by Joseph Joyce
Growth in the Emerging Market Economies
In recent decades the global economy has been transformed by the rise of the emerging market economies. Their growth lifted millions out of poverty and gave their governments the right to call for a larger voice in discussions of international economic governance. Therefore it is of no small importance to understand whether recent declines in the growth rates of these countries is a cyclical phenomenon or a longer-lasting transition to a new, slower state. That such a slowdown has wide ramifications became clear when Federal Reserve Chair Janet Yellen cited concerns about growth in emerging markets for the delay in raising the Fed’s interest rate target in September.
The data show the gap between the record of the advanced economies and that of the emerging markets. I used the IMF’s World Economic Outlook database to calculate averages of annual growth rates of constant GDP for the two groups.
The difference in the average growth rates was notable before the global financial crisis, and rose during the crisis. Since then their growth rates have fallen a bit but continue to exceed those of the sclerotic advanced economies. Since the IMF pools emerging market economies with developing economies, the differences would be higher if we looked only at the record of emerging markets such as China, India and Indonesia.
And yet: behind the averages are disquieting declines in growth rates, if not actual contractions, for some members of the BRICS as well as other emerging markets. The IMF forecasts a fall in economic activity for Brazil of -3.03% for 2015 and for Russia of -3.83%, which makes South Africa ’s projected rise of 1.4% look vigorous. Even China’s anticipated 6.81% rise is lower than its extraordinary growth rates of previous years, and exceeded by India’s projected growth of 7.26%. The IMF sees economic growth for the current year for the emerging markets and developing economies of 4% , a decline from last year’s 4.6%.
What accounts for the falloff, and can it be reversed? The change in China’s economic orientation from an economy driven by investment and export expenditures to one based on consumption spending has slowed that country down. The decline in that country’s demand for raw materials to transform into finished goods for export is rippling through the economies of the major commodity exporters, such as Australia and Brazil. The Economist has claimed that the resulting fall in commodity prices constitutes a “great bear market.”
This downturn may be aggravated by a failure in institutions. Bill Emmott writes that emerging markets need political institutions that “…mediate smoothly between competing interest groups and power blocs in order to permit a broader public interest to prevail.” He specifically cites the leaderships of Brazil, Indonesia, Turkey and South Africa as examples of governments that have not been able to achieve that task.
The basic model of economic growth, the Solow-Swan model, predicts that income in the poorer countries should catch up with those of the advanced economies as the former countries adopt the advanced technology of the latter. This basic result is modified if there are higher population growth rates or lower savings levels, which can lead to lower per capita income levels. On the other hand, the Asian countries used high savings rates to speed up their economic growth while their birth rates fell.
But convergence has not been achieved for most economies despite periods of rapid growth. Some economists have postulated the existence of “middle-income traps.” Maria A. Arias and Yi Wen of the St. Louis Federal Reserve Bank describe this phenomenon in a recent issue of the institution’s publication, The Regional Economist. They explain that while income rose close to U.S. levels in the “Asian Tigers” (Hong Kong, Singapore, South Korea and Taiwan) as well as Ireland and Spain, per-capita income shows no sign of rising in Latin American economies such as Brazil and Mexico. There may also be a “low-income” trap for developing economies that never break out of their much lower per-capita income.
Why the inability to raise living standards? Arias and Wen, after discussing several proposed reasons such as poor institutions, compare the cases of Ireland and Mexico. They claim that the Irish government opened the economy up to global markets slowly in earlier decades, and encouraged foreign direct investment to grow its manufacturing sector. This allowed the country to benefit from the technology embedded in capital goods. Mexico, on the other hand, turned to foreign capital markets to finance government debt, which left the economy vulnerable to currency crises and capital flight. Arias and Wen conclude that governments manage the composition of capital inflows and control capital flows that seek short-term gain rather development of the manufacturing sector.
But there may be a more basic phenomenon taking place. In 2013 Lant Pritchett and Lawrence Summers of Harvard presented a paper with the intriguing title, “Asiaphoria Meets Regression to the Mean.” They examined growth rates for a large number of countries for10 and 20 year periods, extending back to the 1950s. They showed that there is ”…very little persistence in country growth rate differences over time, and consequently, current growth has very little predictive power for future growth.” While acknowledging China and India’s achievements, they cautioned that “…the typical degree of regression to the mean imply substantial slowdowns in China and India relative even to the currently more cautious and less bullish forecasts.” They drew particular attention to the lack of strong institutions in the two countries.
If growth does slow for most emerging market economies, then the recent buildup of corporate debt in those countries may be a troubling legacy of the recent, more robust period. Debt loads that looked manageable when borrowing costs were low and future prospects unlimited are less controllable when that scenario changes. While there may not be a widespread crisis that afflicts all the emerging markets, those countries with extended financial sectors are vulnerable to international volatility.
cross posted with Capital Ebbs and Flows