s GDP is forecast to grow by 7.3 percent in FY2018/19 and 7.5 percent thereafter, in line with A. Growth B. Fiscal balance June forecasts. Private consumption is projected to remain robust and investment growth is expected to continue as the benefits of recent policy reforms begin to materialize and credit rebounds. Strong domestic demand is envisioned to widen the current account deficit to 2.6 percent of GDP next year. Inflation is projected to rise somewhat above the midpoint of the Reserve Bank of India’s target range of 2 to 6 percent, mainly owing to energy and food prices. C. Non-performing assets D. Net portfolio inflows In the rest of the region, economic activity will average 5.6 percent over the forecast horizon. In Pakistan, macroeconomic imbalances weigh on growth outlook. Pakistan is expected to face financing needs due to the large current account and fiscal deficits combined with low international reserves (Figure 2E). GDP growth is projected to decelerate to 3.7 percent in FY2018/19, with financial conditions tightening to help counter E. Current account balance F. External debt rising inflation and external vulnerabilities. Activity is projected to rebound and average 4.4 percent over the medium term with support from stabilizing macroeconomic conditions (World Bank 2018c). In Bangladesh, robust economic activity is expected to be sustained. GDP growth is forecast at 7.0 percent in FY2018/19 and is expected to Sources: Haver Analytics, World Bank. decelerate only slightly over the forecast horizon. A. SAR stands for South Asia Region. Aggregate growth rates are calculated using constant 2010 U.S. dollar GDP-weights. 2018 data are estimates. Shaded areas indicate forecasts. Activity will be supported by strong private B.E. 2018 data are estimates. Shaded areas indicate forecasts. The data represent fiscal years of countries except for Sri Lanka, as described in Table 2.5.1. consumption and investment on the back of C. Data present the ratio of bank non-performing loans to total gross loans. Last observation is 2017. infrastructure projects. Net exports are projected D. Last observation is 2018 Q3 for Bangladesh and Pakistan, and 2018 Q2 for India and Sri Lanka. F. Gross external debt position including both public and private sectors, as of 2018 Q2. to contribute negatively to GDP growth as imports outpace exports in response to strong domestic demand. In Sri Lanka, last year’s recovery from adverse projects. Nepal’s strong post-earthquake weather conditions is expected to continue in momentum is expected to moderate—GDP 2019, with 4.0 percent GDP growth. Activity will growth is forecast to decelerate to 5.9 percent be supported by robust domestic demand as in FY2018/19. Activity will be underpinned consumption rebounds following natural disasters, by strong infrastructure investment and and investment is boosted by infrastructure consumption. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 110 C H A P TE R 2. 5 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 In Bhutan and the Maldives, activity will remain challenging political environment could adversely reliant on construction and tourism. Bhutan’s affect the ongoing reform agenda and economic growth is projected to accelerate to 7.6 percent activity in some countries (e.g. Afghanistan, Sri 2018/19, supported by ongoing infrastructure Lanka). projects and rising tourism. In the Maldives, growth is expected to moderate to 6.3 percent in In South Asia, non-performing assets (NPAs) are 2019 as construction activity returns to long-term still high despite recent measures taken to improve averages, and capital investment projects gradually the recognition of these assets (Figure 2C). slowdown. Afghanistan’s economy is expected to Especially, public sector banks in India, which remain subdued, expanding 2.7 percent in 2019, represent roughly 70 percent of the banking sector as a result of security challenges ahead of elections, assets, still report low profitability and high NPAs. declining business confidence, and worsening Credit expansion could be limited in some major drought conditions. South Asia economies unless further steps are taken to deal with financial and corporate balance In South Asia, a large proportion of activity is sheets. informal, which may constrain productivity, wages, and access to social protection systems On the external front, the region has relatively low (Kanbur 2014). Investing in education and skills, exposure to international trade, which limits the improving the business environment by enhancing benefits from trade over the long term. However, regulatory frameworks and boosting the quality of the low exposure also suggests that that it could be government services provided to formal firms are more insulated from the effects rising trade among the policy measures which can encourage protectionism than other regions. Moreover, the formal activity (Box 2). region may even benefit from trade diversion amid the recent dispute between some major economies (World Bank 2017b). Risks Persistent current account deficits and high levels The risks to the outlook are tilted downside. of external debt make the region more vulnerable Domestic vulnerabilities are being exacerbated by to a faster-than-expected tightening of global fiscal slippages and rising inflation, escalation in financial conditions (Figure 2F). The realization of political uncertainty, and the possibility of delays these domestic or external risks could weaken in needed structural reforms to address weaknesses investor confidence and result in capital outflows, in balance sheets of banks and non-financial currency depreciation leading to rising external corporates. Key external risks include a further debt, a tightening of domestic financing deterioration in current accounts and a faster-than conditions, and a slowdown in regional growth -expected tightening of global financing (Kose et al. 2017; Eichengreen and Gupta 2015). conditions. South Asia is one of the most vulnerable regions to South Asian economies have high levels of public natural disasters (World Bank 2017a). In recent debt in general. Fiscal slippages could further years, the number of affected people and worsen already-precarious public debt positions geographical areas from natural disasters such as and result in a costly rise in already- elevated drought, floods, and earthquakes have risen in the interest payments (Figure 2B). region. Increasingly common natural disasters The upcoming election cycle next year elevates could disrupt infrastructure, agricultural output, and economic activity in general. political uncertainty in the region. The EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S O U TH A S I A 111 TABLE 2.5.1 South Asia forecast summary Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f EMDE South Asia, GDP1, 2 7.5 6.2 6.9 7.1 7.1 7.1 0.0 0.0 -0.1 (Average including countries with full national accounts and balance of payments data only)3 EMDE South Asia, GDP3 7.6 6.2 6.9 7.1 7.2 7.1 0.0 -0.1 0.0 GDP per capita (U.S. dollars) 6.2 4.9 5.7 5.9 6.0 6.0 0.1 0.0 0.0 PPP GDP 7.6 6.2 6.9 7.1 7.2 7.1 0.0 0.0 0.0 Private consumption 7.6 6.0 6.9 7.0 7.0 7.0 0.3 0.1 0.0 Public consumption 8.5 11.1 10.7 9.1 8.5 8.5 1.0 0.3 0.0 Fixed investment 9.4 8.0 8.2 8.0 7.8 7.5 0.6 0.3 0.1 Exports, GNFS4 1.9 6.2 5.6 5.6 5.9 6.0 -0.1 -0.5 -0.2 Imports, GNFS4 2.6 14.6 8.5 6.3 6.7 6.8 1.0 -0.2 0.6 Net exports, contribution to growth -0.3 -2.3 -1.1 -0.6 -0.6 -0.6 -0.4 -0.2 -0.3 Memo items: GDP2 16/17 17/18 18/19e 19/20f 20/21f 21/22f 18/19e 19/20f 20/21f South Asia excluding India 5.8 5.9 5.7 5.5 5.6 5.6 0.1 -0.1 -0.1 India 7.1 6.7 7.3 7.5 7.5 7.5 0.0 0.0 0.0 Pakistan (factor cost) 5.4 5.8 3.7 4.2 4.8 4.8 -1.3 -1.2 -0.6 Bangladesh 7.3 7.9 7.0 6.8 6.8 6.8 0.3 -0.2 -0.2 Source: World Bank. Notes: e = estimate; f = forecast. EMDE = emerging market and developing economy. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. 2. National income and product account data refer to fiscal years (FY) for the South Asian countries, while aggregates are presented in calendar year (CY) terms. The fiscal year runs from July 1 through June 30 in Bangladesh, Bhutan, and Pakistan, from July 16 through July 15 in Nepal, and April 1 through March 31 in India. 3. Sub-region aggregate excludes Afghanistan, Bhutan, and Maldives, for which data limitations prevent the forecasting of GDP components. 4. Exports and imports of goods and non-factor services (GNFS). For additional information, please see www.worldbank.org/gep. TABLE 2.5.2 South Asia country forecasts Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f Calendar year basis 1 Afghanistan 2.4 2.7 2.4 2.7 3.2 3.2 0.2 0.2 -0.1 Maldives 6.2 7.1 8.0 6.3 5.6 5.6 2.5 1.8 0.7 Sri Lanka 4.5 3.3 3.9 4.0 4.1 4.1 -0.9 -0.5 -0.4 Fiscal year basis1 16/17 17/18 18/19e 19/20f 20/21f 21/22f 18/19e 19/20f 20/21f Bangladesh 7.3 7.9 7.0 6.8 6.8 6.8 0.3 -0.2 -0.2 Bhutan 5.8 4.6 7.6 6.4 6.4 6.4 2.2 0.4 -2.3 India 7.1 6.7 7.3 7.5 7.5 7.5 0.0 0.0 0.0 Nepal 7.9 6.3 5.9 6.0 6.0 6.0 1.4 1.8 1.8 Pakistan (factor cost) 5.4 5.8 3.7 4.2 4.8 4.8 -1.3 -1.2 -0.6 Source: World Bank. Notes: e = estimate; f = forecast. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. 1. Historical data is reported on a market price basis. National income and product account data refer to fiscal years (FY) for the South Asian countries with the exception of Afghanistan, Maldives, and Sri Lanka, which report in calendar year (CY). The fiscal year runs from July 1 through June 30 in Bangladesh, Bhutan, and Pakistan, from July 16 through July 15 in Nepal, and April 1 through March 31 in India. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 112 C H A P TE R 2. 5 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.5.1 Informality in South Asia South Asia’s share of informal employment is the largest among EMDE regions, despite a below-average share of informal output. Heavy tax burdens, above-average corruption, and low government effectiveness have contributed to high employment informality. Informal employment is concentrated among low-skilled, young, female and rural workers. The sizable informal sector is associated with lower productivity, lower government revenues, and higher poverty in the region. Policy options to address these challenges include investing in human capital in the form of training programs and improving access to finance. Introduction percent) as of 2016. These differences are reflected in lower labor productivity in the informal sector (relative to South Asia (SAR) is the EMDE region with the highest the formal sector) in India than in Sri Lanka. average share of informal employment among EMDE regions, despite a below-median and declining share of Correlates of informality informal output. Nonetheless, there is significant Business climates. Costs to doing business—such as tax heterogeneity in the share of employment as well as output burdens, labor regulation, and cost of starting business— informality among South Asian countries. are among the main drivers of informality identified in the Against this backdrop, this Box examines the following empirical literature (Goldar and Aggarwal 2012; FICCI questions: 2017). Over the past decade, SAR has suffered from greater corruption and weaker government effectiveness • How has informality evolved in South Asia? than other EMDE regions (Figure 2.5.2). Tax burdens and • What have been the macroeconomic and social indicators of ease of doing business have also been less correlates of informality? favorable than in the average EMDE (World Bank 2017c). Among costs to doing business, heavy tax burdens were • What policy options are available to address particularly strongly associated in India and Pakistan with challenges associated with informality? a larger fraction of firms operating unregistered (Ghani, Kerr, O’Connell 2013; Waseem 2013). Evolution of informality Worker characteristics. South Asia’s informal labor force Informality in SAR. In aggregate, output informality in consists predominantly of low-skilled, female, rural, and the SAR region is below the average of other EMDE young workers (Williams, Shahid, and Martinez 2015; regions—the size of informal sector relative to official Bahadur and Parajuli 2014; Gunatikala 2008; Goldar and GDP was on average 30 percent in South Asia compared Agarwal 2012). The intensity of informal employment in with 35 percent in average EMDE during 2008-2016 South Asia reflects a lack of formal jobs and skills, as well (Figure 2.5.1). During the same period, 96 percent of as a preference towards self-employment (Williams, workers lacked pension coverage and 63 percent were self- Shahid, and Martinez 2015; Gulzar, Junaid, and Haider employed. 2010; Arby, Malik, and Hanif 2010). This means that Evolution of informality in SAR. Output informality informal firms are usually small, agricultural, and consist declined from 37 percent in 1990s to 32 percent in the mostly of self-employed workers (Heintz 2012; FICCI 2010s, broadly in line with the decline in informality in 2017). other EMDEs. However, labor informality over the same Lower productivity and incomes. In South Asia, informal period persisted or rose depending on the measure of workers have had lower earnings, fewer skills, and less informality. For example, the share of the labor force access to social protection systems; this has been reflected without pension coverage rose from 88 percent to 96 and in lower productivity and higher poverty (Likhi 2013; self-employment remained around 63 percent. Kanbur 2017; Chen 2005). Informal employment among Regional heterogeneity. The extent of informality varies underrepresented groups in labor markets, such as women substantially across countries in South Asia. Sri Lanka had and the young, has grown over the past decade and the highest degree of informality (output in the informal constrained these groups’ income security. Low earnings sector is about 40 percent of total output) in 2016 and and limited options available to informal workers constrain India had the lowest share (below 20 percent). However, their benefit from economic growth, which means that this ranking is reversed using labor market indicators of growth has been less inclusive than otherwise (Heintz informality: Sri Lanka has the lowest share of self- 2012; ADB 2016). Conversely, in India, an easing of labor employment (42 percent) and India the highest (76 market restrictions and measures to foster gender EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S O U TH A S I A 113 BOX 2.5.1 Informality in South Asia (continued) FIGURE 2.5.1.1 Informality in South Asia South Asia’s share of informal employment is the largest among EMDE regions, despite a below-average share of informal output. A. Output informality B. Labor informality C. Survey-based perceived informality D. Informality in SAR Source: Elgin et al. (2018), World Bank. A. DGE = dynamic general equilibrium model. MIMIC = multiple indicators multiple causes model. Both DGE and MIMIC estimates measure the informal output in percent of official GDP. B. Labor force without pension is the fraction of the labor force that doesn’t contribute to a retirement pension scheme, which is derived from the original data on pension coverage obtained from WDI. Self-employed is the share of self-employment in total employment. C. WEF = World Economic Forum. WVS = World Values Survey. WEF index is the average responses at the country-year level to the following question (surveyed by World Economic Forum): “In your country, how much economic activity do you estimate to be undeclared or unregistered? (1=Most economic activity is undeclared or unregistered; 7 = Most economic activity is declared or registered).” WEF indices are re-ordered (i.e. 1= Most economic activity is declared or registered; 7= Most economic activity is undeclared or unregistered) so that a higher average at the country level indicates a larger informal economy. The index does not use data for year 2004-2005 due to inconsistency in survey methods. The World Value Survey asks whether respondents can justify cheating on taxes, with responses ranging from 1 (never justifiable) to 10 (always justifiable). The average responses at the country-year level are used as a measure for attitudes towards informality (or tax morality, Oveido et al. 2009), labeled as WVS. A higher average at the country level implies that people find cheating on taxes more justifiable. D. SEMPS stands for self employment share. Both DGE and MIMIC estimates measure the informal output in percent of official GDP. Last observation is 2016. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 114 C H A P TE R 2. 5 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.5.1 Informality in South Asia (continued) FIGURE 2.5.1.2 Drivers of informality in South Asia Heavy tax burdens, above-average corruption, and low government effectiveness likely have contributed to high employment informality. The sizable informal sector is associated with weaker government revenues and higher poverty in the region. Youth unemployment is much higher among women who represent a higher share of informal workers than men. A. Doing business tax burden indicator: B. Doing business overall indicator C. Government effectiveness and control DTF of corruption D. Poverty E. Government revenues F. Youth employment and NEET Source: World Bank, World Development Indicators. A.B. Index denotes Distance to Frontier Score (100-regional score), where 100 equals international best practices. Greater distance indicates further below best practice score. D.E. Episodes are determined based on data availability. F. NEET stands for the share of youth Not in Employment, Education, or Training. Youth is defined as the population between ages of 15 and 24. equality—such as increasing female education and Policy challenges strengthening law enforcement against gender discrimination—have been associated with stronger In South Asia, informal employment is concentrated growth as well as larger formal employment (Khera 2016; among young, low-skilled, female, and rural workers. Goldar and Aggarwal 2012). Policies targeting training and education of these groups, especially in rural areas, could help their transition to Lower government revenues. Large informal sectors—in formal employment (Khera 2016). addition to other factors such as inefficient tax administration and narrow tax base—weigh on tax There is significant room to improve the ease of doing revenues in South Asian economies (Cevik 2016; Ilzetzki business in South Asia. This could reduce informality by and Lagakos 2017). On average, tax revenues as a percent reducing the cost of entry and cost of operating in formal in GDP have historically been below the EMDE average. sector. Measures to reduce the time, cost, and complexity The lack of tax revenues ultimately affects the ability of of registration would also improve the business climate governments to fund its infrastructure investment, social and foster growth (FICCI 2017). programs, etc., and therefore limiting their ability to tackle High quality public services can also provide an incentive poverty and inequality (Chapter 3). for informal firms to become formal in order to access EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S O U TH A S I A 115 BOX 2.5.1 Informality in South Asia (continued) these services. Enhanced monitoring and enforcement, financial resources that could finance growth- or including of tax regulations, could help discourage productivity-enhancing investment (Ghani, Kerr, informality (Ilzetzki and Lagakos 2017). Also, in India the O’Connell 2013). Greater access to credit for the self- recent introduction of a Goods and Services Tax and steps employed and household enterprises could help them grow toward demonetization are expected to encourage a shift into formality (Beck and Hoseini 2014). Microfinance can from the informal to the formal sector. be an effective instrument for providing financial access to informal firms, as many of them are self-employed South Asia’s self-employed, which account for about [80] enterprises (ILO 2013; Likhi 2013). percent of informally employed, have limited access to EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) The recovery in Sub-Saharan Africa has stalled. Growth in the region is estimated at 2.7 percent in 2018, significantly slower than expected, partly due to weaknesses in Nigeria, South Africa, and Angola. Growth is foreseen to rise to 3.4 percent in 2019 and 3.7 percent in 2020-21, as reduced policy uncertainty help support a cyclical rebound in these large economies. However, per capita income growth will remain modest, and progress in poverty reduction limited. Risks to the outlook are tilted to the downside. Key external risks include an unexpectedly sharp decline in commodity prices, an abrupt tightening of global financial conditions, and escalating trade tensions involving major economies. Domestic risks pertain to fiscal slippage, domestic conflicts, and adverse weather conditions. Recent developments which fell sharply due to underinvestment and to key oil fields reaching maturity. South Africa’s The recovery in Sub-Saharan Africa (SSA) economy slipped into recession in the first half of continued in 2018, but activity lost momentum in 2018, with agriculture, mining, and construction several countries. Growth in the region is acting as major drags on economic growth, amid estimated to have risen marginally from 2.6 falling business confidence. Against this backdrop, percent in 2017 to 2.7 percent in 2018, slower the South African government announced than expected and still below potential. This measures to support the economy through reflected a sluggish expansion in the region’s three reprioritized spending and structural reforms to largest economies—Nigeria, South Africa, and improve the business environment. Angola (Figure 2.6.1). The region faced a more Growth in the rest of the region was broadly difficult external environment last year as global steady, although performance varied between trade growth moderated, financing conditions country groups. While growth among metals tightened, and the U.S. dollar strengthened. exporters was subdued in 2018, activity in several Commodity prices diverged, with metals and oil exporters rebounded. In the Central African agriculture prices dampened by weakening global Economic and Monetary Community (CEMAC), demand, while oil prices were higher in most of growth benefitted from an increase in oil 2018, mainly due to supply factors. production, and higher oil prices. Economic In Nigeria, oil production fell, partly owing to activity in non-resource-intensive countries pipeline closures in mid-2018, while non-oil remained robust, supported by agricultural activity was dampened by lackluster consumer production and services on the production side, demand, as well as conflicts over land between and household consumption and public farmers and herders that disrupted crop investment on the demand side. Several countries production. In Angola—the region’s second in the West African Economic and Monetary largest oil exporter—stagnant non-oil activity was Union (WAEMU) grew at 6 percent or more, aggravated by a contraction in oil production, including Benin, Burkina Faso, Côte d’Ivoire, and Senegal. A strong rebound in agriculture in Kenya, Rwanda, and Uganda, following prior droughts, Note: This section was prepared by Gerard Kambou and Rudi underpinned the pickup in activity in East Steinbach. Research assistance was provided by Mengyi Li. Africa. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 118 C H A P TE R 2. 6 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 2.6.1 SSA: Recent developments by strong fiscal adjustments. By contrast, external The recovery in Sub-Saharan Africa has stalled. Growth remains well balances in metals exporters deteriorated, amid below its long-term average, due to a sluggish expansion weaker exports in some countries, and higher in Angola, Nigeria and South Africa—the region’s largest economies. imports in others. In non-resource-intensive The current account deficit has narrowed in oil exporters but deteriorated among metals exporters due to stronger import growth. Fiscal deficits countries, current account deficits remained have narrowed, mainly reflecting consolidation measures in some oil elevated due to high fuel imports and capital exporters. Public debt remains elevated, especially among non-resource- intensive countries due to their continued reliance on public investment to goods imports related to public infrastructure boost growth. projects. Across the region, balance of payments financing became more difficult against the A. GDP Growth B. Nigeria backdrop of rising external borrowing costs and weakening capital inflows. Eurobond issuance slowed markedly in the second half of the year, while FDI inflows remained subdued (UNCTAD 2018). Currencies in the region depreciated in effective terms amid a broad-based strengthening of the U.S. dollar and weaker investor sentiment toward emerging markets. Investors’ renewed focus on C. South Africa D. Current account balance country-specific vulnerabilities contributed to a rapid sell-off of the South African rand and the Zambian kwacha since mid-2018. Elsewhere in the region, the pace of currency depreciation has been more modest. Inflationary pressures persist in the region. In Nigeria and Angola, inflation remained in double digits, due to elevated food price inflation (Nigeria) and continued exchange rate E. Fiscal balance F. Public debt depreciation (Angola). In South Africa, inflation stayed within the 3 to 6 percent target range. Among non-resource-intensive countries, inflation rose sharply in Ethiopia and Sudan, due to a rapid expansion in credit and currency depreciation (Ethiopia) and the monetization of a large fiscal deficit (Sudan). The median fiscal deficit for the region is Source: World Bank, Haver Analytics, World Economic Outlook, National Bureau of Statistics estimated to have narrowed from 4.0 of GDP in (Nigeria), Statistics South Africa. A. Aggregate growth rates calculated using constant 2010 U.S. dollar weights. 2017 to 3.7 percent in 2018. The fiscal balance D.-F. Median of groups. Non-resource intensive countries include agricultural exporters and improved sharply among many oil exporters. The commodity importers. narrower deficit in Angola partly stemmed from higher oil prices. CEMAC countries substantially The median current account deficit is estimated to reduced their fiscal deficits through revenue have widened from 5.8 percent of GDP in 2017 to mobilization efforts and cuts in capital 6.1 percent in 2018, but sizable differences persist expenditures. By contrast, the fiscal deficit across countries. For large oil exporters (e.g., remained elevated in Nigeria, due to low tax Angola, Nigeria), external balances improved, revenue collection. driven by higher oil prices and soft import demand. The current account deficit also In metals exporters, the median fiscal deficit is narrowed significantly in CEMAC, underpinned estimated to have deteriorated sharply, as spending EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S U B- S A H A R A N A F R IC A 119 levels remain elevated in some countries, while FIGURE 2.6.2 SSA: Outlook and risks revenues are suppressed. In non-resource-intensive A gradual recovery is expected, as an increase in oil production supports a countries, the median fiscal deficit is estimated to modest growth pickup in Angola and Nigeria, and easing drought have widened modestly, reflecting continued conditions boosts agricultural production. A rise in investment, as policy uncertainty gradually recedes, should further boost growth in the large public investment supported by enhanced revenue economies. Activity in the rest of the region is expected to expand at a mobilization efforts. solid pace. Nevertheless, sluggish per capita growth implies continued slow progress in poverty reduction. A significant amount of international In all, vulnerabilities remain: government debt-to- bonds are maturing, posing refinancing risks. Rising non-concessional debt is making countries more vulnerable to changes in international GDP ratios are estimated to have risen in more financial conditions. than half of the countries in 2018 and was above 60 percent in one-third (World Bank 2018a). A. Growth B. Growth per capita Exchange rate depreciations (e.g., Zambia), negative growth (e.g., Chad, Republic of Congo, Equatorial Guinea), and the reporting of previously undisclosed debt (e.g., Republic of Congo, Mozambique) contributed to the deterioration in the debt-to-GDP ratios. In addition to the rise in debt ratios, changes in the composition of debt have made many countries more vulnerable to sharp movements in C. International bond redemption in D. Non-concessional debt SSA financing conditions (Chapter 4). As countries have gained access to international capital markets, and non-resident participation in domestic debt markets expanded, non-concessional debt has increased. Non-concessional financing accounted for more than half of total public debt in six countries (Cote d’Ivoire, Ghana, Republic of Congo, Sudan, Zambia, Zimbabwe). Outlook Source: Dealogic, World Bank. A.B. Aggregate growth rates calculated using constant 2010 U.S. dollar weights. Shaded areas represent forecasts. C. Data reflects the principal amount at date of maturity, and excludes any interest payments. Growth in Sub-Saharan Africa is expected to pick D. Excludes Equatorial Guinea, Eswatini, Namibia, Seychelles and South Sudan due to data limitations. up to 3.4 percent in 2019, rising to an average of 3.7 percent in 2020-21 (Figure 2.6.2). This is predicated on diminished policy uncertainty and 21. These forecasts are unchanged from June and improved investment in large economies together assume that oil production will recover, but peak with continued robust growth in non-resource- below government targets, while a slow intensive countries. However, external headwinds improvement in private demand will constrain have intensified, as growth among main trading growth in the non-oil industrial sector. In Angola, partners moderates, global financial conditions the growth forecast has been upgraded to 2.9 tighten, and trade policy uncertainty persists percent in 2019, moderating to 2.7 percent in (Chapter 1). Per capita income growth is 2020-21. A recovery in the oil sector, as new oil predicted to remain well below its long-term fields come on stream, is expected to boost average in many countries, yielding little progress growth, along with a pickup in activity in the non- in poverty reduction, and highlighting the need oil sector as reforms bolster the business for policy measures to raise potential output while environment. raising the productive capacity of the poor (World Growth in South Africa is projected to recover Bank 2018b). more slowly than expected, to 1.3 percent in Growth in Nigeria is projected to rebound to 2.2 2019, before rising to 1.7 percent in 2020-21. percent in 2019 and average 2.4 percent in 2020- High unemployment and slow growth in credit EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 120 C H A P TE R 2. 6 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 extension to households are expected to constrain Risks domestic demand in 2019, while fiscal consolidation limits government spending. Higher Risks to the regional outlook are tilted to the growth in 2020 reflects the expectation that the downside. On the external front, slower-than- government’s structural reform agenda will projected growth in the Euro Area and China, gradually gather speed, helping to boost which have strong trade and investment links with investment growth, as policy uncertainty recedes Sub-Saharan Africa, would adversely affect the and investor sentiment improves. region through lower export demand and investment. Moreover, Sub-Saharan African Excluding, Nigeria, South Africa, and Angola, metals producers would likely be hit the hardest growth in the rest of Sub-Saharan Africa is by escalating trade tensions between the United expected to continue to be relatively solid, but States and China, as metals prices would fall faster with significant variation between country groups. than other commodity prices as a result of Economic activity in CEMAC should benefit weakening demand from China (World Bank from higher oil production and an increase in 2018c). Furthermore, a faster-than-expected domestic demand as fiscal tightening eases. normalization of advanced-economy monetary Growth is expected to rise moderately among policy could result in sharp reductions in capital metals exporters, supported in part by stronger inflows (IMF 2018), higher financing costs, and mining activity. However, non-mining activity dislocating exchange rate depreciations, especially remains subdued owing to weak business in countries with weaker fundamentals or higher confidence, accelerating inflation in some political risks (Arteta et al. 2015). Sharp currency countries, and sluggish credit growth. declines would make the servicing of foreign currency denominated debt, already a rising Among non-resource intensive countries, concern in the region, more challenging. economic activity is expected to remain robust in fast-growing countries, such as Cote d’Ivoire, The increased reliance on foreign currency Kenya, and Tanzania, boosted by public borrowing has heightened refinancing and interest investment and strong agricultural production, rate risk in debtor countries (Chapter 4). and in smaller economies, such as Madagascar, on Furthermore, the rise in non-resident participation the back of solid export performance. Growth is in domestic debt markets has exposed some projected to moderate in Ethiopia, as the countries to the risk of sudden capital outflows. In government implements fiscal consolidation some countries, sizable loans to state-owned measures to stabilize public debt. enterprises, backed by commodity exports, have increased the risk that a negative commodity price Inflation is expected to pick up across the region shock could trigger financial crises. in 2019, reflecting the pass-through of currency depreciations during 2018 and domestic price Domestic risks remain significant. Political pressures among metals exporters and non- uncertainty and a concurrent weakening of resource-intensive countries. While inflation is economic reforms could continue to weigh on the envisioned to continue to recede in Nigeria and economic outlook in many countries. In countries Angola, price pressures are likely to intensify in holding elections in 2019, domestic political Kenya, Tanzania, and Uganda. considerations could undermine the commitments needed to rein in fiscal deficits or implement Fiscal balances are expected to improve further, structural reforms, especially where public debt reflecting fiscal consolidation efforts among the levels are high and rising. Insurgencies and armed large oil exporters and continued adjustment in conflicts, with their adverse effects on economic CEMAC. Policy tightening is likely to yield activity, remain an important risk in several smaller fiscal deficits in metals exporters, while countries. Adverse weather shocks and rising fiscal deficits in non-resource-intensive countries financial sector stress are additional risks. should also continue to narrow as public investment spending slows to stabilize public debt. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S U B- S A H A R A N A F R IC A 121 TABLE 2.6.1 Sub-Saharan Africa forecast summary Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f EMDE SSA, GDP1 1.3 2.6 2.7 3.4 3.6 3.7 -0.4 -0.1 -0.1 (Average including countries with full national accounts and balance of payments data only) 2 EMDE SSA, GDP2 1.3 2.6 2.7 3.4 3.6 3.7 -0.4 -0.1 -0.1 GDP per capita (U.S. dollars) -1.4 -0.1 0.0 0.8 0.9 1.0 -0.4 0.0 -0.1 PPP GDP 1.6 2.9 3.0 3.7 3.8 3.9 -0.4 0.0 0.0 Private consumption 0.5 1.8 2.6 2.8 2.9 2.5 0.0 0.0 0.0 Public consumption 1.3 2.8 2.6 2.9 3.0 2.8 0.1 0.0 0.0 Fixed investment 1.5 4.9 5.6 6.9 7.0 7.1 -1.2 -0.5 -0.6 Exports, GNFS3 2.4 3.6 2.4 3.1 3.4 3.1 -0.8 -0.4 -0.4 Imports, GNFS3 -0.4 3.1 3.2 3.5 3.6 3.8 0.2 0.2 0.2 Net exports, contribution 0.8 0.2 -0.2 -0.1 -0.1 -0.3 -0.3 -0.2 -0.3 to growth Memo items: GDP SSA excluding Nigeria, 4.3 4.8 4.8 5.4 5.4 5.5 -0.1 0.1 -0.1 South Africa, and Angola Oil exporters 4 -0.7 1.4 1.8 2.9 2.8 2.9 -0.5 0.3 0.0 CFA countries 5 2.9 3.3 3.9 4.8 4.7 4.6 -0.2 0.3 -0.2 CEMAC -0.8 -0.2 1.2 2.9 2.6 2.4 -0.2 0.6 -0.4 WAEMU 6.5 6.6 6.3 6.3 6.4 6.3 -0.1 0.0 0.0 SSA3 -0.8 0.9 1.0 1.9 2.1 2.1 -0.7 -0.1 -0.1 Nigeria -1.6 0.8 1.9 2.2 2.4 2.4 -0.2 0.0 0.0 South Africa 0.6 1.3 0.8 1.3 1.7 1.7 -0.6 -0.5 -0.2 Angola -2.6 -0.1 -1.8 2.9 2.6 2.8 -3.5 0.7 0.2 Source: World Bank. Notes: e = estimate; f = forecast. EMDE = emerging market and developing economy. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Central African Republic, São Tomé and Príncipe, Somalia, and South Sudan. 2. Sub-region aggregate excludes Central African Republic, São Tomé and Príncipe, Somalia, and South Sudan, for which data limitations prevent the forecasting of GDP components. 3. Exports and imports of goods and non-factor services (GNFS). 4. Includes Angola, Cameroon, Chad, Republic of Congo, Gabon, Ghana, Nigeria, and Sudan. 5. Includes Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Republic of Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 122 C H A P TE R 2. 6 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 TABLE 2.6.2 Sub-Saharan Africa country forecasts1 Percentage point differences (Real GDP growth at market prices in percent, unless indicated otherwise) from June 2018 projections 2016 2017 2018e 2019f 2020f 2021f 2018e 2019f 2020f Angola -2.6 -0.1 -1.8 2.9 2.6 2.8 -3.5 0.7 0.2 Benin 4.0 5.6 6.0 6.2 6.5 6.6 0.0 0.1 0.2 Botswana2 4.3 2.4 4.4 3.9 4.1 4.1 1.4 0.6 0.3 Burkina Faso 5.9 6.4 6.0 6.0 6.0 6.0 0.0 0.0 0.0 Burundi -0.6 0.5 1.9 2.3 2.5 2.8 0.0 0.0 0.0 Cabo Verde 4.7 4.0 4.5 4.7 4.9 4.9 0.3 0.7 0.9 Cameroon 4.6 3.5 3.8 4.2 4.5 4.5 -0.1 0.1 0.2 Chad -6.3 -3.0 3.1 3.3 6.2 5.2 0.5 0.8 0.4 Comoros 2.2 2.7 2.7 3.1 3.1 3.1 -0.2 0.1 0.1 Congo, Dem. Rep. 2.4 3.4 4.1 4.6 5.5 5.9 0.3 0.5 1.1 Congo, Rep. -2.8 -3.1 2.0 3.7 -0.1 -1.5 1.3 -0.9 1.1 Côte d'Ivoire 8.3 7.8 7.5 7.3 7.4 6.8 0.1 0.1 0.2 Equatorial Guinea -8.5 -4.9 -8.8 -2.1 -5.8 -5.8 -2.4 4.9 -5.3 Eswatini 3.2 1.9 -0.6 1.7 1.8 1.8 -1.7 0.0 0.0 Ethiopia2 7.6 10.3 9.1 9.1 9.0 9.0 -0.5 -0.6 -0.9 Gabon 2.1 0.5 2.0 3.0 3.7 3.7 -0.6 -0.7 -0.2 Gambia, The 0.4 4.6 5.3 5.4 5.2 5.2 -0.1 0.2 0.3 Ghana 3.7 8.5 6.5 7.3 6.0 6.0 -0.4 0.6 0.6 Guinea 10.5 8.2 5.9 5.9 6.0 6.0 -0.1 0.0 0.0 Guinea-Bissau 5.8 5.9 4.8 5.1 5.3 5.5 -0.3 -0.1 -0.1 Kenya 5.9 4.9 5.7 5.8 6.0 6.0 0.2 -0.1 -0.1 Lesotho 3.1 -1.7 1.2 1.2 0.2 1.8 -0.6 -1.4 -2.6 Liberia -1.6 2.5 3.2 4.5 4.8 4.8 0.0 -0.2 0.0 Madagascar 4.2 4.2 5.0 5.4 5.3 5.3 -0.1 -0.2 0.0 Malawi 2.5 4.0 3.5 4.3 5.3 5.5 -0.2 0.2 0.4 Mali 5.8 5.4 5.1 4.8 4.8 4.8 0.1 0.1 0.1 Mauritania 2.0 3.5 3.0 4.9 6.9 6.9 -0.6 0.3 1.7 Mauritius 3.8 3.9 3.9 4.0 3.6 3.6 -0.1 -0.1 -0.2 Mozambique 3.8 3.7 3.3 3.5 4.1 4.1 0.0 0.1 0.5 Namibia 0.6 -0.9 0.7 1.8 2.1 2.1 -0.8 -0.5 -0.9 Niger 4.9 4.9 5.2 5.3 5.7 5.8 -0.1 -0.1 -0.1 Nigeria -1.6 0.8 1.9 2.2 2.4 2.4 -0.2 0.0 0.0 Rwanda 6.0 6.1 7.2 7.8 8.0 8.0 0.4 0.7 0.5 Senegal 6.2 7.2 6.6 6.6 6.8 6.9 -0.2 -0.2 -0.2 Seychelles 4.5 5.3 3.6 3.4 3.3 2.9 -0.4 -0.4 -0.2 Sierra Leone 6.3 3.7 3.7 5.1 6.3 6.3 -1.4 -0.6 -0.2 South Africa 0.6 1.3 0.8 1.3 1.7 1.7 -0.6 -0.5 -0.2 Sudan 4.7 4.3 3.1 3.6 3.8 3.8 0.5 0.5 0.3 Tanzania 7.0 7.1 6.6 6.8 7.0 7.0 0.0 0.0 0.0 Togo 5.1 4.4 4.5 4.8 5.1 5.1 -0.3 -0.2 0.1 Uganda2 4.6 3.9 6.1 6.0 6.4 6.5 0.6 0.0 -0.1 Zambia 3.8 3.4 3.3 3.6 3.8 3.8 -0.8 -0.9 -1.0 Zimbabwe 0.6 3.2 3.0 3.7 4.0 4.0 0.3 -0.1 0.0 Source: World Bank. Notes: e = estimate; f = forecast. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. 1. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Central African Republic, São Tomé and Príncipe, Somalia, and South Sudan. 2. Fiscal-year based numbers. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S U B- S A H A R A N A F R IC A 123 BOX 2.6.1 Informality in Sub-Saharan Africa Sub-Saharan Africa has high levels of informality, especially in West and East Africa, low-income countries, fragile states, and commodity exporters. Policies to increase human capital, improve access to resources, reduce regulatory burdens, and strengthen governance have been associated with a decline in informality, which in turn has been associated with better macroeconomic and social outcomes. However, for these policies to be effective, they need to be tailored to the specific nature of informality and types of informal firms. Introduction 16, at 80 percent and 68 percent, respectively. In contrast, the shares of self-employed workers in Central and Despite a decline over the past three decades, employment Southern Africa were 48 and 43 percent respectively, only informality in Sub-Saharan Africa (SSA) remains among slightly above the EMDE average. Self-employment made the highest in emerging market and developing economies up more than 85 percent of employment in Benin, (EMDEs), with nine out of ten workers informally Burundi, Madagascar, and Uganda whereas it was less than employed (of which six are self-employed). Output 20 percent in South Africa and Mauritius. informality (around 40 percent of official GDP) and perceptions of informality are also high compared to other Evolution of informality in SSA. Informality in SSA has EMDE regions. Yet, there is considerable heterogeneity declined gradually over the past three decades, broadly in within the region—informality is higher in West and East line with the EMDE trend. Some countries, however, have Africa, low-income countries, fragile states, and made significant progress in lowering the shares of commodity exporters. Pervasive informality contributes to informal output and employment, such as Angola, lower government tax revenues, which limits the fiscal Botswana, Ethiopia, Ghana, Malawi, Rwanda, and resources available for much-needed public investment and Tanzania. social programs. Correlates of informality Against this backdrop, this Box examines the following questions: High informality in SSA has reflected wide-ranging economic and development challenges in the region. It has • How has informality evolved? also reflected economic structures and a dearth of skilled labor. • What are the macroeconomic and social correlates of informality? Weak growth and conflict. SSA hosts all but seven of the world’s 34 low-income countries and nearly half of the • What are the policy options to address challenges world’s 36 fragile states (World Bank 2018d, 2018e). In associated with informality? general, informality is higher in low-income SSA countries and, especially, fragile states. Economic disruptions during Evolution of informality conflict and violence have forced people to earn their livelihoods in the informal economy (Heintz and Valodia High average informality. On average in 2010-16, the 2008). Employment losses during recessions or shocks to informal economy in SSA countries amounted to 36-40 crop production have also been associated with increases in percent of official GDP, informal employment made up informal labor supply (Daniels 2003; Calvés and 90 percent of employment and, more narrowly, self- Schoumaker 2004; Otsuka and Yamano 2006). employment accounted for 58 percent of total employment (ILO 2018, Figure 2.6.1.1). Alternative Economic structure. In commodity-exporting countries, measures of informality, such as the share of the labor the capital-intensive mining sector creates few formal force without pension coverage and perceptions of employment opportunities, and economies in most informal activity, were also high compared with other countries in SSA have large agricultural sectors that have EMDE regions. high rates of informal self-employment. In the non- agricultural sector, there is also considerable self- Heterogeneity. There is wide cross-country heterogeneity. employment in labor-intensive services such as street West and East Africa had much higher average shares of vendors, craftsmen, and home-based activities (Fox and self-employed workers in total employment during 2010- Sohnesen 2012). Rural-urban migration and increased labor force participation, especially among women, was mostly absorbed by the informal sector (Kessides 2005). In Note: This box was prepared by Wee Chian Koh with research assistance from Jinxin Wu. some societies, informal businesses are hereditary in EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 124 C H A P TE R 2. 6 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.6.1 Informality in Sub-Saharan Africa (continued) FIGURE 2.6.1.1 Informality in Sub-Saharan Africa Informality has declined in Sub-Saharan Africa, but remains among the highest in the world. Informality is higher in West and East Africa, low-income countries, fragile states, and commodity exporters. A. Measures of informality B. Measures of informality C. Self-employment in SSA D. Reduction in informality Sources: World Bank staff estimates, World Development Indicators, International Labor Organization, World Economic Forum. Notes: A.B. Orange lines are the inter-quartile ranges for EMDEs. A. DGE and MIMIC estimates measure the informal output in percent of official GDP. Self-employed is the share of self-employment in total employment. B. Labor force without pension expressed as a share of total labor force. WEF index is the average response to the following question: “In your country, how much economic activity do you estimate to be undeclared or unregistered? (1=Most economic activity is undeclared or unregistered; 7=Most economic activity is declared or registered).” The index is re-ordered (i.e. 1=Most economic activity is declared or registered; 7=Most economic activity is undeclared or unregistered) so that a higher value indicates larger informality. Data for the period 2004-05 is dropped due to inconsistency in survey methods. C. World Bank classifications. Data for the period 1990-2016. D. Percent change between 1990-2009 and 2010-16. nature, where businesses are passed down to the next 2.6.1.2). Informal workers in SSA tend to be lower skilled generation (Chen 2012). In others, social norms restrict and less educated than formal workers (Adams et al. the mobility of women, compelling them to be informally 2013). This limits opportunities for wage employment in employed (ILO 2009). the formal economy. Self-employed workers with low human capital, and hence low productivity, have an Low human capital. The average years of schooling in SSA incentive to operate in the informal economy to avoid are well below those in any other EMDE regions (Figure EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S U B- S A H A R A N A F R IC A 125 BOX 2.6.1 Informality in Sub-Saharan Africa (continued) paying taxes and incurring other administrative costs governments’ ability to provide quality public services is (Oviedo et al. 2009). Informal firms, with lower constrained. managerial ability, also tend to produce low-quality Poverty and social outcomes. While the informal inexpensive products with little demand from the formal economy can provide important opportunities for sector (La Porta and Shleifer 2016). The HIV/AIDS employment, the majority of those engaged in informal pandemic has also taken a large toll on human capital and activities lack income security, employment benefits, and forced workers into less secure informal employment social protection. Moreover, higher informality in SSA is where discrimination is sometimes less pronounced (ILO associated with lower life expectancy and worse poverty 2009). outcomes (Figure 2.6.1.3). Gender inequality is also Limited access to resources and markets. Informality is prevalent in the informal economy in SSA: women are associated with restricted access to electricity, finance, and often placed in the most hazardous jobs with no access to land (Ingram et al. 2007). Limited availability of resources occupational health and safety measures (ILO 2009). curtails informal firms’ growth and productivity improvements (Steel and Snodgrass 2008). There are also Policy challenges obstacles to market access, such as lack of Unlocking the potential of the informal economy. While telecommunications or transport infrastructure, which is informality is more pervasive in SSA than in other EMDE particularly important for firms that need to frequently regions, the move from informality to formality is more interact with suppliers and customers. Access to public dynamic: more SSA formal firms started out as informal space and urban amenities are also important (Heintz and and the duration of informality is shorter than in other Valodia 2008). EMDEs (Figure 2.6.1.4). SSA also possesses a more High regulatory burden. Compared with other EMDEs, positive attitude than other EMDE regions, despite a SSA has considerably higher regulatory burdens. higher proportion of people who became entrepreneurs Burdensome regulations such as lengthy processes in out of necessity. Two-thirds (65 percent) of survey registering a business, complicated procedures in filing respondents believe they have the required skills and taxes, high costs of export and import documentary knowledge to start a business, 59 percent indicate they see compliance, strict labor regulations, and high tax burden good opportunities to start a firm, and 42 percent intend can make it prohibitively expensive to operate in the to start a business within three years. This intrinsic formal economy (Mbaye and Benjamin 2015). entrepreneurial spirit, despite high regulatory burdens and weak institutions, could render the informal sector a Weak governance. Compared with other EMDEs, SSA reservoir of untapped economic potential (De Soto 1989; has considerably weaker governance and institutions. Poor Grimm et al. 2012). governance and institutions may result in failures in enforcing regulations and containing corruption. This To unlock this potential, both broad-based policy tools— creates an environment for informal enterprises to easily such as better governance—and policy tools targeted at conceal their activities and evade taxes (Mbaye and specific parts of the informal sector are available. In Kenya, Benjamin 2015). improved managerial skills and new marketing channels induced by competition helped metalwork enterprises in Low productivity. Productivity differentials between the the Kariobangi Light Industries grow and transition to the formal and informal sectors are large: value added per formal economy (Sonobe et al. 2011). The local worker of informal firms is only 14 percent that of formal government provided little support other than designating firms in the median SSA country, lower than the median an area for these artisans to operate, but that proved to be in other EMDEs (La Porta and Shleifer 2014). sufficient.1 Competition from informal firms, which do not shoulder the cost of compliances with taxes and regulations, also Tailored policies. Small informal firms, lacking in human weigh on the profitability and investment of formal firms capital, would not sharply increase their productivity by (Oosthuizen et al. 2016; Box 3.3). Although practices of competitors in the informal sector is only the third biggest reported obstacle in SSA, after electricity and access to 1 Also in Kenya, the M-Pesa mobile money transfer system, combined finance, it is more problematic in SSA compared to other with affordable ICT services, increased microenterprises’ profitability EMDEs (Dinh et al. 2010; La Porta and Shleifer 2016). In (Mbogo 2012). Improving the survival chances of these microenterprises is one pathway towards growing the formal economy. David et al. (2012) addition, since informal firms do not pay taxes, provide other examples of successes at the local government level. