TWN Info Service on Finance and Development (Nov11/04)
22 November 2011
Third World Network

South-South cooperation and State-building in LDCs
Published in SUNS #7263 dated 18 November 2011

Geneva, 17 Nov (Kanaga Raja) -- The most effective way for Least Developed Countries (LDCs) to enhance the development impact and realize the development opportunities of South-South cooperation is to build a catalytic developmental State tailored to LDC circumstances.

This is one of the main recommendations of the United Nations Conference on Trade and Development (UNCTAD) in its Least Developed Countries Report 2011, released on 17 November.

According to the report, South-South cooperation has features that make it more likely to support and encourage such State-building than the current traditional forms of development cooperation. It is thus possible to create a positive interaction between building developmental States in LDCs and South-South cooperation.

The report finds that while developed economies remain very important partners for the LDCs, South-South relations already play an important role in the LDCs' integration into the world economy, and are likely to intensify further in the future.

"In the context of growing economic ties within the South, the key issue for the LDCs is the extent to which this dynamism can serve as a springboard for developing their productive capacities and fostering structural transformation, intended not only as the quantitative expansion of production, but also as its qualitative upgrading towards higher value-added and more knowledge-intensive activities."

According to UNCTAD, as a result of the increased interdependence at the global level, the emergence of Southern growth poles will continue to have strong spillover effects on the LDC economies, not only through trade and investment, but through technology diffusion, migration and South-South development cooperation.

"Through all these channels, the ongoing re-calibration of the world economy provides the LDCs with a broad array of emerging partnerships, which can be complementary to traditional North-South partnerships."

The deepening of economic relations between the LDCs and their Southern partners are creating a broader set of opportunities, but also pose challenges, says the report, cautioning that there is also a risk that their commodity dependence will be locked in by the emerging international division of labour and the fierce competition in labour-intensive manufacturing.

"For this reason, it is essential for the LDCs to forge a proactive and strategic approach to their integration with developing country partners, leveraging synergies and complementarities across them."

According to the LDC report, the economies of the LDCs as a group grew by 5.7% in 2010. This is a slight improvement - one percentage point - in comparison with the result in 2009, but is far below the 7.1% average annual growth rate during the boom period 2000-2008. In comparison with the average growth of 7.3% of developing and emerging economies, the LDCs as a group under-performed in 2010 and are forecast to under-perform in 2011 as well.

If these trends continue, cautions UNCTAD, there is a danger that the LDCs will not only continue to diverge from other developing economies in per capita terms - the tendency before the crisis - but also in terms of total gross domestic product (GDP).

At a media briefing Tuesday, Charles Gore, Special Coordinator for cross-sectoral issues in the UNCTAD Division for Africa, LDCs and Special Programmes, said that for the last decade, UNCTAD has been sounding the alarm about the continued marginalisation of the poorest countries in the world.

If current trends persist, he noted, the LDCs are going to become the major locus for extreme poverty in the global economy, sooner rather than later. "These poorest countries are more marginalised than they were in the past. Even though they've grown rapidly during the past decade, they are actually losing ground against other developing countries," he said.

Dr Supachai Panitchpakdi, Secretary-General of UNCTAD, said at the briefing that for the past two decades, the LDCs have been told to become more dependent on market mechanisms. This neoliberal thinking has actually devastated the kind of planning exercise, the role of commodity boards, cooperatives and governments to spur on development in LDCs. The belief in markets has actually turned most sub-Saharan (African) countries from being net-food-producing to net-food-importing countries, he added.

He also pointed to the total "misconception" when assistance to LDCs is shifted to the area of the social system, while neglecting the areas of agricultural, infrastructure and industrial capacity development. The total misallocation of resources has been the hallmark of the last decade, he said.

Dr Supachai further drew attention to the belief in the total positive effects of privatization and liberalization. A lot of countries in Africa that have gone on to very rapid liberalization, have learned through their own painful experience that this could lead to dislocation and de-industrialisation, he added.

