Productive capacity as resilience

Published on the UN least developed countries Portal.

Least developed countries (LDCs) were hit harder than most by a succession of crises in recent years – from the Asian crisis to the dotcom collapse, SARS and bird ‘flu, then the global economic crisis, several climate-related disasters and finally Covid-19. For the nearly 400 million extremely poor people in LDCs, the health, financial and social impact of these shocks were catastrophic. On the breadline, any loss of income is disastrous. LDC governments have fewer resources to cushion the impact. Policymakers are increasingly asking how to deal with this seemingly endless catalogue of calamities. Resilience is the new watchword.

Resilience is sometimes defined as the opposite of vulnerability, or the ability of an economy to withstand or recover from shocks.[1] Economies are supposed to be resilient if they can overcome a crisis and recover, perhaps supported by aid, low debt and fiscal tightening in order to satisfy international lenders, together with labour-market flexibility. Policies should help economies quickly recover their original shape, minimising time in the downturn and resuming their equilibrium path.

But maybe this is the wrong way to think about robustness? After all, most economies are vulnerable. During the past two decades 103 countries—over half the world’s total—at one point had a vulnerability rating too high to pass the LDC graduation threshold. Developing countries on average now have a vulnerability score of 33.6, which would mean they would be too vulnerable to qualify for LDC graduation based on the threshold of 32 or below.[2]

If developing countries in general–never mind LDCs—don’t meet the vulnerability criteria, it implies that the most sensible policy might not be to try to avoid vulnerability using standard tools. Vulnerability seems an inevitable feature of today’s world economy. Considerable time and resources, for example, may be wasted on trying to meet the expectations of international creditors, with little benefit for resilience. The optimal route to robustness may be to form the ability to recover from shocks and re-emerge in a different form.

Resilience is not linear, or only about the ability of an economy to regain its old shape.[3] If this were the case it would be difficult to reconcile the notion with the idea of economic evolution. The more resilient an economy was, the less it would change over time, even in the face of shocks. An economy whose structure doesn’t change can’t be considered resilient on any reasonable understanding.

A more helpful definition may be one in which an economy can adapt to the increasing likelihood of crises and recover – but crucially to a more dynamic, advanced state than before – and without any specific predictions about the future production landscape. This definition fits with the broad notion of building back better, although it can also be thought of as ‘bouncing forward’.[4]

Resilience should be an ongoing process rather than a recovery to a pre-existing or new stable equilibrium. This shifts the debate away from how an economy resists change to how it adapts through time to various kinds of stress. Resilient economies and supply chains emerge from shocks as different entities rather than snapping back like a piece of elastic to some pre-crisis state. This approach is about frequent change rather than hoping for stability and having to try and compensate for unpredictable downturns.

Resilience as transformation

The countries that rebounded fastest from the pandemic—including several in East Asia—were mostly those with the strongest productive capacity, adaptability and technological sophistication. These countries were able to produce and export the goods that were in high demand during the crisis, like electronics and pharmaceuticals, to attract foreign direct investment (FDI) and move into new, high-technology areas. Their resilience lies in their ability to transform the economic structure.

Chinese FDI inflows actually increased in 2020, by 4%, compared with a slump of 69% to developed economies.[5] As a result China overtook the United States as the world’s largest recipient of FDI. Asia accounted for more than half of global cross-border investment in the same year. 

Of course, these are big economies that locked down early, rolled out the vaccine quickly and put in place strong health and fiscal responses. Lessons for LDCs are limited. But the East Asian states that rebounded so quickly are at the forefront of technological advance and have long been the exemplars of structural transformation—often reshaping the domestic economy with unconventional policies.

Development took place during times of frequent crisis. Powerful industrial structures emerged which could respond to, and generate, new demand. At times government expenditure and debt were high as the country invested in structural transformation and pursued expansionary fiscal policy. Job creation was rapid, which supported demand and brought large numbers of people out of poverty.

It is sometimes forgotten just how far-reaching was the transformation and how rocky the journey. In 1964 the Republic of Korea was poorer per head than the Congo. In effect it was an LDC, although the category did not yet exist. Hundreds of millions of Chinese people moved out of extreme rural poverty in the last few decades. Viet Nam’s rise was later but no less remarkable. Resilience, for the most dynamic East Asian countries, had little to do with rebuilding back to a pre-crisis state. Development meant a societal and economic overhaul, often as a process of adaptation in response to shocks.

The implications for LDCs are clear. Recovery from the pandemic is of course the immediate priority, and this should mean equal access to vaccines, international support and a strong economic stimulus where possible—together with a resumption of demand in the developed world. Better international support is critical.

But aid can only play a partial role in rescuing LDCs from the pandemic and protecting them from future instability. Often, governments may need to deviate from the standard prescriptions—perhaps allowing the temporary build-up of debt during crises, spending more and limiting lay-offs. This can allow them to build climate-resilient infrastructure, maintain demand and help workers keep their jobs in a downturn – the ultimate form of resilience.

In the longer term, the most anti-fragile response would be to try to ‘bounce forward,’ changing the economic structure for the better. This will involve policy space to redouble the long-term effort to build productive capacity, defined by the UN Conference on Trade and Development (UNCTAD) and the UN Committee for Development Policy (CDP) as the sustainable development of human and physical resources, entrepreneurship and linkages.

Productive capacity-building needs to take into account the likelihood of crises and expanding the economy so that it can withstand disruptions. Capital accumulation and technological progress are central to this process, alongside sustainable trade and investment.

Governments should try to diagnose the major obstacles to transformation, be it insufficient resources or investment, skills shortages, get-up-and-go among businesspeople, or connections up and down the supply chain. Everything should be done to tackle the binding constraints head-on.

Covid-19 won’t be the last major shock. The best way for LDCs to prepare for the next crisis is to keep building the economic engine and to bounce forward, not back.

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[1] Eg. Briguglio, L. G. Cordina, N. Farrugia and S. Vella (2008) ‘Economic Vulnerability and Resilience,’ UNU-WIDER research paper no. 2008/55, May 2008

[2] Data source: https://www.un.org/development/desa/dpad/least-developed-country-category/ldc-data-retrieval.html

[3] Eg. Nelson, R. and S. Winter (1982) An Evolutionary Theory of Economic Change, Cambridge (MA), The Belknap Press of Harvard University Press, 1982; Simmie, J. and R. Martin (2010) ‘The economic resilience of regions: towards an evolutionary approach,’ Cambridge Journal of Regions, Economy and Society, Volume 3, Issue 1, March 2010, Pages 27–43, https://doi.org/10.1093/cjres/rsp029

[4] ‘Bouncing forward: a resilience approach to dealing with COVID-19 and future systemic shocks,’ https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7247742/

[5] Source: UNCTAD: ‘Global foreign direct investment fell by 42% in 2020, outlook remains weak,’ https://unctad.org/fr/node/31924