How Developing Countries Can Navigate a Complicated and Consequential External Environment

Delivered as keynote address during ABCDE 2025, on July 22, 2025

Introduction

It is such an immense pleasure and honor to be back at the World Bank. I am delighted to see so many familiar faces – friends, colleagues, and acquaintances. My deep appreciation goes to Indermit Gill, Rachel Glennerster and Danny Quah for this wonderful opportunity to share some thoughts with you today on how developing countries can best navigate a complicated and consequential external environment, including some interesting global economic paradox.

This is an especially touching moment for me as I had the privilege of working with Stan Fischer, including as his “advisor,” when he first joined the Fund as First Deputy Managing Director. I learned so much from Stan, and not just from his analytical brilliance and his strong communication skills. The human dimension of his work was as impressive. It was consistently evident whether in his approach to individual country reform cases, his pursuit of a comprehensive, durable, and just peace in the Middle East, or his contributions to the functioning of the international economic order.

Importantly, Stan never used his brilliance to intimidate or to put down the ideas of others. Instead, he used it to enable them to flourish. Like many others in this room and well beyond, I have benefited from his brilliance, and I miss his friendship.

This month, rather remarkably, marks 44 years since I first set foot in this institution as a summer intern. That summer was far more than just a temporary assignment to earn money to help complete my PhD. It was a period of profound intellectual discovery and the forging of enduring friendships, all within an institution that, until then, I had only been able to admire from a distance. It was also a valuable opportunity to appreciate, firsthand, the ways this institution, along with its sister institution across the street, could, and indeed did, assist developing countries in confronting the multifaceted challenges of poverty, inequality, and unfulfilled potential.

The period that immediately followed my internship was anything but smooth for the developing world. Indeed, the very next year, while interning across the street at the Fund, I was afforded a front-row seat to a moment of significant global consequence: the Mexican default. This event, as economic historians now largely agree, marked the official, painful commencement of Latin America’s “Lost Decade” of the 1980s.  Yet, what subsequently unfolded was far more complex and ultimately more transformative than just a series of major debt restructurings that lifted crippling debt overhangs that diverted precious national resources away from vital investment and critical social sectors, thereby eroding growth potential in numerous ways. 

Crucially, that era also saw the quiet, yet profound, emergence of a domestic policy revolution across much of the developing world. For an increasing number of countries, this revolution fundamentally enhanced their capacity to harness the immense power of globalization, enabling them to truly turbocharge their internal growth and development engines.

Today, however, the global economic winds have undergone a disorienting shift. For many developing countries, what was once a tailwind has dramatically transformed into a headwind. The international environment, rather than complementing favorable internal developments, has become an unsettling, almost relentless, source of one negative shock after another. 

We are in a period of lower global growth, increasingly uncertain and fragmented supply chains, a volatile tariff regime, significantly reduced aid flows, less predictable foreign direct investment inflows, and unsettled international bond markets. Naturally, the impulse and much of our collective focus have understandably been on the sources of these adverse shocks. This immediate analytical lens is, of course, crucial. But it should not be at the cost of two other equally vital lines of inquiry. 

The first demands that we frame these shocks not merely as isolated, exogenous events, but as powerful accelerants that exacerbate pre-existing, long-standing structural weaknesses in the global system. The second, and more hopeful, analysis is to seek out and identify the opportunities that invariably emerge, often unexpectedly, amidst all these concerns and dislocations. 

It is this dual perspective – understanding the accelerants and seizing the opportunities – that I hope to bring to our discussion this morning. My conversation with you today will be structured as follows:

We will begin with a simplified characterization of the ongoing, profound evolution of the global economic and financial order. Among the mounting challenges presented by this policy-induced volatility is significant fluidity in a whole set of relationships and standards that, not so long ago, were widely perceived as stable parameters, rather than unpredictable variables.

We will then turn our attention to what lies ahead for the developing world should it fail to react decisively in four critical areas: First, continuing to enhance self-insurance, and building deeper resilience against external shocks. Second, taking a more active role in being part of the evolving international order. Third, exploiting new opportunities to revamp tired growth models and significantly enhance the social sectors, particularly health and education. And fourth, the need for a small but strategically important subgroup of countries with considerable foreign assets, to consider a more nuanced approach for managing wealth for future generations.

We will conclude by discussing the indispensable role that multilateral institutions can play in helping developing countries navigate this increasingly complex and fluid global landscape.

The Context

For much of the post-World War II period, the global economic and financial order operated fundamentally as a core-periphery construct. The core, anchored by the United States, supplied global public goods, such as security guarantees, open sea lanes, and a reserve currency. It collected significant economic rents through its unparalleled financial markets and the global demand for its currency. It had a large influence on decision-making in the major multilateral institutions. And it was trusted to provide that important combination of a source of global stability, a shock absorber for external disturbances, and the firefighter in times of crisis. Nations across the world relied on the US to provide crucial circuit breakers that would prevent localized financial or economic crises from spiraling into widespread contagion.