According to the LDC report, the intensification of the LDCs' economic relations with other Southern partners is a multifaceted process encompassing simultaneously market-driven aspects - such as trade, investment, migration, remittances and technology transfer - as well as policy-driven ones, such as official flows or political representation in global forums. While these dimensions are conceptually different from one another, they are often intertwined.

Owing to its high resource intensity, says the report, the continuing boom of Southern growth poles is likely to affect particularly the markets for hard and soft commodities, especially if economic growth is associated with rapid urbanization and large-scale infrastructural investments. Net exporters of commodities may thus benefit from the resulting terms of trade shift.

However, this prospect could be a double-edged sword for many LDCs. As painfully revealed by the 2008 food and fuel price hikes, while the LDC group as a whole may stand to gain from the sustained demand for commodities, this is not true for many net importers, who conversely may face balance-of-payment difficulties and greater food insecurity.

Data on export revenues of LDCs by destination suggest that the rapid acceleration in their exports performance throughout the 2000s has been driven by a mounting prominence of Southern destination markets. By 2009, LDC exports to Southern partners were worth $62 billion, and nearly $6.5 billion were exported to NIEs (newly industrialised economies); this compares with $59 billion, and little more than $500 million exported to developed and transition economies, respectively.

In other words, developing countries in 2009 absorbed more than half of the LDCs' merchandise exports, up from 40% at the beginning of the decade. Correspondingly, the relative importance of developed economies has declined, even if export revenues for the LDC as a group have been growing at a rate close to 20% per year also in these destination markets.

The evolution of LDC exports has been parallelled by a simultaneous widening of their merchandise imports bill, which rose from $42 billion in 2000 to almost $144 billion in 2009, after peaking in 2008 at more than $169 billion. The relative weight of rich economies has, however, been steadily eroding, as Southern partners expanded their market share by roughly 10 percentage points in less than 10 years, and nowadays account for over half of LDCs' total merchandise imports.

The importance of Southern markets has been steadily on the rise, both as destinations for exports and as sources of imports, not only for the LDCs as a group, but also for the overwhelming majority of individual countries. In the median LDC, the share of merchandise exports absorbed by Southern markets climbed from approximately 34% in 2000 to 54% by 2009. Conversely, in 2000, the median LDC sourced 45% of its imports in Southern markets, while the same percentage had attained 59% in 2009.

According to the report, South-South trade is characterized by a strong geographic concentration, with most major players located in Asia. This holds true, with necessary modifications, of LDCs' trade with Southern partners. Another facet of geographic concentration pertains to the fact that LDCs' exports to Southern markets are largely driven by a few (mostly resource-rich) LDCs. Four of them, namely Angola, Sudan, Yemen and Myanmar, account for roughly two thirds of all LDC exports to Southern partners and their importance has been consistently on the rise in recent years.

"While the expansion of South-South trade clearly boosted LDC export revenues and translated into a greater geographic diversification, the benefits in terms of economic diversification have been more elusive. This bears crucial implications for the development of the LDCs' productive capacities, as structural transformation and industrial upgrading are necessary to create productive employment outside the agricultural and informal sector."

The LDCs' commodity dependence remained extremely high throughout the past decade, with primary products accounting consistently for upwards of 70% of total merchandise exports. A breakdown of the LDCs' export growth by product category, as well as by destination, shows that the surge of fuels exports - and to a lesser extent, mineral exports - played an important role in nearly all destination markets.

In contrast, LDC imports have been dominated by manufactures, food and fuels, which accounted respectively for 65%, 19% and 12% of the total. In spite of the relative price changes and high commodity prices, manufactures continued to be the key drivers of the LDCs' import growth from all origins, though their contribution to the growth of imports is indeed the largest in the case of Southern partners.

The growing importance of Southern markets for the LDCs has been accompanied by two clear tendencies, says the report. First, the composition of the LDCs' merchandise exports to the South has been skewed towards agricultural raw materials and fuels. Secondly, manufactures are significantly and consistently under-represented in the structure of LDC exports to other developing countries, with very little modification from one year to the other.