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 126 C H A P TE R 2. 6 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.6.1 Informality in Sub-Saharan Africa (continued) FIGURE 2.6.1.2 Economic and institutional indicators in Sub-Saharan Africa Low human capital, limited access to resources, heavy regulatory burden, weak governance, and entrepreneurial conditions are important drivers of informality. A. Economic and social characteristics B. Doing business indicators C. Governance indicators D. Entrepreneurial framework conditions Sources: World Development Indicators, Doing Business, Worldwide Governance Indicators, Global Entrepreneurship Monitor, Barro and Lee (2013). Notes: A.-D. Blue bars are +/- one standard deviation of SSA mean. Other EMDE refers to all EMDEs except SSA countries. A. GDP per capita is based on 2011 PPP in thousand dollars, expressed in logarithm. Life expectancy at birth is in years. Poverty is the headcount at $1.90 a day (2011 PPP) in percent of population. B. The index represents the distance to the frontier (100) in Doing Business. A higher index represents better performance. Data for the period 2004-16. C. The score is based on Worldwide Governance Indicators. It ranges from -2.5 to 2.5. A higher score represents better performance. Data for the period 1996-2016. D. The score is based on National Expert Survey of the Global Entrepreneurship Monitor. It ranges from 1 to 9. A higher score represents better perceived condition. merely registering (La Porta and Shleifer 2016). In to encourage small firms to grow into more productive contrast, large informal firms resemble formal firms much formal firms, through skills upgrading and better access to more than their small informal counterparts: productivity resources such as business development services, transport differentials of large informal firms relative to formal firms and communications connectivity, financial services, are minor (Benjamin and Mbaye 2012). In West Africa, health services, land and property rights, infrastructure, the largest and fastest growing sectors are, in fact, and technology (Oosthuizen et al. 2016). As these firms dominated by large informal firms. This argues for policies become more productive and produce higher quality EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S U B- S A H A R A N A F R IC A 127 BOX 2.6.1 Informality in Sub-Saharan Africa (continued) FIGURE 2.6.1.3 Correlates of informality in Sub-Saharan Africa Improvements in economic and institutional factors are associated with a reduction in informality. High informality is associat- ed with worse macroeconomic and social outcomes. A. Correlates of informality: Economic factors B. Correlates of informality: Regulation C. Correlates of informality: Governance D. Correlates of informality: Macroeconomic and social outcomes Sources: World Bank staff estimates, World Development Indicators, Doing Business, Worldwide Governance Indicators, Barro and Lee (2013). Notes: The orange diamonds are the coefficient estimates and the blue bars denote the 90 percent confidence intervals. OLS estimators are applied, with country means over the sample period used for both the dependent and independent variables. The share of self-employed in total employment is the measure of informality. Informality is the dependent variable in A.-C., and it is the independent variable in D. 37 SSA countries are included in the regressions. The coefficient estimate measures the effect on the dependent variable of a unit change in the independent variable. For example, in A., a 1 percent increase in the tax rate is associated with a 0.2 percent increase in informality. In D., a 1 percent increase in informality is associated with a 1.6 percent decline in government tax revenue. A. GDP per capita is based on 2011 PPP in thousand dollars, expressed in logarithm. Trade openness is total trade (exports + imports) as a share of GDP. Financial development is proxied by private credit as a percentage of GDP. Tax burden is the total tax rate using data from Doing Business. Data for the period 1990-2016. B. The correlates are the distance to the frontier in Doing Business. Data for the period 2004-16. C. The correlates are the scores based on Worldwide Governance Indicators. Data for the period 1996-2016. D. Investment is gross fixed capital formation as a percentage of GDP. Tax revenue is expressed as a share of GDP. Life expectancy at birth is in years. Poverty is the headcount at $1.90 a day (2011 PPP) in percent of population. products, they could then perhaps be able to participate in encourage formal registration can be combined with supply chains in the formal sector (La Porta and Shleifer tighter enforcement (Mbaye and Benjamin 2015). 2016). For large firms or those that voluntarily remain Building institutions. Regulatory and institutional reforms informal to evade taxes or avoid labor codes, incentives to to build public trust can strengthen incentives for firms to EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 128 C H A P TE R 2. 6 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 2.6.1 Informality in Sub-Saharan Africa (continued) operate formally (Mbaye and Benjamin 2015). This includes improving the business environment by removing FIGURE 2.6.1.4 Entrepreneurship attitude unnecessary regulatory barriers, strengthening monitoring and informality indicators in Sub-Saharan and enforcement capabilities, and upholding legal and Africa judicial systems. These policies apply equally to formal Despite a relatively higher proportion of necessity-driven firms as an enabling environment is critical for investment informal entrepreneurs, SSA benefits from more and employment generation. Improving macroeconomic dynamic entrepreneurial attitudes. More formal firms in stability with sound fiscal and monetary policy frameworks Sub-Saharan Africa than in other EMDE regions started is also essential. out as informal firms. Stakeholder engagement. Governments can actively A. Entrepreneurship attitude engage with the informal community to encourage a shift towards greater formality (ILO 2009). This can involve educating informal firms on the benefits of formal registration, providing information on the procedures, participating in social dialogues to understand pressing issues for informal firms, customizing household surveys to better capture important aspects of informality, and collaborating with informal actors to design and implement effective development policies. B. Informality indicators Sources: Global Entrepreneurship Monitor, World Bank Enterprise Surveys. Notes: Blue bars are +/- one standard deviation of SSA mean. Other EMDE refers to all EMDEs except SSA countries. A. Data from the Adult Population Survey of the Global Entrepreneurship Monitor for the period 2001-16. Motivation index is the percentage of those who have recently started a business that are improvement-driven opportunity motivated divided by the percentage that is necessity- motivated. A lower ratio indicates a higher proportion that is necessity- driven. B. Data from the World Bank Enterprise Surveys for the period 2006-16. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 2 129 _________. 2016. “Policies, Strategies and Practices References for the Formalisation of Micro and Small Enterprises.” East Asia and Pacific International Labour Organization, Geneva, Switzerland. ADB (Asian Development Bank). 2010. e Informal Sector and Informal Employment in Indonesia. 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EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 2 137 Washington, DC. World Bank. 2018c. “ e Implications of Tari s for Commodity Markets.” In Commodity Markets Outlook. Sonobe, T., J. E. Akoten, and K. Otsuka. 2011. “ e e Changing of the Guard: Shifts in Industrial Growth Process of Informal Enterprises in Sub-Saharan Commodity Demand. October. Washington, DC: Africa: A Case Study of a Metalworking Cluster in World Bank. Nairobi.” Small Business Economics 36 (3): 323-335. World Bank. 2018d. “World Bank Country and Steel, W., and D. Snodgrass. 2008. “Raising Lending Groups.” Accessed October 1, 2018. https:// Productivity and Reducing Risks of Household datahelpdesk.worldbank.org/knowledgebase/ Enterprises.” Diagnostic Methodology Framework, articles/906519-world-bank-country-and-lending- World Bank, Washington, DC. groups. UNCTAD (United Nations Conference on Trade and World Bank. 2018e. “Harmonized List of Fragile Development). 2018. World Investment Report – Situations.” Accessed October 1, 2018. http:// Investment and New Industrial Policies. Geneva, www.worldbank.org/en/topic/fragilitycon ictviolence/ Switzerland: UNCTAD. brief/harmonized-list-of-fragile-situations. World Bank. 2018a. Africa’s Pulse. October. Washington, DC: World Bank. World Bank. 2018b. “Piecing Together the Poverty Puzzle.” In Poverty and Shared Prosperity. October. Washington, DC: World Bank. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) CHAPTER 3 GROWING IN THE SHADOW: Challenges of Informality EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 141 The informal sector accounts for about a third of GDP and 70 percent of employment (of which self- employment is more than a half) in emerging market and developing economies. Informality is more widespread in lower-income countries with a large agricultural sector and a high share of unskilled workers. While offering the advantage of flexibility and employment in some economies, a larger informal sector is associated with lower productivity, reduced tax revenues, and greater poverty and inequality. Overcoming the challenges of informality requires a balanced mix of policies that carefully take into account country-specific drivers. A well- designed policy framework should include measures aimed at reducing regulatory and tax burdens, expanding access to finance, improving education and other public services, and strengthening public revenue frameworks. Introduction countries, the informal sector is a major source of income to many low‐skilled individuals whose The livelihoods of the poor in emerging market income would otherwise fall below subsistence and developing economies (EMDEs) often (Docquier, Muller, and Naval 2017). These depend on informal activity. In these economies, reasons for participating in the informal economy informal sector output on average accounts for mean informal workers range from agricultural about one-third of GDP and informal day laborers to self-employed lawyers with a few employment constitutes about 70 percent of employees.2 employment (of which self-employment accounts Regardless of the reason why individual workers or for more than a half; Figure 3.1). In some firms choose between formal and informal countries in Sub-Saharan Africa, informal activity, a large informal sector has been associated employment accounts for more than 90 percent of with unfavorable macroeconomic and employment and informal output is as much as 62 development outcomes. On average, economies percent of official GDP (ILO 2018a). with larger informal sectors tend to have lower Informality is a multidimensional concept, productivity, slower physical and human capital differing in nature across workers and countries accumulation, higher poverty and inequality, and (Perry et al. 2007). Some workers and firms are smaller fiscal resources.3 The informal sector itself “excluded” from the modern economy or critical has, on average, lower productivity than the state benefits by tax and regulatory burdens (de formal sector because it tends to employ less- Soto 1989; Loayza, Oviedo, and Serven 2006). skilled workers, have restricted access to funding, This type of informality is frequently associated services and markets, and lack economies of scale.4 with low productivity and poorly paid low-skilled Employment in the informal sector can provide a employment (La Porta and Shleifer 2014; Loayza 2018). Other informal workers voluntarily “exit” the formal sector and choose informal activity for 2 Research suggests the coexistence of both “excluded” and its flexibility and independence (Maloney 2004; “existing” types of informality (e.g. Perry et al. 2007; Hazans 2011; Bosh and Maloney 2008 and 2010; Lehmann and Pignatti 2007; Günther and Launov 2012).1 In lower-income Fiess, Fugazza and Maloney 2010; Nordman et al. 2016). 3 La Porta and Shleifer (2014) provide evidence that informality is associated with lower productivity, less access to financing, and less- Note: This chapter was prepared by a team led by M. Ayhan educated managers. Some studies show that informality is associated Kose, Franziska Ohnsorge and Shu Yu, and including Mohammad with higher income inequality and poverty (Rosser, Rosser and Ah- Amin, Sinem Kilic Celik, Gene Joseph Kindberg Hanlon, Ergys med 2000; Perry et al. 2007; Chong and Gradstein 2007; and Lo- Islamaj, Sergiy Kasyanenko, Cedric Okou, Naotaka Sugawara, Temel ayza, Serven and Sugawara 2010). Lower physical investment in the Taskin, and Collette Wheeler. informal sector could reflect an unwillingness of informal firms to 1 Several studies find that some informal workers in EMDEs adopt technologies or scale up that would make them visible to tax operate voluntarily in the informal sector. For instance, Falco et al. and other authorities (Dabla-Norris and Inchauste 2008; Gandelman (2015) use survey data from Ghana and find little evidence for the and Rasteletti 2017). Docquier, Muller, and Naval (2017) develop a overall inferiority of working in the informal sector compared with model that predicts that the informal sector would lead to slower the formal sector. Falco and Haywood (2016) report that returns to human capital formation. Less educated managers partially explain productive characteristics in self-employment have increased lower labor productivity observed in informal firms (Cirera and significantly in Ghana between 2004 and 2011 whilst self- Maloney 2017). Benjamin et al. (2014) show that informality is employment has attracted increasingly skilled workers. Blanchflower, associated with weaker international competitiveness. Oswald and Stutzer (2001) note that many workers in advanced 4 For details, see Jovanovic (1982); Amaral and Quintin (2006); economies, such as the United States and Portugal, report preferring Galiani and Weinschelbaum (2012); Loayza (2018). to be self-employed. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 142 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 safety net by keeping or creating employment • Informal competition and formal rm during periods when the formal sector is shedding productivity. e chapter presents the rst jobs (Loayza and Rigolini 2011). However, cross-country study that quanti es the lower workers in the informal economy are largely productivity of formal rms that face excluded from the social security system and less competition from informal rms. is adds to protected against negative shocks than workers in the rich literature that documents the sizable the formal sector (Box 3.1) . productivity di erential between formal and informal rms. Against this backdrop, this chapter examines the main features of informal economies and possible • Policy implications. e chapter analyzes the policies to address the challenges associated with implications of country-speci c policy changes informality. Specifically, it addresses the following for the informal sector and synthesizes the questions: lessons from these changes to o er a menu of policy options that takes into account the • What are the main features of the informal importance of complementarities. economy? The chapter reports the following main findings: • What are the empirical linkages between informality and development outcomes? • Main features of the informal economy. In EMDEs, the informal economy in 2016 on • Which policies can mitigate the adverse e ects average accounts for 32 percent of GDP and, of informality? 70 percent of employment, with self- The chapter makes the following contributions to employment accounting for 43 percent of the literature on informality: employment (Figure 3.1). Informality tends to be higher in lower-income economies that • Broad database on informality. e chapter are less open to international trade, have larger compiles a new database from a wide range of agricultural sectors, and have larger pools of informality measures. It employs these young and unskilled workers. Both informal measures to provide a rich set of stylized facts output and employment have declined since on informality that are robust to the choice of 1990. Informality declined faster in countries measure. with higher output growth, rapid physical capital accumulation, and stronger • Informality, poverty and income (wage) improvements in governance and business inequality. e chapter documents that climates. higher informality is associated with greater poverty. is may, in part, re ect lower wages • Prevalence of informality. One-half of the for informal workers than formal workers. world’s informal output and 95 percent of its While many survey-based studies have informal employment is in EMDEs. ree documented the existence of such wage EMDE regions (East Asia and Paci c (EAP), di erentials (especially at the country-level), Latin America and the Caribbean (LAC), and this chapter distills broader lessons from a Europe and Central Asia (ECA)) accounted large number of studies. for more than one-third of the world’s informal output, but only one-quarter of its • Informality and scal indicators. e chapter formal output. Meanwhile, South Asia (SAR) is the rst to document the empirical link hosts almost half of the world’s informal between higher informality and unfavorable workers, although the region accounts for less aggregate scal outcomes, including revenues than one-tenth of the world’s formal and expenditures. is goes beyond previous employment and less than one-twentieth of studies that have focused on the implications the world’s formal output. Another 14 percent for speci c tax categories, such as value-added of the world’s informally employed are in taxes (Keen 2008). Sub-Saharan Africa (SSA), two to ve times EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 143 the region’s share of the world’s formal output FIGURE 3.1 Informality: Magnitude and correlates or formal employment. The informal sector accounts for about a third of GDP and 70 percent of employment (of which self-employment is more than a half) in emerging • Informality and development outcomes. market and developing economies. A large informal sector is associated Higher informality is associated with lower with slower GDP growth and weaker governance as well as greater poverty and income inequality. Widespread informality is also seen in output growth, lower productivity, and higher economies with lower government expenditures and revenues, and a skew poverty and income inequality. Potential towards trade-based taxation. reasons for greater poverty in economies with A. Share of informal output and B. Informality: Output, employment, higher informality may include a lack of scal employment and perception resources to fund public services or wage di erentials between informal and formal workers. Workers in the formal economy earn, on average, about 19 percent more than workers in the informal economy. ese wage di erentials largely re ect the characteristics of informal workers, who tend to be lower- skilled than formal workers. • Informality and rm productivity. e C. Informal output and institutional D. Brazil: Share of informal workers quality, 2016 preferring informal over formal average informal rm in EMDEs is only one- employment quarter as productive as the average rm operating in the formal sector. Moreover, rms in the formal sector that face informal competition are, on average, only three- quarters as productive as those that do not. Better business climates can mitigate some of these productivity di erentials. • Informality and scal indicators. In EMDEs E. Informality, poverty, and income F. Differences in fiscal indicators with the most pervasive informality, inequality between the lowest and highest government revenues are lower by 5-10 output informality in EMDEs percentage points of GDP (and expenditures lower by 4-10 percentage points of GDP) than in those with the lowest levels of informality. In developing economies, pervasive informality further limits governments’ limited ability to implement redistributive measures, invest in public infrastructure, or carry out other growth- enhancing policies. Sources: Elgin et al. (forthcoming a), Maloney (2004), World Development Indicators, World Governance Indicators (WGI), Doing Business Reports, World Bank, IMF World Economic Outlook, International Labor Organization, World Economic Forum. A. Unweighted averages. Informal employment uses self-employment shares in the closest (latest) • Policy implications. A review of studies of available year around 1990 and 2016 (with informal employment shares in shaded red). World policy measures that have had repercussions averages between 1990-2016 are in orange. B. Unweighted average for each informality measure for latest available year (with the corresponding for informality highlights the need for a +/-1 standard deviation shown in vertical bars). See Annex 3.1 for details. C. Group averages of DGE-based informal output in percent of official GDP in year 2016 are shown comprehensive policy package that takes into in diamonds, with bars showing 95 percent confidence interval. Dashed line shows the world average. “High” (“Low”) indicates countries with above- (below-) median values in the following two account country-speci c features that lead to measures: Doing Business distance-to-frontier and governance effectiveness (WGI). informality and determine its consequences. D. The share of informal workers preferring informal over formal employment (Maloney 2004). E. Data are for 1990-2016. Group means (diamonds) and 95 percent confidence intervals (bars) are First, strategies to reduce informality outright shown for poverty headcount ratio at $1.90 a day (2011 PPP, percent of population) and Gini coefficients. “High informality” (“Low informality”) indicates countries with above- (below-) median may hurt vulnerable groups and disrupt informal output (DGE-based). F. Difference (between the 2000-16 average fiscal indicators among the third of EMDEs with the formal activity that relies on informal- highest and lowest informality by the share of DGE-based informal output averaged during 2000-16. economy inputs. ese e ects can be Vertical bars indicate 10 percent confidence intervals of the difference. Sample includes 70 non- energy exporting EMDEs with populations above 3 million people. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 144 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.1 Linkages between formal and informal sectors Empirical evidence on the degree of cyclicality of the informal economy with the formal business cycle is mixed. The cyclicality and sensitivity of informal employment to formal business cycles depends on the source of shocks that cause business cycle fluctuations, the presence of rigidities in the formal sector, the initial extent of informality, and the availability of informal jobs. While there is broad consensus that the informal economy Informal economy as a countercyclical safety net is sizable in emerging market and developing countries (EMDEs), evidence for its behavior over the business Informal economies can serve as buffers and safety nets for cycles remains inconclusive. An informal economy that the poor if they absorb labor during recessions.3 This can expands while the formal economy contracts may support facilitate an economic recovery provided that re-entry into household incomes during economic downturns and serve the formal sector is open when the formal economy as a safety net (Loayza and Rigolini 2011). An informal returns to expansion (Colombo, Onnis, and Tirelli 2016; economy that behaves procyclically could function as a IMF 2017; Loayza and Rigolini 2011). “growth engine” by providing more services and Macroeconomic evidence. Macroeconomic studies suggest intermediate inputs to the formal economy during that the informal economy can behave “countercyclically” economic expansions but, conversely, could also amplify in the sense that the share of informal employment indeed the adverse effect of recessions (Dell’Anno 2008; Chen rises during business cycle downturns.4 Using data from 54 2005; Meagher 2013).1 Earlier work suggests that the countries for 1984-2008, Loayza and Rigolini (2011) show degree of cyclicality of the informal economy depends on that, on average, a one standard deviation slowdown in the measure of informality used and country GDP per capita growth (i.e., 3 percentage points) is linked characteristics. with a short-run increase in the share of self-employment in the total labor force by 1.2 percentage points. However, Against this backdrop, this box reviews the literature and they also find considerable heterogeneity across presents results from a set of empirical exercises to address countries—the counter-cyclicality of informal employment the following questions: is much weaker in economies with more pervasive • What conclusions does the literature offer about the informality.5 cyclical behavior of the informal economy? Using quarterly data for Mexico, Fernandez and Meza (2015) find that the correlation between informal • How synchronized have been movements in informal employment and official GDP is modest (about -0.3), and formal economies? whereas the correlation between formal employment and formal output is strongly positive. The authors argue that • What are the policy implications of cyclicality? this lowers cyclicality of total employment. Colombo, Literature review Onnis, and Tirelli (2016) use electricity consumption as a proxy for total economic activity to study cyclical The evidence on the cyclical behavior of the informal economy offers mixed conclusions. Studies focusing on the share of the informal economy in total output or 3 Due to its flexibility, the informal sector is able to adjust in wages employment tend to find countercyclical behavior whereas rather than employment during recessions, which explains the informal studies focusing on output or employment levels tend to employment’s lack of responses to economic downturns (Maloney 2004, find procyclical behavior. This section summarizes this Guriev, Speciale and Tuccio 2016). 4 Remittances, as a buffer against shocks to formal economy, may also literature.2 influence the cyclicality of the informal sector. Remittances appear to be largely absorbed by the informal sector as Ivlevs (2016) finds that high level of remittances tends to be associated with more informality. Shapiro and Mandelman (2016) and Santanu and Turnovsky (2018) show that Note: This box was prepared by Sergiy Kasyanenko and Shu Yu. countercyclical remittances are associated with higher informal 1 See Meagher (2013) for a literature review on studies concerning the employment during recessions as formal employment declines. linkage between formal and informal economy. 5 The countercyclicality drops as the share of informal employment in 2 Several recent studies also argue that pervasive informality may total employment increases and disappears when informal employment influence the measured cyclicality of the formal economy. For example, accounts for more than 42-43 percent of total employment. Restrepo-Echavarria (2014) and Horvath (2018) show that models with a Theoretically, Shapiro (2014) suggest that while the share of self- large and poorly measured informal sector can generate excess volatility of employment tends to decline during economic upturns, the ease of entry formal consumption relative to formal output – a common feature of into self-employment explains the differences in cyclical behavior across business cycles in many EMDEs. countries. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 145 BOX 3.1 Linkages between formal and informal sectors (continued) properties of informality in 48 countries over the period Macroeconomic evidence. Using informal output levels 1984-2005 and illustrate that the informal economy (as opposed to the share of the informal economy), Bajada expands following a banking crisis. Finally, Kaufmann and (2003), Giles (1997), Giles and Tedds (2000), and Kaliberda (1996), Busato and Chiarini (2004), and Elgin Dell’Anno (2008) find that informal-economy output (2012) present empirical evidence that the informal movements correlate positively (i.e. move pro-cyclically) economy acts as a buffer, increasing its share of official with formal-economy output movements in Australia, GDP during economic downturns.6 New Zealand, Canada, and a group of 19 Latin American countries. In a group of developing countries, Fiess, More procyclical fiscal policy in less developed economies Fugazza, and Maloney (2010) identify episodes where with weaker institutions may contribute to the counter- relative demand or productivity shocks to the non- cyclicality of informal activity. Fiscal policy tends to be tradables sector (as opposed to the tradables sector) are more procyclical in countries with higher informality associated with higher informal employment (hence, pro- (Çiçek and Elgin 2011). In particular, procyclical fiscal cyclicality). In Brazil and Mexico, higher separation rates consolidation during recessions, including through higher from informal jobs and a large drop of the formal job taxes, may encourage more informal employment and finding rate may induce labor outflows from the informal strengthen the counter-cyclicality of informal activity. sector during recessions (Bosch and Maloney 2008). Arvin Microeconomic evidence. In work flow data for Brazilian -Rad et al. (2010) develop a theoretical model that metropolitan labor markets between 1983 and 2002, establishes procyclical informal-formal sector linkages, Bosch, Goni and Maloney (2007) find that the informal particularly when formal firms sub-contract labor-intensive sector is able to absorb more labor during economic stages of production to the informal sector. downturns as jobs became scarce in the formal sectors. Microeconomic evidence. Schneider (1998) reports that in Bosch and Esteban-Pretel (2012) use the same data and Germany and Austria at least two-thirds of the income find that the share of formal employment falls as formal- earned in the informal economy is immediately spent in economy output contracts, in part because the rate at the official economy resulting in considerable (positive) which workers find formal jobs plummets while that at stimulating effects on the official economy. In firm-level which they find informal jobs remains broadly stable.7 data for India, Moreno-Monroy, Pieters, and Erumban (2014) find that formal and informal sector employment Informal economy as an engine of growth are positively correlated, in part because subcontracting by Since informal firms provide services, as well as final and formal-sector firms to informal firms contributes to job intermediate goods to the formal sector, one would expect creation in the informal sector. Data from Indian a positive correlation between formal and informal sector manufacturing firms show that the gross value added for activity (Lubell 1991; Arvin-Rad et al. 2010; Moreno- several predominantly informal industries is positively Monroy et al. 2014). In addition, informal-economy correlated with that in the formal sector and FDI. This income can support formal-economy demand.8 may be indicative of technological spillovers contributing to both formal and informal sectors (Beladi, Dutta, Kar 2016). 6 This empirical relationship between informal and formal activities appears to be present in both advanced economies and EMDEs. For Factors determining the degree of procyclicality of the example, Kaufmann and Kaliberda (1996) cover a panel of 16 Central and Eastern European countries in 1989-1994; Busato and Chiarini informal economy (2004) used data on the share of informal output in total GDP from the United States, Italy, the United Kingdom, and New Zealand over the Cross-country heterogeneity. There is considerable cross- period 1960-1997; Elgin (2012) utilizes a panel dataset of 152 countries country heterogeneity in the degree of pro-cyclicality of from 1999 to 2007. informal employment. It tends to be higher when 7 Job separation rates are countercyclical (i.e rise during recessions) for both sectors, with a much higher probability of losing an informal job informality is greater (Loayza and Rigolini 2011), when during recessions. informal employment is more common (Shapiro 2014), 8 See Schneider (1998), Gibson (2005), Docquier, Muller, and Naval when there are stronger informal-formal sector linkages (2017), Kanbur (2017), Eliat and Zinnes (2002), World Development such as through subcontracting (e.g., Moreno-Monroy, Report (2014). Although the relationship between formal and informal Pieters, and Erumban 2014; Mbaye, Benjamin, and Gueye sectors may be symbiotic in the short-run especially when policymakers are concerned about the welfare of low-skilled working poor, argue that 2017). in the long-run pervasive informality may create poverty traps and stymie economic development. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 146 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.1 Linkages between formal and informal sectors (continued) Source of shocks causing business cycles. The informal • Business cycle turning points. About three fourths of economy can move procyclically or countercyclically, business cycle troughs in formal output coincide with depending on the sectoral origin of the shocks that a trough in the informal output; seven out of ten generate business cycles in the presence of wage rigidities, formal output peaks coincide with informal output especially in the formal sector (Fiess, Fugazza, and peaks (Elgin et al. forthcoming b). In contrast, Maloney 2010). Positive relative demand or productivity turning points in self-employment, as a proxy for shocks to the non-tradable (largely informal) sector could informal employment, rarely coincide with turning increase informal employment, i.e. generate procyclicality points in formal employment or formal output. in informal employment, especially when combined with wage rigidities in the formal sector. For instance, in • Correlations. Lead, lag, and contemporaneous Colombia, capital account liberalization in the context of correlations of formal-economy output with informal- broader reforms during 1991-1996 raised permanent economy output are highly and statistically significant income and constituted a positive demand shock to the whereas those between formal output and informal non-tradeable sector. This upturn resulted in an expanding employment are statistically insignificant (Figure non-tradable informal sector. Conversely, in the presence 3.1.1; Elgin et al. forthcoming b). This is consistent of wage rigidities, a negative shock to the tradables sector with studies that find countercyclicality in the share of would expand informal (nontradables) employment and the informal economy and those show that informal thus appear as countercyclicality. firms are flexible enough to adjust in wages rather than employment during economic downturns Synchronization in formal and informal-economy (Maloney 2004, Loayza and Rigolini 2011, Guriev, movements Speciale and Tuccio 2016).10 As in other studies that examine levels of employment and • Common factors. A dynamic factor model applied to output, the dataset used in this chapter suggests that, at the formal and informal output and employment finds macroeconomic level, formal employment levels and that a single common factor accounts for 38 and 40 informal output levels comove with formal output levels percent of the output variance of the informal and but informal employment levels do not. Several formal economies, respectively (Kose, Prasad, and methodologies point to this finding, including Terrones 2003; Elgin et al. forthcoming b). This examinations of volatility, business cycle turning points, common factor explains only a negligible share of the correlations and factor models. variance in informal employment. • Macroeconomic volatility. Since formal and informal Policy implications employment move marginally (but statistically significantly) in opposite directions, the volatility of A large degree of comovement of informal employment total (formal and informal) employment is somewhat and formal output in and of itself may not warrant policy lower than the volatility of each type of employment action for two reasons. First, the direction of comovement in isolation (Figure 3.1.1, Elgin et al. forthcoming a; can change over time if business cycle fluctuations are Loayza and Rigolini 2011; Fernandez and Meza caused by changing sources of sectoral shocks. Second, the 2015).9 Self-employment (as a proxy for informal appropriate policy response would depend on the source of employment) is somewhat more volatile than formal the shock that generates comovement. If a procyclical employment where labor market regulations may slow expansion in informal employment is largely the reflection the response to movements in aggregate demand of shocks in the nontradable sector, such as in a (Djankov and Ramalho 2009). In contrast, informal construction boom, no policy response specifically related output is somewhat less volatile than formal output, to informality may be needed. In contrast, if a possibly reflecting flexible adjustments in hours countercyclical expansion in informal employment reflects worked in the informal economy (Meghir et al. 2015; a downturn in the tradable sector, such as in Guriev, Speciale, and Tuccio 2016). 10 This lack of comovement between formal output and informal employment is particularly pronounced in EMDEs, possibly reflecting data challenges in EMDEs, genuinely lesser synchronicity between formal 9 The correlation between formal and informal employment growth economic output and formal employment in advanced economies, or higher labor market rigidities in EMDEs (Neumeyer and Perri 2005; rates is above 0.2 and significant at 1 percent level. Botero et al. 2004; Campos and Nugent 2012). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 147 BOX 3.1 Linkages between formal and informal sectors (continued) FIGURE 3.1.1 Interaction between formal and informal economies Formal employment and informal output levels tend to comove with formal output levels, whereas informal employment levels do not. Since formal and informal employment are marginally negatively correlated, total (formal and informal employment) is less volatile than each in isolation. A. Synchronization of turning points B. Correlations between formal and informal business cycles C. Volatility of output D. Volatility of employment Sources: Elgin et al. (forthcoming a and b). Notes: Data are from 1990 to 2016. DGE-based estimates are used for informal output in A-B, while data on self-employment are used for informal employment. A. Troughs and peaks are identified as in Harding and Pagan (2002). The bars show the share of formal peaks (or troughs) that coincide with informal peaks (or troughs). B. Each bar shows the correlation between the cyclical components of formal-economy output (in logs) of year t(-2), t(-1) and t(0) and the cyclical components of informal -economy output and informal employment (in logs) of year t(0)). C-D. Standard deviations in annual growth rates are shown in bars. “***” indicates statistically significant differences at least at 10 percent level between informal and informal output (employment). “+++” indicates statistically significant differences at least at 10 percent level between advanced economies and EMDEs. manufacturing, in the presence of labor market rigidities, these implications warrant a carefully calibrated policy measures to ease labor market rigidities may be the mix. appropriate response (Fiess, Fugazza and Maloney 2010). The resilience of informal employment to business cycle In addition to measures taken explicitly to address swings, juxtaposed with the weaker development outcomes informality, many measures undertaken for other reasons, associated with informality (discussed in the main text), such as tax measures, may have implications for suggests a tradeoff. In the short-run, informal activity can informality. The discussion in this box highlights that provide a safety net during business cycle swings and labor EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 148 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.1 Linkages between formal and informal sectors (continued) dislocations caused by major structural changes such as Similarly, if comovement between formal and informal trade liberalizations; in the long-term, however, output reflects synergies, such as through subcontracting, informality can create poverty traps and stymie policy measures aimed at curtailing informal activity can development (Docquier, Muller, and Naval 2017; Dix- disrupt formal activity. These effects could be mitigated if Carniero, Goldberg and Meghir 2018). Policy measures measures that reduce informality were accompanied by that—deliberately or inadvertently—reduce informality greater labor and product market flexibility in the formal can therefore protect vulnerable population groups better sector that facilitates a reallocation of workers and firms. if they are accompanied by strengthened social safety nets that can fulfill some of the roles of the informal sector. mitigated by stronger safety nets, greater labor encompasses many types of informal activity and product market exibility, and better among workers and firms.6 Some studies access to resources for informal rms. Second, distinguish different types of informality by the policies to spur development, as a collateral motives of participating in the informal economy. bene t, can help reduce informality. Speci c For example, some classify informal workers and measures discussed in this chapter include firms into those that are “excluded” and those that simpli cation of tax codes and enhanced “voluntarily exit” from the formal sector (Perry et enforcement of revenue collection, which can al. 2007). Others focus on “subsistence reduce the incentive to operate informally informality”, which is pervasive in lower-income depending on country-speci c circumstances; countries and characterized by low‐skill easing of labor market regulations to lower the technology. In the absence of such an informal relative cost of employing formal workers and economy, the income of low-skilled workers create a level playing eld for formal and would fall below subsistence levels (Docquier, informal rms and workers; as well as greater Muller, and Naval 2017). access to nance and public services to help increase productivity in the informal sector Some others classify informal workers and firms and encourage a shift of activity to the formal into evaders, avoiders, and outsiders depending on sector. their compliance with regulations and regulations’ applicability (Kanbur and Keen 2015; Kanbur Informality: Conceptual 2009). Evaders are firms that are covered by the regulation but do not comply; avoiders are firms considerations and that adjust to be outside the remit of the measurement regulation; outsiders are firms that are simply not covered by the regulation. More recent studies Definition of informality. Informality is often distinguish different types of informality by the defined as market-based legal production of goods entities engaged in informal activity, separate from and services that are hidden from public their motivation: within firms, formal and authorities for monetary, regulatory, and informal workers or activities (“interfirm margin”) institutional reasons (Schneider, Buehn, and Montenegro 2010).5 This general definition cover illegal activities or household production (Schneider, Buehn, 5 Monetary reasons include avoiding taxes and social security and Montenegro 2010; Medina and Schneider 2018). e di erences contributions; regulatory reasons include avoiding government between informal production and household production is that the bureaucracy or regulatory burdens, while institutional reasons include latter does not encounter monetary transactions. corruption, the quality of political institutions and weak rule of law. 6 e de nition and classi cation of informality is deeply context For the purposes of this chapter, the informal economy re ects speci c. Similarly, the choice of informality measures largely depends activities that, if recorded, would contribute to GDP, and does not on the research question (see Elgin et al. (forthcoming a) for details). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 149 and, within sectors, informal and formal firms or the number of workers employed on a workers (“intersectoral margin”, Maloney 2006; continuous basis and below a threshold Ulyssea 2018).7 Individual country practices vary determined by the country; it is not registered; widely but typically adhere to these broad or its workers are not registered. principles. Measurement of informality. Reflecting the • Informal workers. Informal employment difficulty of measuring informality, the literature covers all workers of the informal sector and has developed a wide range of estimation methods informal workers outside the informal sector to capture its extent. In this chapter, a database of (ILO 2018a).8 e former comprises all all commonly used measures of informality is persons who were employed in at least one compiled (summarized in Annex Table 3.1.1), informal rm. e latter group includes both ranging from model-based estimates of the share self-employed and workers that are not of informality in official GDP (MIMIC and DGE employed in formal contractual arrangements estimates), to survey-based measures of the share or not subject to social protection or of informality in total employment (share of self- employment bene ts. Some have de ned employed and share of workers covered by pension informal employment more speci cally as that schemes), and public perceptions of the extent of of workers without pension coverage, which is informality (World Economic Forum index, a part of social protection (Loayza et al. World Value Survey index, and Enterprise 2010). Surveys).10 The database includes up to 187 economies (36 advanced and 151 emerging • Informal rms.9 An informal rm satis es the market and developing economies) over the 1990- following criteria (ILO 2018a). First, it is not 2016 period. Both cross-country rankings and an incorporated enterprise that is a legal entity time trends are consistent for most countries. That separate from its owners, has its own complete said, the chapter relies mainly on the two model- set of accounts, but is not owned nor based (DGE and MIMIC) estimates of the share controlled by one or a few household of informal output and the share of self-employed members. Second, it is a market enterprise (from ILO, World Development Indicators, and that sells its goods or services. ird, it falls national statistical offices’ databases), which stand into one of the following categories: it keeps out in their time and country coverage.11 7 See Perry et al. (2007, p.27) for a more detailed description of informal employment and di erent types of informal employment. 8 e most frequently used informal employment measure is the 10 For the compiled dataset, see Elgin et al. (forthcoming a). In the share of self-employment in total employment, which is a lower dataset, the Multiple Indicators Multiple Causes (MIMIC) model is a bound of informal employment (e.g. La Porta and Shleifer 2014). As model of structural equations that use observable causes and de ned by the 1993 International Classi cation of Status in indicators to capture the latent level of informal output. Elgin et al. Employment (ICSE-93), self-employed workers are those workers (2018 a) follow Schneider, Buehn, and Montenegro (2010) closely who, working on their own account or with one or a few partners or when estimating the MIMIC model for 160 countries over the period in a cooperative, hold the type of jobs de ned as "self-employment 1993-2015. e dynamic general equilibrium (DGE) model of Elgin jobs." e other measure, informal employment, comprises all and Oztunali (2014) provides an alternative estimate of the size of the workers of the informal sector and informal workers outside the informal sector for 158 countries (36 AEs and 122 EMDEs) over the informal sector. e former covers all persons who, during a given period 1950-2016. To make the measures comparable with those in reference period, were employed in at least one informal sector the literature, both measures are reported in percent of o cial GDP. enterprise, irrespective of their status in employment and whether it In the following sections, “in percent of GDP or output” is used as was their main or a secondary job. e latter covers self-employment the equivalent of “in percent of o cial GDP” in the context of the and employees holding informal jobs. See Annex 3.1 for details. For share of informal output (both DGE-based and MIMIC-based the remainder of the chapter, informal employment will be proxied estimates), while “in percent of employment” is used as the by self-employment since data on informal employment is not equivalent of “in percent of total employment.” available for advanced economies. e numbers here refer to the 11 For presentational simplicity, throughout this chapter, the latest available years. output share of informality refers to the share of informal output 9 Benjamin and Mbaye (2012) and Mbaye, Benjamin, and Gueye based on DGE model estimates, unless otherwise noted. e main (2017) provide an alternative de nition of informal rms as a results for features of informality, correlates of informality, and continuum depending on size, registration, honest accounting, tax developmental implications are robust to the use of MIMIC-based payments, mobility of work-place and access to bank credit. estimates. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 150 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 3.2 Informality in advanced economies and EMDEs Main features of the There is wide cross-country heterogeneity in informality, especially among informal economy EMDEs. Since 1990, the share of informal employment and output has declined in both advanced economies and EMDEs, despite largely Informality: Lower in advanced economies than unchanged perceptions of the size of the informal sector. in EMDEs. On average, the size of the informal economy is about 32 percent of official GDP and, A. Share of informal activity B. Informal activity over time in EMDEs, 71 percent of total employment in 2016, of which self-employment accounts for 43 percent of total employment (based on latest available data for each country). A higher level of development, e.g., as measured by per capita income, is associated with lower informality, regardless of the measure of informality or the year chosen (La Porta and Shleifer 2014, Figure 3.2). As a result, informality tends to be considerably more pervasive in EMDEs than in advanced C. Share of informal employment D. Informal employment over time economies: in advanced economies, informal output accounts for about 17 percent of output and self-employment accounts for 14 percent of employment. Perceptions from business owners and managers about the pervasiveness of informality also suggest greater informal activity in EMDEs than in advanced economies. Cross-country heterogeneity: Pronounced in EMDEs. The size of the informal economy varies E. Perceived informal activity F. Perceived informal activity over time widely across countries (Figure 3.2). In EMDEs, the informal economy ranged from around 10 (in China) to 69 (in Equatorial Guinea) percent of GDP—depending on the measure used—and self- employment ranged from near-zero (Qatar) to 94 (Burundi) percent of employment. Among advanced economies, the share of informal output in GDP has varied from less than 12 percent, in Switzerland and Singapore, to about 32 percent in Estonia. During 2006-16, Greece registered the Sources: Elgin et al. (forthcoming a), World Development Indicators, International Labor Organiza- tion, World Economic Forum. highest share of informal employment (37 Notes: See Annex 3.1 for data definitions. A.C.E. Group means for the period 2006-16 are shown in blues with +/-1 standard deviation shown in percent) among advanced economies. orange vertical bars. World means are shown in yellow lines (dashed line for MIMIC estimates in A). The group statistics are calculated for the world, advanced economies (AEs) and emerging markets and developing economies (EMDEs). Regional informality: Common in all EMDE B.D.F. Group means are calculated for advanced economies (AEs, in blue) and emerging and devel- oping economies (EMDEs, in red). Dashed lines are for MIMIC estimates in B. Due to missing values, regions. Informality is common in all EMDE data in EMDEs are extrapolated for informal employment for earlier years with missing value in recent years filled by the latest available observation in D. regions but takes different forms (World Bank E.F. WEF (World Economic Forum) index of informality. 2012). On average, the informal economy’s share of output is highest in Sub-Saharan Africa (SSA), Europe and Central Asia (ECA), and Latin America and the Caribbean (LAC). The share of self-employment, however, is highest in Sub- Saharan Africa (SSA), South Asia (SAR), and East Asia and the Pacific (EAP, Figure 3.3). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 151 Two country examples illustrate differences across FIGURE 3.3 Informality by EMDE region regions. In Brazil, the informal sector employs one Informality is common in all EMDE regions but takes different forms. On -third of total employment and produces one- average, the share of informal output is highest in Sub-Saharan Africa, third of GDP. In Pakistan, the informal sector Europe and Central Asia, and Latin America and the Caribbean. The share of self-employment is highest in Sub-Saharan Africa, South Asia, and East provides two-thirds of total employment but Asia and the Pacific. produces only about one-third of GDP. This difference points to considerably lower informal A. DGE-based informal activity B. MIMIC-based informal activity labor productivity relative to total labor productivity in Pakistan than in Brazil, in part reflecting lower educational attainment of informal workers (La Porta and Shleifer 2014; Loayza 2018). Three EMDE regions (EAP, LAC and ECA), alone accounted for more than one-third of the world’s informal output in 2016, but only one- quarter of the world’s formal output. Almost half C. Informal employment D. Labor force without pension (42 percent) of the world’s informal workers can be found in South Asia (SAR), although the region only accounts for 9 percent of the world’s formal employment and 3 percent of the world’s formal output (Box 3.2). Another 14 percent of the world’s informally employed are in Sub- Saharan Africa (SSA), well above SSA’s share of the world’s formal output (2 percent) or formal employment (5 percent). Informality over time: Downward trend. The E. Perceived informal activity F. Share of EMDE regions of world shares of both informal output and self- output and employment employment have declined since 1990, especially in EMDEs (Figure 3.2 and 3.4). Between 1990- 16, on average, the share of informal output fell by about 7 percentage points of GDP in EMDEs (to 32 percent of GDP) and by about 4 percentage points (to 17 percent of GDP) in advanced economies. Over the same period, the average share of self-employment declined by about 4 percentage points (to 14 percent of total Sources: Elgin et al. (forthcoming a), World Development Indicators, International Labor Organization, and World Economic Forum. employment) in advanced economies and by Notes: See Annex 3.1 for data definitions. Blue and red bars indicate group means for 2006-16, with orange vertical bars indicating +/-1 standard deviation. EAP = East Asia and Pacific, ECA = Europe and about 4.5 percentage points (to 43 percent of total Central Asia, LAC = Latin America and the Caribbean, MNA = Middle East and North Africa, SAR = employment) in EMDEs. These declines were South Asia, and SSA = Sub-Saharan Africa. C. Self-employment shares are used here. broad-based: the share of informal output declined F. DGE-based estimates of informal output in each region as a proportion of total estimated informal GDP. Estimates are based on their respective average shares of output and employment during 2010-16. by 5 percentage points of output or more between 1990 and 2016 in all advanced economies and 86 percent of EMDEs.12 12 e DGE-based measure of informal output shows that between 1990 and 2016, the share of informal output over o cial GDP fell in In EMDEs, the largest declines in the shares of 140 (36 AEs and 104 EMDEs) out of 157 countries where data are informal output and employment occurred from available. Similar results are found in MIMIC-based measure on the mid-2000s onwards in a reversal of a decade of informal output. During the same period, 84 (18 AEs and 66 EMDEs) out of 127 countries experienced a drop in the share of self- rising informal employment and barely shrinking employment. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 152 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.2 Regional dimensions of informality: An overview Informality, especially employment informality, is most prevalent in lower-income EMDE regions. Together, South Asia and Sub- Saharan Africa account for nearly 60 percent of all informal workers in EMDEs. However, even in some wealthier EMDE regions, such as Latin America and the Caribbean and Europe and Central Asia, informality remains significant in part due to weak institutions and high levels of taxation and regulation. Both the drivers and implications of informality vary across and within regions, suggesting the need for tailored policy responses. The informal economy accounts for a significant In terms of employment, almost half (42 percent) of the proportion of both employment and output across world’s informal workers can be found in South Asia EMDEs. Around three-quarters of EMDE employment is (SAR), although the region accounts for just 9 percent of estimated to be in the informal sector. Self-employment, the world’s formal employment and 3 percent of the which is relatively easy to measure and provides a lower world’s formal output (Figure 3.2.1). Sub-Saharan Africa bound estimate of informality, is 43% of total (SSA) is also over-represented in its share of informal employment in the average EMDE, although this employment, accounting for 14 percent of the world’s proportion ranges from 22 percent in the Middle East and total, well above its share of the world’s formal output (2 North Africa (MENA), to 62 percent in Sub-Saharan percent) or formal employment (5 percent). Africa (SSA). Informal-sector productivity in EMDE regions. In all Informality has both costs and benefits. It can provide an EMDE regions, the proportion of informal employment important source of income in EMDEs, often to those exceeded the share of informal output, reflecting a with few available alternatives. That said, informal tendency for the informal sector to be less productive than employment is often associated with lower and more the formal sector (La Porta and Shleifer 2014; Fajnzylber uncertain incomes for workers and lower revenues et al. 2011). This difference is particularly pronounced for available for governments to fund their development SAR and SSA, where the informal employment share is objectives.1 approximately double the informal output share. The regional disparities in the scale of informality depend Trend decline in informality. In all EMDE regions, the on a wide range of factors. To summarize these regional informal sector has steadily declined in relative importance distinctions, this box addresses the following questions: since the 1990s. On average, informality has fallen by 5 percentage points of GDP since the 1990s, partially driven • Where is global informality concentrated? by economic development and improvement in • What have been the correlates of informality across governance. The decline in relative importance was largest EMDE regions? in EAP and SAR with informality falling by 8 percentage points in both regions. Faster-than-average formalization • What policy options are available? of the economy in these two regions is likely to in part reflect faster-than-average per capital GDP growth since Where is global informality concentrated? the 1990s. Conversely, informality in the Middle East and Regional composition of EMDE informal sectors. One- North Africa (MENA) decreased only modestly amid half of the world’s informal output and 95 percent of persistently weak growth and entrenched weak governance. informal employment is located in EMDEs. Three EMDE Within-region heterogeneity. The regions with the widest regions alone accounted for one-third of the world’s per capita income heterogeneity were also those with the informal output in 2016: East Asia and Pacific (EAP), widest range of informality as a share of output or Latin America and the Caribbean (LAC), and Europe and employment. Informality is significantly more prevalent in Central Asia (ECA). They are also the largest EMDE lower-income economies within EAP despite the relatively regions by formal GDP, accounting for one-quarter of the low share of informal output for the region as a whole. In world’s formal output. MENA, the non-Gulf Cooperation Council (GCC) economies have elevated levels of informality while the Note: This box was prepared by Gene Kindberg-Hanlon with research share for MENA as a whole is the lowest of all EMDE assistance from Jinxin Wu and Zhuo Chen. It summarizes six boxes on regions (Box 2.4). In contrast, in SSA, where the variation the regional dimensions of informality featured in Chapter 2. of per capita incomes is one-fifth that of MENA (the 1 For the purposes of this box, informal employment is proxied by self- EMDE region with the largest per capita income employment because of good data coverage, and the regional disparities identified in this box are robust to other measures. heterogeneity), informality amounted to over 30 percent EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 153 BOX 3.2 Regional dimensions of informality: An overview (continued) FIGURE 3.2.1 Informality in EMDE regions Informality is pervasive across all EMDEs-- although the share of informal output in GDP has been falling over time, its incidence is higher in the poorest regions. A. Share of EMDE regions of world B. Share of aggregate EMDE informal C. Employment and output share by output and employment employment and output region D. Share of informal GDP over time E. GDP per capita and share of informal F. GDP per capita and share of informal output employment Sources: Elgin et al. (forthcoming a), World Bank. Notes. Data are between 2010 and 2016. A.B. DGE-based estimates of informal output in each region as a proportion of total estimated informal GDP. Estimates of self-employment shares are used to proxy informal employment. Estimates are based on their respective average shares of output and employment. C. Mean of informal output (DGE-based estimates) and employment estimate (share of self-employment) in each region. D. Average DGE estimate of informal output relative to total output in each time period. E.F. Grey markers show average log GDP (2011 PPP $ - averaged 2010-16) relative to DGE/SEMP estimate of informal output/employment for 145 economies, with the fitted lines shown in blue and the corresponding +1 and -1 standard errors shown in shaded gray areas. Regional markers show median GDP per capita and median informal output/employment in EMDE regions. of output and 39 percent of employment in three-quarters role of informality as both a driver and consequence of of countries. poverty (La Porta and Shleifer 2014). None of the regional shares of informal output or employment deviates What have been the correlates of informality statistically significantly from what might have been across regions? expected based on average per capita incomes alone Informality is concentrated in countries which are less (Figure 3.2.1). developed and suffer from a range of institutional Low human capital. Informality is also more prevalent weaknesses. Poverty and low human capital are strongly where educational attainment is weak.2 In SSA, where associated with those regions with the highest incidence of educational attainment is the lowest on average among informality. In contrast, in wealthier regions such as LAC and ECA, institutional weaknesses and tax policy have 2 Docquier, Muller and Naval (2017) demonstrates that a sizeable contributed to elevated levels of informality. informal sector that competes with the formal sector for low-skilled workers reduces the incentives to invest in human capital in the long run. Economic development. Informality is most prevalent in In addition, weak educational attainment is a feature of lack of EMDE regions with low income per capita, reflecting the development, which contributes to informality (Loayza 2016). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 154 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.2 Regional dimensions of informality: An overview (continued) FIGURE 3.2.2 Regional correlates of informality Informality is most prevalent in regions with poor educational attainment. In some wealthier regions, informality is also associated with weak institutions, such as poor governance, and higher regulatory costs of doing business. A. Years of schooling B. Share of agricultural sector in total output C. Rule of law and ease of doing business indicators D. Corporate tax rates Sources: Barro and Lee (2013), Doing Business, World Governance Indicators, Vegh and Vuletin (2015), World Bank. A. Average years of schooling for those aged 15 and older, taken from Barro and Lee (2013). B. Average agricultural output as a percentage of total GDP. C. “Control of corruption” survey response is taken from the World Bank’s World Governance Indicators (2017), with a higher value indicating better institutional quality in 2016. The “Ease of doing business” (Doing Business 2017) indicator is taken from the World Bank’s Doing Business database and measured as “Distance to Frontier”, with a higher value indicating an easier environment for businesses. Both surveys cover respondents in a sample of 149 EMDEs. D. Corporate tax rates are constructed as regional averages using Vegh and Vuletin (2015), with the EMDE averages shown in dashed lines. EMDEs, informal sector workers are much less likely to High regulatory and tax burdens. In LAC, several studies have completed primary education than those in the have found a strong relationship between the region’s formal sector (Figure 3.2.2; Adams, Johansson de Silva above-average tax rates and ease of tax avoidance, and the and Razmara, 2013). Education levels have also been level of informality (Figure 3.2.2; Loayza 1996; Vuletin found to be an important driver of informality in SAR, 2008; Ordóñez 2014). For ECA, labor market regulations where attainment is also below the EMDE average.3 that are more restrictive than elsewhere have been identified as drivers of informal employment (Fialová 2011). 3 Williams, Shahid and Martinez (2016); Bahadur and Parajuli (2014); Gunatikala (2008). Weak institutions. Some economies in ECA have below- EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 155 BOX 3.2 Regional dimensions of informality: An overview (continued) average institution quality, which may explain the region’s lack of access to nancial resources is common for the self- slightly above-average degree of output informality despite employed (Ghani, Kerr, O. Connell 2013, Box 2.5). ECA’s relatively high per capita income. In non-GCC Enabling access to micro nance has been found to increase MENA economies, corruption has been cited among the investment and productivity in the informal sector (Likhi biggest hindrances to firms which may increase incentives 2013; Donou-Adonsou and Sylwester 2017; Imai and to operate informally (World Bank 2016). Azam 2012). Region-specific factors. A number of region-specific Easing tax and regulatory burdens. Several studies in LAC factors have contributed to informality. have found that policies to reduce tax rates and simplify tax systems have incentivized rms to transition to the • In ECA, a high share of informal output is partly a formal sector. Payroll or business tax cuts in Colombia, legacy of the collapse of the Soviet Union in the late Brazil and Uruguay have been associated with higher 1980s and early 1990s as well large remittance inflows formal employment and rm registration.3 However, in that have financed informal sector activity (Box 2.2). regions where tax rates or tax compliance costs are not • In some LAC economies, the trade liberalizations of elevated, cutting taxes can be counterproductive in the 1990s have been identified as contributors to reducing informality. In ECA, where corporate tax rates growing informality, as formal firms that were unable are lower than the EMDE average, higher taxation was to compete in a liberalized formal economy retreated associated with increased formalization in some studies into informality (Box 2.3). because of the lack of public goods provided in regions with insu cient tax revenue (Fialová 2011; Freedman, • In MENA, although informality is particularly Johnson and Kaufmann 2000). Separately, less restrictive pronounced in non-GCC economies, in the GCC employment protection has been associated with a smaller informality is low partly because of its heavy reliance informal economy (both in employment and output) in on documented foreign workers and government ECA countries (Fialová 2011, Lehmann and Muravyev employment (Box 2.4 and World Bank 2018). 2009). • In SSA, large agricultural sectors help explain Tightening enforcement. Enforcement that is widespread informal employment as does the conflict economically and socially sensible can help reduce the and violence that have afflicted the region and forced presence of the informal sector (Loayza 2018). In LAC, people to earn their livelihoods in the informal policies such as labor inspections have been found to economy (Box 2.6). induce informal workers and rms to formalize (De Andrade, Bruhn, and McKenzie 2013; and Almeida and What policy options are available? Carneiro 2012). Studies in ECA, SAR and EAP have also To mitigate the damaging e ects associated with found that lower levels of enforcement are associated with informality, policy responses can be tailored to the higher rates of informality (Box 3.4). Regulatory and tax circumstances and drivers of informality in that economy. compliance rates increase more if increased labor or tax inspections are accompanied by other measures such as Policy options can be broadly split into several categories: awareness campaigns (Rani et al. 2013). Improving human capital. By investing in education and social services to improve human capital, policy makers Reducing corruption. In ECA, where informality rose can improve the productive capacity of workers that are considerably following the disruptions associated with the currently uncompetitive in the formal sector. Training has collapse of the Soviet Union, higher corruption has been been found to boost worker income and rm revenue in linked with higher informality (Friedman et al 2000). studies in the informal sectors of SSA and SAR (Verner Economies in ECA that were slower to implement structural reforms and control corruption in the 1990s saw and Verner 2005; Burki and Abbas 1991). a smaller-than-average decline in informality (Kaufmann Improving access to public services and nance. E orts to and Kaliberda 1996). Corruption is also a key disincentive facilitate informal sector business can bene t informal to enter the formal sector in MENA according to rm sector workers and make them more competitive (Box 2.6; surveys. Sonobe et al. 2011). For example, in SSA, providing informal traders public goods, such as a market to trade in or access to water and sanitation, has helped increase 3 Fernandez and Villar (2016); Fajnzylber, Maloney, and Montes-Rojas informal rm pro tability and product quality. In SAR, a (2011); and Monteiro and Assuncão (2012). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 156 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 3.4 Changes in informality (2012), do not differ statistically significantly from Informality declined in EMDEs during the period 1990-2016, with the share those in the formal economy (Figure 3.5, Elgin of output dropping especially in East Asia and the Pacific, Latin America forthcoming a). On average, both formal and and Caribbean, and South Asia. informal recessions last about 1.5 years, which are about 0.5 years shorter than formal and informal A. Changes in informality: income B. Changes in informality: EMDE groups regions recoveries. The speeds of adjustment in recessions (about 4 percentage points decline per year) and of recoveries do not differ statistically significantly between formal and informal sector. Causes and implications of informality Causes of informality. Theoretical models present Sources: Elgin et al. (forthcoming a), World Development Indicators, Barro and Lee (2013), and two major reasons for the emergence of informal World Governance Indicators. Notes: See Annex 3.1 for data definitions. Data are 1990-2016 group averages. EAP = East Asia and activity: lack of development (Harris and Todaro Pacific, ECA = Europe and Central Asia, LAC = Latin America and the Caribbean, MNA = Middle East and North Africa, SAR = South Asia, and SSA = Sub-Saharan Africa. 1970; Loayza 2016), and poor governance A. The bars indicate the group means for advanced economies and EMDEs, with the red bars for self -employment (in percent of total employment) and blue bars for DGE-based informal output (in including burdensome regulations, corruption, or percent of official GDP). The world means are shown in dashed lines. poor public services (de Soto 1989). B. The bars indicate the group means for EMDE regions, with the red bars for self-employment (in percent of total employment) and blue bars for DGE-based informal output (in percent of official GDP). The EMDE means are shown in dashed lines. • Lack of development. Informality has often been attributed to under-development. is re ects an inability of an urban modern informal output.13 In advanced economies, the formal sector to absorb rural migrants during largest declines in the share of informal the urbanization process (Harris and Todaro employment occurred between the late 1990s and 1970; Fields 1975; Loayza 2016). the global financial crisis; they have since partly Development can further shrink the informal reversed, amid anemic post-crisis growth (Figure sector because households tend to shift away 3.2).14 Among EMDE regions, the informal from agricultural and informal sector goods as economy’s share of output dropped most in EAP, their incomes grow (Saracoglu 2008). Finally, ECA, and SAR, while the share of self- limited access to credit, often associated with employment dropped most in EAP, the Middle less development, constrains informal rms’ East and North Africa (MNA), and SSA (Box ability to overcome barriers to entry into the 3.2). formal sector.15 Characteristics of informal sector business cycles. • Heavy-handed regulation. Higher taxation The main features of recessions and recoveries in and heavy-handed regulation increases rms’ the formal economy, defined as in Harding and incentives to reduce taxation or the cost of Pagan (2002) and Claessens, Kose and Terrones regulatory compliance by remaining informal (Ihrig and Moe 2004; Amaral and Quintin 2006; D'Erasmo and Boedo, 2012; Auriol and Warlters, 2005; Prado 2011; Kanbur 2017; 13 e small-scale decline in the beginning of the 1990s is also Dabla et al. 2018; Ulyssea 2018).16 Excessive driven by the expanding informal sector in countries in Eastern and labor regulations encourage informal Central Europe during their economic transition (Kaufmann and Kaliberda 1996). 14 A country-speci c regression of the share of the informal economy in GDP and employment on a time trend over the period 1990-2016 captures this secular decline. In 50 (WEF)-100 (DGE) 15 See Ferreira-Tiyaki (2008); D’Erasmo and Boedo (2012); percent of advanced economies (depending on the measure) and 48 (WEF)-81 (MIMIC) percent of EMDEs, there has been a signi cant Cappasso and Jappelli (2013). 16 Also see Busato and Chiarini (2004), Charlot et al. (2015), downward trend in the share of the informal economy in GDP and employment. Saracoglu (2008), and Ordonez (2014). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 157 employment by increasing the cost of formal FIGURE 3.5 Characteristics of informal and formal- employment (Rauch 1991; Loayza 2016). economy business cycles Informal-economy business cycles are not significantly different from • Poor governance. Corruption and rent- formal-economy business cycles. seeking bureaucracies increase rms’ incentives to avoid interaction with the state A. Recessions in the formal and B. Recoveries in the formal and by remaining informal (Sarte 2000; Choi and informal sectors informal sectors um 2005; Freidman et al. 2000). Conversely, access to productivity-enhancing public goods, such as to electricity or the court system, can lead to an increase in the share of formal production (Mendicino and Prado 2014). Implications of informality. A sizeable informal sector could impede growth, encourage poor governance, and limit a government’s ability to Sources: World Development Indicators, Penn World Table, Elgin et al. (forthcoming a). reduce income inequality. Notes: Data are for the period 1990-2016. Diamonds indicate sample means; bars indicate 95 percent confidence intervals. Business cycle turning points are determined based on formal and informal GDP levels (i.e., official GDP statistics, DGE estimates) using the algorithm of Harding and • Slower growth. A sizeable informal sector that Pagan (2002). Recession is defined as the phase from peak to trough, recovery as the phase from trough to a return to pre-recession output levels, expansion as the phase from trough to peak. competes with the formal sector for low- “Duration”, and “Speed of adjustment” (often termed as “Slope”) are defined as in Annex 3.2. skilled workers reduces the incentives to invest in human and physical capital and new technologies and slows growth in the long run 3.3). Informality is also associated with less (Docquier, Muller and Naval 2017; Loayza effective institutions, such as weak governance and 1996; Sarte 2000). excessive tax and regulatory burdens (Loayza, • Poor governance. Several theoretical models Oviedo, and Serven 2006; Enste and Schneider attribute corruption and excessive regulations 1998). to the presence of an informal economy. Under-development. A lower level of Government o cials are incentivized to development, as measured by per capita income, is impose excessive regulations and permits to associated with higher informality (Figure 3.6).17 have the power to collect bribes in return for In the case of both output and employment providing permits (Shleifer and Vishny 1993). informality, GDP per capita in countries with Others have argued that the government below-median (“low”) informality is about 2-3 strategically designs a system of poor times of those in countries with above-median governance to promote informality for the (“high”) informality (Figure 3.6).18 The lower poor, which acts as an alternative productivity and resource misallocation associated redistributive strategy (Marjit, Mukherjee and with higher informality may also be reflected in Kolmar 2006). slower output growth.19 Correlates of informality Slower accumulation of physical and human The causes and implications of informality capital. A larger informal economy is associated predicted by theoretical models are also confirmed by empirical studies as many correlates of 17 See also Loayza, Serven, and Sugawara (2005) and La Porta and informality are symptoms of under-development. Shleifer (2014). A large informal economy is associated with 18 Median informality amounts to about 32 percent of GDP for weaker economic outcomes, such as a under- DGE-based informal output and 34 percent of total employment for self-employment. development, less access to credit, limited trade 19 See Hsieh and Klenow (2009), Loayza and Rigolini (2011), openness, less skilled labor force, as well as weaker Docquier, Muller, and Naval (2017), Cirera and Maloney (2017), output, investment and productivity growth (Box Levy (2018), and Bachas et al. (2018) . EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 158 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.3 Casting a shadow: Productivity in formal and informal firms The average informal firm in emerging markets and developing economies (EMDEs) is only one-quarter as productive as the average firm operating in the formal sector. Moreover, firms in the formal sector that face informal competition are, on average, only three-quarters as productive as those that do not. This suggests that competition from the informal sector can erode formal firms’ market share and resources available to boost productivity where formal firms shoulder the additional cost of regulatory compliance. More effective governance and stronger control of corruption can help mitigate these effects. e productivity di erential between formal and informal Moreover, labor productivity varies within the informal rms is well established in the literature (Loayza and sector along di erent dimensions such as rm size and Rigolini 2006; Oviedo 2009). However, there is mixed type of activity (Amin and Huang 2014, Amin and Islam evidence on the impact of a large informal sector on formal 2015). rms’ productivity. Some studies suggest that the informal and formal sectors operate independently so that there are Methodology. In this box, the productivity gap between no productivity spillovers (La Porta and Shleifer 2014). formal and informal rms is estimated using World Bank’s Others report that competition from the informal sector Enterprise Survey data collected over a period spanning may erode the pro tability of rms that operate in the 2007 to 2014 for a cross-section of 4,036 informal rms formal sector, which leads to limited resources to enhance and 7,558 formal rms in 18 EMDEs (Annex Table 3.1). rm productivity.1 e aggregate e ect depends on Formal rms are those that comply with tax, customs, country characteristics. labor, and licensing regulations and register with the relevant authorities; unregistered rms belong to the Against this backdrop, this box documents the informal sector. To estimate the productivity gap, a productivity gap between formal and informal rms and measure of labor productivity—log annual sales in 2009 their interactions. Speci cally, it addresses the following U.S. dollars per worker—is regressed on a dummy variable questions: that takes the value 1 for informal rms and 0 otherwise and a set of control variables capturing additional rm characteristics (employment size, time in business, • How large is the productivity di erential between location, sector, country). formal and informal rms? Lower productivity in informal than formal rms. • To what extent are formal rms exposed to informal Virtually across the board, rm-level labor productivity is competition? much lower in the informal sector than in the formal sector (Annex Table 3.1).3 e productivity di erentials • How does informal competition a ect the vary widely in this sample, from 48 (Cote-d’Ivoire) to 93 productivity of formal rms? percent (Argentina). On average across the whole sample, the productivity of informal rms is only one-quarter of Productivity differential between formal and the productivity of formal rms (Figure 3.3.1). informal firms Drivers of productivity gap between informal and formal rms. Firm size, age, location in the capital city and Literature review. e literature documents that informal manager experience are associated with signi cantly larger rms in EMDEs are less productive than formal rms, productivity gaps between informal and formal sectors with a productivity gap ranging between 30 to 216 percent (Figure 3.3.1, Annex Table 3.2).4 Formal rms appear to (Perry et al. 2007, La Porta and Shleifer 2008). is be better equipped to reap the productivity bene ts from productivity gap between informal and formal rms is size, age, and location than informal rms. attributed to modest technological improvements, reliance on unskilled labor, limited economies of scale, and • Firm age. As rms grow older, they are either restricted access to services, markets, and funding.2 su ciently productive to survive or they disappear 3 Exceptions are Democratic Republic of Congo and Cabo Verde Note: This box was prepared by Mohammad Amin and Cedric Okou. possibly due to a low productivity of formal rms. 1 Gonzalez and Lamanna (2007); Heredia et al. (2017); Mendi and 4 e results are robust to comparing the coe cient estimates for the Costamagna (2017). informal- rm dummy between a baseline regression including all controls 2 Jovanovic (1982); Amaral and Quintin (2006); Galiani and and an alternative regression dropping each dummy one at a time (Annex Weinschelbaum (2012). Table 3.2). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 159 BOX 3.3 Casting a shadow: Productivity in formal and informal firms (continued) FIGURE 3.3.1 Characteristics of informal firms Among informal firms, those with managers with higher education and those without any employees other than the owner are significantly more productive. The average informal firm in emerging markets and developing economies has only one-quarter of the productivity of the average firm operating in the formal sector. This productivity differential between formal and informal firms is particularly pronounced among larger and older firms that operate in the capital city and are led by experienced managers. A. Average productivity in formal and B. Productivity differential between C. Productivity differential between informal firms different types of informal firms formal and informal firms, by type of informal firm Source: World Bank. Notes: World Bank’s Enterprise Survey data for 135 countries (2008-18). Labor productivity is proxied by the annual sales in 2009 U.S. dollars per worker. A. Labor productivity in the average formal and average informal firm, controlling for firm characteristics (firm size and age, manufacturing sector activity, location in the capital city and country fixed effects) as shown in column (1) in Annex Table 3.2. B. Cross-country average of percent difference between labor productivity in the median informal firm with a manager with higher education or without any employees other than the owner, and the median informal firm with a manager without higher education or with more employees than the owner. Estimates from Annex Table 3.1. C. Difference in log of labor productivity between the average formal and average informal firm in each group, as estimated in coefficient estimates of Annex Table 3.2. “Other” stands for “not located in capital city”; “Cap.” stands for “located in capital city.” (“selection e ect”; Brandt et al. 2012). In addition, infrastructure to access markets and operate, a larger learning from experience may have taught older rms pool of workers, greater technology spillovers productivity gains (“learning effect”; Luttmer 2007). (Rosenthal and Strange 2004; Duranton and Puga These effects appear to be much more pronounced 2004). Again, formal firms appear to be better able to among formal firms than among informal firms. As a benefit from these locational advantages, but the result, the productivity differential between formal effect is economically modest (although statistically and informal firms widens as the age of firms significant). Among firms operating inside the capital increases. Among one-year-old firms, informal firms city, informal firms’ productivity is 31 percent that of have about half the productivity of formal firms. similar formal firms; outside the capital city, informal Among ten-year-old firms, informal firms have less firms’ productivity is 30 percent that of similar formal than one-quarter the productivity of formal firms. firms. • Firm size. Larger firms can reap economies of scale • Manager experience. Managerial ability has been that raises their productivity compared to smaller associated with higher productivity, through a variety firms. Again, in this sample, this effect appears to be of channels including hiring decisions and input stronger among formal firms than among informal choices (Fernandes 2008). Again, managerial firms. Among firms with one employee, informal experience appears to benefit formal firms’ firms have just under one-third the productivity of productivity more than informal firms’ productivity. formal firms; among firms with ten employees, Among firms managed by managers with one year of informal firms have less than one-quarter the experience, informal firms’ productivity is just over productivity of formal firms. one-third that of formal firms; among firms with managers with ten years of experience, informal firms’ • Firm location. Capital cities are typically among productivity is less than one-quarter that of formal countries’ largest economic centers and so can offer firms. agglomeration benefits: larger markets, better EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 160 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.3 Casting a shadow: Productivity in formal and informal firms (continued) FIGURE 3.3.2 Formal firms facing informal competition On average, more than half (55 percent) of formal firms reported facing informal competition. Nearly 60 percent of formal firms in EMDEs were exposed to informal competition whereas 47 percent of formal firms in advanced economies reported facing informal competition. The degree of informal competition reported by formal firms was higher for smaller than larger firms but comparable across sectors or formal firms’ productivity. A. Formal firms reporting competition B. Formal firms reporting competition C. Formal firms reporting competition from informal firms, by country from informal firms, by firm size from informal firms, by firm sector Source: World Bank. Note: World Bank’s Enterprise Survey data for 135 countries (2008-18). Figures show share of formal firms. Productivity differentials across informal firms. Labor productivity rms may be forced into informal operations productivity also differs across different types of informal or, even if they operate formally, employing informal firms, although the characteristics that are associated with workers because this may reduce their costs (Ulyssea 2018; higher labor productivity of informal firms differ across Boly 2018). Operating in the informal sector and countries.5 In two-fifths of countries, informal firms employing informal labor may, therefore, be a survival managed by a manager with higher education or without strategy for less-productive rms that belong to any employees other than the owner are significantly more fundamentally di erent markets (La Porta and Shleifer productive than other informal firms (column (1) in 2014). “Surviving” informal rms are likely to operate in Annex Table 3.2). Other informal firm characteristics, very di erent markets and sell di erent products than such as operating in the services sector or being a startup, formal rms (La Porta and Shleifer 2014). In such are accompanied by higher productivity in some countries circumstances, competition between informal and formal but lower productivity in other countries. rms and its impact on formal rms may be limited. Competition between formal and informal firms Informality as an evasion strategy of productive rms. Some informal rms may be su ciently productive to survive in Impact of informal competition on formal rms: eory. the formal sector yet choose to remain informal to bene t e extent of competition between formal and informal from the cost advantage of noncompliance with (possibly rms depends on the underlying reasons for the existence excessive) taxes and regulations (Maloney 2004; de Mel, of informal rms.6 McKenzie, and Woodru 2011).7 Such informal rms could constitute an untapped potential for a productivity Informality as a survival strategy of unproductive rms. Low- boost (De Soto 1989). On the other hand, they can create aggressive competition with formal rms that do shoulder 5 Haltiwanger et al. (1999), Maloney (2004), Deininger et al. (2007), de Mel et al. (2010), Grimm et al. (2012), Amin and Huang (2014), Amin and Islam (2015), and Islam (2018). semi-formally: they sell their output into formal product markets but 6 is discussion assumes that rms are either formal or informal. In employ, in part, informal labor. practice, the degree of informality can vary (Perry et al 2007; Ulyssea 7 Such circumstances are likely to be associated with an environment 2018). At the extensive margin are rms that operate fully informally, in of weak regulatory and tax enforcement (Quintin 2008, Dabla­-Norris et product markets and labor markets. ey sell their output informally and al. 2008, Ulyssea 2010, Benjamin and Mbaye 2012). employ informal labor. At the intensive margin are rms that operate EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 161 BOX 3.3 Casting a shadow: Productivity in formal and informal firms (continued) FIGURE 3.3.3 Productivity of formal firms facing informal competition On average, formal firms that face informal competition have only three-quarters of the productivity of firms that do not face informal competition, after controlling for firm characteristics. Better business climates and governance and more economic development can narrow this productivity differential. A. Productivity differential of formal B. Productivity differential of formal C. Productivity differential of formal firms with and without informal firms with average informal competition firms with average informal competition competition, by intensity and without, conditional on level of and without, by business climate development indicator Notes: Based on coefficient estimates from Annex Table 3.3. Annex Table 3.3. shows results from an OLS regression with labor productivity as the dependent variable, as proxied by annual sales (in 2009 U.S. dollars) per worker, in a sample of World Bank’s Enterprise Survey data collected during 2007-14 for 4,036 informal firms and 7,558 formal firms in 18 countries. A. Figure shows log productivity differential between formal firms facing informal competition and formal firms not facing informal competition. Maximum informal competition assumes that all firms in a cell face informal competition; average informal competition assumes that 55 percent of firms in a cell face informal competition. B.C. Figures shows log productivity differential between formal firms facing informal competition and formal firms not facing informal competition, conditional on development and instituitional quality. Assumes that 55 percent of firms in a cell face informal competition. Each bar conditions on the GDP per capita (B), control of corruption (C), ease of doing business (C), or business freedom index (C) of the median country in the top (“highest quartile”) or bottom (“lowest quartile”) quarter of countries in terms of GDP per capita, control of corruption, ease of doing business or business freedom index. the additional cost of tax and regulatory compliance. Such facing competition form informal rms.10 e share of informal competition can reduce the pro tability necessary informal rms competing against formal rms was about for formal rms to invest in productivity-enhancing new 60 percent in EMDEs, 13 percentage points higher than technologies or to innovate, especially in a context of weak in advanced economies. e level of competition varied property rights enforcement.8 Alternatively, this very widely across countries, ranging from about 7 percent in competition could force formal rms to increase Bhutan to 95 percent in Uganda. Smaller rms were productivity or, for the lowest-productivity ones, to exit.9 signi cantly more likely to be exposed to informal competition than larger rms but there is little evidence of Extent of informal- rm competition for formal rms. In any other systematic di erence between rms that were the World Bank’s nationally representative survey data for exposed and those that were not (Figure 3.3.2). 75,137 formal (registered) rms in 135 countries between 2008 and 2018, about 55 percent of formal rms reported Productivity of formal firms facing informal competition Methodology. OLS regressions are used to estimate the 8 is has been documented for Argentina, Bolivia, Brazil, Chile, di erence in labor productivity between formal rms that Colombia, Mexico, India, Panama, Peru, Poland, Portugal, Russia, compete against informal rms and those that do not. In Turkey, and Uruguay. For evidence, see Heredia et al. (2017); Perry et al. (2007); Farrell (2004); Capp et al. (2005); Cunha (2006); Gonzlez and the baseline speci cation, the dependent variable is again Lamanna (2007); Friesen and Wacker (2013); Allen and Schipper (2016); Iriyamaet al. (2016); and Distinguin et al (2016). 9 is has been documented for Egypt, see Ali and Najman (2017); 10 In the World Bank’s Enterprise Surveys, formal rms are asked the Melitz (2003); Schipper (2016). following question: “Does this establishment compete against unregistered or informal rms?” EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 162 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.3 Casting a shadow: Productivity in formal and informal firms (continued) labor productivity measured by the (log of) annual sales in contrast, on average in countries in the lowest quartile 2009 U.S. dollars per worker. e main explanatory of per capita incomes, formal firms facing informal variable is the informal competition indicator proxied by competition are 30 percent less productive than those the proportion of formal rms in a cell that report facing firms that do not face such competition. competition from informal rms. A cell is de ned as a group of rms of similar size and in the same region and • Control of corruption. Again, the sample is split into sector.11 those countries in the quartile of countries with the strongest control of corruption and those in the Productivity gap between formal rms with and without quartile with the weakest control of corruption. In informal competition. Formal rms that face informal countries with the strongest control of corruption, on competition are, on average, 24 percent less productive average, formal firms that face informal competition than those that do not (Figure 3.3.3, Annex Table 3.3). are only 22 percentage point less productive than After controlling for the informal competition, formal formal firms that do not face such competition, firms in the manufacturing and retail industries have whereas in the countries with the weakest control of higher productivity than those in other services. Older, corruption, this differential grows to 35 percent. exporting, and foreign-owned formal firms also have higher productivity even if they face competition from • Ease of Doing Business. Similarly, the productivity informal firms. differential between formal firms that face informal competition and those that do not might halve (to 21 Role of the business climate and development. Economic percent) if a country like Angola (in the quartile of development and the business climate may substantially countries with the most difficult business climates) shape the productivity gap between formal firms that face were to improve its business climate to the level of a informal competition and those that do not. This is country like the Former Yugoslav Republic of captured in interaction terms between the share of similar Macedonia (among the countries with the most formal firms reporting informal competition and conducive business climates). indicators of development (the logarithm of per capita GDP), the quality of business climate as proxied by the Conclusion distance to the frontier in the Doing Business Index, the control of corruption of the World Governance Indicators, The productivity gap between informal and formal firms is and the Business Freedom index of the Economic substantial in EMDEs, averaging 75 percent in a sample of Freedom indicators; Annex Table 3.3). Higher GDP per 18 EMDEs between 2007-14. Competition from informal capita, better control of corruption, and a business firms also appears to weigh on the productivity of exposed environment that is freer and closer to best-practices formal firms: the productivity of formal firms that dampen the detrimental impact of informal competition compete with informal firms is only three-quarters that of on formal firm productivity. formal firms that do not compete with informal firms, after controlling for other firm characteristics. • Development. The sample is split into those countries Improvements in the business climate, and economic with per capita income in the highest quartile in the development more broadly, can mitigate some of these sample and those in the lowest quartile in the sample. negative productivity spillovers from informal to formal Formal firms that face informal competition in the firms. average country with the highest per capita incomes are only 14 percentage point less productive than formal firms that do not face such competition. In 11 As a caveat, the informal competition faced by a speci c rm may also be driven by its productivity, thus generating endogeneity concerns. To address possible endogeneity issue, we use the proportion of formal rms facing informal competition in a group of rms of similar size in the same region and sector (a “cell”) rather than a rm dummy. A cell proportion should be much less correlated with the productivity of a speci c rm, and therefore, should be more robust to endogeneity concerns. