The Ukraine war is reshaping development models

The global economic recovery from the Covid-19 pandemic was always fragile, especially in the developing world. With Russia's disastrous war in Ukraine, it has been all but shattered. But the invasion's immediate consequences are just the beginning. In a world yet again defined by great-power conflict, countries will have to rethink their approach to development.

There was a time when development economists focused primarily on growth. Rapid economic expansion, it was believed, was the key to delivering broad prosperity. But, in the 1980s, social inclusivity and the environment began to feature in the policy agenda, and have become increasingly prominent over the years.

Even before Russia invaded Ukraine – and even before the pandemic took hold – emerging markets and developing economies (EMDEs) were struggling on all of these fronts. In March 2020, the World Bank estimated that inequality within EMDEs, and the gap between them and the advanced economies, had reached levels last seen a decade prior. Amid soaring poverty, catastrophic natural disasters, and intensifying civil strife, it should not be surprising that developing-country policymakers struggled to formulate climate policies that could fulfil international commitments.

And more challenges await. With inflation having reached 7.5% in the United States in January, the US Federal Reserve has embarked on monetary tightening, implementing the first of this year's seven planned quarter-point interest-rate increases. Fed Chair Jerome Powell has indicated that even bigger hikes might be needed, if inflation continues to rise. For EMDEs, this will create a difficult policy environment, characterised by less liquidity, a stronger US dollar, and rapid capital outflows.

Russia's war in Ukraine has made matters much worse. According to the OECD, the conflict will reduce global GDP by at least one percentage point this year, owing to the deep recession in Russia, and cause consumer prices to rise by about 2.5 percentage points. For EMDEs (not including China), this implies growth of less than 3.2% this year, less than half their average annual growth rate before the 2008 global financial crisis.

But growth is only part of the picture. The United Nations Conference on Trade and Development (UNCTAD) predicts that heightened financial volatility and rising food, fuel, and trade costs could trigger a vicious cycle of asset fire sales, exchange-rate devaluations, and debt crises.

EMDEs have few options for mitigating the risks they face. With debt levels at historic highs, they lack the fiscal space to support their economies. Furthermore, unlike countries that issue reserve currencies, they cannot turn to quantitative easing. And with the advanced economies, particularly in Europe, facing increased security risks, rising defence-spending needs, and the biggest refugee crisis since World War II, EMDEs cannot count on much external help in dealing with debt defaults or financial and governance crises.

Complicating the policy response still further, the intensity and duration of Russian President Vladimir Putin's war, the sanctions the West has imposed in response to it, and the resulting supply-chain bottlenecks remain impossible to predict. In other words, there is no telling how severe the risks will become.

But, however the war unfolds, it seems clear that countries will have to give national security a far more prominent position in their development agendas. As the OECD noted, this does not only mean increasing defence spending, though there is significant pressure to do just that. It also means diversifying energy and food sources – and preparing for global economic fragmentation.

In recent decades, "liberal globalisation" has enabled the integration of EMDEs into the global economy. But, as Harvard's Dani Rodrik recently explained, Russia's invasion of Ukraine "nailed shut the coffin of the post-1989 'liberal' international order," including the hyper-globalisation it enabled.

The economic and financial sanctions Russia is facing – not least its partial exclusion from the SWIFT financial messaging system for international bank payments – will hasten the effort to develop alternative systems and structures. This could, the OECD warns, erode the US dollar's dominance in financial markets and cross-border payments.

For EMDEs, changes to the currency composition of foreign-exchange reserves may be needed. More broadly, they will have to adapt to a world where specialisation, economies of scale, and the diffusion of information and know-how is far more difficult.

Here, EMDEs might be able to draw lessons from a recent Unctad report on China's structural transformation, which highlights the country's success in devising pragmatic, comprehensive, and cohesive policy strategies in areas including finance, industrial development, international trade, and the digital economy. As we have long argued, China's history of learning from its mistakes and adapting to changing conditions has been essential to its success, in terms not only of growth, but also of resilience.

"Realists" in the West insist that China's governance model is not replicable in other countries. But Western countries, facing new challenges of their own, seem unlikely to give EMDEs the support they need to keep development on track. Given this, it is up to EMDEs to transform their approach to development. They may be well served by using China's experience as a guide.

Disclaimer: This article first appeared on Project Syndicate and is published by special syndication arrangement.