However, the prominence of primary commodities in LDCs' export structure obscures the fact that manufacturing exports to Southern markets has grown at about 18% per year over the last decade. A similar performance, albeit lower than that of total merchandise exports, suggests that opportunities for structural transformation indeed exist.

Overall, UNCTAD underscores that it is clear that South-South trade is not a panacea for the LDCs' commodity dependence. Although hard commodities exporters appear to have benefited disproportionately, there are no doubts that the remarkable growth of large Southern countries has boosted exports revenues across the board - also providing new opportunities for structural transformation and economic diversification.

"Whether the LDCs will be able to harness emerging opportunities or replicate the old pattern of North-South relationships is likely to depend - at least to some extent - on their capacity to devise an appropriate engagement strategy and set up a policy framework to promote economic diversification."

The rise of Southern growth poles has not only boosted global trade, but it has also translated into sharp increases of cross-border investments, partly directed to other developing countries. Between 2000 and 2009, South-South FDI (foreign direct investment) worldwide more than tripled, attaining $140 billion in the latter year, when they accounted for 14% of world total.

Between 2003 and 2010, when total FDI inflows to LDCs were growing on an average of nearly 20% per year, the share of FDI projects accounted for by Southern investors climbed from 25% to upwards of 40%. A similar expansion has not redressed the LDCs' marginalisation - still less than 3% of the world's total FDI flows is directed to the LDCs; yet, it clearly boosted access to capital and foreign exchange.

According to the report, the growing significance of South-South development cooperation is unanimously recognized by both academia and policy-makers. The ODA (official development assistance) disbursements to LDCs from developing countries reporting to the OECD-DAC that include the Republic of Korea, Thailand, Turkey, the United Arab Emirates, and other Arab countries and multilateral institutions have grown four times in real terms over the last decade and surpassed $900 million in 2009.

Although these flows reported to OECD-DAC represent a minor fraction of those granted by traditional donors (slightly above 2% of total aid to LDCs), their evolution suggests a pronounced expansion of South-South development cooperation in the LDCs.

From the viewpoint of the LDCs, says the report, the surge of Southern official flows is a key factor boosting the availability of development finance, whose role remains crucial in view of the LDCs' weak capacities to mobilize domestic resources. In this context, South-South official financial resources are all the more welcome at the present crossroads, as they may help cushion the possible slump in aid receipts from traditional donors, currently engulfed by a fragile recovery and debt problems.

Noting that Southern countries openly found their partnership on the principles of equality, solidarity, mutual benefit and non-interference in internal policy, UNCTAD says that these principles are typically mirrored in the absence of policy conditionalities, thereby enhancing ownership and broadening the policy space available to recipient countries. This contrasts with the practices of traditional donors, which acknowledge the importance of country ownership, but in some cases continued to apply policy conditionalities even in the aftermath of the global financial crisis.

Unlike traditional donors, who focus mostly on social issues, Southern partners devote a significant share of their assistance to infrastructure and productive sectors. Historically, technical assistance programmes have also featured prominently in South-South cooperation initiatives. This trend is likely to persist in the future, as developing country partners have acquired world-class experience in areas of immediate relevance for LDCs, and are better placed to transfer this knowledge to their counterparts, owing to their cultural and geographic proximity.

"Overall, the expansion of South-South development cooperation has already changed the perception of poor countries, while its innovative modalities are starting to influence the behaviours of Northern donors, and vice versa."

The report also finds that regional integration can be supportive to deeper South-South economic relations by offering greater opportunities for export diversification, despite the fact that regional markets have generally expanded at a slightly slower pace than the main Southern markets. Manufactured goods tend to play a significantly bigger role in the LDCs' exports to regional partners than in those destined to major developing countries, whose economic growth tends to be highly resource-intensive.