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 163 with a lower rate of output growth. This may FIGURE 3.6 Correlates of informality: Economic and reflect slower accumulation of physical or human institutional factors capital (Ovedio et al. 2009). At the firm level, Higher informality is associated with lower levels of development, poorer informality can limit access to conventional bank access to credit, heavier regulatory burdens, and weaker governance. credit, because of a lack of documentation for assets and inadequate financial statements.20 A. Economic correlates in EMDEs with B. Economic correlates in EMDEs with Investment activity in the informal sector may also low and high output informality low and high employment informality be subdued because informal firms may be unwilling to adopt technologies that would make them more visible to tax and other authorities (Dabla-Norris and Inchauste 2008; Gandelman and Rasteletti 2017). For example, about 11,600 firms that participated in Enterprise Surveys in 18 countries during 2007-2014, the fraction of firms that invested in any given year in the formal sector was significantly higher than that in the informal sector. In the long run, the tendency to hire less C. Informality and GDP growth D. Ratio of informal labor productivity to total labor productivity skilled workers in the informal sector may slow human capital accumulation. Indeed, countries with below-median informality tend to have significantly higher levels of human capital (Maloney, 2004; Docquier, Muller, and Naval 2017; Figure 3.6). Slower productivity growth. At the macroeconomic level, the evidence for a correlation between productivity growth and E. Regulatory burdens in EMDEs with F. Governance in EMDEs with low and informality has been mixed (Perry et al. 2007; low and high informality high informality D’Erasmo and Moscoso Boedo 2012). At the firm level, in contrast, many studies have shown that informal firms tend to be less productive than their formal counterparts; although this productivity differential in part reflects the characteristics of informal firms.21 On average, informal labor productivity is lower than total labor productivity in EMDEs, although not in advanced economies (Figure 3.6, Loayza 2018). In addition, competition from informal firms has Sources: Barro and Lee (2013), Doing Business, Elgin et al. (forthcoming a), Heritage Foundation, World Development Indicators, World Governance Indicators (WGI), World Bank. been associated with lower productivity of formal Notes: Data are between 1990 and 2016. firms. The presence of informal competitors, A-B. The group means for the following correlates are calculated for EMDEs with “high informality” (i.e., above median DGE-based informal output measure, A; above median self- which do not shoulder regulatory and tax burdens, employment share, B) and those with “low informality” (i.e., below median DGE-based informal output measure, A; below median self-employment share, B) over the period 1990-2016: Per capita real can reduce formal firms’ profitability, thus eroding GDP (in logs, WDI), access to credit (i.e., private sector credit in percent of GDP); human capital (i.e., average years of schooling), trade openness (i.e. the sum of exports and imports in percent of GDP). their ability to invest in productivity-enhancing The 90 percent confidence intervals are shown as bars. technologies or human capital (Perry et al. 2007, C. Annual GDP growth rates are regressed against the six measures of informality while controlling for real GDP per capita (logged). Box 3.3). D. The average relative ratio of informal labor productivity over total labor productivity in 2016 are shown in bars for advanced economies, EMDEs, and world, with corresponding 95 percent confidence interval shown in orange vertical bars. The relative ratio is calculated using DGE-based estimates and the share of self-employment following the method in Loayza (2018). 20 See Koeda and Dabla-Norris (2008) for details. Empirically, E-F. Group averages over the period 1990-2016 (shown as the orange diamonds) for EMDEs with high-informality (above median DGE-based informal output measure) and those with low-informality greater access to credit has been associated with lower informality are shown for the following correlates: Doing Business (measured as the overall distance to frontier (Maloney 2004, Straub 2005, La Porta and Shleifer 2014). with 100 being the frontier and 0 being the farthest from the frontier, Doing Business 2017); business 21 La Porta and Shleifer (2014), Fajnzylber et al. (2011), De Mel freedom and economic freedom (Heritage Foundation); government effectiveness; control of corruption and rules of law (as defined in WGI). Their corresponding 95 percent confidence intervals et al. (2013), Demenet et al. (2016), McKenzie and Sakho (2010). are shown in bars. Are their corresponding 95 percent confidence intervals. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 164 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 3.7 EMDES: Correlates of changes in informality (or administrative) burdens may encourage informality as workers and firms join the informal Among EMDEs, countries with larger declines in informality also have faster physical accumulation, improved access to credit, and better sector to avoid regulatory and administrative governance. compliance costs.24 The Doing Business distance-to -frontier scores for countries with below-median A. Correlates of changes in B. Correlates of changes in informality (by DGE estimates) is 60 points— informality: Economic factors informality: Governance which is significantly higher (by about 6 points or three-fifths of a standard deviation) than in countries with high (above-median) output informality (Figure 3.6). Similarly, the Business Freedom index is 7.5 points (about half of a standard deviation) higher in countries with low (below-median) output informality than in countries with high (above-median) informality. Sources: Barro and Lee (2013), Elgin et al. (forthcoming a), World Development Indicators, World Weaker governance. Research points to the Governance Indicators (WGI), World Bank. Notes: See Annex 3.1 for data definitions. Data between 1990 and 2016 in EMDEs are used here. contribution of poor governance to the pervasive A-B. The orange diamonds show the coefficient estimates obtained from regressing the annual change in informal output (DGE-based estimates in percent of official GDP) or informal employment informality in some EMDEs, especially in Latin (self-employment in total employment) upon annual changes in various economic and governance America and the Caribbean and Europe and indicators, with the corresponding 90 percent confidence intervals shown in bars. The indicators include real GDP growth, investment (in percent of GDP), access to credit (private sector credit in Central Asia regions (Box 3.2).25 On average, percent of GDP), human capital (average years of schooling), trade openness (the sum of exports and imports in percent of GDP) and three measures from WGI (2018). The fixed-effects estimates are countries with above-median informality over the used here. period 1990-2016 have had weaker government effectiveness (by about 0.6 points, or three- quarters of a standard deviations) than countries Less trade openness. A smaller informal sector is with below-median informality (Figure 3.6). associated with greater economic openness, Similar differences are found in the case of control especially to trade.22 On average, the trade-to- of corruption and rule of law. For example, in GDP ratio is lower by 17 percentage points in Georgia, during the period 1996-2016, the countries with a greater share of self-employment transition to a market economy brought than countries with a smaller share of self- significant improvements in government employment (Figure 3.6).23 Similarly, higher effectiveness, control of corruption, and rule of capital account openness is associated with less law. With output growth averaging about 6 output and employment informality. That said, percent per year, the share of informal output fell the impact of major trade liberalization episodes from 66 percent to 57 percent of GDP, and the on informality varies across countries and differs share of informal employment in total between the short- and the long-term (Box 3.4; employment fell by a similar magnitude. Goldberg and Pavcnik 2003; Fugazza and Fiess 2010; Dix-Carneiro and Kovak 2017). Heavier regulatory burden. Both empirical and theoretical studies suggest that heavier regulatory 24 Perry et al. (2007); Ulyssea (2010); Buhn (2011); De Mel, McKenzie, and Woodruff (2013); Rocha, Ulyssea, and Rachter (2018). 25 Loayza, Oviedo, and Serven (2006) nd that poorer 22 Empirical studies, such as Goldberg and Pavcnik (2004 and bureaucratic quality is associated with more informality. Choi and 2007), Shama (2009), Boly (2018), and McCaig and Pavcnik (2018), um (2005) and Dreher and Schneider (2010) report an association show that informality declined following some trade liberalization between higher informality and weaker law and order and control of episodes. Conversely, a short-term increase in informality has been corruption. Iriyama, Kishore, and Talukda (2016) show that rms attributed to trade liberalization amid inflexible labor markets in are more likely to engage in corruption when facing competition studies such as Goldberg and Pavcnik (2003), Attanasio, Goldberg from informal rms. Dabla-Norris, Gradstein, and Inchauste (2008) and Pavcnik (2004), and Bosch, Goni-Pacchioni and Maloney show that the quality of the legal framework is important in (2012). determining the size of the informal sector. Loayza and Wada (2010) 23 However, the trade-to-GDP ratio is not different between estimate, for example, that 75 percent of the di erence in labor countries with a greater share of informal output than countries with informality between Peru and Chile is due to causes related to poor a smaller share of informal output. governance. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 165 Correlates of the decline in informality since FIGURE 3.8 EMDES: Estimates of informal-formal wage 1990. The decline in informality was larger in gap countries with the bigger improvements in Estimates of informal-formal wage gaps vary considerably across countries governance and, for output informality, faster and definitions of informality. Countries in Latin America and the Caribbean growth in GDP and investment, and better access and Sub-Saharan Africa tend to exhibit both a higher incidence of informality and a larger wage premium in the formal sector. to credit (Figure 3.7).26 Perceptions of informality appear to change much more slowly than actual A. EMDEs: Informal-formal wage gaps B. Informal-formal wage gap: informal output and employment shares. Since meta-analysis 2000, perceptions have shifted significantly (into a different quartile of informality) in only 14 percent of all EMDEs (Elgin et al. forthcoming a). Informality, poverty and income inequality Many studies document that informal-sector wages are below those in the formal sector, for a variety of reasons.27 This raises concerns that, over C. Informal-formal wage gap and D. Changes in poverty headcount and income inequality by EMDE regions informality the long-term, informality may entrench earnings differentials and income inequality and may contribute to greater poverty in countries with high informality.28 Worker earnings differentials Causes of wage differentials. Lower wage in the informal sector could result from different worker characteristics in the formal and informal sectors, Sources: Elgin et al. (forthcoming a), Gindling et al. (2016), World Bank. Notes: A positive wage gap indicates a penalty for working informally—a lower wage for informal possibly in response to the comparative advantage workers than for comparable formal workers; a negative wage gap indicates a premium for working that some workers might have in informal sector informally—a higher wage for informal workers than for comparable formal workers. EMDE regions include ECA=Europe and Central Asia, EAP=East Asia and Pacific, LAC=Latin America and the activities, or to non-wage benefits that might Caribbean, MNA=Middle East and North Africa, SAR=South Asia Region, and SSA=Sub-Saharan Africa. Wage gap between wage employees in the informal and formal sectors is displayed on the accrue to work in the informal sector (Maloney vertical axis in A-C. A. Formal vs. informal=a wage gap between wage employees in the formal and informal sectors; 2004; Heckman and Li 2003). Alternatively, wage formal vs. self-employed=a wage gap between workers with formal jobs and self-employed workers; self-employed vs. informal: a wage gap between self-employed workers and wage employees in the differentials could stem from rigidities and other informal sector. factors that create a wedge in wages between B. UKR=Ukraine, VNM=Vietnam, RUS=Russian Federation, BRA=Brazil, MEX=Mexico, MDG=Madagascar, PER=Peru, ECU=Ecuador, TUR=Turkey, CRI=Costa Rica, ZAF=South Africa, similar workers in informal and formal SLV=El Salvador. The number of studies or estimates for each country is shown in parenthesis; country means are calculated using a random-effects meta-analysis model. employment. These factors can include labor C. Income inequality is measured as Gini coefficient provided by WDI. D. Self-employment is that percent of self-employed in total employment. Poverty headcount is the poverty headcount ratio at $1.90 a day (2011 PPP, percent of population). Informal output is the GDP weighted average of the World Bank country estimates of the informal output as a percent of official output. Average changes for these measured during the period 2005-15 are shown here. 26 A panel regression suggests that faster declines in the share of agricultural employment and faster increases in the share of industrial employment are associated with larger long-term reductions in informality, controlling for per capital GDP. regulations or tax provisions that force workers 27 Perry et al. (2007), Marcouiller et al. (1997), Tansel and Kan into the informal sector (Harris and Todaro (2012), Bargain and Kwenda (2014), Goldberg and Pavcnik (2003), Pavcnik et al. (2004), Goldberg and Pavcnik (2003, 2007), and Paz 1970). An alternative to measuring wage (2014) all document the existence of wage premia. Pratap and differentials could be an assessment of the Quintin (2006), El Badaoui, Strobl, and Walsh (2008), El Badaoui, subjective well-being or job satisfaction of workers Strobl, and Walsh (2010) caution that this premium disappears depending on model speci cations, estimation methods or country in the formal and informal sectors where workers samples. benefit from flexibility and independence (e.g. 28 e linkage between informality and poverty could also be due Blanchflower, Oswald, and Stutzer 2001; Sanfey to the absence of better formal jobs in underdeveloped countries (Perry et al. 2007). and Utku 2007; Falco et al. 2015). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 166 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 3.9 Informality, poverty, and income inequality Empirical estimates of wage differentials. The estimates of the wage differential between informal A larger informal economy is associated with higher poverty rates and income inequality. It is also linked with smaller declines in poverty rates. and formal workers in the 18 studies selected here range from a formal sector wage penalty of 50 A. Informality and poverty B. Informality and income inequality percent in Tajikistan (Huber and Rahimov 2014) to a premium of 113 percent in South Africa (El Badaoui, Strobl, and Walsh 2008). The average formal wage premium in the studies is 19 percent (Figure 3.8). This wage differential between formal and informal jobs is particularly wide in Latin America and the Caribbean and Sub- Saharan Africa but below-average in Europe and Central Asia and South Asia. It is also larger for informally employed than self-employed workers. C. Informality and change in poverty D. Informality and change in income Self-employed and contributing family members inequality (predominantly women) constitute the majority of informal workers in developing Asia and Africa, whereas informal employees dominate the informal sector in Europe and Central Asia and in Latin America (ILO 2018b). Wage premia in the formal sector tend to be higher where informality is more widespread.29 Sources of observed wage differentials. The Sources: Elgin et al. (forthcoming a), World Development Indicators, World Bank. formal wage premium largely disappears in studies Notes. The estimated coefficients are shown in diamonds while the corresponding 90 percent confidence intervals (calculated from robust standard error) are shown in bars. See Annex 3.1 for that control for unobserved characteristics of data definitions. “SEMP” is the share of self-employment in percent of total employment. workers. Informal employment tends to be A.B. The average measure of poverty (i.e. the poverty headcount ratio at $1.90 a day at 2011 PPP exchange rate in percent of the population) and Gini coefficient (World Bank estimates) over 1990- associated with lower education and with workers 2016 for countries with higher informality (above median) and those with lower informality (below median) are shown in diamonds with the 95 percent confidence intervals shown in bars. Output that are, on average, either younger or older than informality is measured as DGE-based informal output in percent of official GDP, while employment informality is measured as self-employment in percent of total employment. in the formal sector. It is also more prevalent in C.D. Estimates from Annex Tables 3.4.1 (poverty) and 3.4.2 (income inequality). Informality indicators are averages over 1990-2005. Control variable, initial level of poverty rate (earliest year over 1990- rural areas, where there are fewer alternatives in 2005), is included (the same applies to Gini index). The dependent variable is an annual change in poverty headcount ratio (measured as $1.90 a day (2011 PPP, WDI) in percent of the population) the formal sector, and among women (Hazans over the earliest year and the latest year (as in C; or the annual change in Gini index over the earliest 2011; Gasparini and Tornarolli 2007). The and the latest year in D). For the comparison and scaling issues, coefficients of DGE, MIMIC, and self -employment are multiplied by 10. informal sector employs more low-skilled labor than the formal sector, which can slow human capital accumulation in the long-run (Docquier, Methodology: Meta-Regression Analysis. A meta- Muller, and Naval 2017). Thus, differences in regression analysis is employed to aggregate characteristics of workers (e.g. education) largely estimates of the formal wage premium from a set account for the formal sector wage premium. of studies to obtain a quantitative assessment of the sources of cross-study variation. The analysis Aggregate income inequality and poverty focuses on 18 studies that test for the presence of The wage gap between the formal economy and significant wage differentials between formal and the informal economy has been associated with informal jobs, and its main sources (a detailed persistent income inequality and poverty.30 review of literature and methodology are presented in Annex 3.3). As is common practice in such meta-regression analyses, no study is excluded ex 29 Chong and Gradstein (2007), Amaral and Quintin (2006); ante based on its source or its results, but rather Pratap and Quiten (2006), and Loayza, Serven, and Sugawara (2010). the selection of studies is constrained to those that 30 is is in line with other studies that nd an insigni cant relationship between inequality and informality after controlling for present numerical estimates with confidence bands institutional outcomes (Perry et al. 2007) or focus on causality for country samples since 2000. running from inequality to informality (Chong and Gradstein 2007). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 167 BOX 3.4 Under the magnifying glass: How do policies affect informality? Country-specific studies have found that reductions in tax and regulatory burdens are often been associated with lower informality. In contrast, trade liberalization that raised competition level in the tradable sector is associated with greater informality, unless it is accompanied by measures that increase labor market flexibility. The reduction in informality was greater for reforms accompanied by business development and training programs, public awareness campaigns and stronger enforcement. Cross-country studies have identi ed a menu of policies impact of policy changes on informal activity. Speci cally, associated with lower informality. ese policies have the box addresses the following questions: typically fallen into three categories: tax reform, regulatory reform, and trade liberalization.1 • Which policy changes have been studied? • Tax reform. Lower tax rates, simpli ed tax systems, • What are the common lessons from these policy harmonized tax regulations, technology-based changes? monitoring and consolidated electronic tax payment systems can encourage rms and workers in the • What is the role of complementary policy measures? informal sector to move to the formal sector. Studies of policy changes • Regulatory reform. Lower minimum wages and lower barriers to worker recruitment and dismissal have Selection of studies. 19 studies are selected based on two been associated with lower informal activity. In criteria: (i) they examine speci c policy changes in a single addition, a wide range of institutional factors have EMDE and (ii) they measure an outcome that relates to been associated with reduced informality: more informal activity, such as the share of informal workers or e cient legal systems, better property right rms.2 ese studies cover 15 policy changes in Brazil protection, lower regulatory burden, less cumbersome (mid-1980s, 1990s, 2003), Colombia (1980s, 1990s), registration processes, easier access to credit, and lower Egypt (1998, 2004), Georgia (2010), India (1988-2000, corruption. 2017), Indonesia (1996-2004), Mexico (2002-06), Pakistan (2009), Russia (2001), Turkey (2004-05), and • Trade liberalization. In Latin America, trade Vietnam (1999-2013). Five of these country cases liberalization has often been followed by an increase implemented tax changes, four implemented regulatory in informal activity, unless accompanied by changes in labor markets, two implemented other complementary measures to increase labor market regulatory changes, and four implemented trade exibility. liberalization measures (Annex Table 3.4).3 Many EMDEs have implemented these types of reforms Tax reform. e studies examined both tax rate changes either with the explicit purpose of reducing informal and tax simpli cation. In 2017, India streamlined and activity, or for other purposes with collateral e ects on lowered the average tax rate of goods and services (Keats informal activity. Many of these reforms were 2017). Georgia introduced a preferential tax regime for implemented as part of broad-based, multi-pronged small businesses in 2010 (Bruhn and Loeprick 2014). reform packages. Against this backdrop, this box compiles Russia introduced a at personal income tax and cut a comprehensive review of single-country studies on the payroll taxes and social security contributions in 2001 (Slonimczyk 2012). Conversely, Pakistan raised income taxes on noncorporate partnership rms in 2009 (Waseem Note: This box was prepared by Cedric Okou. 1 Lower tax rates have been associated with smaller informal sectors (Loayza and Rigolini 2006; Loayza 1996). Greater labor market flexibility has been associated with lower informality (Maloney 1999; Heckman and 2 Studies are identi ed from the English-language repositories of Pagés 2004; Oviedo 2009). Institutional reforms that improve the academic articles and working papers, including EconLit, JSTOR, business climate have been accompanied by lower informal activity (Beck, EBSCO, Google Scholar, RePEc, Social Science Research Network Demirguc-Kunt, and Maksimovic 2006; Bosch, Goni and Maloney 2007; (SSRN), the National Bureau of Economic Research (NBER), World Friedman, Johnson, Kaufmann and Zoido-Lobaton 2000; Loayza 1996; Bank Policy Research Working Paper Series, International Monetary Loayza, Oviedo and Serven 2005; Loayza and Rigolini 2006; Monteiro Fund Working Paper Series, and IZA Working Papers. and Assunção 2012; Perry et al. 2007; Rocha, Ulyssea, and Rachter 2018; 3 Other studies documented the outcomes of randomized experiments Schneider and Enste 2000; Ulyssea 2018; Wellalage and Locke 2016). and counterfactual prototypical policies in Benin, Brazil, Malawi and Sri Trade liberalization in a context of labor market rigidity has been Lanka (Benhassine et al 2016; Ulyssea 2018; Campos, Goldstein and associated with higher informality (Goldberg and Pavcnik 2004; 2007). McKenzie 2015; De Mel, McKenzie and Woodru 2012). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 168 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.4 Under the magnifying glass: How do policies affect informality? (continued) 2018). In addition to lowering the average tax rate for Common lessons small rms, the SIMPLES reform in Brazil in 1996 simpli ed the tax and social security contributions regime Most studies have found the expected impact of these for small rms (Fajnzylber, Maloney and Rojas 2011; policy changes on informality (Figure 3.4.1). Tax Maloney and Mendez 2004). simpli cation, tax cuts and regulatory easing tended to reduce informality. Trade liberalization tended to increase Regulatory changes. A few episodes of labor market and informality unless it was accompanied by increased labor other regulatory reforms have been studied. In 2001, as market exibility. part of scal decentralization in Indonesia, minimum-wage setting responsibilities were transferred to provinces and Tax simpli cation and tax cuts were associated with lower local governments. e move was accompanied by a sharp informality in India, Russia, Georgia and Mexico—in the increase in the average real minimum wage (Comola and form of greater formal rm registration (India, Brazil, Mello 2011). In 2004-05, Turkey implemented two Georgia), greater income reporting (Brazil, Russia), greater employment subsidy schemes that strengthened incentives or a greater share of formal employment (Brazil, Russia). to register for the social security system (Betcherman, e reforms raised the number of registered rms by about Daysal and Pages 2010). Mexico simpli ed business 5 percent in Brazil and by 18-30 percent in Georgia registration by introducing its Rapid Business Opening (Bruhn and Loeprick 2014; Fajnzylber, Maloney and System (SARE) in various municipalities during 2002-06 Rojas 2011). In India, the introduction of the General (Fajnzylber, Maloney and Rojas 2011). Services Tax has been credited with halving the share of informal rms (Keats 2017). Conversely, Pakistan’s Trade liberalization. Several studies have examined corporate tax hike was followed by rising informality as episodes of major trade liberalization. Comprehensive rms switched business models and reported lower trade liberalizations with drastic tari reductions were earning. implemented in Colombia in the late 1980s and early 1990s. ey followed Colombia’s GATT accession in Regulatory changes to encourage reporting (Turkey) or 1981 (Goldberg and Pavcnik 2003; Attanasio, Goldberg simplify business registration (Mexico) were associated and Pavcnik 2004). Egypt introduced gradual trade with greater formal employment and rm registration, liberalization measures in 1998 and, more whereas higher minimum wages were associated with comprehensively, again in 2004 in the context of greater informal employment. Employment subsidy macroeconomic stabilization plans (Selwaness and Zaki schemes in Turkey raised the number of registered jobs in 2015). In Vietnam, the U.S.-Vietnam bilateral trade eligible provinces by up to 13 percent (Betcherman, agreement (BAT) came into e ect in 2001 (McCaig and Daysal and Pages 2010). In India, following broad-based Pavcnik 2015 and 2018) and, in the span of ten years, industrial liberalization measures, the number of informal turned the United States from Vietnam’s fth-largest to its establishments fell faster (by 25 percentage points) in states largest export destination between 1998 and 2008. e with more pro-employer labor laws than in states with less trade agreement was followed by reforms in 2006 to exible labor laws (Sharma 2009). A 5 percent increase in increase labor market exibility. In 1988, Brazil took the number of registered rms was attributed to simpli ed initial steps to liberalize trade but at the same time business registration procedures in Mexico (Bruhn 2011, restricted labor market exibility in its Constitutional 2013). Conversely, in Indonesia a 10 percentage point Reform. e 1988 reform included cuts in maximum increase in the minimum wage over the mean wage was work hours, higher vacation pays, longer maternity leave, associated by a 0.9-1.1 percent increase in informal higher dismissal cost, and limits on union power (Bosch, employment (Comola and Mello 2011). Goni and Maloney 2007).4 In 1991, India liberalized trade, removed price controls, and removed license Trade liberalizations in Brazil, Colombia, and Egypt were requirements in most industries (Sharma 2009). typically associated with greater informality—unless accompanied by measures to improve labor market exibility. During Colombia’s trade liberalization in the 4 Bosch, Goni and Maloney (2007) focus on this initial reform phase. 1980s and 1990s, a 10-percentage point decline in tari s From 1990-1997, the pace of trade liberalization picked up signi cantly in a given industry was associated with a 1 percentage and was accompanied by the 1994 Plano Real of scal reform, social point increase in the probability of informal security reform, state monopoly reform, and civil service reform (Ferreira employment—but only for the period preceding a major and Rossi 2003). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 169 BOX 3.4 Under the magnifying glass: How do policies affect informality? (continued) FIGURE 3.4.1 Overview of policy changes Most surveyed policy changes, including five tax reforms, six regulatory reforms, and four trade reforms were conducted in Latin America and the Caribbean, East Asia and Pacific, and Europe and Central Asia. The bulk of these reforms delivered the expected outcomes and were implemented post-2000. A. Number of reform episodes across B. Share of reform episodes delivering C. Number of reform episodes over time regions expected informality outcomes Source: World Bank. Note: Descriptive summary of surveyed reform episodes. A. Number of surveyed policies across regions. EAP = East Asia and Pacific, ECA = Europe and Central Asia, LAC = Latin America and the Caribbean, MNA = Middle East and North Africa, SAR = South Asia, and SSA = Sub-Saharan Africa. “Other” includes MNA, SAR and SSA. B. “Yes (No)” means that the outcome of a policy intervention is (not) consistent with the expected impact. “Mixed” means that the outcome of a policy intervention varies over time. The expected impacts of reforms are: (i) reduced tax burden would reduce informality; (ii) increased labor market flexibility would reduce informality; (iii) lowered entry and exit barriers in formal sector would reduce informality; (iv) trade liberalization would increase informality due to intense foreign competition that disrupts existing formal firms. C. Number of surveyed policies implemented before and after 2000. Waves of trade liberalization in Egypt were fielded pre- (1998) and post-2000. labor market reform that increased labor market exibility in Georgia. ree factors accounted for these: interactions (Goldberg and Pavcnik 2003; Attanasio, Goldberg and between multiple reforms; scale of reform; and Pavcnik 2004). In Egypt, the trade liberalization of 1998 enforcement. was associated with increased informal employment whereas the trade liberalization measures of 2004—which Interactions between multiple reforms. In Egypt, trade were preceded by 2003 reforms to increase labor market liberalization implemented in a supportive environment, exibility—were not (Selwaness and Zaki 2015). Similarly, with reforms to increase labor market exibility, was trade liberalization accompanied by measures to reduce associated with lower informality in 2004 but, in the labor market exibility, such as in Brazil in the late 1980s absence of labor reforms, informality increased following and early 1990s was accompanied by rising informal the 1998 trade liberalization. Similarly, trade liberalization employment (Bosch, Goni and Maloney 2007). In combined with increased labor market rigidities raised Vietnam, rapid export growth was associated with a 5 informality in Brazil in the late 1980s and early 1990s. percentage point higher share of formal manufacturing When product markets are restructured, such as during employment, a growing share of formal employment, and trade liberalization, greater labor market exibility shrinking informal employment (McCaig and Pavcnik facilitated the reallocation of workers to more competitive 2018; Boly 2018). industries. A large share of unskilled labor may also have increased the likelihood that trade liberalization raised Role of complementary policy measures informal employment (Loayza and Rigolini 2006; Selwaness and Zaki 2015). In Brazil, Colombia, and Several of the policies discussed above were not primarily Vietnam, the increase in informal employment was implemented with informality in mind. Yet, they had the particularly pronounced among less skilled workers unintended consequence of raising informality: tax (Goldberg and Pavcnik 2003; McCaig and Pavcnik 2015). increases in Pakistan, decentralization of minimum wage regulation in Indonesia, and trade liberalization in Egypt, Scale of reform. Some reforms were simply too narrowly Brazil and Colombia. Other reforms did not have as large targeted to have a sizeable or lasting impact on informality. an e ect on informality as expected, such as the tax reform For example, the short-lived impact of tax reform in EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 170 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 BOX 3.4 Under the magnifying glass: How do policies affect informality? (continued) Georgia—found only in the rst year—has been attributed Conclusion to the modest scale of the reform (Bruhn and Loeprick 2014). e studies of microeconomic impacts of policy changes are a reminder of the importance of comprehensive reform Weak enforcement. Particularly in environments with packages. Several of the packages discussed above, as an weak enforcement of rm and employment regulation, unintended consequence, raised informal employment or higher taxes or minimum wages can encourage informal rm activity. Such unintended reform impacts can be activity. In Pakistan, Turkey, and Indonesia, weaker mitigated by bundling mutually reinforcing reforms, such enforcement was associated with greater informality.5 as trade liberalization with labor market reform, or tax and minimum wage hikes with strengthened enforcement and 5 Oviedo (2009), Betcherman, Daysal and Pages (2010), Vargas public awareness campaigns. (2015), McGraig and Pavcnik (2015 and 2018), Waseem (2018), Comola and Mello (2011), and Loayza (1996). Conversely, the decline in poverty rates across all not on inequality) is statistically significant (Figure EMDEs regions (and especially in South Asia and 3.9).31 The association with changes in poverty is Sub-Saharan Africa) during 2005-15 was similar for employment and output informality. In accompanied by a contraction of informal the average EMDE, the share of extreme poor in activities (Figure 3.8). At the country-level, a the population (the headcount ratio) declined by larger informal economy is associated with a about 0.8 percentage point between 2011 and higher poverty headcount (Figure 3.9). However, 2016. These estimates imply that a country with a the direction of causality between informality and 10 percentage points higher share of informal poverty remains an open question. output than its peers witnessed 0.1 percentage point slower poverty reduction per year. Regression analysis. The relationship between pre -existing informality and changes in the share of the population living in extreme poverty (i.e., the Informality and fiscal poverty headcount ratio at $1.90 a day at 2011 outcomes PPP exchange rate in percent of the population) or the Gini coefficient (World Bank estimates) is A large informal economy erodes the tax base and estimated in an ordinary least squares regression. constrains governments’ ability to provide public Specifically, the annual average change in the services, conduct countercyclical policies, serve poverty headcount ratio (or Gini coefficient) debt, and implement redistributive measures between the latest (in the period 2011-16) and (Chapter 4; Ordonez 2014; Besley and Persson earliest available data (in the period 1990-2005) 2014). This puts a premium on designing tax and for up to 74 countries is regressed on 1990-2005 social security systems that avoid unintended average informality. To mitigate concerns about incentives to shift activity from the formal to the endogeneity, time horizons considered for informal sector and level the playfield for both informality measures precede those for the change formal and informal sectors (Perry et al. 2007; in the poverty rate or Gini coefficient (Loayza, Djankov et al. 2010; Loayza 2018; Dabla-Norris Serven and Sugawara 2010; Annex 3.4). The et al. 2018). regression controls for the initial level of poverty (or Gini coefficient) and income per capita, using Revenue outcomes. Regardless of the measure of the earliest available income data. informality, on average, government revenues in Pre-existing informality and changes in poverty. 31 Reforms that reduce tax burdens account for about one fth of The estimated impact of pre-existing informality all policy reforms that could facilitate the formalization process in on changes in the poverty rate (but in this sample EAP and LAC. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 171 EMDEs with the most pervasive informality have FIGURE 3.10 EMDEs: Informality and fiscal outcomes been 5-10 percentage points of GDP below those Widespread informality is associated with lower government revenues, a with the least pervasive informality (Figure 3.10). skew towards trade-based taxation, and lower government expenditures. The composition of tax revenues is tilted towards trade taxes in economies with more pronounced A. Differential in fiscal indicators B. Differential in fiscal indicators informality. Revenues from trade taxes have been between third of EMDEs with the between third of EMDEs with the lowest and highest output informality lowest and highest employment 0.7-1.0 percentage points of GDP higher in informality EMDEs with greater informality compared with those with the lowest levels of informality. Income tax revenues, in contrast, tend to be lower in the EMDEs with the highest output informality. Greater reliance on indirect taxation makes the tax system less progressive and, hence, less redistributive than a system based on more progressive direct taxation. Expenditure outcomes. Revenue weakness is also Sources: Elgin et al. (forthcoming a), World Development Indicators, IMF World Economic Outlook. Notes: Fiscal indicators and informality measures are 2000-16 averages. Sample includes 70 non- reflected in lower government expenditures. In energy exporting EMDEs with populations above 3 million people. A.B. Difference (in percentage points of GDP) between the average fiscal indicators among the third EMDEs with the most pervasive informality, of EMDEs with the highest and lowest informality by the share of informal output (as measured by the DGE methodology) in percent of official GDP (A) or by the share of self-employment in percent of government expenditures were 4-10 percentage total employment (B). Vertical bars indicate 10 percent confidence intervals of the differences. points of GDP lower than in those with the lowest informality (Figure 3.10). Insufficient resources for redistributive policies may contribute to the sector activity and productivity and leveling the playfield for all workers and firms, particularly correlation between informality and poverty. measures to make the labor market more flexible, the regulatory framework more adaptable, and Policy options governance more effective, can lower informality and/or improve the working conditions in the Many EMDE governments implemented policies informal sector. Finally, supportive macro- at the microeconomic level and found that the economic and social policies (such as enhancing implications for informality were more benign public service and social protection) can ease the when these reforms were implemented in a implementation of these reforms and facilitate a supportive institutional and macroeconomic smoother transition from the informal sector to environment. For instance, trade liberalization the formal sector. programs that raised real wages and reduced firms’ profitability in the tradable sector were associated These policy measures can help lower informality with greater informality in the short-term—unless while also spurring growth more broadly. They they were accompanied by higher labor market should be accompanied by strengthening the basic flexibility and more skilled labor force (Box 3.4; social safety nets to preserve incomes of vulnerable Goldberg and Pavcnik 2003; McCaig and Pavcnik groups. Disruptions to formal activity from 2015). interventions to lower informality could be mitigated by reforms to increase labor and product Country experiences suggest the need for a market flexibility. comprehensive development strategy that is informed by the drivers of and challenges posed by Fiscal policy measures informality and carefully tailored to country circumstances. Policies that seek to improve fiscal Some countries have implemented reforms to accounts, such as strengthened tax administration reduce the fiscal impact of informality on the or streamlined tax regulations, can be associated state’s ability to provide public goods and, in the with lowering informality in some economies. collection process, to reduce fiscal barriers or Separately, policies that aim at invigorating private incentives for firms to operate informally. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 172 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 3.11 EMDEs: Policies to address challenges of • Value-added taxation (VAT) can help informality strengthen tax collection even in the presence Governments have implemented a wide range of reforms that could affect of a sizable informal sector (World Bank 2018 informality. b). Since informal rms would not be allowed to claim VAT refunds on taxed inputs, the A. Reforms across regions, 2008-18 B. Reforms over time VAT would implicitly serve as an input tax (De Paula and Scheinkman 2010; Loayza 2018). Conversely, more e ective VAT administration, including through digitalization of receipts, could signi cantly raise tax revenues while also increasing incentives to register for tax refunds.33 • Better tax morale, re ecting the perception that tax dollars are spent judiciously (for the Sources: Doing Business, World Bank. Notes: See Doing Business 2008-18 for reform details. appropriate objectives and in the correct way), A. The number of policy reforms that have been implemented after year 2008 and are regarded as “improvement” in the ease of doing business or “neutral” (which only applies to “labor market can encourage greater tax compliance and regulation”) by Doing Business 2008-18. lessen informality (Sung, Awasthi and Lee B. The annual average number of policy reforms that have been implemented during 2008-10 in comparison to the annual average number of reforms conducted during 2016-18 (shown in bars). 2017). Measures to cultivate better tax morale include appeals to people to declare their activities, campaigns to encourage a culture of • Tax compliance has been encouraged by commitment to declaration, and e orts to simplifying tax codes, improving tax change perceptions of the tax system’s fairness (Williams and Schneider 2016). Tax systems enforcement (e.g., via the use of information technology and communication tools), that create an unlevel play eld for di erent building tax administrations’ capacity, types of rms (e.g. size-dependent tax policies) harmonizing tax regulations or forms (e.g. and encourage informality may warrant across rms of di erent sizes), limiting the use reform. of cash transactions, and encouraging the use • An improved provision of public goods and of bank-based tax payments (Medina and services, such as better education or Morales 2016; Ulyssea 2018; Rocha, Ulyssea, infrastructure, could help improve the and Rachter 2018; Awastchi and Engelschalk productivity in both formal and informal 2018). sectors (Oviedo, omas, and Karakurum- Ozdemir 2009; Benjamin and Mbaye 2012, • Tax burdens have been reduced for formal rms by o ering tax relief for new employees Kim, Loayza, and Meza-Cuadra 2016; World or simplifying tax bases in industries with a Bank 2018 b). high percentage of undeclared workers (e.g., • Social security systems can be reformed to domestic work). Reducing tax burdens has been among the most common policy reforms reduce the incentives to hire informal workers.34 Measures include steps to shift the in EMDEs, especially in East Asia and Paci c (EAP) and Latin America and Caribbean (LAC) (Figure 3.11).32 33 See Loayza (2018) for a detailed discussion on how to reform the social security system to reduce informality. See World Bank (2018b) for a discussion on how to provide better social security to informal workers. Levy (2008) and Maloney (2004) suggest that 32 In China, for example, the computerization of VAT invoices establishing parallel non-contributory systems in the presence of between 1998-2007 explained roughly 15 percent of cumulative informality could further encourage informality. VAT revenues and increased the e ective average tax rate by 34 See Johnson, Kaufman and Zoido-Lobaton (1998), Djankov et approximately 5-14 percent paid by rms (Fan, Quian, and Wen al. (2002), Prado (2011), USAID (2015), Baksi and Bose (2016), 2018). Kanbur (2017), and Divanbeigi and Ramalho (2015). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 173 burden of payments of contributions from and firing, to working arrangements, and to wage employers to employees (e.g. in Latvia, rates. Other types of policy changes, such as Poland, Slovenia), to reduce employers’ social providing incentives for worker registration (e.g. security contributions (e.g. in Bulgaria), and legalization of undocumented workers) and to link social bene ts to personal improved enforcement of existing labor laws, may contributions (e.g. in most EU 27 countries; also encourage workers to move to the formal Oviedo, omas, and Karakurum-Ozdemir sector (Anand and Khera 2016; Munkacsi and 2009). Transitions from an employment- Saxegaard 2017). For example, Japan has allowed based social security system to a well-designed undeclared workers to claim certain social benefits, model of risk sharing can provide a better thereby improving the monitoring of their safety net for informal workers and help employment. In countries with large rural protect both formal and informal workers populations, easing labor market regulation could during economic downturns (World Bank play an important role in enabling workers to 2013 and 2018 a; Box 3.1). move into the urban, more productive and more modern sectors (Annex Figure 3.5.1, Annex 3.5, Business climate and governance measures Loayza 2016).37 Many reforms that are designed to invigorate Firm regulations. A variety of measures can private sector growth can also help reduce encourage firms to participate in the formal sector. informality, such as reducing corruption, For example, formal entry of firms can be improving business climates and governance, facilitated and encouraged by creating “one-stop- strengthening enforcement, or liberalizing labor shop” registration to simplify the process (e.g. in and product markets, including through trade Australia, Belgium, Ukraine), training and liberalization.35 Policy measures that narrow the business services can be provided to firms that earnings gap between informal and formal workers register (e.g. in Mexico and Malawi, Campos, or those that reduce the productivity gap between Goldstein, and McKenzie 2018), and access to informal and formal firms (for example, through credit can be made easier for firms in the formal measures to improve education or expand access sector. EMDEs in the ECA and SSA regions have to conventional sources of credit) can also help implemented an above-average number of reforms lower the extent of informal activity. Trade to reduce the costs of starting a business during liberalization, however, may encourage informality the past decade (Figure 3.11). Easier firm in the short-term unless complementary reforms registration and lower registration costs can also are implemented (Box 3.4; Figure 3.11). encourage the entry of young and productive firms, which can boost the productivity of the Labor regulations. Over the past decade, economy (Haltiwanger, Jarmin, and Miranda governments—especially in ECA, SSA and, more 2013; Nguimkeu 2015; Loayza 2018). recently, LAC—have implemented reforms to increase labor market flexibility.36 These include Regulatory enforcement. While other policy less restrictive regulations with respect to hiring options increase the benefits of joining the formal economy, stricter enforcement can increase the cost of remaining in the informal economy. Policy 35 Kuddo (2018) shows that about 60 percent of the reforms options include increasing the frequency of passed between 2007 and 2017 throughout the world aimed at inspections (in most EU15 countries and improving labor market exibility. Bangladesh), creating a national-level firm or 36 Loayza (2016) develops a theoretical model that traces informality, government regulations, economic growth and urban employee registry (in Poland), and launching migration through the process of development. e model highlights the potential e ect of the minimum wage on labor misallocation and on capital accumulation. A higher minimum wage slows capital accumulation and pushes workers into the informal economy. See 37 See, for instance, Oviedo, omas, and Karakurum-Ozdemir Annex 3.5 for details. Caballero et al. (2013) show that job security (2009), Bruhn and McKenzie (2014), Awastchi and Engelschalk regulation hampers the creative-destruction process, which could (2018), and de Giorgi, Ploenzke, and Rahman (2018). impede growth. