A decade-long economic growth spurt in emerging
markets, averaging 6.9 percent annually between 2003 and 2012, pulled an
estimated 300 million people out of poverty. During the same period, the
developed world grew just 1.3 percent per year, as it was beset by financial crises and a
loss of competitiveness. As a result, 2013 will be the first year in which
emerging markets, led by Brazil, Russia, India, and China (the BRICs), account
for over half of world GDP on the basis of purchasing power. Looked at another
way, these markets' share of the global economy has steadily increased by nearly
1 percent on average for each of the past 20 years -- a remarkable achievement.
Yet many investors are starting to ask whether this golden
age of emerging-markets growth is now over. Growth has slowed dramatically in
recent years, especially in some larger emerging markets. In 2013, for
instance, the BRICs are projected to have grown at roughly half the pace they
did in 2007. Although emerging markets as a group are forecast to grow by a
respectable 5 percent this year, twice the pace of developed economies, the
overall slowdown has disappointed investors.
This BRICs-led slowdown can also be seen in the
performance of equities. From the beginning of 2002 to their post-financial crisis
peak in April 2011, emerging markets' equities, as measured by the Morgan
Stanley Capital International (MSCI) Emerging Markets Index, gained 280
percent. Developed-market equities, as measured by the MSCI World Index, gained
just 36 percent during the same period. Since then, however, emerging markets have
lost 17 percent of their value while developed markets have gained 14 percent. This too has spooked investors,
even though recent decades have shown that there is little direct correlation
between growth and stock market returns.
Is this just a short-term, cyclical phenomenon, or
are we at the start of a rebalancing of global growth? In reality, the slowdown
reflects the influence of several factors: a business cycle that has taken a
somewhat different shape than it did last time, as well as several deeper
causes, around which the fog is lifting only now.
With regard to the first factor, it is true that developed
economies were at the heart of the 2008-2009 financial and economic crises, while
emerging markets were mostly innocent bystanders that suffered collateral
damage. These crises exposed some serious structural problems in developed
economies that are taking time to fix, dragging down growth and job creation. Many
corporations, however, did not "waste" the crisis and were quite successful in
becoming leaner and more productive to bring themselves back into the
competitive race. That is making the return of jobs slower but the recovery
more sustainable in developed economies. Only now are Europe and Japan slowly
coming out of their deep, rolling recessions.
In contrast, the recession in most emerging markets has
had a V-shape, with a steep decline but quick recovery. Emerging markets are,
on the whole, further advanced in their economic cycle at this point. Thus, their
short-term growth is now tapering off for normal business-cycle reasons.
Beyond this impact of the business cycle,
however, there are four deeper causes behind emerging markets' diminished growth. The first
cause is known among economists as the middle-income trap. Now that economies
like China and Brazil have grown to reach middle-income status, the
competitiveness catch-up of the last decade is leveling off. Further dramatic gains
relative to developed economies will be harder to achieve. Overall, the world
has less catch-up potential than it used to, because its most populous
countries are no longer so poor.
The second cause is a reversal in the competitive
edge. In fact, in terms of competitiveness, OECD countries have been gaining on emerging markets. There are
several game-changers behind this development: Shale gas has made energy not
only more ubiquitous but dramatically cheaper as a cost of manufacturing,
especially in energy-intensive industries and starting in the United States. The
wage gap has narrowed, with wages from China to Turkey escalating rapidly. At
the same time, the Great Recession has kept labor costs in check in developed
economies. Costs have also been diminished thanks to breakthroughs in manufacturing,
such as the use of cheaper, more versatile robots, 3-D printing, and laser
cutting. Moreover, research and development discoveries in nanotechnology and
biomanufacturing, combined with the mapping of the human genome, are yielding
new materials, foods, and medicines. This has further sharpened developed
economies' competitive edge.
Also, broadly speaking, the age of mass production
is shifting toward a new interest in customized products and niche markets. Together,
the United States and the European Union remain larger recipients of foreign
direct investment than China. More importantly, the outsourcing trend of the
past decade is increasingly being questioned and replaced by "reshoring."
As many as 200 companies have come back to the United States, and during a recent
trip through Northern Europe, we heard many similar stories there.
A third reason for the slowdown in emerging markets'
growth is political uncertainty. At first glance, the protests witnessed in the
past year in Turkey, Egypt, Brazil, and Indonesia all have specific domestic causes.
But they also have deeper, shared roots: Growth in these economies can no
longer keep pace with popular aspirations that were raised during the previous
boom period. Better communications technology and broader movements of young people
-- for example, to study abroad -- have made it easier to compare living standards
and career prospects and to blame governments for a failure to offer
comparable opportunities. In many ways, this logic is correct. Governments can
do a lot to improve the lives of youth, not just by investing in infrastructure
-- a staple of development in emerging countries over the last decade -- but also
by creating opportunities for entrepreneurship and the entry of new businesses
into sectors dominated by state enterprises or the friends and family of
politicians. This implies, among other things, a liberalized financial market
where new promising ideas get funded. Yet the financial sectors in emerging
markets are quite conservative, catering to only a select few.