Noting that policy should play a crucial role in further leveraging these multidimensional relations to promote the LDCs' long-term development objectives, the report stresses that the governments of LDCs need to make use of the greater policy space opened to them by the emergence of new partnerships, forging a clear engagement strategy to harness the benefits of the ongoing re-calibration of the world economy.

"This, in turn, will require the setting up of a developmental State, as well as the reinforcement of particular types of mutually beneficial South-South cooperation."

The report underscores that the most effective way for LDCs to enhance the development impact, and realize the development opportunities, of South-South cooperation is to build a catalytic developmental State (CDS) tailored to LDC circumstances.

UNCTAD said that its LDC report is based on the view that the opportunity for rapid poverty reduction in LDCs through the development of productive capacities and associated expansion of productive employment is real and significant. It can emerge from (a) mobilizing under-utilised resources, as well as the addition of new capacity through investment in agricultural productivity, plant and equipment; (b) the diffusion of available technologies; (c) public spending on infrastructure, skills and capabilities; and (d) the creation of new products and markets.

In all dynamic developing economies and in all countries now classified as developed market economies, the government has played an influential role in promoting and supporting economic development. In this context, the coordinating function of the developmental State is stressed, as well as its role in formulating a development vision and creating the policy space required to combine and integrate policy measures in support of structural transformation.

UNCTAD defines the developmental State as a set of institutions, tools, capacities and capabilities committed to national development with a capacity to implement its articulated economic and social strategies.

The CDS (catalytic developmental State) focuses on creating new productive capacities rather than "re-allocating" given resources and putting given productive capacities to more efficient use. In other words, its focus is on creating dynamic comparative advantage, and ensuring financial resources for long-term investment and for evolution of new productive capacities.

In order to accelerate growth, the CDS will need to carry out significant shifting and reallocating of national and possibly international assets and resources to the growth-enhancing sectors. For this purpose, the catalytic developmental State in LDCs, should engage in a more strategic type of integration into the global economy that would enable these countries to integrate in a manner which is in their interest to do so, rather than pursuing rapid trade liberalization based on current and given comparative advantage.

According to the report, South-South cooperation can play an important role in supporting LDCs to build developmental State capabilities. This can happen through three main channels: (a) supporting capacity-building efforts; (b) sharing policy lessons; and (c) providing alternative sources of finance.

The provision of alternative sources of finance is another major channel through which South-South cooperation can support the building of the CDS in LDCs. Financing public investment, particularly in social sectors and for physical and technological infrastructure, is a critical function of the developmental State.

Noting that at present, the effectiveness of the State in LDCs is handicapped by a scarcity of public resources, UNCTAD says that channelling only a tiny part - 1% - of the $3.5 trillion of foreign exchange reserves held by developing countries in their sovereign wealth funds (SWF) to LDCs can lead to a significant increase in development finance for these countries.

The report suggests that if only 1% of Southern SWF assets were invested into regional development banks, for example, this would increase their paid-in capital by $35 billion. Assuming a conservative ratio of authorized capital to paid-in capital of 2.8, this would translate into an additional $98 billion of authorized capital, corresponding to an additional annual lending capacity of over $84 billion.

Another important basis for positive synergies between CDSs in LDCs and South-South cooperation arises because South-South cooperation is often oriented to building productive capacities and at the same time the development of productive capacities is one of the primary objectives of the CDS. As a result, South-South cooperation can not only support the building of catalytically effective States in LDCs, but also the achievement of the objectives of such States.

The report points to three main channels through which South-South cooperation potentially supports the development of productive capacities in LDCs: (a) through official financial flows for production and economic infrastructure; (b) through technology transfer and support for technological learning at the enterprise level in LDCs; and (c) through the provision of preferential market access in a manner which permits, or even promotes, learning.

"South-South cooperation should not be romanticized or seen as a panacea. But it can be a win-win strategy for LDCs and their Southern partners. Moreover, as LDCs become more developmentally effective, this will also contribute to improving the effectiveness of North-South development cooperation," the report concludes. +