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 174 C H A P TE R 3 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 public awareness campaigns regarding tax integrated reforms that complement each other compliance (e.g. in China and Korea).38 However, and address the complexity of informality (Loayza these enforcement measures tend to be most 2018). effective when implemented in conjunction with steps to improve the governance and business Tailoring implementation. Cross-country climate (e.g. making the labor market flexible) and experiences also highlight the importance of a when they are applied even-handedly to both country-specific implementation plan: each reform formal and informal firms (Loayza 2018). component requires a diagnosis of the country´s current situation, followed by specific reforms to Education. Informal workers tend to be less address the main weaknesses associated with and productive than formal workers. To the extent underlying sources of informality (Loayza 2018). that workers remain in the informal sector for lack In SSA, SAR, and the non-GCC economies of of human capital or skills, better and more MENA, for example, general education and accessible public education may help workers (or training programs to raise human capital could be their dependents) to move into better paid formal prioritized (Box 3.2, Boxes 2.1-2.6). In LAC, employment (Maloney 2004; Perry et al. 2007; reducing particularly high tax and regulatory costs Andres, Sanchez and Johansson 2011). This can to businesses could incentivize firms to join the also have the benefit of reducing income formal sector. In ECA, improving government inequality and poverty. effectiveness and reducing corruption could be policy priorities. The success of implementation Access to finance. Firms in the informal sector also depends on careful monitoring of potential have more limited access to credit from the unintended consequences and a supportive banking sector and capital markets, which restricts macroeconomic, political and institutional their ability to invest in productivity-enhancing environment. The latter ensures the political and new technologies (Ferreira-Tiyaki 2008; fiscal viability of the implementation and reduces D’Erasmo 2016; Capasso and Jappelli 2013). One the transition costs for workers moving from the of the options to have greater access to finance is informal sector to the formal sector. to improve personal property registration, which makes loans more accessible for firms operating in Emerging policy opportunities and the informal economy (e.g. Czech Republic; challenges Doing Business 2012). Improving access to credit has been a common policy reform in EAP, MNA, Human capital adaptability. The emerging “gig” SAR and, more recently, in SSA. economy poses opportunities and policy challenges with its higher accessibility, more fluid From a comprehensive strategy to labor arrangements, and greater reliance on digital implementation technology than more traditional forms of informality. Since “gig” workers do not fully A comprehensive strategy: The right policy mix. participate in the social security system, they are, Policy interventions in isolation may only have a by some definitions, informal workers (Loayza et limited impact on informality but can have al. 2009). Regulatory changes, especially in the unintended consequences (Box 3.4; Ulyssea 2018; context of social security systems, may be needed Oviedo, Thomas, and Karakurum-Ozdemir to ensure that “gig” workers’ economic risks are 2009).39 A coherent reform strategy calls for well- manageable and that they do not permanently lose access to the formal economy (World Bank 2014, 38 See, for instance, Oviedo, 2016 and 2018b). Since these workers will likely omas, and Karakurum-Ozdemir (2009), Bruhn and McKenzie (2014), Awastchi and Engelschalk take on many different assignments over the (2018), and De Giorgi, Ploenzke and Rahman (2018). course of their careers, the ability to learn and 39 Ulyssea (2018) shows that formalization policies di er in their adapt will be essential. Policies can support this impact on informality and GDP. For instance, reducing form sector’s entry costs is not as e ective in reducing informality as other adaptability with more provision of education and formalization policies, but it leads to greater GDP and wages. e (re)training programs (World Development reverse holds for increasing enforcement. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 3 175 Report 2019; Card, Kluve, and Weber 2018). 2017; Junquera-Varela et al. 2017; Awastchi and Emphasis should also be given to the development Engelschalk 2018; Capasso, Monferra, and of cognitive skills in primary and secondary Sampagnaro 2018). Digitalization can lower education or via intentional instruction at earlier regulatory burdens, thus reducing the cost of ages, and the improvement of the terms of operating in the formal economy. For example, employment (Almeida, Behrman and Robalino, Costa Rica reduced the time required to register a 2012; World Bank, 2018 a and b). business by digitizing tax registration records and company books in 2009 (Doing Business 2009). Leveraging new technology. New technologies This was followed by a drop in the share of offer governments an opportunity to both reduce informal employment by 4 percentage points of the incentives for and increase the cost of total employment and a fall in the share of operating informally. For example, new informal output by about 2 percentage points of technologies can also help strengthen tax official GDP during 2009-16. Similar reforms administration and improve access to finance, have been carried out in Guyana (2010) and including by improving the ability to broaden the Kenya (2011) (Doing Business 2010 and 2011). tax net and assess credit worthiness (Gupta et al. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 176   ANNEX 3.1 Measures of   captures multiple outcome indicators of informal informality activity.2 Second, it estimates informal activity across country and over time. The data on causes The database includes most informality measures and indicators of informal activity identified in the employed by the literature. These measures cover literature are largely based on macroeconomic up to 187 economies (36 advanced and 151 series in a panel setting and updated annually. emerging market and developing economies) for as much as 1990-2016 (Annex Table 3.1.1). To estimate the size of the informal sector (i.e., in Measures can be divided into indirect (model- percent of official GDP) with the MIMIC model, based) estimates and direct (survey-based) this study closely follows Schneider, Buehn, and estimates. Montenegro (2010) Six causes and three indicators are used in the estimation to capture the Indirect estimates hypothesized relationships between the informal sector (the latent variable) and its causes and Previous studies use various indirect approaches to indicators. Once the relationships are identified estimate the size of the informal sector, including and the parameters are estimated, the estimation the currency-demand approach (e.g. Ardizzi et al. results are used to calculate the MIMIC index, 2014), and the electricity-demand approach (e.g. which gives the absolute values of the size of the Johnson et al., 1997; Lacko 2000), the Multiple informal sector after a benchmarking procedure. Indicators Multiple Causes (MIMIC) model (e.g. The MIMIC approach delivers a panel of Schneider, Buehn, and Montenegro 2010), and estimates (labelled as MIMIC) for 161 countries the Dynamic General Equilibrium (DGE) model over the period 1993-2015. (e.g. Ihrig and Moe 2004; Elgin and Oztunali 2014; Orsi et al. 2014). Among all indirect Six causes and three indicators are used in the estimation methods, the MIMIC and DGE estimation (as in Schneider et al. 2010). The six models stand out in their year and country cause variables used are: (1) size of government coverage. The other two indirect approaches, i.e. (general government final consumption the electricity-demand approach and the currency- expenditure, as a percent of GDP, obtained from demand approach, suffer from limited data UN, spliced with WDI) as proxy for indirect availability and theoretical caveats (see Ahumada taxation; (2) share of direct taxation (direct taxes et al. 2007; Schneider and Buehn 2016 for in percent of overall taxation, WDI); (3) fiscal details). Therefore, the MIMIC and DGE models freedom index obtained from Heritage are used here to estimate the size of the informal Foundation as a tax burden variable in a wide sector. sense; (4) business freedom index provided by Heritage Foundation; (5) the unemployment rate The multiple indicators multiple causes model and GDP per capita to capture the state of the (MIMIC).1 The Multiple Indicators Multiple economy (obtained from WDI, the latter is Causes model is a model of structural equations spliced with WEO); and (6) a measure on that can be applied to estimate the size of informal government effectiveness provided by Worldwide economic activity. There are two features of Governance Indicators. The three indicator MIMIC that make it a preferred estimation variables include: (1) growth rate of GDP per approach for some researchers. First, it explicitly capita (WDI, spliced with WEO); (2) the labor considers multiple causes of informal activity and force participation rate (people over 15 economically active as a percentage of total 1 The limitations of the standard MIMIC model of Schneider, Buehn, and Montenegro (2010) and others include (e.g., Medina and Schneider 2018; Feige 2016): 1) the use of GDP (GDP per capita 2 Indirect approaches like the currency demand approach or the and growth of GDP per capita) as both cause and indicator variables, electricity approach condense the full range of informal activity across 2) its reliance on another independent study’s base-year estimates on product and factor markets into just one indicator. However, the the informal economy to calibrate the size of informal economy in informal sector shows its effects in various markets (Schneider, percent of GDP, and 3) the estimated coefficients are sensitive to Buehn, and Montenegro 2010), which would be captured better in a alternative model specifications and sample coverage. MIMIC model. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 177 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 population,   WDI, spliced with Haver analytics), labor  allocation between the formal and informal and (3) currency as a ratio of M0 (currency sector and allows the estimation of 159 countries outside the banks) over M1 (obtained from IMF (36 AEs and 123 EMDEs) over the period 1950- IFS). 2016. In the model, an infinitely-lived representative household is endowed with certain The estimation results from the model units of productive capital and time. The specification that ensures maximum data coverage household has access to two productive (Annex Table 3.1.2) are used to generate the technologies, denoted formal and informal, and MIMIC index of the share of informal output maximizes its lifetime utility by allocating labor relative to official GDP (ῆt).3 Then we conduct an between the informal and formal economies and additional benchmarking procedure where ῆt is allocating income between consumption and converted into absolute values of the informal investment. sector (η^t) using the following equation: 4 In model, an infinitely-lived representative household is endowed with units of productive ῆt capital and a total of Ht 0 units of time. The ηt η*2000 , (1) ῆ2000  household has access to two productive technologies, denoted formal and informal, and maximizes its lifetime utility by solving the where t denotes year, ῆ2000 is the value of the following optimization problem: estimated index in the base year 2000, and η*2000 is the exogenous estimate (base value) of the shadow economies in 2000. While the estimates   (ῆt) determine the movement of the absolute values of the informal sector over time, the base (2)  values η*2000 decide the rankings of the countries’ Kt 1 It 1 - δ Kt (3) informal sector within the sample in year 2000. The base values η*2000 are taken from Schneider NIt NFt Ht (4)  (2007) or, for another 10 countries, from Schneider, Buehn, and Montenegro (2010). β 1 is the discount factor and the instantaneous utility function U(.) is strictly increasing and The DGE model (DGE). A Dynamic General strictly concave. Eq(2) defines the household's Equilibrium (DGE) model (e.g. Ihrig and Moe resource feasibility constraint: the sum of 2004; Elgin and Oztunali 2014; Orsi et al. 2014; consumption Ct and investment It should equal the Loayza 2016) typically considers how households amount produced using the formal and informal allocate labor between formal and informal technologies. The right-hand side of equation (2) economies within each period and how the shows that the formal technology follows a allocation changes over time. In comparison to standard Cobb-Douglas specification, where AFt is other methods, the DGE approach stands out in the level of productivity exclusive to the formal its comprehensive country-year coverage, clear sector. Kt is the household’s capital stock while NIt, economic reasoning, and its applicability in policy is the number of hours the household devotes to experiments and projection (e.g., Loayza 2016). the formal sector. τt captures the tax rate imposed on formal output. Informal economy depends on The deterministic DGE model of Elgin and the number of hours the household devotes to the Oztunali (2014) is used to estimate the size of the informal sector, NIt, and its exclusive level of informal sector. The model captures the essence of technology, AIt. Assuming no cost for hiding and the government cannot enforce payment, the See the model specification in Column (5) in Annex Table 3.1.2. 3 household will attempt to hide the income Calibration is performed separately for each country. Following 4 received from the informal sector. Schneider, Buehn, and Montenegro (2010), the MIMIC index has been adjusted to the positive range by adding a positive constant. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 178   The rest of the household’s problem is standard:   informality measures are labor related, out of equation (3) specifies the law of motion for which three are related to employment and one to capital, where δ ∈ [0; 1] is the depreciation rate. pension coverage. These measures are mainly equation (4) is the household's time constraint. In gathered from labor force surveys and sometimes this simple model, the government's policy τt is covered by household surveys. Labor related assumed to be exogenously given and the tax measures have the advantages of not replying on revenue is assumed to be used to finance an strong assumptions, having no need for based-year exogenous stream of government spending, Gt. estimates for calibration, and having sufficient Then, given the government policy variable tax time variation for time-series analysis.7 burden τt , a competitive equilibrium of the two- sector model is a set of sequences The most frequently used measure is the share of that maximize expected self-employment in total employment, which is a utility from consumption (i.e. ). lower bound of informal employment (e.g. La Porta and Shleifer 2014, and Maloney 2004)8 As The model provides a reasonable mapping defined by the 1993 International Classification between formal economy and informal economy of Status in Employment (ICSE-93), self- in a dynamic setting. The two key equilibrium employed workers are those workers who, conditions are the equilibrium condition that working on their own account or with one or a connects formal and informal economy through few partners or in a cooperative, hold the type of labor allocation, and the equilibrium condition jobs defined as “self-employment jobs.” These are that captures the intertemporal substitution. The jobs where the remuneration is directly dependent calibration and data construction rely on these two upon the profits derived from the goods and conditions to estimate the ratio, , which can be services produced. WDI and ILO further classify further expressed as . them into the following four sub-categories: employers, own-account workers, members of The calibration takes parameter values suggested producers' cooperatives, and contributing family by the earlier literature (e.g. α is assumed to be workers. equal to 0.36; and γ takes 0.425 Ihrig and Moe (2004) and uses data from PWT 9.0 for capital The two other measures are informal employment stock (Kt), private consumption (Ct), formal (Informal emp) and employment outside the employment (NFt), depreciation rates (δ, country formal sector (Emp inf sector ). These two averages), and tax rates (τt).5 By matching the measures are usually expressed in percent of total productivity in the informal sector to the informal employment and refer to different aspects of economy size in 2007 of the series reported in informality. While employment in the informal Schneider, Buehn and Montenegro (2010) and sector is an enterprise-based concept, informal assuming that AIt grows at the average growth rate employment is a job-based concept and has a of Kt and Aft,6 the DGE estimates are computed broader definition than self-employment. for 159 countries over the period 1950-2016.  Informal employment comprises all workers of the informal sector and informal workers outside Survey-based estimates the informal sector. The former covers all persons who, during a given reference period, were Labor force surveys (LFS) and household surveys (HS) on labor related measures. Four existing 7 They also have the following limitations: 1) the data are costly to gather, which results in limited country and year coverage; 2) 5 The estimation results are qualitatively robust to different model survey methodologies may vary across time and countries, making the specifications such as using alternative values for δ,α,γ, adding labor- measures incomparable; 3) the typical drawbacks of survey-based leisure choice, tax enforcement parameter to informal sector income estimates (such as sample bias) may make the data quality (for example, using revenue in percent of GDP rather than questionable; and 4) employment measures cannot reflect other government spending in percent of GDP for τt), see Elgin and changes in the informal sector, such as productivity. Oztunali (2014) for details. 8 Among all labor-related measures, self-employment stands out 6 This assumption implies that growth in the formal sector can in its time and country coverage and sufficient level of time variation, spillover to the informal sector via capital accumulation and making it suitable for time-series analysis and cross-country technological diffusion. comparison. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 179 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 employed   in at least one informal sector World  Bank Enterprise Surveys compile responses enterprise, irrespective of their status in on various topics (including informality) from face employment and whether it was their main or a -to-face interviews with top managers and business secondary job a job-based concept. The latter owners in over 130,000 companies in 146 covers self-employment and employees holding countries. The surveys yield the following informal jobs. ILO presents a detailed definition measures of informality (used in e.g. Amin 2015; of these two measures (http://www.ilo.org/ilostat- La Porta and Shleifer 2014): percent of firms files/Documents/description_ IFL_EN.pdf). competing against unregistered or informal firms (WB1), percent of firms formally registered when Combining various cross-country databases and they started operations in the country (WB2), additional data from the national statistical offices (average) number of years firms operating without and other sources, the resulting dataset on self- formal registration (WB3), and percent of firms employment is a panel of 182 countries/regions identifying practices of competitors in the over the period 1955-2016. The dataset on informal sector as a major constraint (WB4). A informal employment covers 53 countries/regions higher value of WB1, WB3 and WB4 indicates a from various years during 2001-2016 while the higher level of informality, while the reverse holds dataset on employment outside the formal sector for WB2. contains 56 countries/regions from various years during 1999-2016. In comparison to Enterprise Surveys, Executive Opinion Surveys provide a more balanced panel Data on pension coverage (labeled as Pension dataset, making them more suitable for business coverage) are also gathered from various issues of cycle analysis. World Economic Forum has been the World Bank’s World Development Indicators conducting the Executive Opinion Survey every (book version, reported until 2012). The measure year since 1979. As reported in the 2014 edition, is defined as the fraction of the labor force that over 13,000 executives in 144 economies were contributes to a retirement pension scheme surveyed. From year 2006, when conducting the (Loayza et al. 2010, WDI). It yields a panel that survey, the following question is asked, “In your covers 135 countries from 1990 to 2010. country, how much economic activity do you estimate to be undeclared or unregistered? Firm surveys. Two datasets of firm surveys have (1=Most economic activity is undeclared or comprehensive coverage: World Bank Enterprise unregistered; 7 = Most economic activity is Surveys, and Executive Opinion Surveys declared or registered).” The average responses at conducted by World Economic Forum. World the country-year level constitute a series of Bank Enterprise Surveys cover 139 economies informality measures, labeled as WEF. A lower over the period 2006-2015 while Executive average at the country level indicates a larger Opinion Surveys cover 151 countries over the informal economy. period 2005-2016. Household surveys (HS). Household surveys Both surveys are answered by top managers and either report the extent of informality in an business owners, who are business experts and economy or report people’s opinions on informal should be familiar with the business climate in a economic activities. Among all, World Value country. The surveys could reflect some Surveys (WVS) stand out in their country and dimensions of informality (e.g. the extent of year coverage with others focusing on European competition from the informal sector) that are not countries. It asks whether respondents can justify captured in the other informality measures. Similar to labor-related measures, measures from firm surveys also have the advantages of being free surveys. First, firm surveys tend to have limited year coverage. of strong assumptions and base-year estimates for Second, since people’s perception does not move much over time, this type of measures do not have much time variation. Both calibration.9 drawbacks limit their application in time-series analysis. However, they shed light on the perceived extent of informality in a country and provide guidance for constructing and validating indirect model 9 There are two drawbacks of informality measures from firm estimates. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 180   cheating on taxes in five waves from 1981-1984 to   ANNEX 3.3 Informality and 2010-2014. The responses range from 1 (never earnings inequality: justifiable) to 10 (always justifiable). In total, 96 A meta-analysis approach economies participated in the survey. The average responses at the country-year level are used as a Selection of studies. The collection of the measure for attitudes towards informality (or tax representative sample of studies on informality morality, Oveido et al. 2009), labeled as WVS. A and wage inequality follows selection guidelines higher average at the country level implies that outlined in Stanley et al. (2013) and is broadly people find cheating on taxes more justifiable. similar to criteria applied by van der Sluis et al. Former studies show that the lack of tax morality (2005). An initial search was conducted in the is associated with a higher level of informality. major English language repositories of academic articles and working papers.10 A study was ANNEX 3.2 Characteristics of included in the database if it: (i) provided a informal-economy quantitative estimate of the informal-formal wage business cycles gap and a corresponding standard error or a t- statistic; (ii) used data from micro-level household Harding and Pagan (2002)’s approach is used to or labor surveys to obtain these estimates; (iii) identify business cycle turning points in formal analyzed a developing country or a group of and informal sectors in annual data: Peaks developing economies as defined by the World (troughs) are identified in years when output is Bank classification and (iv) was published after higher (lower) than the two subsequent and two 1990.11 The resulting database included 16 studies preceding years. A recession is defined as the with a total of 83 individual coefficient estimates period from a business cycle peak to a trough. An covering 20 emerging market and developing expansion is the converse, the period from a countries (Annex Table 3.3.1). business cycle trough to its peak. A recovery is the early part of an expansion and is defined as the Definitions matter. Differences in estimates of the period from the business cycle trough to the year incidence of informal employment and the wage in which the output level recovers to that of the differentials between formal and informal workers most recent business cycle peak (Claessens et al. in part reflect differences in data coverage and 2012). The main characteristics of recessions and definitions of informal workers.12 Self-employed recoveries include duration and speed of workers constitute the core of informal adjustment (often termed as “slope”) are defined employment since they typically lack registration as in Claessens et al. (2012). at the national level, do not contribute to social security and are not entitled to paid annual and  Duration captures, for a recession, the period sick leave.13 However, not all informal workers are from peak to trough, for a recovery, the self-employed, while the informal sector itself may period it takes for output to return to its pre- be divided into several tiers such as informal self- trough peak, and for an expansion the period employed entrepreneurs or professional workers from trough to peak.  Speed of adjustment (“slope”) measures the speed of a cyclical phase and is defined as the 10 Covered online databases include EconLit, JSTOR, EBSCO, ratio of amplitude over duration for a Google Scholar, RePEc, Social Science Research Network (SSRN), the National Bureau of Economic Research (NBER), World Bank recession and the ratio of the change from the Policy Research Working Paper Series, International Monetary Fund trough to the last peak divided by the Working Paper Series, and IZA Working Papers. duration for a recovery (Claessens et al. 2012). 11 Prior to 1990, reliable and comparable individual or household level survey data, which is used to estimate wage gaps between the formal and informal sectors, is very limited for developing countries. 12 Perry et al. (2007), Hussmanns (2004), ILO (2013). 13 According to ILO 2018, nearly 90 percent of all own-account workers—the largest component of self-employed, in the emerging markets and developing economies—are in the informal sector ac- counting for over 45 percent of all informal jobs. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 181 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 and   informal non-professional employees.14 In   and informal jobs (Pratap and Quintin formal developing economies, about half of informal 2006). workers are non-professional self-employed workers—who migrate to formal employment as Meta Regression Analysis of informal-formal per capita incomes grow—­­and the majority of wage gap. A random-effects model assumes that the remainder are informal employees (Gindling, there is a distribution of true effects rather than a Mossaad and Newhouse 2016). Studies typically common fixed effect across the studies find that self-employed informal workers earn the (DerSimonian and Laird, 1986). In particular, a same or more than formal workers, but employed study-specific estimate of the informal-formal informal workers earn less than formal workers, wage gap has a sampling distribution especially in the lower tail of the wage distribution where σ2 is the within study (Figure 3.8).15 Given data constraints, most variance of the estimate due to a sampling error; studies on wage differentials between formal and while the true effect has the following distribution informal sectors look at gross reported earnings. . Meta-analysis pools information Several studies use imputed net wages calculated across many studies to estimate μ and τ2, where τ2 based on the national income tax tables. Their measure the degree of across-study variations.17 conclusions are broadly in line with the rest of the The proportion of total variation in study literature (El Badaoui et al. 2008, 2010). estimates is equal to I2=τ2/(τ2+σ2) and reflects the impact of across-study heterogeneity (Higgins and Methodology matters. Empirical research of the Thompson, 2002). The meta-regression analysis wage differential between informal and formal (MRA) can be performed to associate this workers has largely relied on estimating variation with any characteristics of the study or “Mincerian” wage regressions conditional on the sample. observed characteristics of workers, although more recent studies have used quantile regressions to The MRA of estimated wage differentials between assess sector wage gaps along the wage formal and informal jobs uses estimates of the distribution.16 Such cross-sectional wage wage gap drawn from each study as the dependent regressions are biased when workers’ unobserved variable. The set of regressors, or moderator characteristics affect both their choice of sector variables, includes study characteristics that are and their wage. For example, several studies find deemed consequential for the reported results, for workers transitioning from the formal sector into example, identification and estimation methods, the informal sector after spending several years study design and data sources. This, in particular, accumulating experience and knowledge in the helps clarify the diversity of research outcomes on formal sector (Maloney 2004, Gong et al. 2004). the size of the informal-formal wage gap and Hence, studies that rely on panel data to control identify the sensitivity of reported wage gaps to for time-invariant unobserved worker study-specific methods and data. A random-effects characteristics find much smaller informal-formal MRA is performed by estimating the following wage differentials (Badaoui et al. 2008, Cho and regression: Cho 2011, Botelho and Ponczek 2011). Similarly, semiparametric matching methods, such as propensity score matching and difference-in- difference estimators that are immune to the Where is a study-specific estimate of the misspecification of the wage regressions, find informal-formal wage gap, ∈i is a sampling error modest or insignificant wage differentials between with a standard deviation that may vary across 14 Fields (1990, 2005), Cunningham and Maloney (2001), Günther and Launov (2006). 17 The random-effects meta-analysis estimate is a special case of a 15 Arias and Khamis (2008), Nguyen et al. (2013), Lehmann and generalized method of moments estimator, where each estimate is Pignatti (2007) and Maloney (1999). weighted proportionally to its sampling error. Thus, it can only be 16 Tansel and Kan (2012), Lehmann and Zaiceva (2013), Bagain applied to studies that reported standard errors of their inform-formal and Kwenda (2014). wage gap estimates EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 182   studies, ϑi is an error term reflecting across-study   and the latest year, in percentage points, (over the variation of true effects with a constant across- period 2011-2016). The average measure for pre- study variance τ2; finally, the set of moderator existing informality in country i (i.e. ) variables, X, includes: over the period 1990-2005—including the share of DGE/MIMIC-based estimates of informal  A dummy variable accounts for differences in output in official GDP, the share of self-employed methodology: FEi is 1 if fixed effects were used in employed, — is the variable of interest. The to correct for unobserved workers’ initial condition of poverty or income inequality characteristics and 0 otherwise. (Initial yi, i.e. the level of poverty / income inequality in the earliest available year between  Two dummy variables reflect the gender 1990-2005) and GDP per capita (Initial GDPpci , composition of the sample: FEMALEi is 1 if i.e. the level of real GDP per capita in the earliest estimates were obtained for female workers available year between 1990-2005) are controlled only and 0 otherwise, MALEi is 1 if estimates for. were obtained for male workers only and 0 otherwise, the reference category for this set of The proxies for poverty and income inequality dummy variables are estimates obtained with (Gini coeffieicent) are taken from World samples containing both female and male Development Indicators (WDI). The former is workers. Poverty headcount ratio at $1.90 a day (2011 PPP), percent of population.  Regional dummy variables are included to account for regional heterogeneity. ANNEX 3.5 Labor legislation and  Self‐employedi is a dummy variable indicating informality that a study measured the wage gap between self-employed and formal employees. The implications of labor market deregulation for informality can be traced out in the theoretical The sample coverage is reported in Annex Table model of Loayza (2016). It is shown that 3.3.1, while the regression results are reported in minimum wage restraint will speed up Annex Table 3.3.2. formalization of economies in Europe and Central Asia and Middle East and North Africa and ANNEX 3.4 Pre-existing informality modernization—whether informal or formal—of and changes in poverty and economies in South Asia and Sub-Saharan Africa. income inequality Theoretical mechanism for empirical link Following Loayza, Serven and Sugawara (2009), Loayza (2016) develops a theoretical model that the following OLS model is estimated to gauge the traces informality, government regulations, impact of informality on changes in poverty and economic growth and urban migration through income inequality: the process of development. The model highlights the doubly distortionary effect of the minimum wage on labor misallocation and on capital The results are reported in Annex Table 3.4.1. accumulation. A higher minimum wage slows Dependent variable ( ) in Column [1]-[3] is capital accumulation and pushes workers into the annual change in poverty headcount ratio (i.e. informal economy. Poverty headcount ratio at $1.90 a day (2011 A developing economy can be interpreted as PPP), percent of population) over the earliest year consisting of two coexisting economies: a modern and the latest year, in percentage points, in economy that is organized in firms using a high- country i (over the period 2011-2016). In productivity technology and employing both Column [4]-[6], the dependent variable ( ) is capital and labor and a rudimentary, informal annual change in Gini index over the earliest year economy that represents the self-employed using EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 183 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 only   labor with a low-productivity technology. over 2015-2035   is considered for two scenarios.21 The modern economy, itself, consists of two sectors: a capital-intensive modern formal sector  Baseline scenario. The minimum wage rises at that complies with government-mandated labor the rate of labor productivity. costs including the minimum wage; and a modern  Reformist scenario. The minimum wage rises informal sector that is less capital intensive, pays one percentage point more slowly than labor low labor costs and high capital costs and productivity growth. produces with lower productivity by contravening labor regulations. The outcomes of both scenarios depend on the initial conditions of the country, future A developing economy passes through three stages population and TFP growth rates, and the rate of of development as it becomes richer. In the first change of the minimum wage.22 In the baseline phase, modern informal employment expands as scenario, the minimum wage is assumed to grow falling relative cost of urban living encourage rural in line with labor productivity growth, such that workers (in the rudimentary informal sector) to informal rudimentary employment shrinks while migrate to cities. In the second phase, rural-urban the formal and informal modern employment migration slows, the relative shares of the modern expand at a similar rate. In the reformist scenario, informal and formal sectors stabilize, but the slower minimum wage growth will speed up relative size of the rudimentary informal sector capital accumulation, increase rural-urban shrinks.18 In the third phase, modern informal migration, raise capital-labor ratio, reduce the employment declines as rural-urban migration wage distortion created by the minimum wage, stalls and a rising capital-labor ratio reduces the and result in an expanding modern and formal relative (and absolute) size of the modern informal sector. sector.19 Global implications in theory: Employment in Theoretical impact of changes in minimum the modern economy. On average, in both the wages on informality baseline and reformist scenarios, the employment The model provides a framework for tracing out share of the modern economy is predicted to the implications for growth and informality of expand, by, respectively, 18 (more than one- changes to labor market regulations, here quarter) and 23 (more than one-third) percentage represented by the minimum wage.20 When the points (Annex Figure 3.5.1). In both scenarios, minimum wage is higher than the unregulated capital accumulation attracts rural workers from market wage, it creates a distortion in the labor the rudimentary informal sector, reduces the wage market, which moves labors to the modern distortion created by the minimum wage, and informal sector where the minimum wage is not results in allocating more labor in the modern binding. For 127 economies, of which 28 are formal sector. In the baseline scenario, capital advanced and 99 are EMDEs, the evolution of the accumulation encourages rural-urban migration relative size of informal output and employment and modern employment. Employment in both formal and informal modern sectors grow at similar rates. As a result, share of informal modern 18 The relative shares of modern informal sector remain stable due employment in modern employment remains to the constant urban capital-labor ratio during the second phase. steady but its share in total (modern and 19 The size of the modern informal sector diminishes when the rudimentary) employment increases by 9 rate of natural increase in urban population is not too large and when percentage points. the minimum legal wage is no longer binding. 20 The relative sizes of different sectors are projected using the parameter values, population projections and total factor productivity growth from Loayza and Meza-Suadra (2016). 2015 is taken as the starting year and the relative sizes of the three sectors are projected for year 2015-2035. The real cost of capital are assumed to match labor 22 The initial conditions include the capital stock, total factor productivity growth. productivity, and the labor force, and the share of formal and 21 The country classification is listed in Annex 3.5.1. See Loayza informal labor, both rudimentary and modern (See Loayza 2016 for (2016) for the list of countries. details). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 184 ANNEX FIGURE   3.5.1 Implications of relaxing the   In the reformist scenario, the slower growth in the minimum wage restraint minimum wage encourages faster capital Over the next two decades, according to the model, the employment share accumulation and migration to the modern of the modern economy is expected to expand. In the baseline scenario, economy, which speeds up the modernization the informal economy would grow faster than the formal economy, whereas process. Minimum wage growth below the informal economy would shrink in the minimum wage restraint scenario. The theoretical model suggests that lowering the minimum wage would productivity growth in the formal sector gradually speed up formalization in regions like Europe and Central Asia and Middle widens the wage gap between the formal and East and North Africa and accelerate economic modernization in South informal wages in the modern sector and Asia and Sub-Saharan Africa. encourages more formal, modern employment. As A. Employment composition, 2015 B. Employment composition, 2035 a result, the share of formal modern employment in modern employment rises by 22 percentage points and the share of formal modern employment in total (modern and rudimentary) employment increases by 33 percentage points. Differences between advanced economies and EMDEs. Advanced economies have small rural and modern informal sectors compared with C. Employment composition, 2015 D. Employment composition, 2035: EMDEs, to begin with. The rural sector is already Baseline scenario negligible in advanced economies, accounting for 9 percent of employment, whereas it accounts for 44 percent of employment in EMDEs. The modern informal sector already accounts for a similarly modest 8 percent of employment in advanced economies, but 28 percent of employment in EMDEs. Under the baseline scenario, and even more quickly and comprehensively under the reformist scenario, the E. Employment composition, 2035: F. Average output growth, 2015-35: modern informal and rudimentary sectors will Reformist scenario Baseline and reformist scenario virtually disappear in advanced economies, together accounting for about 10 percent of employment from 18 percent initially. In EMDEs, the rural sector will continue to play an important, albeit shrinking, role, accounting for 15-22 percent of employment. Rural-urban migration will continue to fuel the expansion of the modern economy, but only in the reformist scenario will Sources: World Bank staff calculation using the model of Loayza (2016). this migration ensure that the modern formal Notes: “MF” stands for employment in the modern formal sector (in orange), “MIF” stands for sector grows more rapidly than the modern employment in the modern informal sector (in red), while “RIF” stands for employment in the rudimentary informal sector (in blue). The relative sizes of different sectors are projected using the informal sector. parameter values, population projections and total factor productivity growth from Loayza (2016). Under the baseline scenario, the minimum wage rises at the rate of labor productivity. Under the reformist scenario, the minimum wage rises one percentage point more slowly than the rate of labor Differences across EMDE regions. EMDE regions productivity growth. 2015 is taken as the starting year for the projection exercise. “Advanced economies” represents the unweighted average of the 28 advanced economies in the sample, while differ widely in their initial conditions, hence also “EMDEs” represents the unweighted average of the 99 emerging markets and developing economies in the sample. These group averages are calculated for East Asia and Pacific (EAP), Europe and in the implications of policy changes. In 2015, Central Asia (ECA), Latin America and Caribbean (LAC), Middle East and North Africa (MNA), South Asia (SAS), and Sub-Saharan Africa (SSA). Sub-Saharan Africa (SSA) and South Asia (SAR) A. The stacked bars show the average employment shares in 2015 for each sector in advanced economies and in EMDEs. had large rural economies, accounting for more B. The stacked bars show the average employment shares projected for 2035 in advanced than 60 percent of employment, whereas Europe economies and in EMDEs. C. The stacked bars show the average employment shares across all EMDE regions in the sample for and Central Asia (ECA) and the Middle East and each sector in 2015. D.E. The stacked bars show the average employment shares across all EMDE regions in the sample North Africa (MNA) had predominantly modern for each sector in 2035 under baseline and reformist scenario. economies, which accounted for about 80 percent F. The diamond shows average annual GDP growth between 2015-35 across all EMDE regions for the reformist scenario. The blue bars show the growth rate for the baseline scenario. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 185 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 of employment.   Over the next two decades, economy   is almost coming to a halt and further reformist or baseline policies would reduce the capital accumulation will raise the unregulated share of rural employment in SSA below the market wage, making minimum wage no longer current EMDE regional median and would binding in the formal modern sector and virtually eliminate rural employment in ECA and allocating more labor in the formal modern sector. MNA (under reformist policies, also in East Asia The reformist scenario could raise growth by 0.1- and Pacific, EAP, Latin America and the 1.2 percentage point per year over the baseline Caribbean, LAC, and South Asia, SAR). The scenario. In SAR and SSA, the reformist scenario reformist scenario would speed up this could generate the largest boosts to output growth formalization process, especially in MNA and because of their initially large rural sectors increase LAC, where the migration to the modern the potential for rural-urban migration. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 186   types of firms (Percent)  ANNEX  TABLE 3.1 Labor productivity differential between Informal firms Manager has Informal versus Main own- Services Firm has Single-employee Young firm higher formal firms er is male sector bank loan firm (<=5 years) education Angola 45.8 70.0 44.9 -60.0 225.0 20.0 -75.5*** Argentina 25.0 200*** 0.0 0.0 11.1 -16.7 -92.5*** Burkina Faso -6.2 -6.2 28.6 6.7 66.7 -10.0 -79.8*** Botswana 89.4* 72.7** -29.1 100.0 -35.0 -18.2 -89.8*** Côte d'Ivoire 0.0 25.0 66.7** -40.0 50.0 40.0 -47.5* Cameroon -41.7* 36.4 77.8** -24.0 140.0*** 56.2** -55.8*** Congo, Dem. Rep. 33.3 0.0 36.0** 50.0 50.0*** 0.0 10.7 Cabo Verde 133.3 -25.0 185.7 1585** 566.7* 100.0 0.89 Ghana 0.0 12.5 0.0 25.0 66.7*** 0.0 -51.8*** Guatemala 25.0 46.7*** 33.3** 50.0 57.1*** -20.0 -86.0*** Kenya 50.0*** 6.7 -40*** 44.0** 12.0 -20.0** -81.6*** Madagascar 40.0 -33.3 100*** 33.3 60.0* 8.3 -88.1*** Mali 13.2 14.3 -19.4 31.4 57.1 -46.2** -71.3*** Myanmar 80.0* -11.1 63.6*** 11.3 31.2 0.0 -89.1*** Mauritius 66.7* 6.7 114.3*** 25.0 6.7 25.0 -82.9*** Nepal 11.1 0.0 0.0 33.3 150.0*** -16.7 -56.5*** Peru 28.6* 12.5 -50*** -11.1 2.9 -7.4 -74.2*** Rwanda 50.0*** 28.6** 25.0* -25.9 50.0*** -11.1 -91.4*** All countries 48.1*** 10.2 8.2 20.0** 41.2*** -6.7 -79.4*** Source: World Bank. Note. Productivity differential between the median informal and the median formal firm (last column) or between median informal firms among different groups of firms (all other columns). For example, “Manager has higher education” shows the difference in the median productivity among informal firms with managers with higher education and the median productivity among informal firms with managers without higher education. Other firm characteristics are not controlled for, hence results are similar but not identical to column (1) in Annex Table 3.2. Productivity is defined as annual sales (in 2009 U.S. dollars) relative to the number of workers. “All countries” is the unweighted average across each column. ***, **, * indicates statistical significance at the 1, 5, and 10 percent level. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 187 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 ANNEX   TABLE 3.2 Labor productivity of formal and informal   firms  (1) (2) (3) (4) (5) Informal firm Y:1 N:0 -1.400*** -0.648*** -1.131*** -1.200*** -1.008*** (0.091) (0.184) (0.131) (0.121) (0.160) Firm age (logs) 0.120*** 0.285*** 0.118*** 0.116** 0.137*** (0.045) (0.053) (0.045) (0.045) (0.045) Firm size (logs, workers) -0.102*** -0.119*** -0.056* -0.104*** -0.108*** (0.027) (0.027) (0.032) (0.028) (0.028) Manufacturing Y:1 N:0 -0.402*** -0.407*** -0.401*** -0.401*** -0.399*** (0.056) (0.056) (0.056) (0.056) (0.056) Capital city Y:1 N:0 0.201*** 0.190*** 0.187*** 0.394*** 0.201*** (0.061) (0.061) (0.061) (0.087) (0.061) Manager experience (logs, years) 0.094** 0.141*** 0.107*** 0.091** 0.190*** (0.040) (0.041) (0.040) (0.040) (0.055) Informal firm * Firm age (logs) -0.353*** (0.069) Informal firm * Firm size (logs, workers) -0.208*** (0.066) Informal firm * Capital city Y:1 N:0 -0.360*** (0.114) Informal firm * Manager experience -0.176*** (logs, years) (0.060) Country fixed effects Yes Yes Yes Yes Yes Constant 9.013*** 8.552*** 8.859*** 8.909*** 8.748*** (0.131) (0.164) (0.149) (0.139) (0.162) Number of observations 10,527 10,527 10,527 10,527 10,527 R2 0.291 0.296 0.293 0.293 0.292 Source: World Bank. Note: Standard errors in brackets. Significance is denoted by *** (1 percent), ** (5 percent), * (10 percent). OLS regression with labor productivity as dependent variable, as proxied by annual sales (in 2009 U.S. dollars) per worker, based on a sample using World Bank’s Enterprise Survey data collected during 2007-14 for 4,036 informal firms and 7,558 formal firms in 18 countries. “Informal firm” is a dummy variable taking the value of 1 if a firm is unregistered and 0 otherwise. “Manufacturing” is a dummy variable taking the value of 1 if a firm operates in the manufacturing sector and 0 otherwise. “Capital city” is a dummy variable taking the value of 1 if a firm is located in the capital city and 0 otherwise. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 188  ANNEX TABLE 3.3 Labor productivity of formal firms   facing informal competition   (1) (2) (3) (4) (5) Informal Competition -0.268*** -1.642*** -1.919*** -0.574*** -1.657*** (Proportion of firms in the cell that report competing with (0.067) (0.602) (0.618) (0.059) (0.307) informal firms) Number of workers (logs) -0.197*** -0.150*** -0.175*** -0.166*** -0.179*** (0.016) (0.017) (0.019) (0.019) (0.020) Firm's age (logs) 0.208*** 0.215*** 0.296*** 0.286*** 0.356*** (0.023) (0.026) (0.032) (0.029) (0.032) Firm belongs to manufacturing sector: Yes 1 No 0 0.137*** 0.077* 0.164*** 0.157*** 0.139*** (0.044) (0.046) (0.052) (0.048) (0.053) Firm belongs to retail sector: Yes 1 No 0 0.695*** 0.747*** 0.896*** 0.862*** 0.879*** (0.045) (0.047) (0.053) (0.049) (0.054) Top manager is female: Yes 1 No 0 -0.051 -0.125** -0.128* -0.086 -0.063 (0.048) (0.058) (0.073) (0.067) (0.070) Exports (proportion of sales) 0.268** 0.403*** 0.431*** 0.385*** 0.397*** (0.114) (0.117) (0.145) (0.133) (0.148) Firm has foreign owners: Yes 1 No 0 0.638*** 0.836*** 0.821*** 0.658*** 0.781*** (0.063) (0.062) (0.070) (0.066) (0.074) Log GDP per capita (PPP, 2009 Int'l Dollars) 0.631*** (0.043) Informal Competition * Log GDP per capita 0.138** (0.067) Distance to Frontier (Doing Business) 0.031*** (Higher values imply better regulatory practices) (0.006) Informal Competition * DTF 0.022** (0.010) Corruption (Governance Indicators) 0.574*** (Higher values imply less corruption) (0.048) Informal Competition * Corruption 0.177** (0.085) Business Freedom index (Economic Freedom of the World) 0.015*** (Higher values imply less regulation and more freedom for businesses) (0.003) Informal Competition*Business Freedom index (Economic Freedom of the World) 0.016*** (0.005) Constant 8.771*** 3.818*** 7.469*** 9.410*** 8.163*** (0.178) (0.390) (0.381) (0.088) (0.224) Country fixed effects YES NO NO NO NO Number of observations 45,996 45,996 44,770 45,996 43,760 R-squared 0.404 0.259 0.184 0.191 0.154 Source: World Bank. Note: Standard errors in brackets. Significance is denoted by *** (1 percent), ** (5 percent), * (10 percent). OLS regression with labor productivity as dependent variable, as proxied by annual sales (in 2009 U.S. dollars) per worker, based on a sample of formal firms only using World Bank’s Enterprise Survey data collected during 2007-14 for 4,036 informal firms and 7,558 formal firms in 18 countries. “Informal competition” is the share of firms in a cell (a group of firms of similar size in the same region and sector) that report competition from informal firms. It is worth mentioning that one could use a firm-level dummy rather than the proportion of formal firms in a cell to proxy informal competition. However, endogeneity concerns may arise because the informal competition faced by a specific firm may also be driven by its productivity. Therefore, the proportion of formal firms facing informal competition in a cell, which would be uncorrelated with the productivity of a specific firm, should be more robust to endogeneity concerns. “Manufacturing” is a dummy variable taking the value of 1 if a firm operates in the manufacturing sector and 0 otherwise. “Capital city” is a dummy variable taking the value of 1 if a firm is located in the capital city and 0 otherwise 189 Study Country Years Methodology Policy change Estimated impact as expected Tax reforms ANNEX CHAPTER 3 YES. The introduction of preferential tax regimes for micro and small Introduction of preferential tax regimes Bruhn and Regression Discontinuity businesses in 2010 increased the number of newly registered formal firms Georgia 2010 for micro and small businesses in Loeprick (2014) Design (RDD) regression by 18-30 percent below the eligibility threshold during the first year of the 2010. reform. No significant effect was seen in subsequent years. YES. SIMPLES raised the proportion of firms that have a license to operate Fajnzylber, The SIMPLES program introduced in by 4.5 percent (20.8 to 25.3 percent), are registered as a legal entity, pay Maloney and November 1996 consolidated multiple taxes and make social security contributions. Newly created firms (with OLS regression on firm- taxes and social security contributions employees) that opted for operating formally achieved higher levels of Rojas (2011); Brazil 1996 level survey data into a single payment and reduced tax revenue and profits, employed more workers and were more capital Maloney and burdens (on average 8 percent) for intensive. This occurred, not through greater access to credit or contracts Mendez (2004) eligible small firms. with larger firms, but through lower cost of contracting labor that allowed the adoption of more productive technologies.   TABLE 3.4 Survey of policy changes The GST reform introduced in 2017 simplified the taxation of goods and YES. The GST reform reduced the percentage of informal firms by 50 Keats (2017) India 2017 descriptive services and reduced the incidence of percent. taxation from 26.5 percent to 15-20   percent. The fiscal reform implemented in 2001 reduced payroll and social taxes. The Slonimczyk Difference-In-Differences YES. The tax reform reduced the share of informal labor. The decline was Russia 2001 reform lowered the average personal (2012) (DID) estimation sharpest among individuals with the largest gains from the tax reform. income tax (PIT) to a flat rate of 13 percent. TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) YES. In a context of weak enforcement and widespread informality, an The tax reform implemented in 2009 increase in the tax rate (from 5 to 25 percent) on noncorporate partnership Difference-In-Differences raised the income tax rate on earnings EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL Waseem (2018) Pakistan 2009 income led firms to report significantly lower earnings (roughly half), (DID) estimation for noncorporate partnership firms migrate into informality, and switch business form to avoid the additional tax from 5 to 25 percent. burden. GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 Study Country Years Methodology Policy change Estimated impact as expected Regulatory (labor and business) reforms   The constitutional reform in 1988 cut YES. A large fraction of the 10 percentage point rise in informal Bosch, Goni and Mid 1980s Cross-section weighted maximum work hours, raised vacation ANNEX TABLE Brazil employment in Brazil during 1990-2000 was driven by rising labor costs and Maloney (2007) and 1990s least squares pay, extended maternity leave, and reduced flexibility. raised dismissal cost. Betcherman, YES. Employment subsidies significantly raised the number of registered 2004 and Difference-In-Differences Two employment subsidy schemes Daysal and Turkey jobs in eligible provinces (5-13 percent for the first program and 11-15 2005 (DID) estimation were introduced in 2004 and 2005. Pages (2010) percent for the second). YES. The fiscal decentralization led to a sharp increase in the real value of As part of fiscal decentralization, the the minimum wage. District-level survey data suggests that an increase in central government transferred Comola and Mello seemingly unrelated the ratio of the minimum wage to the mean wage by 10 percentage point Indonesia 1996 to 2004 minimum-wage setting responsibilities (2011) regression (SUR) was associated with a rise in informal sector employment by 0.9-1.1 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 to provinces and local governments percentage point and a drop in formal sector employment by 0.5-0.7 after 2001. percentage point. 3.4 Survey of policy changes (continued)   YES. From 1999 to 2009, the labor force surged (up by 35 percent) in a fast -growing Vietnamese economy (with 78 percent increase in GDP per McGraig and Labor market reforms in 2006 1999 to 2009 capita). This economic upturn led to a contraction of the informal established a new flexible system in Pavcnik (2015); Vietnam and 2005 to Linear probability model employment (from 86 to 79 percent). Younger and more educated male which minimum wages vary according and Boly (2018) 2013 workers were more likely to migrate from informal to formal activities, in to location and sector of employment. sharp contrast to older and poorly educated females. Firms opting out of informality achieved higher profit and greater value added. The major deregulation in 1991 in YES. Informality dropped, and the reduction in informality was greatest in OLS regression on firm- India removed license requirements states with more pro-employer labor laws. In states with pro-employer labor Sharma (2009) India 1988 to 2000 level survey data on the setup and expansion of laws, the number of informal establishments declined by 25 percent more factories in nearly half of all industries. than in states with less flexible labor laws. TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL YES. SARE was exclusively implemented for eligible low-risk industries The business registration reform such as commerce and restaurants, excluding high-risk industries (e.g., established a Rapid Business Opening Bruhn (2011); OLS regression on firm- chemical plants, transportation). The reform induced a 5 percent increase in Mexico 2002 to 2006 System (SARE) in various (2013) level survey data the number of registered businesses. This increase was mainly driven by municipalities in Mexico from 2002 to former wage earners switching from ineligible industries to launch eligible 2006. businesses, rather than the registration of existing informal businesses. CHAPTER 3 190 191 Study Country Years Methodology Policy change Estimated impact as expected Trade liberalization ANNEX CHAPTER 3 In addition to major changes in Bosch, Goni Mid 1980s Cross-section weighted labor legislation, the constitutional YES. A small fraction of the 10 percentage point rise in informal employment in Brazil and Maloney Brazil and 1990s least squares reform in 1988 introduced trade during 1990-2000 was driven by trade liberalization in the mid1980s and 1990s. (2007) liberalization policies. Goldberg and Pavcnik (2003); YES. Employment informality expanded (i.e. a 1-percentage point decline in a tariff in a Two-step restricted Trade liberalization measures 1980s and given industry is associated with a 0.1 percentage point increase in the probability of Attanasio, Colombia least squares were implemented in the 1980s 1990s informal employment), but only for the period preceding a major labor market reform Goldberg and estimation and 1990s. that increased labor market flexibility. Pavcnik (2004) Waves of trade liberalization in MIXED (YES in 1998, NO in 2004). The impact depended on the observation period 1998 and 2004 reduced tariffs OLS regression on and the degree of labor market rigidity. Trade liberalization reforms increased Selwaness and 1998 and nearly by 70 percentage points, Egypt individual-level survey informality among workers in 1998, but lowered the likelihood of informal employment Zaki (2015) 2004 from 110 percent at the end of the data post-2004. This difference may be attributed to labor reforms implemented in 2003 that 1980s to reach 40 percent by the added flexibility to the market during the second wave liberalization. end of 1990’s.     TABLE 3.4. Survey of policy changes (continued) NO. Evidence from household surveys in 2001/2002 and 2003/2004 shows that US tariffs reduction (20.9 percent average annual drop) induced a sharp increase in exports to the US, which grew from 3.6 to 10.4 percent of Vietnam’s GDP. This positive 2001/2002 US-Vietnam bilateral trade export shock generated 5 percentage point increase in the share of manufacturing McCaig, on household survey Vietnam and agreement (BAT) went into effect workers in the formal sector. In addition, the prevailing labor productivity gap of 3.7 Pavcnik (2018) data 2003/2004 in 2001. (when heterogeneity and measurement errors are accounted for) between the informal and the formal sector induced a reallocation of labor towards the formal sector, and increased the aggregate labor productivity within manufacturing by 2.8 percent per year. Source: World Bank. TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) YES (NO) means that the outcome of a policy intervention is (not) consistent with the expected impact. MIXED means that the outcome of a policy intervention varies over time. The expected impacts of reforms are: (i) reduced tax burden would reduce informality; (ii) increased labor market flexibility would reduce informality; (iii) lowered entry and exit barriers in formal sector would reduce informality; (iv) trade liberalization would increase informality due to intense foreign competition that disrupts existing formal firms. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 192 ANNEX  TABLE 3.1.1 Data coverage   Estimation # of Aspect Measures # of AE Time period method EMDE DGE (percent of GDP) 36 122 1950-2016 Indirect Output MIMIC (percent of GDP) 36 124 1993-2015 Pension coverage (percent of labor force) 23 34 1990-2010 Labor Force Surveys Employment Self-employment (percent of total employment) 37 86 1955-2016 Informal employment (percent of total employment) 0 30 2001-2016 Direct (Survey-based) Employment outside the formal sector (percent of total employment) 0 32 1999-2016 (a) WEF(1-7=Most informal) 36 111 2006-2016 WB: percent Competing against informal firms 7 46 2006-2016 Firm surveys Perception WB: percent firms formally registered when founded 7 46 2006-2016 Firms WB: Number of years operated without registration 7 46 2006-2016 WB: percent firms that found competitors in the informal sector as a constraint 7 46 2006-2016 HS (b) WVS: Justifiable (Cheating on taxes) 20 43 1981-2010 Notes: DGE is benchmarked to Schneider et al. (2010). World Value Survey (WVS) asks whether cheating on taxes is justifiable (1 is “never justifiable” and 10 is “always justifiable”) and reports average responses at the country-year level, with a higher level suggesting that the country is more tolerant towards the informal sector. World Economic Forum (WEF) asks “In your country, how much economic activity do you estimate to be undeclared or unregistered? (1= Most economic activity is undeclared or unregistered; 7= Most economic activity is declared or registered)” and reports average responses at the country-year level. Here the average responses have been reordered to make “7= Most economic activity is undeclared or unregistered; 1= Most economic activity is declared or registered” where a higher level suggesting a larger informal sector in the country. The WEF data for year 2004 and 2005 are dropped since different ordering were used before 2006, which makes the numbers incomparable over time. WB shows the results for World Bank Enterprise Surveys. “HS” stands for “Household surveys”. “(a)” stands for “Output, and “(b)” stands for “Opinions/Tax Morality”. Detailed information is listed in Table A.1. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 193 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 ANNEX   TABLE 3.1.2. MIMIC model estimation results  (1993-2015) [1] [2] [3] [4] [5] 88 Developing 98 Developing 120 Countries 151 Countries 161 Countries Countries Countries Size of government 0.133*** 0.143*** 0.157*** 0.152*** 0.145*** (0.023) (0.021) (0.024) (0.019) (0.019) Share of direct taxation 0.035 0.009 (0.023) (0.022) Business Freedom 0.035 0.040** 0.058** (0.021) (0.020) (0.024) Fiscal Freedom 0.002 -0.010 -0.038 (0.023) (0.020) (0.025) Unemployment rate 0.078*** 0.105*** 0.055** 0.067*** 0.066*** (0.023) (0.021) (0.022) (0.019) (0.019) GDP per capita -0.342*** -0.324*** -0.393*** -0.381*** -0.385*** (0.035) (0.027) (0.029) (0.022) (0.022) Government effectiveness -0.069*** -0.043** -0.042** (0.020) (0.018) (0.018) Growth rate of GDP per capita -0.835*** -0.618*** -0.362*** -0.310*** -0.306*** (0.119) (0.085) (0.079) (0.064) (0.064) Labor force participation rate -0.321*** -0.219*** -0.167*** -0.155*** (0.091) (0.073) (0.053) (0.052) Growth rate of labor force -0.091 (0.064) Currency (M0/M1) 1.000 1.000 1.000 1.000 1.000 (0.000) (0.000) (0.000) (0.000) (0.000) Statistical tests RMSEA 0.061 0.057 0.070 0.087 0.089 p(RMSEA<=0.05) 0.097 0.190 0.002 0.000 0.000 Chi^2 (p) 63.922 (0.00) 60.646 (0.000) 124.517 (0.000) 153.29 (0.000) 160.63 (0.000) AIC 27388.448 33527.217 41436.305 43231.405 44080.904 BIC 27464.278 33602.241 41522.616 43306.446 44156.205 CFI 0.820 0.852 0.761 0.771 0.764 TLI 0.685 0.734 0.590 0.571 0.558 SRMR 0.033 0.030 0.041 0.046 0.047 CD 0.846 1 1 1 1 Observations 1,159 1,570 1,627 2,374 2,422 Note: Absolute z-statistics in parentheses. ***, **, * denote significance at the 1, 5, and 10percent significance levels. All variables are used as their standardized deviations from the mean. Data sources for variables used in the model are listed in Section II footnote 6. Following the MIMIC models’ identification rule, the currency (M0/M1) variable is fixed to an a priori value. The currency variable shows the level of money(cash) in circulation. “AIC” stands for “Akaike’s information criterion” and “BIC” stands for “Bayesian information criterion. “RMSEA” stands for “Root Mean Square Error of Approximation”. “TLI” stands for “Tucker Lewis Index”, “CFI” stands for “Comparative Fit Index”, “SRMR” stands for “Standardized Root Mean Square Residual”, and “CD” shows the coefficient of determination. These are goodness-of-fit statistics. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 194 ANNEX  TABLE 3.3.1 Database of studies for meta regressions   analysis Study Countries/Estimates Sample period Methodology Mean wage gap* Aydin et al. (2010) 1/4 1998-2007 OLS, ML logit 57.75 Badaoui et al. (2008) 1/17 2001-2003 OLS, DID, PSM 28.48 Badaoui et al. (2010) 1/6 1994 OLS, PSM 25.65 Bakaya and Hulagu (2011) 1/2 2005-2009 OLS, PSM 15.45 Bargain and Kwenda (2014) 3/6 2001, 2005 OLS, FE 19.19 Botelho and Ponczek (2011) 1/2 1995-2001 OLS, FE 11.76 Earle and Sakova (2000) 6/6 1993, 1994 ML Logit -13.33 Funkhouser (1997) 1/4 1991-1992 OLS 23.82 Gindling (1991) 1/1 1982 OLS 28.50 Huber and Rahimov (2014) 1/2 2007 OLS -34.98 Lehmann and Pignatti (2007) 1/2 2004 OLS -6.80 Lehmann and Zaiceva (2013) 1/5 2003-2011 OLS, QR, FE 6.90 Magnac (1991) 1/1 1980 OLS 30.30 Marcouiller et al. (1997) 3/6 1990 OLS 16.50 Nguyen et al. (2013) 1/4 2002-2006 OLS, FE 4.83 Nordmanet al. (2016) 1/6 2000-2004 OLS, FE 15.33 Paratap and Quintin (2006) 1/3 1993-1995 OLS, FE 28.49 Tansel and Kan (2012) 1/6 2006-2009 OLS, FE 11.56 Source: World Bank. Notes: OLS=pooled ordinary least squares, FE=fixed effects regression, ML logit=multinomial logit regression, PSM=propensity score matching, DID=difference-in-difference estimators, QR=quantile regression. The sample covers these EMDE countries: Argentina, Brazil, Columbia, Costa Rica, Czech Republic, Ecuador, El Salvador, Hungary, Madagascar, Mexico, Peru, Poland, Russian Federation, Slovakia, South Africa, Tajikistan, Turkey, Ukraine and Vietnam. *Average formal sector premium across all estimates, percent; a negative number indicates a wage penalty for formal sector workers. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 195 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 ANNEX   TABLE 3.3.2 Meta regression analysis summary   Moderator variables [1] [2] [3] [4] [5] [6] [7] [8] μ 0.195*** 0.11** 0.23*** 0.21*** 0.14*** 0.24*** 0.17*** 0.18*** (0.03) (0.04) (0.03) (0.03) (0.04) (0.04) (0.05) (0.06) Female 0.16* 0.15* 0.12 0.12 (0.08) (0.08) (0.08) (0.08) Male 0.14** 0.13** 0.11* 0.10 (0.06) (0.06) (0.06) (0.06) Fixed Effects -0.15** -0.13** -0.14** -0.13** -0.13** (0.07) (0.06) (0.06) (0.06) (0.07) Self-employed -0.34* -0.32** -0.25* -0.26* (0.14) (0.13) (0.14) (0.14) Latin America and the Caribbean 0.00 (0.07) Europe and Central Asia -0.03 (0.07) Adjusted R 2 7.8 5.8 6.4 12.0 11.4 14.8 12.4 Number of obs. 83 83 83 83 83 83 83 83 τ2 0.06 0.05 0.05 0.05 0.05 0.05 0.05 0.05 I2 99.6 99.5 99.4 99.5 99.4 99.4 99.4 99.1 Source: World Bank. Notes: *** p<0.01, ** p<0.05, * p<0.1; standard errors are in parenthesis. Within study standard errors of the estimates are used as weights to correct for the heterodasticity. The dependent variable is the informal-formal wage gap estimates by former studies (listed in Annex Table 3.3.1). - estimates of across-study variance. - residual variance due to study heterogeneity. τ2 captures the degree of across-study variations, and I2 reflects the impact of across-study heterogeneity. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 196 ANNEX TABLE   3.4.1 Pre-existing informality and changes  in poverty and income inequality: OLS [1] [2] [3] [4] [5] [6] Moderator variables Annual change in poverty Annual change in income inequality Initial poverty rate -0.024 -0.025 -0.029 -0.020 -0.020 -0.017 Initial Gini index [7.90]*** [7.94]*** [7.31]*** [-5.58]*** [-5.51]*** [-5.58]*** DGE 0.010 0.001 DGE [1.84]* [0.24] MIMIC 0.011 -0.000 MIMIC [1.83]* [-0.04] Self-employment 0.010 0.001 Self-employment [2.23]** [0.84] Constant -0.507 -0.533 -0.466 0.671 -0.705 0.534 Constant [2.13]** [2.13]** [2.81]*** [4.72]*** [4.91]*** [3.45]*** Observations 73 74 71 Observations 72 73 69 R-squared 0.48 0.47 0.45 R-squared 0.28 0.26 0.26 Source: World Bank. Note: Estimated by ordinary least squares method. Dependent variable in Column [1]-[3]: Annual change in poverty headcount ratio (i.e. Poverty headcount ratio at $1.90 a day (2011 PPP), percent of population) over the earliest year and the latest year, in percentage points. Dependent variable in Column [4]-[6]: Annual change in Gini index over the earliest year and the latest year, in percentage points. Annual change in poverty headcount ratio (i.e. Poverty headcount ratio at $1.90 a day (2011 PPP), percent of population) over the earliest year and the latest year, in percentage points. Initial poverty rate (or Gini index for Column [4]-[6]) is the earliest available year between 1990-2005. Informality indicators are averages over 1990-2005. *, **, and *** denote that the coefficients are statistically significant at the 10 percent, 5 percent, and 1 percent levels, respectively. Heteroskedasticity-robust standard errors are estimated with t-statisitcs presented below the corresponding coefficients. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 197 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2019   TABLE 3.5.1 Sample ANNEX   EMDEs (99) Advanced Economies (28) Angola Gambia, The Nigeria Australia Albania Ghana Oman Austria Algeria Guatemala Pakistan Belgium Argentina Guinea Panama Canada Bahamas, The Guinea-Bissau Paraguay Cyprus Bahrain Haiti Peru Denmark Bangladesh Honduras Philippines Finland Barbados Hungary Poland France Belize India Qatar Germany Benin Indonesia Romania Greece Bhutan Iran, Islamic Rep. Rwana Iceland Bolivia Iraq Saudi Arabia Ireland Botswana Jamaica Senegal Israel Brazil Jordan Sierra Leone Italy Brunei Darussalam Kenya South Africa Japan Bulgaria Kuwait Sri Lanka Korea, Rep. Burkina Faso Lao PDR St. Lucia Luxembourg Burundi Lebanon St. Vincent and the Grenadines Malta Cabo Verde Liberia Sudan Netherlands Cambodia Madagascar Swaziland Norway Cameroon Malawi Tanzania Portugal Central African Republic Malaysia Thailand Singapore Chad Mali Togo Spain Chile Mauritania Trinidad and Tobago Sweden China Mauritius Tunisia Switzerland Colombia Mexico Turkey United Kingdom Congo, Dem. Rep. Mongolia Uganda United States Congo, Rep. Morocco Uruguay Cote d'Ivoire Mozambique Venezuela, RB Dominican Republic Namibia Vietnam Ecuador Nepal West Bank and Gaza Egypt, Arab Rep. Nicaragua Zambia El Salvador Niger Zimbabwe Source: World Bank. Note: The country sample and classification are taken from Loayza (2016). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) GLOBAL ECONOMIC PROSPECTS | JANUARY 2019 CHAPTER 3 198 Costs.” Journal of Development Economics 133: 396-   References   414.Arvin-Rad, H., A. 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EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) CHAPTER 4 TWO TOPICAL ESSAYS: Debt in Low-Income Countries: Evolution, Implications, and Remedies Poverty Impact of Food Price Shocks and Policies EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 211 Debt in Low-Income Countries: Evolution, Implications, and Remedies Debt vulnerabilities in low-income countries (LICs) have increased substantially in recent years. Since 2013, median government debt has risen by more than 17 percentage points of GDP and increasingly comes from non -concessional and private sources. As a result, in most LICs interest payments are absorbing an increasing proportion of government revenues. The majority of LICs would be hard hit by a sudden weakening in trade or global financial conditions given high levels of external debt, lack of fiscal space, low foreign currency reserves, and undiversified exports. A proactive effort to reduce debt-related vulnerabilities is a policy priority for many LICs, and focus needs to be placed on domestic resource mobilization, strengthening management practices for debt and public investment, building more resilient macro-fiscal frameworks, and developing domestic financial systems. Introduction • What are the key characteristics of the recent rise in LIC debt? In recent years, many low-income countries • How does rising debt relate to other LIC (LICs) have gained access to additional sources of vulnerabilities? finance, including private and non-Paris Club creditors.1 While this has enabled these countries • How can better debt management help reduce to fund important development needs, it has also LIC vulnerabilities? led to higher levels of public debt. The increasing share of market-based debt exposes many LICs to • How can complementary policy measures interest rate, and refinancing risks. These trends reduce LIC vulnerabilities? take place as the external environment is becoming more challenging and borrowing costs Key characteristics of the are expected to rise around the world, as described recent rise in LIC debt in Chapter 1. This means that, in the event of an abrupt deterioration in market conditions, some A recent sharp rise. Debt relief under the Heavily LICs may struggle to refinance debts from foreign Indebted Poor Countries (HIPC) initiative and sources and are at risk of capital flow reversals and the Multilateral Debt Relief Initiative (MDRI) dislocating currency depreciations. In this context, helped to reduce public debt among LICs from a it is important for LICs to develop their domestic median debt-to-GDP ratio of close to 100 percent financial systems, strengthen capacity for domestic in the early 2000s to a median of just over 30 resource mobilization, improve macro-fiscal percent in 2013.2 This downward trend reversed frameworks, and improve their resilience to shocks sharply thereafter, with the median debt ratio through the sound management of public debt rising to above 50 percent by 2017 (Figure 4.1.1). and investment. The increase was large relative to other EMDEs, whose median debt rose by less than 11 percent of Against this backdrop, this Special Focus addresses GDP from 2013 to 2017, compared to 20 percent the following questions: for LICs. It was also broad-based: debt ratios rose in almost 90 percent of LICs, and a third experienced debt increases of more than 20 percentage points. is Special Focus was prepared by Sinem Kilic Celik and Patrick The key role of fiscal deficits. Primary fiscal Kirby in collaboration with Andre Proite and Sebastian Essl from the Global Macro and Debt Analytics Group of the Macro, Trade, and deficits had largely been closed among LICs by Investment Global Practice. 1 LICs refers to countries meeting the World Bank Group’s de nition of countries with per capita gross national income below 2 Most LICs—27 out of 33—benefited from either or both of the $995 per year in 2017. is group includes 33 countries (Annex 4.1). HIPC and MDRI programs. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 212 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 4.1.1 LIC government finances median LIC public investment as a share of GDP from 3 percent in 2000 to 6 percent in 2015. This LIC government debt ratios have risen since 2013, in part because of widening fiscal deficits, but still remain well below levels in the early 2000s. was the experience of Guinea-Bissau, Madagascar, Mali, and Nepal, where wider fiscal deficits were A. Gross government debt B. Gross government debt by LIC matched by higher public investment (IMF category 2018a). These countries form a minority, however, as a substantial part of LIC borrowing has been used to finance a rise in current consumption. In resource-intensive countries in Sub-Saharan Africa, for example, the bulk of increased spending enabled by a rise in commodity prices went to public sector wages (World Bank 2018c). Some borrowing may also have been redirected toward the accumulation of C. Primary fiscal balance D. LICs with largest increase in private assets stored abroad.3 government debt Dependence on external debt. Given their typically small local creditor base, a significant share of LIC borrowing comes from abroad and is denominated in foreign currencies. The resulting currency mismatch poses a challenge to LICs, as a depreciating currency can lead to a rise in the domestic value of the country’s debt burden and interest payments. This challenge is more severe in Sources: International Monetary Fund, World Bank. countries with a significant share of external debt A. Dashed blue lines denote the interquartile range, while the solid blue line is the median. A.B.C. LICs= Low-income countries. The sample includes 30 low-income countries, of which 2 are oil priced at market rates, and less so for countries exporters, 8 metals exporters, and the remaining 20 are non-resource intensive. It excludes Somalia, benefiting from the low interest rates on South Sudan, and Syria due to data restrictions. A.B. Figure shows median gross government debt in percent of GDP. concessional debt. The median LIC carries external debt, including both public and private debt, equivalent to 28 2006, but widened steadily following the global percent of GDP and almost half of total debt. financial crisis, especially among commodity Median external debt as a share of GDP has risen exporters suffering from falling commodity prices. about 3 percentage points since 2012, with several Rising deficits may also be the result of LICs’ important outliers. Commercial debt issuances increased ability to borrow as a result of HIPC have contributed to external debt rising to 94 and and MDRI debt relief (Bayraktar and Fofack 77 percent of GDP in Mozambique and 2013; Marcelino and Hakobyan 2014). The Tajikistan, respectively. In Uganda, external debt primary balance of most LICs has been negative as a share of GDP has more than doubled since since the mid-2000s, and all but five (of 31 with 2012, to more than 40 percent of GDP in 2017. available data) LICs had primary deficits in 2017, The maturity composition of LIC external debt with a third carrying a primary deficit exceeding 3 has remained broadly stable—short-term debt percent of GDP. remained moderate at 5 percent of total external debt in 2016. Uses of borrowed funds. A rising debt burden is typically less of a reason for concern if it is used to Shift toward non-traditional creditors. The finance investment that raises countries’ potential output, and therefore their ability to repay loans in the future (World Bank 2017). In some LICs, 3 Ndikumana and Boyce (2011) find that for every dollar in growing deficits reflected a push to finance public external loans to Sub-Saharan Africa, capital outflows increased by investment, as suggested by the doubling of roughly 60 cents in the same year. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 213 composition of public debt has shifted over the FIGURE 4.1.2 Public debt in LICs last decade, becoming increasingly non- Higher debt, and the shift from concessional to market financing, makes concessional as LICs have increased reliance on LICs more vulnerable to rising interest rates. financing from non-traditional sources (Figure 4.1.2). The median share of non-concessional debt A. Change in creditor composition B. Share of non-concessional debt of public and publicly-guaranteed in public debt rose to 55 percent in 2016 (the external debt, 2007-16 latest year for which data are available), an increase of nearly 8 percentage points since 2013, and 15 percentage points compared with a decade earlier. Commercial creditors have become an important source of credit for some countries (World Bank and IMF 2018b). Ethiopia, Mozambique, Rwanda, Senegal, Tajikistan, and Tanzania have all issued commercial public debt since 2010, generally denominated in U.S. dollars.4 C. Interest payments D. Share of LICs in debt distress or at high risk of distress Non-Paris Club creditors, notably China, have also become a more important source of financing over the past decade, especially in Sub-Saharan Africa (World Bank 2015a). In 2016, non-Paris Club debt accounted for more than a fifth of the median LIC’s external debt, and about 13 percent of their public debt (World Bank 2018d). Major recipients of lending from non-Paris Club creditors (notably China) include the Democratic Sources: International Monetary Fund, World Bank. Republic of Congo, Ethiopia, Tanzania, Uganda, A. GDP-weighted average across 32 low-income countries. “Bilateral” includes public and publicly and Zimbabwe (Atkins et al. 2017).5 Chinese guaranteed (PPG) loans from governments and their agencies (including central banks), loans from autonomous bodies, and direct loans from official export credit agencies. “Multilateral” includes PPG lending is typically provided for infrastructure loans and credits from the World Bank, regional development banks, and other multilateral and intergovernmental agencies. It excludes loans from funds administered by an international projects, with approximately a third of loans to organization on behalf of a single donor government. “Bonds” include PPG bonds that are either publicly issued or privately placed. “Commercial” includes PPG debt from commercial bank loans Africa funding transportation projects such as from private banks and other private financial institutions, as well as export and supplier credits. B.C. Dashed blue lines denote the interquartile range, while solid blue line is the median. includes 30 airports, railways, roads, and ports (Dreher et al. low-income countries and excludes Somalia, South Sudan, and Syria due to data restrictions. 2017). Loans are often tied to procurement from D. Figure shows the percent of low-income countries eligible to access the IMF’s concessional lending facilities that are either at high risk of, or in, debt distress. A country is considered to be in Chinese companies and are often administered debt distress if it is experiencing difficulties in servicing its debt, as evidenced, for example, by the existence of arrears, ongoing or impending debt restructuring, or if there are indications that a future through the China Export-Import Bank or the debt distress event is probable. The sample includes 30 low-income countries. China Development Bank (Brautigan and Hwang 2016). According to estimates from Eom, Brautigam and Benabdallah (2018), loans from collateralized, which could reduce budget China account for at least 20 percent of total flexibility by earmarking revenues, could weaken public debt in Ethiopia, Mozambique, and the creditor’s incentive to assess the borrower’s Zimbabwe. Lending arrangements are often not debt sustainability, and (if large) could increase public, and they can be complex and varied funding costs from other creditors who may (World Bank 2018b). While detailed information reassess the probability of being repaid. is scarce, some non-Paris Club debt is Rising cost of debt service. As debt loads have grown and become less concessional, interest 4 Of 11 LIC debt issuances since 2010, all were denominated in payments have absorbed a growing share of U.S. dollars, with the exception of one of Senegal’s two issuances in government revenues. Among LICs, the median 2018, which was euro-denominated. 5 Each of these countries are estimated to have borrowed more interest payments-to-revenue ratio rose to over 5 than $2 billion from China between 2000 to 2017. Note that data on percent in 2017, up from just over 3 percent in Chinese lending to LICs are estimates and have not been verified by 2013. The increase in the ratio was due to rapidly the World Bank. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 214 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 rising interest payments, with median interest commercial loans make many LICs vulnerable to payments among LICs having grown by over 128 currency, interest rate, and refinancing risks percent versus 31 percent growth in government (Devarajan 2018; Gill and Karakülah 2018a,b).6 revenues. LIC vulnerabilities are reflected by the fact that almost all LICs have the lowest or second lowest Drivers of rising debt. Countries with the fastest grade in the OECD’s country credit risk rise in debt were often fragile and affected by a classification.7 Because of rising arrears or the need combination of conflict, weak governance, or for debt restructuring, as of September 2018, commodity-dependence (World Bank 2018b). In eleven LICs were assessed as being in debt distress The Gambia, government debt increased from or at a high risk of debt distress, compared to only nearly 60 percent of GDP in 2013 to an estimated six in 2015.8 For LICs assessed at low or moderate 88 percent in 2017, with interest payments risk of debt distress, safety margins have eroded. absorbing 42 percent of revenue. The rise in debt was a result of loose fiscal policy, bailouts of state- owned enterprises, and widespread Other LIC vulnerabilities mismanagement by the previous government prior to a transition to democracy in early 2017 (IMF Private debt: Due to shallow domestic capital 2018b). markets and limited access to international finance, the median LIC has total private debt In Mozambique, the government debt-to-GDP equivalent to only 18 percent of GDP, ratio has increased by close to 50 percentage significantly less than the 41 percent ratio for the points since 2013, reaching an estimated 102 median non-LIC EMDE (Figure 4.1.3).9 percent in 2018, with interest payments rising Nonetheless, LIC private sector debt has been on a from 2.6 percent of revenues to 16.5 percent over steady upward trend since 2005, rising by almost the same period. The deterioration was 8 percentage points. Excess private debt can underpinned by rising deficits as fiscal policy sometimes be transformed into public debt, either remained loose amid lower commodity prices and directly through bailouts or indirectly through subdued growth, and was aggravated by the countercyclical government spending in response inclusion of previously-undisclosed external to private deleveraging, suggesting that the line commercial debt in 2016 (IMF 2018e). The between public and private debt can blur (Mbaye, country is in debt distress, and several payments to Badia and Chae 2018). external borrowers have been missed. Growth subject to downside risks. Growth in Zimbabwe is also classified as being in debt LICs is expected to remain resilient, supporting distress. Over the last five years, government debt has risen substantially from just over 48 percent of GDP in 2013 to an estimated 82 percent in 2017. 6 Separately, some countries such as The Gambia are vulnerable to Persistently large fiscal deficits have partly been rollover risk because of heavy reliance on short-term domestic debt (IMF 2018c). the result of an elevated public wage bill, which 7 There is one exception: The credit rating for Senegal has absorbed 90 percent of revenues in 2017 (IMF improved recently in the OECD credit risk classification, improving 2017). In addition, revenues remain subdued from 6 to 5 in a 0-7 rating system, with a higher number indicating higher credit risk (OECD 2018). amid weak growth and structural rigidities, while 8 A country is considered to be in debt distress if it is experiencing transfers to the agricultural sector have kept non- difficulties in servicing its debt, as evidenced, for example, by the wage expenditure elevated. Moreover, the deficits existence of arrears, ongoing or impending debt restructuring, or if there are indications that a future debt distress event is probable. have partly been financed through an overdraft LICs in debt distress are The Gambia, Mozambique, South Sudan, facility at the Reserve Bank of Zimbabwe that, and Zimbabwe. LICs at high risk of debt distress are Afghanistan, given insufficient reserves, has led to money Burundi, Central African Republic, Chad, Ethiopia, Haiti, and Tajikistan. There is a total of 30 LICs who have a debt sustainability creation and exacerbated foreign-currency analysis (DSA) available under the Joint World Bank / IMF debt shortages. sustainability framework (DSF). 9 Private sector debt refers to the sum of commercial banks’ and Risk of debt distress. Higher levels of public debt, other financial corporations’ claims on the non-financial private sector, in percent of GDP. much of it external, and an increased reliance on EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 215 their ability to service debt, but risks are tilted to FIGURE 4.1.3 Risks to LIC debt the downside. LIC growth is expected to average Private sector debt has risen alongside public debt in LICs. LIC exports 5.7 percent in 2018 and accelerate to just over 6 tend to be concentrated in a few products, generally commodities. LIC percent in 2019-20, supported by rising growth is accelerating but risks are tilted to the downside. Over the medium-term, demand for many commodities is expected to slow, which agricultural output and continued infrastructure may pose a challenge for exporters. investment (Chapter 1). However, over the next decade, weaker growth in major emerging markets A. Private sector debt B. Median export concentration may slow global demand for metals, which dampens growth prospects for LICs that depend on metals for government and export revenues (World Bank 2018b). Downside risks to this outlook predominate and include the possibility of a faster-than-expected slowdown among major trading partners (including China, a major commodity consumer); a renewed plunge in commodity prices; faster-than-expected tightening of financing conditions; and the possibility of C. Growth D. Global commodity demand growth natural disasters, conflict, or severe weather events. Elevated debt, lower investment growth, increased risks. Rising levels of non-concessional public debt, often at variable rates, make some LICs susceptible to a sudden increase in borrowing costs, especially when they have substantial refinancing needs in coming years or have borrowed in foreign currencies. As advanced Sources: BP Statistical Review, United Nations, United States Department of Agriculture, World Bank, economies continue to withdraw monetary policy World Bureau of Metals Statistics. A. Non-LIC EMDEs= emerging market and developing countries excluding LICs; LICs= Low-income accommodation, new debt issuances and debt countries. Domestic credit to the non-financial private sector provided by commercial banks and, if data are available, by other financial corporations. Median debt, based on 148 EMDEs and 29 LICs. rollovers may become more expensive, resulting in B. Orange lines indicate interquartile ranges of Herfindahl-Hirschmann concentration index, which measures the degree of product concentration, with values closer to 1 indicating a country’s exports rising LIC debt service costs that could weaken are highly concentrated in a few products. investment and lower medium-term growth D. To ensure comparability, 2010-16 is model-predicted commodity demand growth. (World Bank 2015b, 2016, and 2017). Fiscal consolidation, while often necessary, can also dampen growth in the short term. Substantial current account deficits. Almost all LICs carry persistent, substantial current account In the absence of sufficient lending made available deficits, with an estimated median of 6.8 percent at concessional terms, there is a risk that high of GDP in 2017 (Figure 4.1.4). Forty percent of public debt will lead to higher interest rates, LICs had current account deficits that widened by crowding out private investment and slowing at least 3 percentage points of GDP over the last growth.10 Similarly, rising interest payments to decade. Among metals exporters, rising deficits domestic creditors may encourage policymakers to reflected the pickup in import-intensive mining engage in financial repression—using investment, while in non-resource-intensive administrative or other means to channel domestic countries it reflected high public investment. savings toward the purchase of public debt— which can dampen private sector investment and Countries relying on capital inflows to finance a limit the development of domestic financial large and persistent current account can be more markets (Fry 1997). vulnerable to currency crises, as weaker investor confidence can result in a slowdown in capital 10 Bevan (2012) argues that although evidence in the literature for inflows, leading to higher borrowing costs, the crowding out effect on investment in LICs is weak, it may be more important where financial depth is low. downward currency pressures, difficulties in EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 216 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 rolling over debt, and possibly macroeconomic the level of debt is mainly determined by fiscal and financial market stress (Roubini and Wachtel policy, ex post the composition of debt can play 1999). Current account deficits in LICs, however, an important role in safeguarding debt are typically financed by capital inflows from sustainability. Effective debt management plays a development assistance, remittances, foreign critical role in funding the government’s financing lending, and foreign direct investment. The stable, needs in a timely fashion, helping ensure low debt long-term and often concessional nature of this servicing costs at an acceptable degree of risk, and financing mitigates some of the risks usually supporting the development of domestic securities associated with large current account deficits. markets. In addition, debt management can help Foreign direct investment and development minimize fiscal risks stemming from contingent assistance flows were generally more than adequate liabilities, such as guarantees or on-lending to to finance LICs’ current account deficits—the state-owned enterprises or through public-private median LIC received inflows of these types 1.6 partnerships, through effective monitoring and times as large as its current account deficit. In reporting. more than half of LICs, development assistance alone was greater than the total current account The benefits of sound debt management are deficit. Median FDI inflows were equal to about fourfold: half the current account, except for metals • Lowers debt servicing costs. In many LICs, exporters where it was considerably more. debt service payments absorb a signi cant FDI flows to LICs, however, are particularly share of public revenues (as much as 20 sensitive to fluctuations in global growth and percent in Burundi, Eritrea, and e liquidity (Burger and Ianchovichina 2017). Gambia), re ecting low revenue bases and Among these countries, commodity exporters, sizable debt loads. E ective debt management particularly metals exporters, are particularly can help avoid excessive debt service costs by vulnerable to sudden swings in FDI flows that increasing awareness of the nancial options accompany changes in the external environment— available, enabling countries to borrow at FDI flows are more than twice as volatile in metal- competitive costs with a prudent degree of exporting LICs than in other EMDEs. While risk. external vulnerabilities can be mitigated by a • Supports financial sector development. More strong foreign reserve position, more than 40 developed local-currency bond markets can percent of LICs with available data have reserves promote economic stability by reducing the close to or below three months of imports. reliance on external debt, facilitating the Moreover, increased exposure to non-Paris Club implementation of counter-cyclical scal and commercial creditors may pose coordination policies, and enhancing resilience to sudden challenges for debt resolutions in the future, reversals of capital ows. Public debt making the consequences of debt distress even instruments can serve as a benchmark for more disruptive, especially if debt is collateralized pricing of private sector debt instruments. (World Bank and IMF 2018a). Local-currency bond markets can enable diversi cation from bank nancing and Role of better debt provide a savings vehicle for a variety of management investors to support growth (World Bank and IMF 2014). Goal of sound debt management. In most LICs, government debt is the largest domestic financial • Reduces economic volatility. E ective debt portfolio, and debt management operations can be management can reduce economic volatility substantial relative to public spending and by selecting debt instruments that help economic activity. A sound macro-fiscal policy insulate the government balance sheet from framework requires that public debt is sustainable uncertainties. Both currency and interest rate and can be serviced under a wide range of shocks can be mitigated in this fashion, circumstances at reasonable costs. While ex ante making a country less susceptible to contagion EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 217 and nancial risks, and supporting cheaper FIGURE 4.1.4 External positions in LICs and more stable funding for the private sector. LICs carry persistent current account deficits, largely financed by development assistance and FDI. However, FDI flows can be volatile, • Enhances public sector transparency and especially for metals exporters. Modest foreign exchange reserves make medium-term planning. A key element of some countries vulnerable to changes in foreign investor sentiment. sound public debt management is the public and comprehensive reporting of government A. Current account balance B. Current account funding debt, which improves the capacity of policymakers and the broader public to assess the scal position and appropriately weigh public balance sheet risks alongside spending and revenue priorities. Evolution of debt management in LICs. Despite some improvements, debt management in LICs still suffers from substantial deficiencies. Weaknesses in debt transparency, notably in C. Foreign direct investment D. Median foreign reserves monitoring and reporting, are pervasive. Medium- term debt strategies are becoming more common but have shortcomings in quality and implementation. Capacity and institutional set-up are often lagging. • Debt transparency. Better compilation and monitoring of public debt and guarantees are needed to ensure that risks are detected before Sources: International Monetary Fund, World Bank. they materialize (World Bank 2007). Recent A. LICs= Low-income countries. Figure shows median current account balance in percent of GDP. examples of hidden debt and discrepancies The sample represents a total of 30 low-income countries, of which 2 are oil exporters, 8 are metals exporters, and the remaining 20 are non-resource intensive. It excludes Somalia, South Sudan, and among debt statistics point to continued low Syria due to data restrictions. B. The sample represents a total of 21 low-income countries, including 6 metals-exporting LICs, with debt recording capacity, weak legal current account deficits in 2016. frameworks, and governance challenges. Debt C. EMDEs= Emerging market and developing countries. Standard deviation represents the median standard deviation of foreign direct investment in percent of GDP from 2000 to 2017. Management Performance Assessments D. LIDCs=Low-income developing countries; LICs=Low-income countries. See Annex 41 for details. Orange lines indicate interquartile range. Data is as of the last reported year, mostly 2016. (DeMPA) suggest that, of the seventeen LICs with available data, minimum requirements in debt recording are met by only eight, and managing medium-term debt with their monitoring guarantees are met by only four. budget process. 