Next Steps for Emerging Economies
Most of the financial commentary on emerging markets has turned negative. This reflects a combination of uncertainties about growth in emerging markets, associated with continued slow growth in advanced economies; possible overvaluations resulting from past optimistic expectations, now being revised; and anticipated capital flows out of emerging markets associated with a tapering and eventual normalization of the interest rate environments in the United States and Europe.
This view from the asset allocation perspective probably paints a more pessimistic picture than is justified with respect to growth alone. Indeed, in a period of unconventional policies, divergences between asset price performance and underlying economic fundamentals have become quite common.
One way to assess growth prospects is to ask whether economies in various classes have the resources, policy expertise and political will to take decisions that restore or alter growth patterns to adapt to the current environment. In general, emerging economies tend to pass these tests and hence be adaptive and resilient.
For good reasons, much attention focuses on China. Its performance, one way or the other, will affect the rest of the global economy. The aggressive and comprehensive reform program announced in November and detailed in December, if implemented, is likely to transform the Chinese growth model and sustain future growth in the seven-percent-plus range. There is some risk in the current year that there will be a dip as unregulated leverage and excess low-return investment is reined in and the growth drivers associated with consumption and a liberalized service sector kick into high gear. That may make markets nervous, but does not imply a major defect in the plan. In fact, it is the opposite: a commitment to use whatever policy levers are available to sustain growth above, say, eight percent, would surely risk stalling the structural transformation of the economy.
As a group, developing countries are not heavily indebted. They have resources and a growing level of sophisticated policy expertise. They do not have the benefits of sustained growth in advanced countries, which still account for half the global economy. That surely reduces their potential growth to some extent. But the huge and growing Chinese market is a partial counterweight and the still partial recovery in the US is helping
India and Brazil are both approaching important elections, which will affect the direction and vigor of growth-oriented policies. In both cases, growth potential is high. With India, the challenge is to reverse the pattern of political gridlock and unleash a set of reforms and investments that will restore confidence and trigger new growth potential in a wide variety of areas, including manufacturing. India should still benefit from China’s middle-income transition – its per capita income is about a third of China’s, and it can still play in labor-intensive, lower-valued space, absorbing labor from rural areas.
Brazil has focused resources on inclusivity, especially through education, with the goal of eliminating the dual economy structure. This is an important continuing agenda. To it needs to be added a higher level of public sector investment in infrastructure, which will, over time, help to elevate the investment rate above 18% of GDP, the latter not being sufficient to sustain high growth.
A number of emerging markets (India, Brazil, Indonesia and Turkey to name a few) are experiencing transitory slowdowns associated with rebalancing to the withdrawal of low-cost capital, a process that accelerated last spring with the tapering announcement and a normalizing interest rate environment. Current account deficits will come down, and the question is whether investment will fall or savings rise, and in what combination.
Many Sub-Saharan African countries continue to sustain growth and reform momentum, diversifying from dominant dependence on natural resource sectors alone. Their global market shares are not yet large enough that global slowdowns led by advanced countries will inevitably slow growth. More of a medium-term challenge would be technologies that supersede labor-intensive production and bring back manufacturing and assembly closer to their markets.
As a group, developing countries are not heavily indebted. They have resources and a growing level of sophisticated policy expertise. They do not have the benefits of sustained growth in advanced countries, which still account for half the global economy. That surely reduces their potential growth to some extent. But the huge and growing Chinese market is a partial counterweight, and the still partial recovery in the US is helping.
As has been true of a wide range of countries – advanced and developing – for some time, the principal uncertainties are associated with political will and legitimacy, and social consensus.
My overall impression is that developing-country growth will be somewhat uneven in 2014 across countries and regions but is, on balance, likely to surprise in a positive direction with an expected acceleration in 2015 and beyond. This presumes negligible growth but no catastrophic reversal in Europe and a continuation of the structural rebalancing of the US economy.
Michael Spence, a Nobel laureate, is William R. Berkley Professor in Economics and Business at the NYU Stern School of Business, New York. He participated in the World Economic Forum’s Annual Meeting 2014.