This entire construct was, for a considerable period, governed by a generalized understanding of rules and standards. The overarching objective, a kind of shared global aspiration, was convergence over time, leading towards an ever more integrated, peaceful, and ultimately, prosperous global economy and financial system. There was, in essence, a common story being told, a narrative of progressive integration and shared prosperity.

Yet, for all its strengths, this construct was ultimately undermined by three powerful factors. First, insufficient attention to increasingly bad and inherently destabilizing distributional outcomes – and with that, destabilizing waves of alienation and marginalization among politically influential segments of society. This led to a profound reversal: economics, which had for decades influenced politics, became subservient to it.

Second, the profound challenge posed by the inability of successful and rapidly expanding large developing countries, most notably China, to be adequately absorbed into the traditional construct. The structural setup for China’s truly remarkable economic development presented a unique and unprecedented challenge to the existing order. Its economy, huge in absolute terms, yet still possessing a relatively low, albeit rapidly improving, per capita income level, fueled a damaging misalignment between China’s immediate domestic development priorities – often centered on export-led growth and industrial expansion – and what was increasingly expected from Beijing in terms of broader global responsibilities, such as market liberalization, intellectual property protection, and environmental stewardship. 

The longer China delayed in fundamentally evolving its growth model, the more pronounced and destabilizing this misalignment. Meanwhile, the world was no longer vast enough to comfortably absorb China’s export push. This created a tension that the existing global governance structures struggled – and struggles – to resolve.

Third was a series of developments that have transformed the United States itself from a perceived trusted stabilizer into an unpredictable, and at times, direct source of shocks to the rest of the world. The 2008 global financial crisis emanated directly from the United States, the very core of the core, as did the 2017-2019 weaponization of tariffs and the increasingly common use of payment system sanctions. Similarly, the 2021-2022 failures to ensure the fair and equitable sharing of Covid vaccines globally, undermining trust in global cooperation during a public health emergency. And the 2025 "uber-weaponization" of the tariff regime, the dismantling of established international aid systems, and a continued indifference to tragic humanitarian crises alongside repeated violations of international law. 

These actions have profoundly eroded the predictability and reliability that the world had come to expect from its principal anchor. By its very design, the traditional core-periphery model is inherently ill-equipped, indeed, not built, to handle a core that is increasingly unpredictable and a source of policy-induced volatility for the global system. Yet there is no readily available or robust replacement for the United States at the very center of this complex global system. Furthermore, the alternative "pipes" that have been built around the core by some countries are not big enough to offer a comprehensive alternative.

What was once largely driven by universally accepted principles and predictable norms is now in constant motion – an undeniably bumpy journey towards a still profoundly unclear destination. Most passengers on this uncertain journey find it extraordinarily difficult to predict what will constitute the next round of policy-induced volatility emanating from the core. 

The ability to respond is challenged in a growing number of cases by a significantly eroded level of human and financial resilience that limits their inherent ability to absorb shocks and respond effectively to them. For a vast number of developing countries, this is the new reality: a world characterized by lower global growth, increasingly less reliable supply chains, significantly reduced aid flows, bouts of financial instability, less predictable inflows of foreign direct investment, and markedly more uncertain foreign markets. And it is a world of increasing economic dispersion, both within and across countries.

This peculiar role reversal – or what is now commonly described in market chatter as "DM becoming EM" (developed markets exhibiting characteristics of emerging markets) – is unsettling. Just consider the sheer extent to which the following phrases are now routinely used to describe developments not in a struggling developing country, but rather in the very heart of the global core, the United States: “the weaponization of tariffs pursuing conflicting objectives," “irresponsible fiscal policy," "creeping fiscal dominance," and “threats to central bank independence." 

This role reversal, unsettling as it is, has not been the only unusual development in recent times.  Crucially, this time around, the developing countries, on the whole, did not end up in the economic intensive care unit, even though the US, the global locomotive, caught more than just a common cold. Instead, the hard-earned policy improvements, institutional reforms, and the enhanced macroeconomic frameworks implemented by many developing countries over the past few decades have enabled them to navigate this challenging landscape relatively well. 

Looking Forward

Of course, what holds true for developing countries as a collective does not apply uniformly to every single nation. Nor, crucially, is past success an automatic guarantee of future success. Indeed, policymakers need to fundamentally strengthen their policy resolve in four critically important areas ahead of additional policy-induced volatility from abroad.

