From investment accelerations to growth miracles

The 2020s were supposed to be the decade in which significant progress would be made toward achieving the Sustainable Development Goals (SDGs). Instead, the 2020s have delivered the weakest half-decade of global growth of the past 30 years. Weak investment growth is a major reason for this disappointing outcome.

In developing economies, per capita investment growth fell from 9.8 percent in 2010 to 2.6 percent in 2019 before collapsing during the global pandemic in 2020. There was a short-lived rebound after the pandemic, but investment is expected to grow at just 3.5 percent this year, even lower than during the 2009 global recession. With these meager growth rates, it will not be possible to meet the substantial additional investment required to achieve the development goals, estimated to amount to several percentage points of GDP annually with the largest needs in the most vulnerable economies.

It is eminently possible, however, to speed up investment growth. From 1950 to 2022, nearly 200 investment accelerations occurred in 93 economies. During these episodes, per capita investment growth averaged at least 4 percent, sustained for at least six years. The typical developing economy experienced almost two accelerations over the past seven decades, and half of all developing economies started an acceleration during the first decade of the 2000s. However, alongside slowing investment growth in the 2010s, that share fell to 23 percent in the 2010s (figure 1.A).

Investment accelerations were often periods of transformative growth. In a typical acceleration, investment growth increased by a factor of three, from around 3 percent per year in non-acceleration years to just over 10 percent per year during acceleration years. Output growth was 2 percentage points higher than in non-acceleration years, and the growth rate of productivity quadrupled (figure 1.B). Because per capita output growth more than doubled during accelerations, developing economies experienced strong improvements in living standards accompanied by a significant reduction in poverty.
 

Figure 1. Investment accelerations: infrequent but magical when they happen

^{Source: Global Economic Prospects, January (2024).
Note: EMDEs = emerging market and developing economies. TFP = total factor productivity; investment refers to gross fixed capital formation. Investment accelerations are defined as periods of relatively rapid investment growth during which per capita investment growth averaged at least 4 percent and was sustained for at least six years (Global Economic Prospects, January 2024).
A. Bars show the decadal average share of EMDEs that started an investment acceleration during the corresponding periods. The red line shows the average share of EMDEs that started an investment acceleration over the past six decades. Only episodes starting between 1960 and 2017 are included.
B. Bars show median growth rates during acceleration years, and red tick marks show median growth rates in all non-acceleration years for EMDEs. At the 10 percent level, differences between non-acceleration years and acceleration years are statistically significant.}

The Republic of Korea and Uruguay became high-income countries during investment accelerations. In the late 1980s and early 1990s, these two countries consolidated public finances. Korea adopted a balanced budget rule. Uruguay benefitted from debt relief and engaged in a large fiscal adjustment to rein in spending. Both countries granted their central banks independence and liberalized trade regimes. Korea also improved its business climate through a wide range of competition reforms. As a result, Korea had an investment acceleration from 1985 to 1996 and Uruguay from 1991 to 1998.

Remarkably, they did it again. Following the Asian financial crisis of 1997, Korea engaged in further fiscal consolidation, increased exchange rate flexibility, adopted an inflation target, and liberalized capital markets—which led to a second acceleration episode from 1999 to 2007. In the early 2000s, Uruguay improved its public balance sheet management, also adopted an inflation target, implemented banking reforms, and improved the business climate. Uruguay then enjoyed another acceleration from 2004 to 2014. Both countries took advantage of the opportunities that these accelerations created: Korea has been a high-income country since 2001, and Uruguay since 2012.

Korea and Uruguay are hardly unique. Many other developing countries were able to spark investment accelerations more than once and seize similar growth opportunities: Over 60 percent of transitions from low-income status to middle-income status, and more than 80 percent of transitions from middle-income to high-income status happened during or right after investment accelerations.

 The good news is that the policy prescriptions to spark such accelerations are well-known. Investment accelerations were often triggered by a comprehensive package of policy measures that strengthened fiscal and monetary frameworks combined with structural policies that expanded cross-border trade and financial flows (figure 2.A).

Thanks to these policies, inflation fell, fiscal balances improved, credit growth strengthened, and exports and FDI inflows increased during the accelerations (figure 2.B). Not surprisingly, the policy packages were particularly effective in triggering investment accelerations when combined with well-functioning institutions. It helped when the policy interventions coincided with the periods of elevated global growth. The international community also played a role in some cases by granting debt relief to heavily indebted countries and through official development assistance.
 

Figure 2. Comprehensive policies trigger investment accelerations with better macroeconomic outcomes

^{Source: Global Economic Prospects, January (2024).
A. Bars show the increase in the probability of an investment acceleration following a one standard deviation improvement in economic policy. Right bar shows the combined impact of increasing all three policy variables by one standard deviation.
B. “Before” corresponds to the six years before investment accelerations. “During” corresponds to the full duration of the acceleration. Bars show median growth rates during accelerations; the red tickers indicate median growth before acceleration years in the sample. At the 10 percent level, differences between before and during periods are statistically significant. Inflation and government debt show median annual inflation in percent and median annual debt as percent of GDP, respectively}

The 2020s are not shaping up to be the transformative decade the global community hoped for. But better development outcomes are still within the world’s grasp. It often takes a herculean effort to put in place the policies necessary to start sustained investment accelerations—but the effects are often magical, and fully worth the effort. If developing economies adopt the right reform policies and manage to spark accelerations again, it would be possible to turn the tide on the slowdown in investment growth this decade.

The global community can help developing countries—by offering financial instruments and support, loan guarantees, and also by providing technical assistance on the design of regulatory and institutional frameworks for well-functioning markets to attract foreign capital. These national and global policy interventions would also increase the odds of putting these economies back on track to overcome the climate and broader development challenges.