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The need directly to target sustainable productive capacity in least developed countries

June 28, 2021

Published on the UN International Support measures Portal for Least Developed Countries.

Photo: EIF

Covid-19 uncovered an uncomfortable truth. International support for least developed countries (LDCs), though welcome and contributing to some success, hasn’t done as was hoped to build economies over the long run or to mitigate crises.

The pandemic hit trade, tourism, debt, remittances and foreign direct investment in LDCs at least as badly as other countries. Gross domestic product for the group shrank an expected 1.3 per cent in 2020, according to the UN’s comprehensive study on the impact of Covid-19 on the LDC category. Of 46 LDCs for which data are available, the economies of 37 contracted during the year – and the impact of the crisis will play out for many years.

Governments were too short of funds to support their populations during the downturn. Furlough was impossible for cash-strapped Ministries of Finance. Most LDCs don’t have any social insurance.

Unlike in many middle-income or developed countries, a lack of Internet access and the absence of digital economies meant that most people in LDCs couldn’t work remotely. The economies of many LDCs sputtered to a halt as workers were forced to stay at home.

The human cost was enormous. Thirty-two million people in LDCs fell back into extreme poverty in 2020.

To help address the downturn, donors delivered 1.8% more official development assistance (ODA) to LDCs in 2020, sending the total to US$ 34 billion. But this was below official pledges – and nowhere near enough to cushion the impact of Covid.

Alongside ODA the main long-term source of international help has been duty-free, quota-free market access to developed and some other countries. In theory it gives exporters a competitive edge.[1]

The absence of caps or taxes on LDC exports particularly benefited Bangladesh, Cambodia and Myanmar, which by 2020 together accounted for 87.3 per cent of imports to the European Union under its Everything But Arms scheme launched nearly two decades earlier.[2]

This select trio of Asian LDCs have successfully used the scheme to raise exports because they possess the production capabilities to take advantage. Dynamic garment producers, exploiting mass cheap labour, leveraged trade concessions to increase output.

Health and education improved dramatically alongside investment and domestic linkages. Several graduating Asian LDCs have been able to piggy-back on their neighbours’ rise.

African countries, however, make up less than five per cent of total Generalised System of Preference imports to Europe. Most African economies don’t make enough of the right products to use preferences, and they struggle to meet the required rules and standards. Trade is also more difficult in a less prosperous or connected continent.

As crisis hit, most LDCs were too fragile to cope as international demand dried up. Even in countries like Bangladesh which made successful use of trade schemes, orders dwindled as Europeans stopped shopping. In tourism destinations, visitors no longer arrived. Commodity demand dropped.

Contrary to the assumptions of the trade models used to justify trade preferences, the economies of most LDCs just aren’t flexible enough to respond quickly to changes in international prices that result from lower taxes – nor will they be for a long time, if ever.

Workers and capital don’t quickly move to where they are most needed. Many countries remain dependent on a narrow range of commodities or products to which little value is added. This is why trade preferences are only a partial solution and don’t help all economies.

The evidence: the Covid crisis capped a period during which the economies of most LDCs fell further behind the rest of the world, despite a few bright spots such as the dozen countries that have been identified for graduation or look likely to graduate from the category during the 2020s.

Data source: UNCTAD Stat

Hitting reset

This was supposed to be the era in which the gap narrowed. International support in the form of aid, trade preferences and other benefits were meant to form a coherent package of support which catapulted LDCs onto the same trajectory as other developing nations.

But most LDCs have not prospered as expected. The UN Conference on Trade and Development Productive Capacities Index shows that productive capacity in LDCs has only risen about 20% in the past two decades – no faster than the world average. The gap remains. 

During the repeated global convulsions of recent decades, many LDCs found themselves over-reliant on international demand in a narrow range of products and services, with limited domestic activity as a back-up – let alone a modern, digital economy. Worse, some LDCs were both internationally disconnected and domestically fragile.

It may be time directly to start targeting the economic engine in LDCs rather than hoping that exposure to overseas markets will automatically spur development and resilience. Given the severity of the situation and the shortcomings of the approach so far, all options should be considered.

A concerted push to boost national production is needed from governments, donor partners and the international system. Donors could, for example, establish an endowment for productive capacity. The fund could raise financing for finance climate-resilient green infrastructure and energy, crowding in private investment and technology transfer to establish the basic building blocks of economic development such as railways, bridges, schools and housing.

Whether this can occur via existing mechanisms like the under-capitalised LDC Climate Fund, or if a dedicated facility is needed, there is little doubt that coordinated action is needed. Diagnostics such as the Organisation for Economic Cooperation and Development Production Transformation Policy Reviews or the Enhanced Integrated Framework are a good place to start when deciding where funds should go.

At only around a fifth of GDP, investment rates in LDCs are mostly too low to spark economic transformation. Governments need to accumulate more domestic resources. Tax revenues in LDCs remain too low to support national investment or to insure populations against crises.

The crisis could even be seized as an opportunity to spark sustainable transformation. As noted by Harvard’s Ricardo Hausmann, developing countries may be able to carve out opportunities in a rapidly greening world. Countries can also the target value chains that underpin the new development paths – including inputs, capital goods, engineering and procurement. Health, pharmaceuticals and medical goods production should be a part of fostering resilience.

Infrastructure and energy fell out of fashion in recent decades as donors worried about corruption, white elephants and sustainability. But power and construction are coming back into vogue. China’s Belt and Road initiative has been supporting priorities including connectivity and infrastructure. The G7 at its latest summit in June 2021 pledged a multibillion dollar ‘Build Back Better for the World’ initiative for green infrastructure in developing countries.

A broad-based push toward green productive capacity would be to the advantage of the whole world as would discourage emerging countries from moving toward carbon-heavy energies like coal.

LDCs also need to embark on digitisation strategies, building up the capabilities to take advantage of the fourth industrial revolution, itself environmentally more sustainable as it relies less on physical transport. Regional trade and cooperation are easier online than in physical products, especially in poorly-connected countries. 

This drive for green and digital investment, and an improvement in LDCs’ ability to make things for themselves, will both bolster domestic economic activity and leave countries less exposed to the seemingly ceaseless shakes coming from the world economy.

This is not to discount the importance of exports nor to advocate isolation. It is to recognise that exports are increasingly digital, and that they won’t emerge spontaneously in response to world demand. Before you export, you must produce.

The pandemic again confirmed how important it is to build the economic engine. No country is resilient until all are resilient.

The views in this article are those of the author and do not necessarily represent the views of CDP, its Secretariat, or the United Nations. This document should not be considered as the official position of the CDP, its Secretariat or the United Nations. Any remaining faults are those of the author.

This article has been made possible with financial support from the UN Peace and Development Fund.

[1] Several donors and multilateral organisations have also long provided various types of technical assistance, travel grants and other support to LDCs.

[2] European Commission (2020) ‘Joint Report to the European Parliament and the Council on the Generalised Scheme of Preferences Covering the Period 2018-2019’. High Representative of the Union for Foreign Affairs And Security Policy, Brussels, 10 February.

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