The first, and perhaps most fundamental, imperative is to continue to enhance self-insurance. This is about systematically reducing the scope for external shocks to trigger a sequential set of destabilizing domestic economic and financial reactions. This extends far beyond merely maintaining macroeconomic stability, though that remains foundational. It’s also about aggressively addressing long-standing structural and financial vulnerabilities, such as shallow financial markets, weak regulatory frameworks, and governance deficits, perhaps leveraging the "air cover" provided by a widely recognized, and indeed, hostile, global environment. This heightened resilience is also absolutely crucial for exploiting several "silver linings" that, I assure you, do exist amidst the pervasive concerns; and we will cover in a moment.

The window for undertaking such reforms is enhanced in the short term by the fact that most advanced countries will likely be running unusually stimulative demand management policies. This is particularly true for the US, where, despite a relatively low unemployment rate of around 4%, the fiscal deficit is programmed to remain in the 6-8% of GDP range for several years to come. Such an expansionary fiscal stance at this stage of the economic cycle is historically unprecedented for a developed economy. America also appears to be on the verge of a renewed series of interest rate reductions by the Federal Reserve.

This combination of loose fiscal and potentially looser monetary policy in the US creates a significant demand impulse. Similarly, led by Germany, Europe is also in the process of loosening fiscal policy in a manner not seen for decades, with the sole exceptions of the extreme crisis periods of Covid and the global financial crisis. Again, this significant fiscal stimulus will likely be accompanied by further declines in interest rates from the European Central Bank. 

This correlated, rather than coordinated, demand stimulus from the advanced economies offers a temporary reprieve and a potential boost to global demand, which developing countries can capitalize on. However, this seemingly favorable, policy-driven external demand stimulus is not without its own set of significant risks. Its beneficial impact could be decisively derailed by two major economic and financial pitfalls.

The first risk is that of a limited market appetite for orderly absorption of the sheer volume of bond issuance by advanced country governments. Should digestion problems become more pronounced, it will inevitably lead to notably higher market interest rates and a steeper yield curve. This would not only translate into significantly higher borrowing costs for developing countries, but it could also severely complicate their orderly and predictable access to international capital markets.

The second risk relates to a highly volatile US tariff regime triggering widespread retaliation from major economic blocs like China, Europe, and some of the larger developing countries. The resulting disruptions in global trade flows would undoubtedly increase costs across the board, as companies scramble to reconfigure supply chains, while simultaneously making cross-border supply chains far less reliable and less effective. 

These inherent risks lead us directly to the second policy priority for developing countries: that of actively exploring and strengthening international linkages that enhance resilience, improve agility, and expand optionality. While South-South trade has expanded significantly in recent decades, it remains well below what would be predicted by initial conditions and economic complementarities. 

There are understandable reasons for this, extending beyond the historically strong gravitational pull of South-North trade. These include significant institutional and market failures which can, and should, be addressed in a coordinated, multi-year effort. This means investing in regional infrastructure, harmonizing regulations, fostering regional financial integration, and building new trade agreements.

The third policy priority for developing countries is to ensure they are better positioned to exploit the immense potential of exciting new innovations. This encompasses more than just leapfrogging opportunities for productivity enhancements in traditional sectors. Crucially, there is also an encouraging door opening for major, transformative improvements in the social sector, particularly in health and education, areas where developing countries often face the most acute challenges and where the returns on investment in human capital are highest. 

-Most countries, however, need to undertake a vast amount of preparatory work if they wish to be truly ready to walk through this door. This includes investing in digital infrastructure, fostering a skilled workforce, and creating regulatory environments that encourage, rather than stifle, innovation.

What is happening in Artificial Intelligence, in particular, is both breathtaking in its speed and profoundly consequential in its implications. -Just consider the staggering evolution of AI over the last three years alone – from merely answering basic questions and executing simple tasks to becoming a powerful intellectual companion that is fundamentally transforming the teaching-learning-research nexus. 

Imagine the potential for AI-powered diagnostic tools in remote clinics, personalized adaptive learning platforms in underserved schools, or AI-optimized agricultural practices to boost food security. In just a couple of years, we may well find ourselves in a world where AI agents can be readily hired via platforms like LinkedIn and play a crucial, even indispensable, role in key sectors of the economy. There is literally no time to waste in building the foundational ecosystem necessary to benefit from what some astute observers are now describing as a "new electricity." 

You simply cannot benefit from this revolutionary electricity if you do not have the fundamental wiring system in place. Moreover, the more time is squandered, the greater the risk of AI and other innovations fueling even greater global dispersion and inequality. 

The fourth area of policy priority is relevant to a small but strategically important subgroup of developing countries – those with high levels of foreign reserves and substantial national financial wealth who have historically maintained a structural overweight position in US dollar assets. This overweight has undoubtedly served them well, particularly during the preceding period of undeniable American economic exceptionalism. However, it is one that is currently subject to mounting challenges – from the overvaluation of many US assets to the increasingly eroded risk mitigation properties of US government bonds, both in terms of their volatility and their correlations with other assets.

