By Peter Blair Henry

In an article adapted from Turnaround: Third World Lessons for First World Growth, Peter Blair Henry argues that despite headlines featuring the collapse of BRIC nations and recovery in the West, advanced countries have settled for underperformance in place of prosperity; their future now depends on whether they have the humility to learn lessons of economic discipline from the developing world they once lectured.

Thirty years ago, today’s emerging markets were so-called Third World nations suffering from crippling debt, hyperinflation, slow (or no) growth, and an aura of hopelessness when it came to economic efficiency. Using decades of hard-won reforms generally pushed on them by advanced nations, many of these countries achieved a dramatic turnaround in their growth narratives to become drivers of the global economy in the 21st century.

Meanwhile, First World nations have strayed off course. Despite recent headlines proclaiming the fall of BRIC nations and recovery in the West, ever since the financial crisis of 2008–2009, advanced nations have settled for underperformance in place of true prosperity. How else would 1.7 percent growth in the United States, 0.9 percent growth in Britain, and a 0.6 percent contraction in the Euro Area—as presented in the IMF’s July 2013 update to the World Economic Outlook—qualify as resurgence? To make matters worse, political grandstanding too frequently substitutes for good conscience, leading to gridlock and shutdowns in capitals from Washington to Rome.

How will advanced economies get back on track? The stories of Turnaround teach us that we need reforms in both advanced and emerging economies. The IMF estimates that for every 2 percentage-points of economic slowdown in the BRICs, growth in the United States will slow by 0.5 percent. Economic growth is not a zero-sum game: the slowdown in emerging markets is bad news for advanced economies that need export expansion for higher growth. For their part, how will developing nations proceed in their own quest for further progress?

There are many ways to grow, but all successful strategies require discipline, courageous leadership, and a dose of humility. Ironically, whether advanced countries regain their potential and the emerging world continues to make policy choices that contribute to shared prosperity for all nations hangs critically on whether we absorb the growth lessons that come from studying the reform history of the former Third World.


The Foundation for Growth
The need for macroeconomic stability was a central theme in the “Program for Sustained Growth” that then-Secretary of the U.S. Treasury James A. Baker III unveiled nearly thirty years ago, in October 1985, during the Annual Meetings of the International Monetary Fund and the World Bank Group in Seoul, South Korea. The economic reform agenda eventually known as the Washington Consensus encouraged former Third World countries to stabilize their economies in order to improve efficiency and lay the foundation for additional reforms that would also contribute to faster growth.

Reasonable people can disagree about the appropriateness of manner in which the agenda was applied, but examining the history of the developing world reveals that where market-friendly reforms were adopted and sustained, they in fact increased efficiency and created value for businesses and for society. Reducing inflation, eliminating many barriers to trade, and privatizing state-owned enterprises generated two decades of improvements, propelling emerging markets from growth rates of 3.5 percent per year from 1980 to 1992, to an annual average of 5.5 percent per year from 1992 to 2007.

Of course, economic reform is not a one-size-fits-all package. We need to focus on facts to discover which elements from the menu of potential policies have worked in which contexts, which showed promise but were implemented too swiftly or rigidly, and which provide the greatest impact per unit of political capital expended.

Identifying the right policies is one piece of the puzzle; how policies are implemented (over what duration) is equally important. Success in economic growth requires the long road of sustained reforms, not the shortcuts of political expediency. It requires, in a word, discipline.


Disciplined Policies
So what do disciplined policies look like? In contrast to what you might think, discipline in the context of economic reform does not mean adopting harsh or extreme positions, such as insisting on fiscal austerity. Nor does it mean seizing on any one particular malady and demanding that it become the central focus of economic policy.

Rather, discipline in this context means: a sustained commitment to a pragmatic growth strategy, executed with a combination of temperance, vigilance, and flexibility that values the long-term prosperity of the entire population over the short-term enrichment of any particular group of individuals.

To shrug off low expectations and get back on track, advanced economies need to embrace discipline and clarity when it comes to monetary and fiscal policy, which should work in concert, not at odds. They also need to regain credibility and reestablish trust, not only with their own populations but also with the developing world.

Across the emerging world, through decades of trial and error, leaders have effectively reduced government debt, harnessed the power of productivity through trade, and seen the benefits of opening their markets to foreign savers and foreign direct investment. Lessons in prosperity are here for the taking, if advanced nations can find the determination (and the humility) to learn from those to whom they used to preach.

When it comes to managing government debt, the lesson is twofold. First, had the governments of advanced nations acted with more discipline and saved for a rainy day when times were flush, we might be experiencing a different recovery today. In South America, Chile sets the positive example. In 2006, Chile’s treasury held $6 billion in savings. As that number increased to almost $50 billion in 2008, protesters burned an effigy of Finance Minister Andrés Velasco, because he refused to share the riches through increased spending and higher public-sector wages. His so-called villainy became heroism, however, when the global recession forced other countries to endure belt-tightening that Chile avoided with billions in timely tax cuts to cushion the impact.

A related lesson in deficit reduction extends from Latin America and other emerging markets, where historic struggles with high and moderate inflation provide clues as to when austerity measures are effective and when they are not. Between 1973 and 1994, 21 emerging nations with the two varieties of inflation engaged in 81 attempts at austerity. Whereas austerity measures succeeded in creating stable environments in many countries with runaway inflation, disappointing outcomes in the context of moderate inflation (sinking stock markets and economic contraction) suggest that a gradual approach is best when inflation is not the primary concern. The relative lack of inflation in advanced nations today suggests a need to move beyond radical, immediate attempts to eliminate deficits and instead adopt long-range targets with clear, credible measures to reduce them more gradually.

