Do emerging markets deserve developed status?
Do emerging markets deserve developed status?
By Alan Taylor
Published: June 8 2011 12:29 | Last updated: June 8 2011 12:29
What would have been your reaction, circa 2006, to someone peddling the following forecast? There would soon erupt the worst, synchronised global financial crisis in 80 years, or possibly ever. World trade would start to collapse as fast as in 1929-31. Many developed markets (DMs) would experience deep recessions, the costliest banking crisis ever and would stagger toward fiscal calamity. But – guess what! – emerging markets (EMs), after a brief panic, would sail on unscathed. They would have no significant crises: currencies, banks and fiscal positions would retain stability. A two-track recovery would take EM growth on to a trajectory away from a troubling slump in the DM world.
Anyone cognisant of the fragility of “high beta” EMs in past episodes of global macroeconomic distress (the 1980s, the 1930s, or back to the 1870s) would have dismissed such thinking as wildly implausible. Yet this is precisely how things turned out, a remarkable turn of events that prompts some to ask if EMs are the new DMs.
EDITOR’S CHOICE
Can the idea that EMs are “graduating” to DM status have merit – now or over the longer term? And, if so, what are the implications? At Morgan Stanley, we examined the macroeconomic characteristics of the EM-DM groups and their socio-political and institutional fundamentals. We find evidence that today’s EM economies may not have fully closed the gap, but they are in a stronger position than in previous moments of short-lived euphoria.
A central macroeconomic indicator, gross domestic product growth and its volatility, speaks to the reversal of fortune. Circa 1970, EMs exhibited high mean and high variance relative to DMs; but after 1980 this risk-reward combination evaporated as EMs suffered a lost decade. But from the 1990s EM growth picked up and volatility moderated; DM growth slowed and, after the crisis, volatility spiked. The EM advantage looks strong again, but other economic indicators buttress the case.
Since the 1980s, EMs achieved a conquest of inflation more dramatic than the DMs. They diversified their exports while opening up more to trade. And to enhance fiscal stability, they reduced public debts relative to GDP, while building large buffers of foreign reserves. EM sovereign ratings have been rising; DM ratings are now turning south.
Yet it would be a mistake to make a case for rethinking EM-DM differences based on narrow economic criteria alone. Long-run development success rests on deep determinants – factors such as health, education, freedoms and inequality. While the causal mechanisms are debated by researchers, these traits can be quantified and they too offer support for our EM-DM view.
On social indicators such as life expectancy and years of schooling, EM averages in 2005 had risen to levels comparable to those in the DMs in 1975. On indices of political and economic freedoms, where EMs scored about five out of 10 in the early 1980s, they now score seven or eight out of 10; close to DM levels of economic freedom and only lagging behind slightly on political freedom.
More impressive, however, are the likely implications for the global economy – some of which will mark a shift or even reversal of recent trends. With faster growth, EMs will overtake DMs as a share of the global economy and their high capital expenditure needs will boost global investment demand. With lower volatility and more fiscal resilience, the EMs’ precautionary saving motive may moderate, unleashing more consumption-led growth and less voracious hoarding of reserves. As investment rises and saving dwindles, the EM current account should decline or reverse – as should the frissons in policy circles triggered by the global imbalance issue.
But the implications for the DM world are also profound. As demographic pressures build and fiscal profligacy runs on, savings will be scarce here too, so real interest rates will probably rise. The abundance of investment opportunities in EMs will pull private capital out of DMs, creating a politically treacherous “sucking sound” that was long ago predicted but, in recent years, offset by official flows.
But while we paint a rosy picture of EM outperformance, there is one trend that policymakers ignore at their own peril – rising inequality. While EM incomes have tripled over the past three decades, not all boats have been lifted. Events in the Middle East show what public discontent can do to political and economic stability. EM policymakers would do well to heed this wake-up call.
As history shows, economic development “graduation” follows from consistently passing stern tests of economic and social capability. This once – but hopefully not for the last time – the EMs aced the examination.
Alan Taylor is professor of economics at the University of California, Davis, and a senior adviser at Morgan Stanley. This piece was co-authored by Manoj Pradhan, global EM economist and an executive director at Morgan Stanley
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