11 Due to shortcomings in accuracy, timeliness, coverage and completeness of debt records, only four of these seventeen countries met the 11 The World Bank, in partnership with the IMF, has been minimum requirements for debt reporting supporting increasing debt management capacity in LICs through its Debt Management Facility (DMF). Building on the progress and evaluation (Figure 4.1.5). Only a third of achieved and on lessons learned in recent years, this involves the 59 countries eligible for International supporting further improvements in debt recording and monitoring, Development Association borrowing report increasing debt transparency, and adding to debt management capacity. The DMF also seeks to strengthen macro-fiscal frameworks, private sector external debt statistics (World including through improved domestic revenue mobilization, and to Bank and IMF 2018d). advance the implementation of growth-enhancing structural reforms. Since 2009, the DMF has supported over 280 Technical Assistance missions in 75 countries and 14 subnational governments, trained • Debt management strategies. A growing client practitioners and hosted around 40 debt management number of countries are producing medium- practitioners. A growing number of countries prepare and publish term debt management strategies. However, debt management strategies, the quality of debt records in many LICs has improved, and many countries have well-structured debt their quality varies signi cantly, and management offices. Several countries have strengthened their legal implementation is often lagging. Few framework and improved their operational risks management with countries are aligning the processes for the support of the DMF. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 218 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 4.1.5 LIC policy frameworks and reduce the need to rely on debt financing (Baum et al. 2017). In the median LIC, Debt management capacity in many LICs is low, especially in the areas of debt reporting and monitoring. Policy frameworks have improved in LICs, government revenues accounted for only 19 with several countries adopting flexible exchange rates and strengthening percent of GDP in 2017, well below 28 percent of their central banks’ independence. GDP in the median non-LIC EMDE. This A. Countries meeting DeMPA B. Countries meeting DeMPA highlights the need to broaden tax bases, especially minimum requirements, select minimum requirements, select for higher-income households, in a way that categories categories minimizes economic distortions and that carefully manages trade-offs between efficiency and equity (World Bank 2018a). Unexpected revenue windfalls from sudden improvements in a country’s terms of trade can be set aside to reduce fiscal deficits and debt. Improving spending efficiency. LICs have significant infrastructure needs that require debt financing. However, debt sustainability concerns C. Central bank transparency index D. Exchange rate regimes associated with the financing of infrastructure may be lessened if these expenditures are accompanied by stronger long-term growth and better macro- fiscal, budgeting, and financing frameworks. There may also be room to cut unproductive spending (often subsidies) in order to allow for more growth-enhancing or better-targeted programs.12 Debt used to finance projects that generate a revenue stream is less likely to be Sources: Bloomberg, Debt Management Performance Assessments (DeMPA), Dincer and Eichengreen (2014), International Monetary Fund, Shambaugh (2004), World Bank. unsustainable. There is also often considerable A.B. BCP=Business Continuity Planning; CBM=Cash Balance Management; CFF=Cash Flow Forecasting; DA=Debt Administration; DMS=Debt Management Strategy; DS=Data Security; scope to improve the efficiency of investment FP=Fiscal Policy; LGLD=Loan Guarantees, On lending Derivatives; MP=Monetary Policy; spending by improving the institutions and SD=Segregation of Duties; SC=Staff Capacity. Sample covers 17 low-income countries. C. Unweighted averages. The range of the index is from 0-15, 0=least transparent and 15=most procedures governing project appraisal, transparent. D. De facto exchange rate regime from the Exchange Rate Regime Classification of Shambaugh procurement, and monitoring. By one estimate, a (2004) is used to determine whether a country has a pegged or flexible exchange rate. The original classification has four categories: “1” reflects no fluctuation at all, “2” indicates movements within 1 country moving from the lowest quartile to the percent bands, “3” indicates movements within 2 percent bands, and “4” indicates a one-time highest quartile in the efficiency of public devaluation with 0 change in the remaining 11 months of the year. Shambaugh (2004) assesses these movements against relevant base currencies. The constructed dummy variable indicating a investment could double the impact of that pegged exchange rate regime was defined to equal 1 for countries classified as 1, 2, 3, or 4. A value of 0 is assigned to flexible exchange rates—i.e., exchange rates that routinely fluctuate outside a 2 investment on growth (IMF 2015). percent band. Based on 31 LICs. Development of local financial markets. Reliance on external funding means that there is often a • Broader issues. Some of the most pressing challenges include insu cient legal currency mismatch in LIC borrowing and revenues, leaving countries vulnerable to swings in frameworks, weak capacity, lack of the value of the currency. The development of coordination between scal and monetary policy, ine cient management of cash and local currency bond markets can help mitigate this risk, though they are often a relatively high-cost scal risks, and poor audit and risk control procedures. option. These markets require a functional money Complementary policy measures 12 Credible and well-designed institutional arrangements—such as fiscal rules, stabilization funds, and medium-term expenditure frameworks—can help build fiscal space, improve the management of Domestic resource mobilization. Among LICs, revenue windfalls, and strengthen policy outcomes (Huidrom, Kose, there is considerable scope to enhance tax revenues and Ohnsorge 2016). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 219 market, primary and secondary markets, a diverse Rigorous and transparent lending standards. base of investors, a stable regulatory system which Creditors also have a role to play in containing includes reliable custody and settlement systems, debt vulnerabilities. The Addis Ababa Action and a significant improvement in debt Agenda calls for debtors and creditors to work management capacity. Sound macroeconomic together to prevent and resolve unsustainable debt policy and financial sector stability are also critical, situations. Creditors can aim for good practice in as is transparent and effective communication by lending, drawing on principles for sustainable the government. Alongside improved debt lending such as those being championed by G20 management, growing local financial markets can countries (G20 2018). help countries graduate from concessional lending by mitigating some of the higher costs and greater Conclusion risks associated with non-concessional debt. In recent years, a broad-based rise in borrowing Better data collection. Transparency about has increased public debt vulnerabilities in LICs. balance sheets is a pre-requisite for sound debt The composition of debt has also shifted, as many management. Among other gaps, there is often LICs have increased their exposure to non-Paris limited data on contingent liabilities (especially Club creditors and market-based debt, which may those arising from state-owned enterprises and pose coordination challenges for any future debt public-private partnerships) and the assets held by resolution. While increased access to market LIC governments. These data limitations are funding has provided LICs with opportunities to especially acute for debt issued by commercial and address development needs, it has also exposed non-Paris Club creditors. Improving data some countries to currency, interest rate, and collection practices for LIC debt would help refinancing risks. policymakers make informed and appropriate borrowing decisions and allow the public to hold The number of LICs at high risk of debt distress the government accountable for its fiscal or in debt distress has increased significantly, and management (World Bank and IMF 2018d). safety margins in many LICs currently assessed at low or moderate risks of debt distress have eroded. Monetary policy and exchange rate regimes. External gross financing needs are likely to rise More resilient monetary policy frameworks and further as current account deficits widen and large foreign reserve buffers can help mitigate the international bonds fall due. By increasing the impact of terms-of-trade and other shocks, effectiveness of resource mobilization, public including on the fiscal position (Adler, Magud and spending, and debt management—supported by Werner 2017). More LICs could join the growing better data collection—LICs can reduce the number of EMDEs where improvements in the probability of costly defaults, enhance debt monetary policy regime have reduced inflation transparency, support sustainable financial sector and, where appropriate, allow greater exchange development, and reduce economic volatility. rate flexibility to absorb shocks. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 220 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 ANNEX 4.1 Comparison of LIDCs and LICs This Special Focus discusses LICs following the World Bank Group definition of countries with per capita gross na- tional income below $995 per year. This group includes 33 countries. It differs from other reports, such as IMF and World Bank (2017a and 2018a), which include additional middle-income countries following the IMF definition of Low-Income Developing Countries (LIDCs). The term “LIDC” refers to countries with low per capita Gross Nation- al Income and comparatively weak socioeconomic indicators. Low-Income Developing Low-Income Countries Low-Income Developing Low-Income Countries Countries (LIDCs) (LICs) Countries (LIDCs) (LICs) 1 Afghanistan 1 Afghanistan 31 Malawi 17 Malawi 2 Bangladesh 32 Mali 18 Mali 3 Benin 2 Benin 33 Mauritania 4 Bhutan 34 Moldova 5 Burkina Faso 3 Burkina Faso 35 Mozambique 19 Mozambique 6 Burundi 4 Burundi 36 Myanmar 7 Cambodia 37 Nepal 20 Nepal 8 Cameroon 38 Nicaragua 9 Central African Republic 5 Central African Republic 39 Niger 21 Niger 10 Chad 6 Chad 40 Nigeria 11 Comoros 7 Comoros 41 Papua New Guinea 12 Congo, Dem. Rep. of 8 Congo, Dem. Rep. of 42 Rwanda 22 Rwanda 13 Congo, Republic of 43 São Tomé and Príncipe 14 Côte d'Ivoire 44 Senegal 23 Senegal 15 Djibouti 45 Sierra Leone 24 Sierra Leone 16 Eritrea 9 Eritrea 46 Solomon Islands 17 Ethiopia 10 Ethiopia 47 Somalia 25 Somalia 18 Gambia, The 11 Gambia, The 48 South Sudan 26 South Sudan 19 Ghana 27 Syrian Arab Republic 20 Guinea 12 Guinea 49 Sudan 21 Guinea-Bissau 13 Guinea-Bissau 50 Tajikistan 28 Tajikistan 22 Haiti 14 Haiti 51 Tanzania, United Rep. of 29 Tanzania, United Rep. of 23 Honduras 52 Timor-Leste 24 Kenya 53 Togo 30 Togo 25 Kiribati 54 Uganda 31 Uganda 26 Kyrgyz Republic 55 Uzbekistan 27 Lao P.D.R. 56 Vietnam 28 Lesotho 57 Yemen, Rep. of 32 Yemen, Rep. of 29 Liberia 15 Liberia 58 Zambia 30 Madagascar 16 Madagascar 59 Zimbabwe 33 Zimbabwe (continues on the next column) Sources: IMF and World Bank. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 221 Poverty Impact of Food Price Shocks and Policies In the event of large swings in world food prices, countries often intervene to dampen the impact of international food price spikes on domestic prices and to lessen the burden of adjustment on vulnerable population groups. While individual countries can succeed at insulating their domestic markets from short-term fluctuations in global food prices, the collective intervention of many countries may exacerbate the volatility of world prices. Insulating policies introduced during the 2010-11 food price spike may have accounted for 40 percent of the increase in the world price of wheat and one-quarter of the increase in the world price of maize. Combined with government policy responses, the 2010-11 food price spike tipped 8.3 million people (almost 1 percent) into poverty. Introduction risks could materialize as a result of higher-than- expected energy prices, El Niño events, or trade In August 2011, nominal international food prices tensions. First, higher-than expected energy prices, hit an all-time high.1 This followed shortly after a key input in the production of most agricultural the 2007-08 food price spike, which pushed an commodities, could raise grain and oilseed prices. estimated 105 million people into extreme poverty Energy prices affect agricultural production costs (Ivanic and Martin 2008). This event also directly (through fuel use) and indirectly (through prompted widespread concerns about the food fertilizer and other chemicals use and an incentive security of the poorest and fears over a potential to shift production to biofuels). Second, an El world food crisis. Although food prices have Niño event is expected with an 80 percent declined considerably since then, in real terms, probability during December 2018-February they are still significantly above their lows in 2000 2019. Should this materialize, heavier-than- (Figure 4.2.1). expected rains could occur in Central Asia, South America, and East Africa, while drier-than-normal Food price spikes such as in 2010-11 may conditions could affect Central America, the materialize again as the growing frequency of Caribbean, and Southern Africa, affecting the extreme weather events increases the risk of prices of many agricultural commodities. Finally, disruption to food production, setbacks in food although the escalation of existing trade frictions availability and access to food. World hunger and represents a downside risk for the price of severe food insecurity rose during 2014-17, agricultural commodities, policy measures reversing the decline of the previous decade. In introduced by major producers and exporters in 2017, the number of undernourished people response to higher tariffs could also affect prices reached 821 million, up by 5 percent since 2014 (World Bank 2018). and a setback in achieving the Sustainable Development Goal of eradicating hunger by 2030 Several forces have raised food prices during the (FAO et al. 2018). G20 policy makers have 2000s. A dramatic increase in demand for recently reiterated the urgency of tackling the feedstock for biofuel production in the early 2000s challenges to achieving food security (G20 2018). put considerable pressure on markets for grain and contributed to a rundown in stocks (Akiyama et While agricultural and food prices are expected to al. 2001; Wright 2014). Population growth and rise only moderately in 2019, significant upside urbanization, as well as a shift in diets toward animal-based foods, created demand pressures despite an increase in agricultural productivity in Note: This Special Focus was prepared by David Laborde, Csilla emerging and developing economies (EMDEs; Lakatos, and Will Martin. Research assistance was provided by Fukase and Martin 2017). Slowing yield growth Xinyue Wang and Heqing Zhao. 1 Unless otherwise stated, the concept of food prices as used in this and declining availability of agricultural land also Special Focus refers to the commodity price of major staple foods constrained food production growth. Extreme such as rice, wheat, and maize. climate events (e.g., El Niño, droughts, and EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 222 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 4.2.1 Global food prices land owners), rising food prices increase real incomes. By contrast, they lower the real incomes In August 2011, shortly after the 2007-08 food price spike, international nominal food prices hit an all-time high. Although food prices have of households who are net buyers of food. On declined considerably since then, in real terms, they are still significantly average, sharp increases in food prices raise above their lows in the 2000s. Evidence points to a rise in world hunger and severe food insecurity between 2014-17, reversing the declining trend poverty, reduce nutrition, and curtail the observed in the previous decade. consumption of essential services such as education and healthcare (World Bank 2011).2 A. Global food prices B. Global food price volatility Countries often use policy interventions to dampen the domestic impact of international food price spikes and lessen the burden on vulnerable population groups. For example, during the 2007- 08 food price spike, close to three-quarters of EMDEs took policy action to insulate their domestic prices from the sharp increase in international food prices (World Bank 2009). In the event of food price spikes, net food-importing countries usually intervene by lowering trade C. Undernourished people D. The prevalence of undernourished protection (typically tariffs) on food items, while net food-exporting countries impose export restrictions or bans. These policies are often complemented with social safety net programs such as cash transfers or school feeding programs. To the extent that policy interventions reduce the transmission of international price spikes to domestic markets, they may appear to be Sources: Food and Agriculture Organization of the United Nations, World Bank. successful for individual countries. However, the A. Based on yearly commodity price indexes between 1960-2017. combined intervention of many countries raises B. Based on monthly nominal commodity price indexes between January 1960 – November 2017. C.D. Undernourishment is defined a state, lasting for at least one year, of inability to acquire enough international prices. These insulating policies tend food, defined as a level of food intake insufficient to meet dietary energy requirements. to encourage consumption and reduce production during price spikes. This, in turn, results in higher natural disasters), particularly when agricultural import demand and reduced export supply that stocks are low, and the financialization of further drive up global prices. During price agricultural futures markets have also contributed plunges, government interventions encourage to food price volatility. greater exports and greater global supply that further depresses prices. Only countries that Food price increases have important macro- and insulate themselves to an above-average degree can microeconomic impacts through several channels. reduce price volatility in their domestic markets At the macroeconomic level, food price increases (Anderson, Martin, and Ivanic 2017). result in higher inflation, which can reduce household real incomes. For food-importing The international community has recognized the countries, high food prices can also result in terms importance of ensuring the stability and -of-trade shocks that lower growth and availability of food supplies as key to addressing government policy space. several development objectives. The Sustainable The microeconomic impact of food price increases on poverty and inequality depends on the net food 2 In the longer term, once producers and consumers have adjusted seller status of the poorest households. For to the increases and wage rates have responded, sustained increases in food prices may lower poverty by raising incomes of poor food households that are net sellers of food products producing households (Ivanic and Martin 2014a; Gillson and Fouad (such as farmers, agricultural workers, and small 2014). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 223 Development Goals (SDGs) give food security a combined interventions make global food high priority: the second SDG sets out explicitly prices more volatile. Insulating policies the goal to “end hunger, achieve food security and introduced during the 2010-11 food price improved nutrition, and promote sustainable spike accounted for 40 percent of the increase agriculture.” Other SDGs are strongly in the world price of wheat and one-quarter of interconnected: food, agriculture and nutrition the increase in the world price of maize. In play an important role in SDGs on ending contrast, a reversal of earlier government poverty, improving health, fostering sustainable interventions in rice markets dampened the consumption and production, and encouraging degree to which world prices increased by climate change adaptation and mitigation. about 50 percent. In this context, this Special Focus addresses the • The 2010-11 food price spike, and the wide- following questions: spread government intervention that accompanied it, increased the number of poor • How do food price shocks affect EMDEs? living on less than $1.90 per day by almost 1 percent or 8.3 million. • How do countries intervene to reduce the impact of food price shocks? Food price shocks and What was the impact of the 2010-11 food • price shock on poverty? their effects At the macroeconomic level, a high share of The Special Focus presents the following findings: agriculture and food in total output, consumption, • At the macroeconomic level, a high share of employment, trade, and government revenues agriculture and food in total output, heighten countries’ vulnerability to volatility in consumption, employment, trade, and international food prices. At the microeconomic government revenues heighten countries’ level, a high share of net food buyers among the vulnerability to volatility in international food poorest segments of society heightens the adverse prices. At the microeconomic level, food price effects of food price spikes on poverty and income spikes are felt most severely by the poorest inequality. segments of the population who tend to be net food buyers. Macroeconomic channels • Governments in EMDEs tend to respond Reliance on food imports and production. particularly strongly to sharp changes in world Agriculture accounts for close to one-third of total prices for staple foods—such as rice, wheat value added and two-thirds of total employment and maize—to smooth volatility. Domestic in LICs. This is almost three times their shares in food prices are considerably less volatile than the average EMDE (Figure 4.2.2; Aksoy and world food prices in the short run, but over Beghin 2004). For example, in Burkina Faso and the longer term, there is a tendency for Burundi, agriculture accounts for more than four- domestic and world prices to return to their fifths of total employment. In Chad and Sierra original relationship. In the short run, a 1 Leone, it accounts for more than half of domestic percent increase in world rice, wheat and value added. In addition, more than three-quarters maize prices is associated with an increase in of LICs are net food importers compared to only domestic prices by 0.6 percent, 0.7 percent, half of EMDEs.3 In these net food-importing and 0.8 percent, respectively. LICs, net food imports amount to 5.4 percent of private consumption. Benin and Gambia are • While individual countries can succeed at insulating their domestic markets from short- 3 High trade costs, such as tariffs and border delays, can bias term fluctuations in global food prices, their downwards estimates of the share of food imports (Tombe 2015). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 224 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 4.2.2 Macroeconomic channels of transmission Inflation. A surge in food prices increases from global food prices consumer price inflation. For example, the 2007- At the macroeconomic level, a high share of agriculture and food in total 08 and 2010-11, LIC inflation more than output, consumption, employment, trade, and government revenues doubled, from 7 to 15 percent during 2007-2008 heighten countries’ vulnerability to volatility in international food prices. and from 5 to 11 percent during 2010-2011. The increase in EMDE inflation was less pronounced, A. Share of agriculture in economy B. Net food imports and exports from 7 to 11 percent during 2007-2008 and from 5 to 6 percent during 2010-2011. Food prices accounted disproportionately for these increases in inflation—for about two-thirds in LICs and more than half in EMDEs. In vulnerable LICs such as Benin and Niger, where net food imports amount to 15 and 7 percent of household consumption, respectively, inflation surged from 1 percent to 8 percent and 0.2 percent to 11 percent, respectively, during the 2007-08 food price spike. C. Inflation in LICs D. Contribution of food prices to inflation Terms of trade. Sharp increases in food prices can constitute significant adverse terms-of-trade shocks that lower growth, especially in countries that are large net importers of food. More than three-quarters of LICs are net food importers. The median LIC‘s terms of trade declined by 2 percent and 4 percent during the 2007-08 and 2010-11 food price spikes, respectively. In some, the deterioration was much steeper. For example, the E. Terms of trade in LICs F. Fiscal balance in LICs terms of trade of Sierra Leone, a LIC highly reliant on food imports, weakened by 10 percent during each of these food price spike episodes.5 In heavy food importers, the exchange rate depreciation typically associated with adverse terms of trade shocks can compel central banks to tighten monetary policy and further lower growth. Indeed, during the 2007-08 food price spike, close to half of EMDE central banks responded to Sources: Kose et al. (2017), World Bank. rising inflation and depreciation by tightening A. Based on a sample of 93 EMDEs and 21 LICs. Averages for 2010-16. B. Blue bars show the share of EMDEs or LICs in which food imports exceed food exports monetary policy.6 (“Net food importers”) or food imports fall short of food exports (“Net food exporters”). Red bars show net food imports relative to consumption in EMDE and LIC food exporters and importers. C. Average inflation based on a sample of 12 LICs. Fiscal policy constraints. Absent stabilizing fiscal D. Share of inflation accounted for by food price inflation. Yellow line indicates half. arrangements, heavy reliance on food and E. Net barter terms-of-trade index, 100=2000. F. Median based on a sample of 26 LICs. agricultural exports can introduce volatility into public finances and erode fiscal sustainability: rising food prices may increase tax revenues from particularly vulnerable to high food prices, with the agricultural sector and encourage governments net food imports adding up to more than 10 percent of private consumption.4 5 Severe terms of trade shocks are considerably more common in LICs than in advanced economies and, of all possible external shocks, 4 Conversely, heavy reliance on food exports heightens tend to have the most severe output cost in LICs (IMF 2011; Becker vulnerability to food price declines. For example, in Malawi, net food and Mauro 2006). exports amount to 12 percent of total private consumption. 6 Based on a sample of 54 EMDEs. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 225 to spend. Conversely, when food prices fall, FIGURE 4.2.3 Microeconomic channels of transmission revenue losses in the agricultural sector are from global food prices exacerbated by political pressures to subsidize food At the microeconomic level, a high share of net food buyers among the production. During the sharp rise in food prices in poorest segments of the population heightens the adverse effects of food 2007-2008, LICs’ fiscal balances deteriorated, on price spikes on income distribution and poverty. average, by close to 1 percentage point of GDP, in part due to higher food import bills. Food price A. Share of food in total consumption B. Consumption expenditure by expenditure product of the poorest households spikes may also cause sociopolitical instability, including political unrest and food riots (Barrett 2013). Microeconomic channels Rising food prices impact households through price and income effects. They reduce households’ purchasing power but raise income generated from food production. The overall impact on poverty and income inequality depends on the relative C. Share of net food sellers D. Share of income generated by food in the income of the poor magnitude of these effects for households in different segments of the income distribution. In LICs, households spend on average close to 60 percent of their income on food, more than one- third more than in EMDEs (Figure 4.2.3). In countries such as Burundi and Guinea, the share of food expenditures is even higher, accounting for more than 70 percent of total consumption of households. In LICs, more than one-third of Sources: International Food Policy Research Institute, World Bank. A. Based on data from the Global Consumption Database reflecting on the share of food in total households’ consumption expenditure on food is consumption expenditure of households. Data is available for 63 EMDEs and 25 LICs. The base year spent on staple foods such as cereals and of the household surveys differs but the data has been converted to a common reference year, 2010. The share of income spent on food is likely to be different. vegetables. These staple foods are considerably B. Based on data from the Global Consumption Database on the share of products in total household consumption expenditure. Data is available for 63 EMDEs and 25 LICs. The base year of the more exposed to international price volatility than household surveys differs but the data has been converted to a common reference year, 2010. The share of income spent on food is likely to be different. domestically-processed food products (Figure C.D. Averages weighted by the number of poor for a sample of 22 EMDEs and 7 LICs. Poverty line is 4.2.1). defined as $1.90/day. For households that are net sellers of agricultural and food products (e.g., farmers), rising food prices raise incomes. More than one-fifth of cut consumption of essential services such as households around and below the poverty line of education and healthcare.7 For example, the 2007- $1.90 per per day are net food sellers in the 2008 rise in food prices is estimated to have raised average EMDE and LIC. Households around and the number of poor by 105 million (10 percent of below the poverty line in these countries tend to the people living on less than a one dollar a day; generate about one-quarter of their incomes from Ivanic and Martin 2008). In extreme cases, food food production. In contrast, poor urban price spikes can induce food insecurity and households are typically net buyers of food that hunger, with severely adverse long-term impacts spend a large share of their consumption on human capital. expenditure on food (Aksoy and Hoekman 2010). On average, many of the poor in EMDEs and LICs are net buyers of food. As a result, food price 7 Vulnerable groups such as women and children, are more likely spikes tend to raise poverty, reduce nutrition and to be disproportionately affected. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 226 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 Government interventions were reductions in taxes, including import duties and consumer taxes (Figure 4.2.4).10 Net during food price shocks importers frequently intervened by lowering import tariffs or even by introducing import In the event of large swings in global food prices, subsidies, while net exporters imposed export governments are confronted with difficult policy restrictions or bans to dampen the increase in choices. One option is to allow domestic prices to domestic prices.11 adjust to world food price changes, exposing domestic consumers and producers to changes in Domestic and world food price dynamics their real incomes. Even if a sizable non-tradeable service component in the cost of providing Domestic food prices are considerably less volatile consumers with food such as transportation, than global food prices in the short run, but over storage, retail dampens the pass-through of world the longer term, there is a tendency for domestic food price shocks into domestic markets, allowing prices to return to their original relationship with domestic food prices to adjust may raise inflation international prices (Figure 4.2.5). This does not in the short-run and, in countries where inflation necessarily imply that protection rates become expectations are poorly-anchored, in the medium- zero, but that they return to their pre-spike levels. to long-run.8 Governments in EMDEs tend to respond Alternatively, governments can spare consumers or particularly strongly to sharp changes in the world producers from these losses by reducing the prices of staple foods—such as rice, wheat and transmission of international food price shocks to maize—to reduce the volatility of domestic prices. domestic markets.9 As measured in this Special For staple foods, domestic price movements can Focus, policy intervention is reflected in the ratio diverge substantially from international price of domestic to world prices—the “protection movements in the short run, but converge in the rate.” During a period of rising world prices, the longer term. protection rate declines when a country seeks to The movements of world and domestic staples insulate its domestic markets from the increase in world prices. If the protection rate rises, food prices during the latest two food price spikes (2007-08 and 2010-11) resembled similar earlier policymakers are compounding the increase in world prices. episodes: world prices rose rapidly, domestic prices rose only gradually. However, the 2010-11 spike In practice, during the 2007-08 food price spike, was different from previous episodes in several close to three quarters of EMDEs took policy aspects. The 2007-08 increase in food prices came action to insulate their economies from the sharp after a long period of stability in food prices. In increase in international food prices (World Bank 2007-08, world prices of all staple foods increased 2009). The most commonly used interventions steeply, led by the strong increase in the world price of rice. Most countries reacted strongly by introducing insulating policies. In contrast, the 8 The decline in real incomes associated with higher inflation 2010-11 episode occurred when world markets would entail welfare losses, especially when consumers are loss- and risk-averse (Gouel and Jean 2015; Freund and Ozden 2008; and policies were still normalizing from the 2007- Giordani, Rocha, and Ruta 2016; Easterly and Fischer 2001). In 08 episode. Government interventions differed principle, monetary policy tightening can offset inflationary effects from rising global food prices to ensure that rising food prices remain considerably across countries and across a purely relative price change and do not become entrenched in higher inflation. However, this would come at the cost of reduced economic activity (Lustig 2009). 10 If countries are insulating primarily through subsidies and are 9 Policymakers may also have a longer-term goal to protect (or to fiscally constrained, their ability to insulate will be limited tax) domestic agents (Grossman and Helpman 1994). In empirical (Ianchovichina, Leoning and Wood 2014). work based on political economy models, protection rates vary to 11 For net importers, untargeted food subsidies have implications reduce both the costs associated with adjusting prices and the costs of for government revenues and fiscal space. If financed by aid, the providing a rate of protection that differs from the long-run political impact on fiscal space is limited. Alternatively, targeted transfers may equilibrium (Anderson and Nelgen 2011; Ivanic and Martin 2014b). be more effective in protecting vulnerable groups with limited The less than perfect pass-through world price shocks into domestic macroeconomic repercussions. markets is explicitly considered. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 227 commodities. On average, government FIGURE 4.2.4 Food-related government policies interventions (or the unwinding of earlier Countries often use policy interventions to dampen the domestic impact of interventions) actually raised domestic rice prices international food price spikes and lessen the burden on vulnerable more than the modest increase in world prices. population groups. In the short run, domestic markets for key staple foods, such as rice and wheat, are highly insulated from global food price swings. Insulation policies undertaken during the 2010-11 episode exacerbated the Rice. Rice was the staple food with the largest price volatility of world prices and accounted for about 40 percent of the increase during the 2007-08 food price spike. increase in the world price of wheat and one-quarter of the increase in the Between January 2007 and May 2008, world rice world price of maize. prices almost tripled.12 This sharp increase reflected export restrictions introduced by major A. Interventions in agricultural B. Policy interventions during the markets 2008 food price spike producers (e.g., India and Vietnam) motivated by food security concerns, panic buying by several large importers, a weak dollar, and record high prices of oil, which is a major input into food production (Childs and Kiawu 2009). During this episode, domestic markets were largely insulated from this global rice price spike (Ivanic and Martin 2008). By contrast, during the 2010-11 price spike, rice prices increased much less, by about 30 percent between June 2010 and May C. Insulation and correction D. Increase in world prices, 2010-11 2012. In some countries, adverse supply coefficients conditions combined with changes in non-tariff trade policies resulted in domestic rice prices rising above world prices.13 Instead of insulating policies, on average, EMDEs implemented policies that raised domestic prices relative to world prices (Figure 4.2.5). Wheat. Between February 2007 and March 2008, world wheat prices more than doubled, partly in Sources: Ag-Incentives Database, Ivanic and Martin (2014b), World Bank. response to lower-than-anticipated wheat A. Nominal Rate of Protection (NRP) is computed as the price difference between the farm gate price production caused by drought in Australia, received by producers and an undistorted reference price at the farm gate level. The reference price at the farm gate level is defined as the net price of the product when it leaves the farm, after Ukraine and other major exporters.14 Strong marketing costs have been subtracted. The undistorted farm gate price is defined as the price prevailing in competitive world markets. policy intervention partially insulated domestic B. Percent of respondents based on a survey of 80 EMDEs. markets from the global wheat price spike and C. Estimates based on an Error Correction Model described in Annex 4.2.1. The coefficient of price insulation ranges from 0 for countries that do not insulate against the rise in world prices, to -1 for their subsequent collapse in the aftermath of the countries that adopt policies that fully insulate domestic markets. The error correction term represents the cost of being out of equilibrium or the speed with which polices achieve the target level of global financial crisis in 2009-10. Similarly, protection or at which policymakers move back toward this equilibrium after being forced away from it by a shock to world prices. Based on data for 82 countries, of which 26 advanced economies, 44 during the 2010-11 event, world wheat prices EMDEs, and 12 LICs for the period 1955-2011. D. Real terms. Estimates derived based on the methodology described in Annex 4.2.1. more than doubled between June 2010 and May 2011.15 This time, the increase in world prices was partly driven by lower-than-expected production and exports in Kazakhstan, Russia, and Ukraine and excessive rains in Australia that damaged 12 The world price of 5 percent broken white Thai rice increased wheat crops (World Bank 2010). Large orders from $313/mt to $902/mt. 13 In Vietnam, for instance, domestic rice prices rose by 41 percent from major wheat importers in the Middle East between July-October 2010 due to lower-than-expected production, and North Africa added to price pressures. Since prior commitments on exports, and high inflation from a 2011, global and domestic wheat prices have depreciating currency. 14 The world price of U.S. Hard Red Wheat (HRW) increased fluctuated, broadly synchronously. from $196/mt to $440/mt. 15 The world price of U.S. Hard Red Wheat (HRW) increased Maize. During the 2007-08 food price spike, the from $158/mt to $355/mt. world price of maize almost doubled, partly as a EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 228 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 4.2.5 Domestic and global food prices In contrast, many countries in Sub-Saharan Africa benefitted from excellent maize harvests, which in Domestic food prices tend to be less volatile than global food prices. This partly reflects a sizeable services component in the cost of providing combination with unpredictable trade policies led domestic consumers with food, but also policy intervention. to sharp falls in domestic prices. A. Prices of staple foods B. Rice prices Insulation of domestic food markets Measuring insulation of domestic food markets. The degree of insulation of domestic markets from world food price swings can be quantified using an Error Correction Model (Annex 1). The model regresses the log of the protection rate on the log of world prices and the deviation from long-term “equilibrium” food prices. The model estimates the degree of insulation to global price changes in C. Wheat prices D. Maize prices both the short run (specifically, a negative coefficient on shortterm changes in global food prices) and long run (specifically, a negative coefficient on the longterm relationship between domestic and global food prices). The sample used here includes annual data for 8 food commodity prices in 82 countries, of which 44 are EMDEs and 12 are LICs, during 1955-2011. Estimates of short-term insulation. Estimates E. Domestic and global staple food F. Average increase in world and point to considerably short-term insulation in prices during 2007-08 and 2010-11 domestic price index, 2010-11 markets for key staple foods such as rice and wheat (Figure 4.2.4). Among these key staples, insulation is the highest for rice. In the short run, a 1 percent increase in global rice, wheat, and maize prices is associated with an increase in domestic prices of 0.6 percent, 0.7 percent, and 0.8 percent, respectively. Effectiveness of insulating policy measures. Sources: Ivanic and Martin (2014b), World Bank. Certain types of interventions in markets for staple Note: Trade-weighted averages. foods have raised volatility in domestic markets. A. Rice, wheat, maize, oil, and sugar prices. E. Event study based on monthly cross-country average domestic staples prices (average of wheat, For example, during the 2008-09 food price spike, rice and maize prices) and global staples prices (average of wheat, rice and maize) during 2007-08 and 2010-11. Period 0 represents the month of the peak of the world food price spike. several African countries intervened in food F. Average percent increase in the price index. pricing, marketing, and trade policy to stabilize domestic maize markets. Countries that result of increasing U.S. demand for maize intervened most intensively experienced the stimulated by mandatory targets for ethanol highest domestic price volatility, mostly because of production.16 Similarly, during the 2010-11 the ad hoc and unpredictable nature of these episode, the world price of maize increased interventions (Chapoto and Jayne 2009).17 The significantly. As in the case of wheat, adverse weather-related events in major maize exporting 17 After abstaining from the use of interventions in staple food countries contributed to the spike in world prices. markets for several years, policymakers in Eastern and Southern Africa used extensively pricing, marketing, and trade policy tools during the 2015-16 agricultural season to contain the impact of an El 16 Between January 2007 and June 2008, the world price of maize Niño-induced decline in output and food security (Al-Mamun et al. increased from $165/mt to $287/mt. 2017; Tschirley and Jayne 2010). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 229 use of an export ban during food price spikes, Martin and Anderson 2012; Ivanic and Martin possibly related to a domestic drought, illustrates 2014b).18 the tradeoffs between different policy instruments: Poverty impact of the 2010- • Ensuring food security. By restricting the sale of food for exports, an export ban increases 11 food price shock domestic supply and dampens domestic food price increases. This can help net-food buyers The impact of the 2010-2011 food price shock on access food. poverty is quantified in two steps. The first step estimates the degree of policy intervention by • Alleviating poverty. Net food-selling farmers countries (Anderson, Ivanic, and Martin 2014). In are likely to be hardest-hit by a drought. An the second step, these estimates are fed into a export ban reduces their ability to mitigate dynamic computable general equilibrium (CGE) their production losses with higher incomes model in combination with household models for from higher prices. If these farmers are among 285,000 households from 31 countries to the poorer segments of the income determine the impact of policy interventions on distribution, the export ban will likely increase poverty (Annex 1; Laborde, Robichaud and poverty, as it did in Zambia during the 2016- Tokgoz 2013). Two scenarios are compared. In 17 El Niño event (Al-Mamun et al. 2017). the first scenario, the impact of countries’ own interventions on poverty is considered. In the • Volatility. While export bans may alleviate second scenario, the combined effect of all policy pressures during a specific situation, they interventions on global food markets and their heighten domestic price volatility by feedback to domestic poverty is quantified. preventing domestic shocks from being dissipated through changes in trade. If bans Impact of policy interventions on global and are backed up by stockholding measures such domestic prices as those used in India they can be consistent Quantifying policy interventions. A primary with domestic price stabilization, although the shock, such as a weather shock, is assumed to fiscal costs of this policy approach tend to be generate initial production shortfalls that are high relative to that of price insulation calibrated to match the observed changes in (Gouel, Gautam, and Martin 2016). protection rates and world prices shown in Figure Synchronous policy measures. While individual 4.2.6.19 In attempting to insulate domestic markets from the increase in world prices, countries can succeed at insulating their domestic markets from short-term fluctuations in global governments take offsetting trade measures, such as the introduction of export bans (food exporters) food prices, their combined policies may make global food prices more volatile. Government or the reduction of import duties (food interventions tend to increase consumption and importers). These policy responses are calibrated to match the observed protection rates and world reduce production during price spikes and support production and discourage consumption during price increases in 2010-11. As the model distinguishes between domestic and imported price plunges. During price spikes, this results in higher import demand and, hence, higher global goods, two potential policy instruments are demand that further drives up global prices. considered—an import duty (or subsidy) and an During price plunges, it encourages greater exports from each country and, hence, greater global supply that further depresses prices. Only 18 Consistent with Martin and Anderson (2012) and Anderson, countries that insulate themselves to an above- Ivanic, and Martin (2014). 