In Europe, where problems look to be ones of insolvency and overhang, forgiveness and restructuring of debt—not austerity—should be one side of the solution. The other side requires a focus on labor-market reform: from changes to collective bargaining processes that have systematically driven up wages faster than productivity, to easing restrictions on hiring and firing so that firms will be more enthusiastic about employing new workers. Attaining higher levels of productivity is the only reliable way for troubled European countries to generate the resources required to service their debts and provide for their aging populations.

Next, when it comes to global trade, leaders must remember that countries need both imports and exports in order to thrive. Slow growth in advanced nations has lured governments into the “trade trap” of thinking exports are good, imports are bad, and a large trade surplus is the key to recovery. But South Korea’s rise from impoverished Third World nation in the 1950s to the manufacturing powerhouse it is today demonstrates that prosperity lies not in the balance of trade but in the power of productivity unleashed through the process of exporting and importing. From 1965 to 1990, South Korea’s economy ran perennial trade deficits yet still grew by 7.1 percent per year—three times faster than the United States during its “golden era” post–World War II. To reap the full benefits of globalization, countries need to stem protectionist measures and embrace a two-way flow of goods and services. Instead of worrying about importing goods from foreign nations (or that this costs jobs), the concern in advanced nations should be: how do we prepare workers for the jobs of the future, producing goods and services that emerging economies will consume as their incomes rise?

Advanced economies need to embrace discipline and clarity when it comes to monetary and fiscal policy, which should work in concert, not at odds.

Finally, the case for trade in goods extends to trade in capital, but countries should proceed with caution, remembering a critical distinction between debt and equity financing. Opening a country’s stock market to foreign shareholders reduces the cost of capital, drives up wages, and can be an important vehicle for facilitating privatization and foreign direct investment; in contrast, rapid liberalization of debt financing from abroad almost always ends in crises. Mexico, a country that triggered the Third World Debt Crisis in the early1980s and suffered through currency devaluation and a collapse of their banking system in 1995, now leads advanced nations when it comes to reform of its financial sector. Pursuing an aggressive agenda intended to reduce the country’s reliance on debt, Mexico adopted ahead of schedule the changes in capital requirements for banks set out in the Basel III agreement. Until the United States and Europe follow suit, the debt-heavy financial systems of the world’s two largest economic regions leave everyone vulnerable to further, repeated crises.

Data and analysis can tell us what kinds of policies are most likely to help countries grow. But without a sustained, disciplined application of those policies, nations will underachieve at best. Market-friendly reforms have the power to deliver ongoing improvements to the material wellbeing of citizens the world over, but leaders must reject dysfunctional politics and shortcuts, lest they produce prosperity for a day but ultimately impoverish the masses.

The First World taught developing countries what they needed to do in order to prosper. In this new millennium, the Third World has lessons to impart to advanced nations about how to implement the right policies.

Relationships Matter
Having taken the long road to economic success, a number of former Third World countries find themselves in the hall of prospering nations, only to be pushed aside by those who refuse to fully recognize and reward their hard-won gains. Brazil, Russia, India, China, and South Africa account for roughly 20 percent of the world’s economic output but have only 11 percent of the votes on the IMF board. The countries of the European Union account for 24 percent of world output but hold 32 percent of board votes. Furthermore, with almost 18 percent of all votes, the United States has veto power over board decisions that require 85 percent approval.

Due to the glacial pace of First World movement on issues of international economic coordination and governance, emerging economies have begun turning their backs, making their own way with the establishment of regional development banks and arrangements. Advanced nations need to recognize that proper inclusion of emerging nations in the global economic dialogue not only is good form but will bolster developing countries’ resolve to continue embracing the market-friendly policies that were initially thrust upon them but are responsible for their growth. Their ability and willingness to do so can only contribute to worldwide stability, jobs, and greater prosperity for all.


Staying the Course
Developing countries have come a long way since the days when hyperinflation, import substitution, hostility to foreign capital, and a productive sector dominated by state-owned enterprises were the order of the day. Of their own volition in a few cases, but largely as a result of external forces and actors (ranging from devastating debt crises to the U.S. Treasury and the IMF), the nations formerly known as the Third World adopted a different approach to economic policy that earned them a new name and new prospects.

Yet these “emerging markets” would do well to keep in mind a number of lessons they themselves have learned along the way. In order to continue growing, emerging markets need second-stage economic reforms that will increase, for example, the level and efficiency of investment in Brazil and China, and that will make places like India more profitable for doing business. Developing countries must be careful not to reject ideas about how to make their economies more efficient simply because the ideas come from a source they find hard to take.

Of course, the trick lies in distinguishing correctly between reforms that are in the national interest and those that are not. If recommendations seem unpalatable or go against the landscape of the local economy, then the lesson is simple: be prepared to propose constructive and viable alternatives for economic restructuring and growth.

Finally, countries then need to implement policies that are consistent with their plans—and they need to stick with them over time. Not even the most successful emerging economies, however much they have to teach the First World, can afford to throw caution to the wind and abandon years of accretive steps toward excellence.

In economic policy, as in life, how you conduct yourself during the journey is at least as important as the path you choose to take. During the last century, the First World taught developing countries what they needed to do in order to prosper. In this new millennium, the Third World has lessons to impart to advanced nations about how to implement the right policies—with wisdom, character, and a strong commitment to the future, even in the face of present-day political constraints.

Adapted with permission from Turnaround: Third World Lessons for First World Growth, by Peter Blair Henry. Available from Basic Books, a member of The Perseus Books Group. Copyright © 2013.

About the Author
Peter Blair Henry is Dean of New York University’s Stern School of Business. In 2008, he led Barack Obama’s Presidential Transition Team in its review of international lending agencies. He is a member of the board of the National Bureau of Economic Research, the Council on Foreign Relations, and the Kraft Foods Group.