It Is Too Soon to Mourn Emerging Markets
Op-ed in the Financial Times
© Financial Times
When the world's leaders convene in Washington for the World Bank and International Monetary Fund meetings this week, they will be greeted by a muddled outlook for the largest economies. The United States is bouncing back but blighted by polarized politics that could yet extract a heavy economic toll. Europe is recovering at a tepid pace from depressed levels. In Japan, Abenomics is a work in progress.
But leaders will have greater clarity about emerging markets: The party is over. Gloom about these countries' growth prospects is based in large part on the deterioration in the very favorable external economic environment they have enjoyed in the past decade: high commodity prices and cheap capital. But medium-term emerging market growth is misunderstood.
Any assessment of the durability of their growth should take account of timing. Many developing countries started catching up with the rich world, and at an accelerating pace, in the early to mid-1990s. But the favorable external environment—the commodities boom and easy money—was more a hallmark of the first decade of this millennium. In other words, there was more to the improved performance than merely a favorable economic environment.
Such an environment can certainly help growth in the short run but its long-term effects are questionable. Commodities booms have seldom been the basis for durable growth in emerging markets. Countries that have good institutions—for example, Chile—use their revenues prudently and create the conditions for sustained growth. However, most emerging market countries have weak institutions. During booms, they squander revenues, allow export sectors to become uncompetitive, postpone reforms, and succumb to corruption and weak governance—all of which undermine long-run performance. President Vladimir Putin is a bigger drag on Russia when oil prices soar—making him less likely than ever to execute much-needed political and economic reforms—than when they decline.
Even if commodities booms are not harmful, their impact is mixed—for every exporter that gains from higher prices, there is an importer that will lose. Even the BRICs group is divided equally between net importers (China and India) and net exporters (Brazil and Russia).
Similarly, the impact of easy liquidity is misinterpreted. Cheap money and capital flows fuel growth booms in the short run. But the day of reckoning always comes: Those that borrow most suffer the biggest growth collapses from “sudden stops” of capital. This was true in the aftermath of the Lehman Brothers crisis in 2008. It is also true in the recent turmoil affecting emerging markets, when those with the biggest capital flows in the form of current account deficits—Brazil, India, Indonesia, Turkey, and South Africa—registered the greatest currency declines and financial market volatility.
It is this cycle associated with capital flows that is reflected in the finding of a recent book by Olivier Jeanne, John Williamson, and me that, over the medium term (averaging over booms and busts), growth has little association with capital inflows—except flows that take the form of foreign investment.
Finally, an important aspect of the external environment facing developing countries—open markets in trading partners—remains relatively benign. The United States, Europe, and Japan have faced large structural shocks in the form of surging imports from developing countries, especially China. They have also experienced a cyclical shock—the Great Recession. Yet they have not imposed significant trade barriers, which augurs well for developing-country exports. With the launch of new trade initiatives in Asia and Europe, and the tantalizing prospect of reforms by China, the momentum could be moving in favor of further market opening.
All this is not to say that emerging markets, or the BRICs in particular, face an easy task. China must rebalance away from investment towards consumption. Brazil and India must overcome macroeconomic vulnerabilities and recover growth momentum. But these challenges are overwhelmingly domestic.
A changing external environment, while significant in the short run, should not be what keeps emerging market policymakers awake at night. To cry over fleeing hot money or declining commodity prices is to lament things hardly worthy of it.