Since there is no single, readily available replacement for the US dollar as a global reserve currency, nor for the breadth and depth of US financial assets, the process of diversification for these countries is inevitably a protracted and complex one. It requires careful asset disaggregation, revisiting asset allocation methodologies, and new investment mindsets that look beyond conventional safe havens.  The longer the delay in embarking on this process, the greater the risk of absorbing significant losses associated with others’ more successful diversification strategies. 

Implications for Multilateral Institutions

All of these profound shifts – from the changing nature of global shocks to the imperative of domestic resilience and technological adoption – lead us to the critically important role that multilateral institutions can, and indeed should, play in this rapidly changing global economy. While my immediate focus today will be on the World Bank and other multilateral organizations, including the regional development banks. It takes the notion of "beyond aid" to a higher, more complicated yet ultimately far more consequential level of engagement and impact.

Our deeply altered world demands that these institutions fundamentally enhance their expertise and effectiveness as trusted advisors to member countries. This means becoming truly capable of synthesizing, bringing together, and disseminating members’ best practices in new and rapidly evolving areas, acting as a global clearinghouse for policy innovation. They must move beyond words to become indispensable knowledge centers for enabling the efficient and equitable diffusion of technological innovations that can make material and transformative differences to health outcomes, educational attainment, and national productivity. 

The dedicated staff at these institutions must be empowered and equipped to answer questions that would have seemed utterly alien just a few years ago. Examples of such urgent questions include: 

• How best can countries interact with emerging AI agents to effectively supplement existing human capital and bridge skill gaps, rather than displace labor? 

• How can we leverage technology to dramatically improve the timely delivery of essential health and education services to a larger, often underserved, group of citizens, ensuring equity and access? 

• And how best can entire ecosystems be built – encompassing infrastructure, skills, and regulation – to allow for the rapid and equitable diffusion of new, productivity-enhancing technologies throughout an economy, preventing further divergence?

• And how to manage the inevitable risks that come with innovations? 

These are no longer theoretical questions for academic debate; they are urgent operational imperatives that demand practical, scalable solutions.

Then there are the concerted efforts needed to foster deeper regional linkages and robust regional projects. This means a stronger move beyond national silos to support cross-border infrastructure, trade facilitation, and shared resource management. Concurrently, there is an urgent need to dramatically enhance contingency funding mechanisms, including through smarter public/private risk tranching and sharing, for developing countries in a world that is demonstrably more vulnerable to more frequent and more severe external shocks.

More than ever before, the focus must be well "beyond aid" incorporating fundamental, instrumental changes that will increasingly impact not just what countries do, but critically, how they do it, emphasizing domestic ownership, capacity, and resilience.

Finally, and of paramount importance, is the institutions’ role in fragile countries – an area that, in addition to enduring unimaginable humanitarian tragedies, suffers from enormous and debilitating institutional and market failures. These are contexts where traditional development models often falter, and where the challenges of governance, security, and basic service delivery are intricately intertwined. -It’s an area that screams out, urgently, for greater effectiveness, greater coordination among international actors, greater open-mindedness, and often a fundamentally different approach. I am particularly happy to see that David Miliband is here to share his wisdom on this profound and challenging frontier for multilateral engagement.

Conclusion

Rather than conclude with a summary of my main points, which have, I hope, shed light on the increasingly complex and often paradoxical global environment, I will instead choose to re-emphasize the profound two-sided nature of the seemingly endless series of technological innovations that we are privileged to witness as human beings. On one side, these innovations offer unprecedented opportunities to revolutionize productivity, transform social services, and unlock new pathways to inclusive growth. Yet, on the other side, lies a stark warning. If developing countries fail to decisively put in place the foundational conditions necessary for the efficient and equitable diffusion of such innovations throughout their economies – starting, crucially, with the bedrock sectors of health and education – they will inadvertently cement a destructive process of reverse convergence. This means that instead of catching up to advanced economies, they will fall further behind, deepening inequalities within and across nations, and exacerbating the fragmentation of an already unstable global order. 

This imperative for proactive adaptation and systemic "wiring" has urgent operational implications for regional development banks and, indeed, for all multilateral institutions, including the World Bank. As I mentioned at the outset, this institution in particular played such an instrumental role in igniting my own passion for, and enduring interest in, growth and truly inclusive development. Yet its relevance and that of its sister institutions are debated in academic and government circles.

What better opportunity, then, than this gathering of minds here today, to push back against a question that I have heard far too many times over the last few years: "Do the Bretton Woods Institutions still have relevance today?"

The answer is: More than ever. Their relevance is not simply enduring; it is escalating, as the challenges facing developing countries become more complex, more interconnected, and more urgent. The time for hesitant, partial reform is over, as noted by Bank President Ajay Banga. It is time for bold, decisive action, deeply rooted in innovation and cognitive agility. The developing world cannot afford for these institutions to falter.

Thank you very much for your attention.