In the absence of economic opportunity at home,
young people often choose one of two options: look for opportunity elsewhere
or take to the streets in protest. The former choice pushes young, ambitious
people toward richer markets, many of which -- like Sweden, Switzerland, and
Germany -- increasingly need them because of aging populations. The United
States, meanwhile, attracts more than 1 million people each year for study
and work opportunities, and this does not take into account illegal
immigration. The effect is generally a negative one for emerging markets, which
are losing their most talented young people and, with them, economic potential.
With regard to the latter choice, technology for organizing
protests, even across disparate groups, has improved dramatically in the last
decade. We saw the effect of this in Brazil, where protests over increased bus
fares and the buildup of glitzy stadiums for the next World Cup evolved into demonstrations
against the lack of opportunities for urban youth. Similarly, in Turkey, a
protest against the construction of a shopping mall on the grounds of a city
park in Istanbul escalated into countrywide demonstrations against the
political regime. However, while such protests have toppled ossified regimes in
the Arab world, they have also resulted in economic chaos and social unrest
that have hurt emerging markets' growth. What initially inspired protesters in
emerging markets to challenge their governments is now giving others pause.
The fourth cause of emerging markets' slowing growth
is having the most profound effect in terms of slowing that growth. It is the lack
of institutions that support the smooth functioning of society and the
inclusion of larger parts of the population in the increased well-being of countries. In the last few decades, many emerging markets have focused on economic
growth at the expense of building social safety nets. One example is China's
nascent pension system, which is responsible for an increasingly large share of
the population, yet is not up to the task. (According to the World Bank's World
Development Indicators, in 2014, the working-age
population will start shrinking for the first time, which means more dependence
on pensions.) India and Brazil have more favorable demographics but are
struggling to create enough employment to keep their pension systems funded.
Other examples of institutional weaknesses include the lack of food-safety
standards in China and India, Brazil's still-inadequate health-care system, and
Indonesia's inchoate environmental protections.
These and other problems of maturing economies can
be dealt with, but at significant public cost. This draws resources away from
infrastructure projects and talented people away from export-oriented
businesses -- the traditional backbone of fast growth in emerging markets. The result,
then, is slower growth. And if the process of building complementary
institutions is not smooth, growth is further hampered.
There are, however, many reasons to be upbeat about
emerging markets. First, continued peace and better governance in Africa has
established a basis for growth in countries such as Angola, Ethiopia, Ghana,
Kenya, Nigeria, Rwanda, and Zambia. On average, Africa's economy has been growing
at more than 5 percent annually since 2007, and one-third of African countries are
growing at more than 6 percent each year. Moreover, the share of the population
living below the poverty line in Africa has fallen from 48 percent in 2007 to
39 percent in 2012. To be sure, Africa needs significant capital inflows to
build up its infrastructure; it currently invests less than 4 percent of GDP in
infrastructure, one-third of what Asia invests. As this investment increases, so
will the efficiency of Africa's industry. The inequality between urban and
rural communities will also decrease, as more people become connected to job
Second, emerging markets are catching up on
education, which, according to economics research, makes workers more
productive. According to the World Bank, by 2012, over 93 percent of children
in emerging markets had received primary education, up from 82 percent in 1999.
And a much higher percentage of girls -- as much as 20 percentage points more -- had received
an education, compared with only a decade earlier. The focus on improving
education has received a boost from the inclusion of education indicators in
the Millennium Development Goals.
Third, the global demand for the goods and services
provided by emerging markets is still growing. The Indian subcontinent has the
potential to bring at least several hundred million people from rural areas to
the manufacturing and services sectors to meet this demand. This will increase
overall productivity in the export sector and, in turn, create an even larger
consumer market at home. Moreover, slower growth in resource-dependent China is
good news for resource-rich BRICs such as Brazil and Russia, as well as for
Africa and the rest of Latin America. The increasing consumer demand in the
United States and Western Europe after the financial crisis is also boosting growth
rates in emerging markets. The Sept. 18 announcement by the U.S. Federal Reserve that
it's delaying the tapering of easy money will encourage still further
growth in this consumer demand.
Fourth, the past decade has witnessed a marked
improvement in the governance and regulatory indicators in emerging markets. The
Governance Indicators, as measured by the World Bank, show
improved scores in the rule of law and control of corruption in 36 emerging
economies between 1999 and 2012. Noteworthy in their advancement are countries
such as Indonesia, Costa Rica, Ghana, Peru, Ethiopia, and Rwanda. Another World
Bank index, Doing
Business, shows a similar trend: Of the 10 fastest-improving
countries in terms of ease of doing business last year, nine were emerging
markets. These included Costa Rica, Sri Lanka, Mongolia, and Kazakhstan. Over a
10-year period, the fastest-improving countries in terms of business regulation
include Colombia, China, Georgia, Rwanda, Burkina Faso, and Egypt. Looked at
broadly, better governance and an environment more conducive to business
attracts more investors to emerging markets, increasing their growth potential.
It would thus be unwise to write off growth in
emerging markets. Yes, some of the largest emerging markets, particularly the
BRICs, are experiencing growing pains. These are likely to result in governments paying more
attention to institutional and social development. And
unlike in the golden age of emerging markets, growth is going to be more
balanced, both geographically and across sectors. Yet the fundamentals for
growth in emerging markets remain strong and, with them, the prospects for the
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