19 For example, a negative production shock of 55 percent for rice, average degree are able to reduce the transmission 27 percent for wheat, and 35 percent for maize in advanced of international price volatility to their domestic economies and Russia generates an increase of 10 percent in average markets (Anderson, Martin and Ivanic 2017; world prices for these commodities. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 230 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 FIGURE 4.2.6 The extent of government interventions domestic and world prices for 57 countries and 68 during the 2010-11 food price spike agricultural and food commodities during 2005- Some countries reduced trade barriers to insulate themselves from 2015.21 Where data from the Ag-Incentives increasing world prices. Others resorted to policy interventions that database were unavailable, alternative data were ultimately raised domestic prices more than the increase in world prices. used from FAOSTAT, GIEWS and Fewsnet. Overall, this analysis covers 24 major food A. Change in protection rates, 2010-11 B. Change in protection rates, 2010-11 producing and consuming countries, using data on household income sources and spending patterns from 2011. Of these, 18 are EMDEs and 6 are LICs. Impact of policy interventions on global prices. During the food price spike of 2010-11, world prices of maize, wheat and rice rose by 44, 39, and 6 percent, respectively, but domestic prices considerably less (Figure 4.2.4). Model results C. Change in EMDE protection rates, D. Change in LIC protection rates, suggest that the combined action of government 2010-11 2010-11 policies amplified global wheat and maize price increases, accounting for about 40 percent of the increase in world price of wheat and one-quarters of the increase in the price of maize. In contrast, combined policy action reduced the rice price surge compared to a non-action scenario.22 Wheat. Most EMDEs took measures to offset the increase in global wheat prices in 2010-11, Source: Ag-Incentives Database. broadly similar to those employed during the spike Notes: Estimates based on the methodology described in Annex 4.2.1. Changes in the rates of in wheat prices in 2007-08. Policymakers justified protection are presented in the form: Ti = ∆t/(1+t 0), where t is the initial rate of protection (positive if an import tariff or export subsidy) and ∆t is the change in this rate of protection. If the change in the efforts to dampen the impact of the global wheat rate of protection is negative during a period of rising world prices, countries are seeking to insulate their markets from the increase in prices. If it is positive, policymakers are compounding the increase price spike by noting that the world wheat price in world prices with an increase in protection, which may be due to the correction of past “errors”: If domestic prices fall below policymakers’ desired long-run level of protection, or if a policy that spike partly reflected a catching up with rising insulated the domestic market from world markets and a subsequent exogenous shock—such as a harvest shortfall—has caused the domestic price to rise relative to the world price. domestic wheat prices.23 The combined C.D. Median and interquartile range in the change for protection rates for rice, wheat, and maize in intervention of countries accounted for close to 50 EMDEs (C) and LICs (D). percent of the increase in the world price of wheat. Maize. Although most countries insulated their export subsidy (or tax).20 These measures, in turn, domestic maize markets against maize price reinforce the original shock to world prices. The increase during 2010-11, there was considerable data used for quantifying the extent of trade policy interventions are taken primarily from the Ag- Incentives Consortium database of changes in 21 The data is available at www.ag-incentives.org. 22 This primarily reflects the elimination of export restrictions in India and the increased import protection in Pakistan, Indonesia, 20 Many countries typically put in place flanking policies. In 2007- Uganda, and Yemen. 23 Ethiopia is an exception, where domestic wheat prices rose 28 08, for example, Indonesia subsidized imports of wheat and rice, percentage points more than world prices during 2010-11. This respectively, to hold down domestic consumer prices. To avoid reflected domestic supply shocks, combined with limited access to subsidizing exports of the same goods, export restrictions were also global wheat markets to alleviate shortages. In particular, wheat introduced. Because rice, wheat, and maize are bulk commodities that output fell by 10 percent in 2010-11 as a result of a fungus that are less strongly differentiated than manufactured products, two-way destroyed the wheat harvest and lowered stocks in 2011. Wheat trade in these goods is unusual—except when there are regional imports rose but were constrained by tight foreign exchange controls, differences in varieties (for example, Indian exports of Basmati rice effectively stopping private sector imports and ensuing that all grain and imports of Jasmine rice). Models of differentiated products are imports are channeled through the state-owned Ethiopian Grain needed to adequately capture actual bilateral trade flows in these Trade Enterprise (Wakeyo and Lanos 2014; Negassa and Jayne commodities (Thursby, Johnson, and Grennes 1986). 1997). EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 231 heterogeneity in policy responses. In Bangladesh, FIGURE 4.2.7 Poverty impact of policies implemented Ecuador, Malawi, Tanzania, and Zambia, during 2010-11 food price spike protection rates fell, fully offsetting the rise in The 2010-11 food price spike raised global poverty. The combined impact global maize prices. Ethiopia, Uganda, and Yemen of all government interventions raised poverty worldwide, except in a few increased protection rates or used policies that, in countries. Due to the dampening effect of interventions on the world price of rice, however, the impact of the combined interventions is found to have combination with domestic output shocks, raised poverty about 14 percent less than individual action. amplified the increase in domestic prices. A. Regional poverty impact of a 10 B. Global poverty impact of a 10 Rice. Some countries (e.g., Bangladesh, Nepal, percent rice, wheat, and maize price percent rice, wheat, and maize price Panama, Tanzania and Zambia) reduced trade increase, by EMDE region increase barriers to partially offset the rise in world rise prices. However, important net rice exporters such as India, Pakistan, and Yemen implemented policy interventions that, ultimately, raised domestic rice prices more than the increase in world prices. In India, the world’s second-largest rice producer, quantitative restrictions imposed in 2007 initially prevented domestic price increases. However, the subsequent abolition of export quotas in C. Impact of the 2010-11 food price D. Impact of policy responses to the increase on the number of extreme 2010-11 food price shocks on the September 2011 resulted in a surge in exports and number of poor poor, by EMDE region a rise in domestic prices. In Pakistan, heavy summer flooding that affected one-fifth of the country’s land area and inflicted extensive damage to crops raised domestic rice prices relative to the world price over the same period. A large increase in domestic prices relative to external prices occurred, in Yemen, amid persistent water shortages and a shift to less water-intensive non- staple crops and, in Ethiopia and Uganda, amid Source: World Bank. drought. The combined intervention of all Note: Based on estimates using the MIRAGRODEP computable general equilibrium model described in Annex 4.2.1. countries dampened the increase in the world A. Change in the poverty headcount measured at $1.90 per day. price of rice by about 50 percent compared to a B. Poverty impact measured at $1.90 per day. A.C. EAP = East Asia and Pacific; LAC = Latin America and the Caribbean; MNA = Middle East and scenario without insulation policies. North Africa; SAR = South Asia; and SSA = Sub-Saharan Africa. C.D. Assuming increases in the price of maize, rice, and wheat as represented in Figure 4.4.D and based on a poverty line of $1.90/day. Impact of policy intervention on poverty Poverty impact of hypothetical food price spikes without policy intervention. Without government effects of government intervention to reduce the intervention, a hypothetical 10 percent surge in pass-through of rising global to domestic prices, rice, wheat, and maize prices raises the number of model results suggest that the food price spikes of extreme poor living on less than $1.90 per day by 2010-11 still raised poverty in most countries 0.22 percent or 2.1 million. Among staple foods, (Figure 4.2.7). On average, the share of extreme an increase in wheat prices raises the number of poor living at less than $1.90 per day increased by poor most (by 0.01 percentage points for a 10 0.12 percentage point from 13.7 percent. This is percent wheat price increase). Rice price increases equivalent to an additional 8.3 million, or a 1 cause particularly large increases in the number of percent increase in the number of extreme poor. poor in Sub-Saharan Africa (0.13 percentage points). Finally, maize price increases tend to have Heterogeneity in poverty impact. The increase in a lesser impact on the number of poor. world food prices, combined with government intervention, was most strongly felt in countries Poverty impact of 2010-11 food price spike with such as India and Uganda, where the extreme poor policy intervention. When incorporating the tend to be net food-buyers whose real incomes EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 232 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 declined.24 The poverty impact of the 2010-11 following years. In 2010-11, some large wheat and food price spike on some regions such as East Asia maize producers, such as Russia and Ukraine, and the Pacific (EAP), and Latin America and the introduced export restrictions and import bans to Caribbean (LAC) is estimated to have been contain domestic price pressures. limited: low rates of poverty combined with the benefits of the price increase for countries that are Conclusions heavy exporters of rice (EAP) or maize (LAC) offset some of the losses incurred due to the During the 2010-11 food price shock, coming in increase in prices. Even in Sub-Saharan Africa— short succession after 2007-08 food price shock, the region that accounts for two-thirds of the many countries used trade policies to insulate global increase in poverty—countries like Ethiopia domestic food prices from the surge in world and Nigeria implemented insulation policies that prices. While each country’s policies can dampen reduced poverty. domestic price movements, the result of the combined use of policies increases global food Comparison with 2007-08 food price shock. price volatility. For example, widespread These poverty impacts are less than those induced insulation policies accounted for 40 percent of the by the 2007-08 food price shock. The 2007-08 increase in world wheat prices and one-quarter for food price shocks may have increased extreme world maize prices. As a result of this coincidence poverty by 105 million (Ivanic and Martin 2008). of individual government policy responses, the Government policies reduced poverty impacts and 2010-11 food price spike raised global poverty by their combined effect was close to zero (Anderson, almost 1 percent (8.3 million). Ivanic, and Martin 2014). The difference in poverty impacts reflects the greater severity of the These findings highlight that the use of trade 2007-08 price shocks, the stronger transmission of policy interventions to insulate domestic markets price changes from world to domestic markets and from food price shocks compounds the volatility higher initial poverty rates (the poverty headcount of international prices and may not be effective in in India, for instance, fell from 31 percent in 2009 protecting the most vulnerable populations to 21 percent in 2011).25 While the 2007-08 event groups. Instead, targeted safety net interventions was led by rice prices, exacerbated by export such as cash transfers, food and in-kind transfers, restrictions imposed by major rice producers, the school feeding and public works programs can 2010-11 food price surge was led by maize and mitigate the negative impact of food price shocks wheat prices, triggered by adverse weather events on poor households. Measures such as crop and in major wheat and maize producers in Australia weather insurance, warehouse receipt systems, and the Black Sea Basin. During 2007-08, large commodity exchanges and futures markets could rice consumers, such as India, imposed export also be used as risk management instruments. restrictions to contain domestic rice price Additional policy interventions such as targeted increases. These were gradually unwound over the nutrition and health programs can contribute to improving health outcomes in the medium term, while regulatory interventions (taxing unhealthy 24 Results reported here do not take into account the impact of food) can improve health outcomes in the long safety-net programs such as India’s Public Distribution System, which distributes food to poor households at fixed prices and so term. automatically makes larger transfer to the poor when food prices rise. 25 World Bank (2012) estimate that the 2010-11 food price spike More generally, in addition to targeted increased the number of poor by 50 million in the short run, and by interventions it is important to ensure that 34 million in the long-run. These higher estimates do not explicitly countries have detailed strategic framework for account for insulation policies and consider price increases of a wider range of food commodities (also beef, chicken, dairy, vegetable oils food crisis response in place and that these and soybean prices). In addition, there is uncertainty around poverty programs are sufficiently resourced with estimates due to systematic measurement errors in household surveys administrative budgets. International financial that may bias the poor’s dependence on food purchases (Headey and Martin 2016). Finally, Jacoby (2016) and Jacoby and Dasgupta institutions (IFIs) can assist countries to better (2018) highlight the importance of accounting for the endogenous target the people most vulnerable to a food price agricultural wage response and spillover effects to non-agricultural wages. crisis. IFIs can also assist countries to identify EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 233 practical mechanisms (including indicators) for politically-organized producers (Anderson 1995; monitoring nutritional and welfare outcomes and Grossman and Helpman 1994). impacts of food crises and mitigation programs, and work with them to implement those The database on Distortions to Agricultural mechanisms and to report the results. The private Incentives (Anderson and Valenzuela 2008; sector can also play a crucial role in enhancing Anderson and Nelgen 2013) is the main data investments in food supply in the short- and source for estimating the ECM model. It includes medium-term (World Bank 2013). Better estimates of domestic and world price levels which collaboration among public and private also determine the level of protection. The price stakeholders can also help strengthen risk data used in the model capture both natural management and provide effective responses to shocks (oil prices, weather events) as well as the reduce the impacts of extreme weather on impact of trade policy interventions the separate agriculture (G20 2018). impact of which is not possible to disentangle. The model is estimated for eight food Annex 4.2.1: Methodology commodities with data for 82 countries, of which 26 are advanced economies, 44 EMDEs, and 12 Error Correction Model LICs. The analytical framework used to represent the Measuring the extent of trade policy interventions imperfect transmission of changes in international prices into domestic markets relies on an Error The approach to quantify the extent of trade Correction Model (ECM) as described in Ivanic policy interventions builds on that used in and Martin (2014a). As noted by Nickell (1985), Anderson, Ivanic, and Martin (2014). It is this model represents a situation in which assumed that a primary shock, such as weather policymakers seek to reduce both the costs of shock, generates an initial change in domestic and change, and the costs of being out of equilibrium. world prices. In attempting to insulate consumers A simplified version model used by Ivanic and and producers from price increases, governments Martin (2014a), expressed in logs, is: make offsetting changes in protection measures, such as the introduction of export bans or Δτ α pw - pwt-1 β pt-1 - γ pwt-1 , reduction in import duties. These measures, in where p represents domestic prices; pw world turn, reinforce the original shock to world prices. prices; τ the rate of protection, approximated by When a country imposes an export restriction, the p-pw ; α, α 0, the coefficient of price insulation availability of food to the rest of the world is ranging from 0 for countries that do no insulate reduced, and this tends to push up world price. against the rise in world prices, to -1 for countries Similarly, when an importing country reduces its that adopt policies that fully insulate domestic import tariffs, it increases the demand for imports markets; and hence puts upward pressure on the world price. β, β 0, the cost of being out of equilibrium or the speed with which polices achieve the target The impact of the changes in trade policies can be level of protection or at which policymakers move distinguished from those of the primary shocks by back toward this equilibrium after being forced in the following equation: away from it by a shock to world prices; γ ΣiSi i i Σi Di i , determines the long run relationship between a country’s protection and the global level of where Si is supply in region i; Di is demand in agricultural protection; and pt-1 - γ pwt-1 is the region i; i * 1 t i is the domestic price; * deviation from the political-economy equilibrium. is the world price; ti is a country-specific trade It depends on factors like income levels, barrier, such as a proportional tariff; and i is a exportable/importable status, the elasticity of random production shift variable for region i. import demand, and the share of real incomes Totally differentiating the equation above, gains from higher protection that will accrue to rearranging, and expressing the results in EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 234 C H A P TE R 4 G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 percentage changes yields an expression of the If products are homogeneous, and a country is impact of a set of changes in trade distortions on small, the change in ∆t represents the change in the world price: the domestic price of the good. Additionally, if T" i is negative in a period of rising world prices, Σi (Gi i- Hi γi) ̂ *= countries are seeking to insulate their markets Σi Hi ̂i + Σi (Hiγi - Gi i) Ti from the increase in prices. If it is positive, policymakers are compounding the increase in where ̂* is the proportional change in the world prices with an increase in protection. This international price; î is an exogenous output may be due to the correction of past “errors”. This shock such as might result from good or bad might occur if domestic prices fall below seasonal conditions; i is the elasticity of demand policymakers’ desired long-run level, or if policy in market i; γi is the elasticity of supply in market insulated the domestic market from world markets i; Gi is the share at world prices of country i in and an exogenous shock—such a harvest global demand; Hi is the share of country i in shortfall—has caused the domestic price to rise global production, and T" i 1 ti . relative to the world price. Such insulation patterns have been observed in the maize markets In other words, the impact on the world price of a in many African countries (Chapoto and Jayne change in trade policies in country is given as a 2009). weighted average of the changes in trade distortions in different markets, with the weight e MIRAGRODEP model on region i depending on the importance of that country in global supply and demand, as well as The analytical framework to measure the poverty the responsiveness of its production and implications of the 2010-11 food price spike relies consumption to price changes in the country, as on the MIRAGRODEP model (Laborde, represented by γi and i . Robichaud, and Tokgoz 2013) complemented with household surveys for more than 31 countries It is thus assumed that elasticities of demand are and 285,000 representative households. equal between countries, i.e., that imported and MIRAGRODEP is a dynamic, multi-country, and domestic goods are perfect substitutes, and that multi-sector computable general equilibrium there are no supply responses. Alternatively, one (CGE) model. The model relies on GTAP 9, a could allow for differentiation between imported global database for 2011. The GTAP database and domestic products, as well as a limited supply includes input-output tables linked by bilateral response (Jensen and Anderson 2017). The result trade flows for 140 regions (countries or country would be an expression with weights that depend aggregates) and 57 sectors. For the purposes of the on, for instance, the shares of imports in simulations these countries and sectors were consumption in each market. However, the overall aggregated into 31 countries/regions and 15 result is similar in expressing the change in world sectors among which rice, wheat, and maize are prices as a weighted sum of changes in trade represented separately. distortions. On the supply side, the production function is a To avoid having to deal with difficult-to-interpret Leontief function of value-added and intermediate interaction terms, all proportional changes are inputs. The intermediate inputs are represented by converted into log changes in Ti , i’s, and as: a nested, two-level constant elasticity of substitution (CES) function of all goods. Based on ̂ i ̂ T" i this, substitutability exists between intermediate Changes in relative prices are measured as in the goods, but these are more substitutable when they Agricultural Incentives database and capture a are in a same category (such as agricultural inputs wide range of policy measures used to assess or service inputs). Value-added is also represented agricultural trade distortions—including tariffs, by a nested structure of CES functions of export subsidies, export taxes, export bans and unskilled labor, land, natural resources, skilled import subsidies. labor, and capital. This nesting allows the modeler EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 C H A P TE R 4 235 to incorporate some intermediate goods that are Beyond the standard features of a global dynamic substitutes of factors, such as energy or fertilizers. CGE model, the MIRAGRODEP model includes several improvements: sub-national land markets On the demand side, a representative consumer is (agro-ecological zones or administrative districts) assumed to have a constant propensity to save. and endogenous land supply; poverty analysis The remaining national income is used for the through either a top-down approach for global purchase of final consumption goods. Consumers’ coverage or a bottom-up approach (for a subset of preferences are represented by a linear expenditure countries); dual-dual approach for formal/informal system–constant elasticity of substitution (LES– and rural/urban labor markets (Stifel and CES) function, calibrated based on the U.S. Thorbecke 2003); a consistent aggregator for trade Department of Agriculture Economic Research policies (Laborde, Martin, and van der Service (ERS/USDA) income and price elasticities Mensbrugghe 2017); differentiated datasets on to best reflect non-homothetic demand patterns actual trade and farm policies and existing policy with changes in revenue. Given an increase in the space for scenario design and endogenous policy price staple foods such as rice, wheat or maize, responses; macro nutrient (calories, fats, proteins) consumers substitute away to consume other food accounting system based on FAOSTAT food products. Armington elasticities, which measure balance sheets and a global Input-Output matrix; the elasticity of substitution between products of and sensitivity analysis framework based on different countries, are drawn from the GTAP Monte-Carlo simulations. database and are assumed to be the same across regions. While the elasticities of substitution for rice, wheat, and maize used in this model, are higher Factor endowments are assumed to be fully than for manufactured goods, they are not infinite employed. The supply of capital goods is modified as assumed using the perfect substitutes model each year because of depreciation and investment. (Thursby, Johnson, and Grennes 1986). This New capital is allocated among sectors according specification has important implications for both to an investment function. Growth rates of labor the economy-wide analysis and at the household supply are fixed exogenously. Land supply is level. Given these assumptions, an increase in the endogenous and depends on the real remuneration price of an imported good has a muted impact on of land. Skilled labor is the only factor that is the domestic consumer price of that good. Since, perfectly mobile; unskilled labor is imperfectly with the Armington assumption—imported goods mobile between agricultural and nonagricultural differentiated based on their country of origin—, sectors according to a constant elasticity of the composite price of the consumer good is transformation (CET) function. Unskilled labor’s weighted by the shares of domestic and imported remuneration in agricultural activities is different goods, the impact of a unit change in the world from that of nonagricultural activities. The only price, or in trade policy, is given by the share of factor whose supply is constant is the natural imports in total consumption. Because the share resources factor. It is, however, possible to of imports in total consumption of staple foods is endogenously change the factor endowment in the typically small, the impact of trade policy on baseline in order to reflect long-term depletion of consumer prices is much more muted than under resources with respect to a price trajectory. the assumption of perfect substitution used in Anderson, Ivanic, and Martin (2014). On the The poverty impact is captured through a top- production side, the assumption that each down approach using a dataset of household country’s export product is the same as the surveys for more than 31 countries and 285,000 products sold domestically means that changes in representative households. 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EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) STATISTICAL APPENDIX EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S T A TI S T I C A L A P P E N D IX 243 Real GDP growth Annual estimates and forecasts1 Quarterly growth2 2016 2017 2018e 2019f 2020f 2021f 17Q2 17Q3 17Q4 18Q1 18Q2 18Q3e World 2.5 3.0 3.0 2.9 2.8 2.8 2.9 3.3 3.4 3.2 3.4 … Advanced economies 1.7 2.3 2.2 2.0 1.6 1.5 2.1 2.4 2.4 2.2 2.4 2.1 United States 1.6 2.2 2.9 2.5 1.7 1.6 2.1 2.3 2.5 2.6 2.9 3.0 Euro Area 1.9 2.4 1.9 1.6 1.5 1.3 2.5 2.8 2.7 2.4 2.2 1.7 Japan 1.0 1.7 0.9 0.9 0.5 0.7 1.5 2.0 1.9 1.1 1.4 0.3 United Kingdom 1.8 1.7 1.3 1.4 1.7 1.8 1.9 1.8 1.4 1.1 1.2 1.5 Emerging market and developing economies 3.7 4.3 4.2 4.2 4.5 4.6 4.4 4.9 4.9 5.0 5.0 … East Asia and Pacific 6.3 6.6 6.3 6.0 6.0 5.8 6.6 6.6 6.5 6.6 6.4 6.2 Cambodia 6.9 7.0 7.1 6.8 6.8 6.7 .. .. .. .. .. .. China 6.7 6.9 6.5 6.2 6.2 6.0 6.9 6.8 6.8 6.8 6.7 6.5 Fiji 0.4 3.8 3.5 3.4 3.3 3.3 .. .. .. .. .. .. Indonesia 5.0 5.1 5.2 5.2 5.3 5.3 5.0 5.1 5.2 5.1 5.3 5.2 Lao PDR 7.0 6.9 6.7 6.9 6.9 6.7 .. .. .. .. .. .. Malaysia 4.2 5.9 4.7 4.7 4.6 4.6 5.8 6.2 5.9 5.4 4.5 4.4 Mongolia 1.4 5.4 5.9 6.6 6.3 6.2 6.2 5.3 6.3 6.3 6.1 6.6 Myanmar 5.9 6.8 6.2 6.5 6.6 6.8 .. .. .. .. .. .. Papua New Guinea 2.6 2.8 0.3 5.1 3.1 3.4 .. .. .. .. .. .. Philippines 6.9 6.7 6.5 6.7 6.6 6.6 6.6 7.2 6.5 6.6 6.2 6.1 Solomon Islands 3.5 3.5 3.4 2.9 2.8 2.7 .. .. .. .. .. .. Thailand 3.3 3.9 4.1 3.8 3.9 3.9 3.9 4.3 4.0 4.9 4.6 3.3 Timor-Leste 5.3 -4.7 0.8 3.3 4.9 5.0 .. .. .. .. .. .. Vietnam 6.2 6.8 6.8 6.6 6.5 6.3 6.2 7.5 7.7 7.4 6.7 6.9 Europe and Central Asia 1.7 4.0 3.1 2.3 2.7 2.9 3.8 5.5 3.7 3.9 3.7 3.5 Albania 3.4 3.8 4.0 3.6 3.5 3.5 4.2 3.6 3.6 4.5 4.3 .. Armenia 0.2 7.5 5.3 4.3 4.6 4.6 .. .. .. .. .. .. Azerbaijan -3.1 0.1 1.1 3.6 3.3 2.7 .. .. .. .. .. .. Belarus -2.5 2.4 3.8 2.0 2.5 2.5 1.7 3.0 4.3 5.2 4.0 .. Bosnia and Herzegovina 3.1 3.0 3.2 3.4 3.9 4.0 3.2 2.8 3.3 2.0 3.4 .. Bulgaria 3.9 3.8 3.3 3.1 3.0 2.8 3.8 4.3 3.3 3.5 3.2 2.9 Croatia 3.5 2.9 2.7 2.8 2.8 2.6 3.2 3.4 2.2 2.5 2.9 2.8 Georgia 2.8 5.0 5.3 5.0 5.0 5.0 4.8 4.0 5.3 5.2 5.6 .. Hungary 2.2 4.0 4.6 3.2 2.8 2.4 3.5 4.1 4.5 4.5 4.9 4.8 Kazakhstan 1.1 4.1 3.8 3.5 3.2 3.2 5.3 4.2 3.1 4.1 4.3 .. Kosovo 4.1 4.2 4.2 4.5 4.5 4.5 .. .. .. .. .. .. Kyrgyz Republic 4.3 4.6 3.1 3.4 3.9 4.0 .. .. .. .. .. .. Macedonia, FYR 2.9 0.0 2.5 2.9 3.2 3.3 -1.3 0.2 1.2 0.1 3.1 .. Moldova 4.5 4.5 4.8 3.8 3.5 3.2 .. .. .. .. .. .. Montenegro 2.9 4.4 3.8 2.8 2.5 2.5 .. .. .. .. .. .. Poland 3.0 4.6 4.7 3.9 3.6 3.3 4.4 5.4 4.5 5.1 5.1 5.1 Romania 4.8 6.9 4.1 3.5 3.1 2.8 6.1 8.8 6.7 4.0 4.1 4.3 Russia -0.2 1.5 1.6 1.5 1.8 1.8 2.5 2.2 0.9 1.3 1.9 1.3 Serbia 2.8 1.9 3.5 3.5 4.0 4.0 1.8 2.2 2.5 4.8 4.9 3.8 Tajikistan 6.9 7.1 6.1 6.0 6.0 6.0 .. .. .. .. .. .. Turkey 3.2 7.4 3.6 1.6 3.0 4.2 5.3 11.5 7.3 7.3 5.2 .. Turkmenistan 6.2 6.5 6.2 5.6 5.1 4.9 .. .. .. .. .. .. Ukraine 2.3 2.5 3.5 2.9 3.4 3.8 2.6 2.5 2.3 3.1 3.8 2.8 Uzbekistan 7.8 5.3 5.0 5.1 5.5 6.0 .. .. .. .. .. .. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 244 S T A TI S T I C A L A P P E N D IX G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 Real GDP growth (continued) Annual estimates and forecasts1 Quarterly growth2 2016 2017 2018e 2019f 2020f 2021f 17Q2 17Q3 17Q4 18Q1 18Q2 18Q3e Latin America and the Caribbean -1.5 0.8 0.7 1.8 2.4 2.5 2.0 2.3 3.6 3.3 3.3 3.2 Argentina -1.8 2.9 -2.8 -1.7 2.7 3.1 3.0 3.8 3.9 3.9 -4.2 .. Belize -0.5 1.2 1.5 1.9 1.7 1.7 .. .. .. .. .. .. Bolivia 4.3 4.2 4.5 4.3 3.8 3.4 3.8 4.3 5.2 4.4 4.4 .. Brazil -3.3 1.1 1.2 2.2 2.4 2.4 0.6 1.4 2.2 1.2 0.9 1.3 Chile 1.3 1.5 4.0 3.5 3.3 3.2 0.5 2.5 3.3 4.5 5.4 2.8 Colombia 2.0 1.8 2.7 3.3 3.7 3.6 1.7 1.7 1.8 2.2 2.8 2.7 Costa Rica 4.2 3.3 2.7 2.6 2.5 2.5 3.7 2.7 3.0 2.8 3.6 .. Dominican Republic 6.6 4.6 5.8 5.1 5.0 4.8 3.1 3.1 6.5 6.4 7.1 .. Ecuador -1.2 2.4 1.5 1.6 1.6 1.9 2.1 2.9 2.8 1.6 0.9 .. El Salvador 2.6 2.3 2.8 2.5 2.4 2.4 0.3 3.2 2.4 2.7 2.9 .. Grenada 3.7 5.1 5.2 4.2 2.8 2.8 .. .. .. .. .. .. Guatemala 3.1 2.8 2.7 2.9 3.0 3.1 2.2 2.7 2.9 2.0 3.3 .. Guyana 2.6 2.1 3.4 4.6 30.0 24.8 -0.7 4.5 .. .. .. .. Haiti 3 1.5 1.2 1.6 2.3 2.4 2.5 .. .. .. .. .. .. Honduras 3.8 4.8 3.6 3.8 3.8 3.7 3.5 5.9 4.2 3.0 4.0 .. Jamaica 1.4 0.5 1.7 1.8 2.0 2.0 -0.1 0.8 1.1 .. .. .. Mexico 2.9 2.0 2.2 2.2 2.4 2.4 1.9 1.5 1.5 1.2 2.6 2.5 Nicaragua 4.7 4.9 -3.8 -0.5 2.6 3.6 4.1 3.2 4.7 2.5 -4.4 .. Panama 5.0 5.4 4.0 5.0 6.2 5.2 5.2 5.3 4.9 4.2 3.1 .. Paraguay 4.3 4.8 4.0 3.9 4.0 4.0 2.8 5.8 5.4 4.7 6.2 .. Peru 4.0 2.5 3.9 3.8 3.8 3.7 2.5 2.9 2.4 3.2 5.5 2.3 St. Lucia 3.4 3.8 1.5 2.7 2.8 2.3 .. .. .. .. .. .. St. Vincent and the Grenadines 1.3 0.5 1.2 1.6 1.6 2.0 .. .. .. .. .. .. Suriname -5.1 -2.1 1.4 1.6 1.8 1.9 .. .. .. .. .. .. Trinidad and Tobago -6.0 -2.3 0.7 0.9 1.2 1.2 .. .. .. .. .. .. Uruguay 1.7 2.7 2.1 2.1 2.3 2.5 2.8 1.9 2.0 2.2 2.5 .. Venezuela -16.5 -14.5 -18.0 -8.0 -5.0 -4.0 .. .. .. .. .. .. Middle East and North Africa 5.1 1.2 1.7 1.9 2.7 2.7 1.4 2.3 1.1 2.2 2.6 2.6 Algeria 3.2 1.4 2.5 2.3 1.8 1.8 .. .. .. .. .. .. Bahrain 3.2 3.9 3.2 2.6 2.8 2.8 5.0 2.9 2.5 -1.2 2.4 .. Djibouti 8.6 5.7 6.7 7.3 7.5 7.5 .. .. .. .. .. .. Egypt 3 4.3 4.2 5.3 5.6 5.8 6.0 5.0 5.2 5.3 5.4 5.4 .. Iran 13.4 3.8 -1.5 -3.6 1.0 1.1 3.5 6.1 2.4 2.9 2.5 .. Iraq 13.0 -2.1 1.9 6.2 2.9 2.8 .. .. .. .. .. .. Jordan 2.0 2.0 2.1 2.3 2.4 2.7 0.2 0.2 2.2 1.9 2.1 .. Kuwait 2.9 -3.5 1.7 3.6 3.6 3.6 -2.9 -3.6 -2.7 -0.5 1.9 .. Lebanon 1.7 1.5 1.0 1.3 1.5 1.5 .. .. .. .. .. .. Morocco 1.1 4.1 3.2 2.9 3.5 3.5 .. .. .. .. .. .. Oman 5.0 -0.9 1.9 3.4 2.8 2.8 .. .. .. .. .. .. Qatar 2.1 1.6 2.3 2.7 3.0 3.0 0.8 0.7 3.3 2.0 2.5 .. Saudi Arabia 1.7 -0.9 2.0 2.1 2.2 2.2 -0.8 -0.3 -1.4 1.2 1.6 .. Tunisia 1.1 2.0 2.6 2.9 3.4 3.6 1.8 2.1 2.0 2.3 2.9 2.6 United Arab Emirates 3.0 0.8 2.0 3.0 3.2 3.2 .. .. .. .. .. .. West Bank and Gaza 4.7 3.1 1.7 1.9 1.9 1.9 .. .. .. .. .. .. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S T A TI S T I C A L A P P E N D IX 245 Real GDP growth (continued) Annual estimates and forecasts1 Quarterly growth2 2016 2017 2018e 2019f 2020f 2021f 17Q2 17Q3 17Q4 18Q1 18Q2 18Q3e South Asia 7.5 6.2 6.9 7.1 7.1 7.1 5.5 6.2 6.8 7.6 8.1 7.0 Afghanistan 2.4 2.7 2.4 2.7 3.2 3.2 .. .. .. .. .. .. Bangladesh3,4 7.1 7.3 7.9 7.0 6.8 6.8 .. .. .. .. .. .. Bhutan 3,4 7.4 5.8 4.6 7.6 6.4 6.4 .. .. .. .. .. .. India 3,4 7.1 6.7 7.3 7.5 7.5 7.5 5.6 6.3 7.0 7.7 8.2 7.1 Maldives 6.2 7.1 8.0 6.3 5.6 5.6 .. .. .. .. .. .. Nepal3,4 0.6 7.9 6.3 5.9 6.0 6.0 .. .. .. .. .. .. Pakistan3,4 4.6 5.4 5.8 3.7 4.2 4.8 .. .. .. .. .. .. Sri Lanka 4.5 3.3 3.9 4.0 4.1 4.1 3.0 3.2 3.5 3.5 3.7 .. Sub-Saharan Africa 1.3 2.6 2.7 3.4 3.6 3.7 2.4 2.5 2.7 2.5 2.1 .. Angola -2.6 -0.1 -1.8 2.9 2.5 2.8 .. .. .. .. .. .. Benin 4.0 5.6 6.0 6.2 6.5 6.6 .. .. .. .. .. .. Botswana3 4.3 2.4 4.4 3.9 4.1 4.1 1.0 1.1 6.4 4.8 5.3 .. Burkina Faso 5.9 6.4 6.0 6.0 6.0 6.0 .. .. .. .. .. .. Burundi -0.6 0.5 1.9 2.3 2.5 2.8 .. .. .. .. .. .. Cabo Verde 4.7 4.0 4.5 4.7 4.9 4.9 .. .. .. .. .. .. Cameroon 4.6 3.5 3.8 4.2 4.5 4.5 .. .. .. .. .. .. Chad -6.3 -3.0 3.0 3.3 6.1 5.2 .. .. .. .. .. .. Comoros 2.2 2.7 2.7 3.1 3.1 3.1 .. .. .. .. .. .. Congo, Dem. Rep. 2.4 3.4 4.1 4.6 5.5 5.9 .. .. .. .. .. .. Congo, Rep. -2.8 -3.1 2.0 3.7 -0.1 -1.5 .. .. .. .. .. .. Côte d'Ivoire 8.3 7.8 7.5 7.3 7.3 6.8 .. .. .. .. .. .. Equatorial Guinea -8.5 -4.9 -8.8 -2.1 -5.8 -5.8 .. .. .. .. .. .. Eswatini 3.2 1.9 -0.6 1.7 1.8 1.8 .. .. .. .. .. .. Ethiopia3 7.6 10.3 9.1 9.1 9.0 9.0 .. .. .. .. .. .. Gabon 2.1 0.5 2.0 3.0 3.7 3.7 .. .. .. .. .. .. Gambia, The 0.4 4.6 5.3 5.4 5.2 5.2 .. .. .. .. .. .. Ghana 3.7 8.5 6.5 7.3 6.0 6.0 11.1 8.7 5.5 5.4 5.4 .. Guinea 10.5 8.2 5.9 5.8 6.0 6.0 .. .. .. .. .. .. Guinea-Bissau 5.8 5.9 4.8 5.1 5.3 5.5 .. .. .. .. .. .. Kenya 5.9 4.9 5.7 5.8 6.0 6.0 4.7 4.7 5.4 5.7 6.3 .. Lesotho 3.1 -1.7 1.2 1.2 0.2 1.8 .. .. .. .. .. .. Liberia -1.6 2.5 3.2 4.4 4.8 4.8 .. .. .. .. .. .. Madagascar 4.2 4.2 5.0 5.4 5.3 5.3 .. .. .. .. .. .. Malawi 2.5 4.0 3.5 4.3 5.3 5.5 .. .. .. .. .. .. Mali 5.8 5.4 5.1 4.8 4.8 4.8 .. .. .. .. .. .. Mauritania 2.0 3.5 3.0 4.9 6.9 6.9 .. .. .. .. .. .. Mauritius 3.8 3.9 3.9 4.0 3.6 3.6 .. .. .. .. .. .. Mozambique 3.8 3.7 3.3 3.5 4.0 4.1 .. .. .. .. .. .. Namibia 0.6 -0.9 0.7 1.8 2.1 2.1 .. .. .. .. .. .. Niger 4.9 4.9 5.2 5.3 5.7 5.8 .. .. .. .. .. .. Nigeria -1.6 0.8 1.9 2.2 2.4 2.4 0.7 1.2 2.0 2.1 1.5 .. Rwanda 6.0 6.1 7.2 7.8 8.0 8.0 .. .. .. .. .. .. Senegal 6.2 7.2 6.6 6.6 6.7 6.9 .. .. .. .. .. .. Seychelles 4.5 5.3 3.5 3.4 3.2 2.9 .. .. .. .. .. .. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 246 S T A TI S T I C A L A P P E N D IX G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 Real GDP growth (continued) Annual estimates and forecasts1 Quarterly growth2 2016 2017 2018e 2019f 2020f 2021f 17Q2 17Q3 17Q4 18Q1 18Q2 18Q3e Sub-Saharan Africa (continued) Sierra Leone 6.3 3.7 3.7 5.1 6.3 6.3 .. .. .. .. .. .. South Africa 0.6 1.3 0.8 1.3 1.6 1.7 1.2 1.6 1.4 0.8 0.4 .. Sudan 4.7 4.3 3.1 3.6 3.7 3.8 .. .. .. .. .. .. Tanzania 7.0 7.1 6.6 6.8 6.9 7.0 7.8 6.8 8.4 .. .. .. Togo 5.1 4.4 4.5 4.8 5.1 5.1 .. .. .. .. .. .. Uganda3 4.6 3.9 6.1 6.0 6.4 6.5 6.4 7.0 6.1 6.2 5.0 .. Zambia 3.8 3.4 3.3 3.6 3.8 3.8 3.4 5.3 4.1 2.7 3.9 .. Zimbabwe 0.6 3.2 3.0 3.7 4.0 4.0 .. .. .. .. .. .. Sources: World Bank and Haver Analytics. Notes: e = estimate; f = forecast. 1. Aggregate growth rates calculated using constant 2010 U.S. dollars GDP weights. 2. Year-over-year quarterly growth of not-seasonally-adjusted real GDP, except for Ecuador, the Euro Area and the United Kingdom. Data for Bosnia and Herzegovina are from the production approach. Regional averages are calculated based on data from following countries. East Asia and Pacific: China, Indonesia, Malaysia, Mongolia, Philippines, Thailand, and Vietnam. Europe and Central Asia: Albania, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Georgia, Hungary, Kazakhstan, FYR Macedonia, Poland, Romania, Russia, Serbia, Turkey, and Ukraine. Latin America and the Caribbean: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Guyana, Honduras, Jamaica, Mexico, Nicaragua, Paraguay, Peru, and Uruguay. Middle East and North Africa: Bahrain, Egypt, Iran, Jordan, Kuwait, Qatar, Saudi Arabia, and Tunisia. South Asia: India and Sri Lanka. Sub-Saharan Africa: Botswana, Ghana, Kenya, Nigeria, South Africa, Tanzania, Uganda, and Zambia. 3. Annual GDP is on fiscal year basis, as per reporting practice in the country. 4. GDP data for Pakistan are based on factor cost. For Bangladesh, Bhutan, Nepal, and Pakistan, the column labeled 2017 refers to FY2016/17. For India, the column labeled 2016 refers to FY2016/17. For additional information, please see www.worldbank.org/gep. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S T A TI S T I C A L A P P E N D IX 247 Data and Forecast Conventions The macroeconomic forecasts presented in this House Prices Indicators, IMF Balance of Pay- report are prepared by staff of the Prospects ments Statistics, and IMF International Financial Group of the Development Economics Vice- Statistics. Presidency, in coordination with staff from the Macroeconomics, Trade, and Investment Global Aggregations. Aggregate growth for the world and Practice and from regional and country offices, all sub-groups of countries (such as regions and and with input from regional Chief Economist income groups) is calculated as GDP-weighted offices. They are the result of an iterative process average (at 2010 prices) of country-specific that incorporates data, macroeconometric models, growth rates. Income groups are defined as in the and judgment. World Bank’s classification of country groups. Data. Data used to prepare country forecasts Forecast Process. The process starts with initial come from a variety of sources. National Income assumptions about advanced-economy growth Accounts (NIA), Balance of Payments (BOP), and and commodity price forecasts. These are used as fiscal data are from Haver Analytics; the World conditioning assumptions for the first set of Development Indicators by the World Bank; the growth forecasts for EMDEs, which are produced World Economic Outlook, Balance of Payments using macroeconometric models, accounting Statistics, and International Financial Statistics by frameworks to ensure national account identities the International Monetary Fund. Population and global consistency, estimates of spillovers data and forecasts are from the United Nations from major economies, and high-frequency World Population Prospects. Country- and indicators. These forecasts are then evaluated to lending-group classifications are from the World ensure consistency of treatment across similar Bank. DECPG databases include commodity EMDEs. This is followed by extensive discussions prices, data on previous forecast vintages, and in- with World Bank country teams, who conduct house country classifications. Other internal continuous macroeconomic monitoring and databases include high-frequency indicators such dialogue with country authorities. Throughout as industrial production, consumer price indexes, the forecasting process, staff use macro- house prices, exchange rates, exports, imports, and econometric models that allow the combination stock market indexes, based on data from of judgement and consistency with model-based Bloomberg, Haver Analytics, OECD Analytical insights. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S E L E CTE D TO P I C S 249 Global Economic Prospects: Selected Topics, 2015-19 Growth and Business Cycles Global output gap Is the global economy turning the corner? January 2018, Box 1.1 Low-income countries Recent developments and outlook January 2019, Box 1.2 Recent developments and outlook June 2018, Box 1.2 Recent developments and outlook January 2018, Box 1.2 Recent developments and outlook June 2017, Box 1.1 Recent developments and outlook January 2017, Box 1.1 Recent developments and outlook June 2016, Box 1.1 Graduation, recent developments, and prospects January 2015, Chapter 1 Regional perspectives Recent developments and outlook January 2019, Box 1.3 Recent developments and outlook June 2018, Box 1.3 Recent developments and outlook January 2018, Box 1.3 Recent developments and outlook June 2017, Box 1.2 Recent developments and outlook January 2017, Box 1.2 Recent developments and outlook June, 2016, Box 1.2 Potential growth What is potential growth? January 2018, Box 3.1 Understanding the recent productivity slowdown: Facts and explanations January 2018, Box 3.2 Moving together? Investment and potential output January 2018, Box 3.3 The long shadow of contractions over potential output January 2018, Box 3.4 Productivity and investment growth during reforms January 2018, Box 3.5 East Asia and Pacific January 2018, Box 2.1.1 Europe and Central Asia January 2018, Box 2.2.1 Latin America and the Caribbean January 2018, Box 2.3.1 Middle East and North Africa January 2018, Box 2.4.1 South Asia January 2018, Box 2.5.1 Sub-Saharan Africa January 2018, Box 2.6.1 Recent investment slowdown Investment developments and outlook: East Asia and Pacific January 2017, Box 2.1.1 Europe and Central Asia January 2017, Box 2.2.1 Latin America and the Caribbean January 2017, Box 2.3.1 Middle East and North Africa January 2017, Box 2.4.1 South Asia January 2017, Box 2.5.1 Sub-Saharan Africa January 2017, Box 2.6.1 Regional integration and spillovers East Asia and Pacific January 2016, Box 2.1.1 Europe and Central Asia January 2016, Box 2.2.1 Latin America and the Caribbean January 2016, Box 2.3.1 EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 250 S E L E CTE D TO P I C S G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 Global Economic Prospects: Selected Topics, 2015-19 Growth and Business Cycles (continued) Regional integration and spillovers (continued) Middle East and North Africa January 2016, Box 2.4.1 South Asia January 2016, Box 2.5.1 Sub-Saharan Africa January 2016, Box 2.6.1 Regional informality East Asia and Pacific January 2019, Box 2.1.1 Europe and Central Asia January 2019, Box 2.2.1 Latin America and the Caribbean January 2019, Box 2.3.1 Middle East and North Africa January 2019, Box 2.4.1 South Asia January 2019, Box 2.5.1 Sub-Saharan Africa January 2019, Box 2.6.1 Other topics Growing in the shadow: Challenges of informality January 2019, Chapter 3 Long-term growth prospects: Downgraded no more? June 2018, Box 1.1 Education demographics and global inequality January 2018, SF 2 Weak investment in uncertain times: Causes, implications and policy responses January 2017, Chapter 3 Implications of rising uncertainty for investment in EMDEs January 2017, Box 3.2 Implications of the investment slowdown in China January 2017, Box 3.3 Interactions between public and private investment January 2017, Box 3.4 Quantifying uncertainties in global growth forecasts June 2016, SF 2 Who catches a cold when emerging markets sneeze? January 2016, Chapter 3 Sources of the growth slowdown in BRICS January 2016, Box 3.1 Understanding cross-border growth spillovers January 2016, Box 3.2 Within-region spillovers January 2016, Box 3.3 Recent developments in emerging and developing country labor markets June 2015, Box 1.3 Linkages between China and Sub-Saharan Africa June 2015, Box 2.1 What does weak growth mean for poverty in the future? January 2015, Box 1.1 What does a slowdown in China mean for Latin America and the Caribbean? January 2015, Box 2.2 is Sub-Saharan Africa? How resilientMarkets Commodity January 2015, Box 2.4 The role of the EM7 in commodity production June 2018, SF1, Box SF1.1 Commodity consumption: Implications of government policies June 2018, SF1, Box SF1.2 With the benefit of hindsight: The impact of the 2014–16 oil price collapse January 2018, SF1 From commodity discovery to production: Vulnerabilities and policies in LICs January 2016, Chapter 1 After the commodities boom: What next for low-income countries? June 2015, Chapter 1, SF Low oil prices in perspective June 2015, Box 1.2 Understanding the plunge in oil prices: Sources and implications January 2015, Chapter 4 What do we know about the impact of oil prices on output and inflation? A brief survey January 2015, Box 4.1 EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 S E L E CTE D TO P I C S 251 Global Economic Prospects: Selected Topics, 2015-19 Globalization of Trade and Financial Flows Poverty impact of food price shocks and policies January 2019, Chapter 4 Arm’s-Length trade: A source of post-crisis trade weakness June 2017, SF The U.S. economy and the world January 2017, SF Regulatory convergence in mega-regional trade agreements January 2016, Box 4.1.1 Can remittances help promote consumption stability? January 2016, Chapter 4 Potential macroeconomic implications of the Trans-Pacific Partnership Agreement January 2016, Chapter 4 Regulatory convergence in mega-regional trade agreements January 2016, Box 4.1.1 China’s integration in global supply chains: Review and implications January 2015, Box 2.1 What lies behind the global trade slowdown? January 2015, Chapter 4 Monetary and Exchange Rate Policies The great disinflation in EMDEs January 2019, Box 1.1 Corporate debt: Financial stability and investment implications June 2018, SF2 Investment-less credit booms January 2017, Box 3.1 Recent credit surge in historical context June 2016, SF1 Peg and control? The links between exchange rate regimes and capital account policies January 2016, Chapter 4 Negative interest rates in Europe: A glance at their causes and implications June 2015, Box 1.1 Hoping for the best, preparing for the worst: Risks around U.S. rate liftoff and policy options June 2015, SF1.1 Countercyclical monetary policy in emerging markets: Review and evidence January 2015, Box 1.2 Fiscal Policies Debt in low-income countries: Evolution, implications, and remedies January 2019, Chapter 4 Debt dynamics in emerging market and developing economies: Time to act? June 2017, SF Having fiscal space and using it: Fiscal challenges in developing economies January 2015, Chapter 3 Revenue mobilization in South Asia: Policy challenges and recommendations January 2015, Box 2.3 Fiscal policy in low-income countries January 2015, Box 3.1 What affects the size of fiscal multipliers? January 2015, Box 3.2 Chile’s fiscal rule—An example of success January 2015, Box 3.3 Narrow fiscal space and the risk of a debt crisis January 2015, Box 3.4 EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) 252 S E L E CTE D TO P I C S G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 9 Development Economics Prospects Group (DECPG): Selected Other Publications on the Global Economy, 2015-19 Commodity Markets Outlook Column1 The implications of tariffs for commodity markets October 2018, Box The changing of the guard: Shifts in industrial commodity demand October 2018, SF Oil exporters: Policies and challenges April, 2018, SF Investment weakness in commodity exporters January 2017, SF OPEC in historical context: Commodity agreements and market fundamentals October 2016, SF Energy and food prices: Moving in tandem? July 2016, SF Resource development in an era of cheap commodities April 2016, SF Weak growth in emerging market economies: What does it imply for commodity markets? January 2016, SF Understanding El Niño: What does it mean for commodity markets? October 2015, SF How important are China and India in global commodity consumption July 2015, SF Anatomy of the last four oil price crashes April 2015, SF Putting the recent plunge in oil prices in perspective January 2015, SF High-Frequency Monitoring Column1 Global Monthly newsletter Global Weekly newsletter ECO-AUDIT Environmental Benefits Statement e World Bank Group is committed to reducing its environmental footprint. In support of this commitment, we leverage electronic publishing options and print-on-demand technology, which is located in regional hubs worldwide. Together, these initiatives enable print runs to be lowered and shipping distances decreased, resulting in reduced paper consumption, chemical use, greenhouse gas emissions, and waste. We follow the recommended standards for paper use set by the Green Press Initiative. e majority of our books are printed on Forest Stewardship Council (FSC)-certi ed paper, with nearly all containing 50-100 percent recycled content. e recycled ber in our book paper is either unbleached or bleached using totally chlorine-free (TCF), processed chlorine-free (PCF), or enhanced elemental chlorine-free (EECF) processes. More information about the Bank’s environmental philosophy can be found at http://www.worldbank.org/corporateresponsibility. EMBARGOED: NOT FOR PUBLICATION, BROADCAST, OR TRANSMISSION UNTIL TUESDAY, JANUARY 8, 2019 AT 4:00 PM EST (9:00 PM UTC/GMT) G lobal economic prospects have darkened. Financing conditions have tightened, industrial production has moderated, and trade tensions remain elevated. The recovery in emerging market and developing economies has stalled, and some countries have experienced significant financial stress. Downside risks have increased, including the possibility of disorderly financial market movements and escalating trade disputes. It is thus critical to rebuild policy buffers while fostering potential growth by boosting human capital, promoting trade integration, and addressing informality. In addition to discussing global and regional economic developments and prospects, this edition of Global Economic Prospects includes a chapter on the challenges posed by informality and associated policy options. The report also contains pieces on the remarkable decline in EMDE inflation over the past decades, rising debt vulnerabilities in low-income countries, and the implications of large spikes in food prices for poverty. Global Economic Prospects is a World Bank Group Flagship Report that examines global economic developments and prospects, with a special focus on emerging market and developing countries, on a semiannual basis (in January and June). The January edition includes in-depth analyses of topical policy challenges faced by these economies, while the June edition contains shorter analytical pieces.