What can the G8 do to restore growth?

The annual meeting of the G8 traditionally aims to address some of the world’s most pressing challenges. In the past, the small gathering of world leaders has centred on issues such as poverty reduction, international aid, peace and security, and climate change. The agenda of this year’s meeting in Lough Erne, Northern Ireland, includes strengthening international tax standards; reducing investment barriers and advancing free trade agreements; facilitating greater transparency in land deals and extractive industries; and working to promote more open and readily available data. However, the greatest challenge, according to UK Prime Minister David Cameron, host of the meeting, is to “restore strong and sustainable growth to the world economy.”

Prime Minister Cameron is right to acknowledge the importance of restoring growth, as the IMF revised downward its global forecast for 2013, suggesting that “an uneven recovery is also a dangerous one.” Developing economies are still projected to account for the majority of global growth over the coming years and, while many emerging markets managed to get through the financial crisis relatively unscathed, some of the key players are experiencing a slowdown that could put additional pressure on what has already been a protracted recovery.

In 2012, for instance, Brazil and South Africa grew by only 0.9% and 2.5%, respectively. India has also experienced a slowdown and growth has fallen to a decade low. Russia has, thus far, been unsuccessful in diversifying its economy, and growth continues to be determined by the whims of commodity price fluctuations. Despite their size and strategic importance, these countries are clearly underperforming relative to their potential.

While growth across the BRICS, excluding China, has somewhat faltered, there are a number of developing economies that have picked up the slack. Indonesia, Thailand, the Philippines, Peru and Nigeria are just a few of the star economies that grew more than 6% in 2012. Still, for these and other emerging markets to carry this momentum over the medium and long term, they will need to further develop their financial systems.

So, what does financial development have to do with promoting economic growth? According to the World Economic Forum’s annual Financial Development Report, which measures and analyses the factors enabling the development of financial systems in more than 60 economies around the world, “the performance and long-term economic growth and welfare of a country are related to its degree of financial development.” The reasons for this, the report suggests, are twofold. First, a more developed financial system is able to efficiently mobilize savings and allocate capital to the highest-return investment projects. Second, “by allocating capital to the right investment projects and promoting sound corporate governance, financial development increases the rate of technological innovation and productivity growth, further enhancing economic growth and welfare.”

Restoring strong and sustainable growth is undeniably one of the most pressing issues facing the global economy. However, the path forward is neither clear nor straightforward as the factors that contribute to growth will vary across countries based on their level of development. Nevertheless, maintaining or boosting growth across emerging economies will depend, in part, on their ability to create more advanced financial systems.

Todd Glass is a Project Associate on the Financial Services Industries Team at the World Economic Forum USA and co-author of the Financial Development Report.

Image: The Lough Erne Golf Resort in County Fermanagh, venue of the G8 summit. REUTERS/Cathal McNaughton