As emerging markets sink, developed economies rise

The biggest economic story of the 2000s was undoubtedly the rise of emerging markets. As China and India shook off decades of stagnation, they became the engines that drove the world economy, joined by other fast-growing emerging nations like Turkey, Brazil, Indonesia and Mexico. As these economies achieved scorching rates of economic growth, investment capital flooded into them, shunning the slower-growing economies of the developed world. But in the last twelve months or so, the picture has begun to change. Suddenly, emerging markets are stumbling. Their growth is slowing, their currencies are weakening, and the positive capital inflows they have enjoyed for the last 20 years are showing signs of reversal. In this fascinating podcast, Wharton professor Mauro F. Guillen looks at the changing global economic picture. He discusses the factors driving the slowdown in emerging markets, and he looks at how developed markets are picking up the slack, attracting investment inflows and offering unexpected growth opportunities. His discussion of the role of US monetary policy in these shifts is especially illuminating, given the recent attention this issue has attracted. As the US has begun considering monetary policy tightening, experts have noted that this could hurt emerging markets, which have enjoyed an artificial boost in investment as investors in the rich world have looked for better returns than those offered by their domestic low-interest rate environments.  If rates start to rise, investors will likely return their money to their home shores. The sudden drying up of inflows would be bad news for emerging markets that have grown to rely on this easy money. Guillen traces out the consequences of these changes for the future of global growth. – FD

 

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This podcast is brought to you by Knowledge@Wharton.  For more information, please visit knowledge.wharton.upenn.edu. It’s been a good ten-year run for fast-growing emerging markets, but now, many of them face severe economic imbalances built up during the go-go years.  Those structural flaws could be papered over in good times, but they have finally undermined sustainable growth and the cracks are starting to show.  Wharton management professor Mauro F. Guillen discusses how formerly hot emerging market countries are passing the growth engine baton back to developed countries.

Knowledge@Wharton:  We are meeting today with Mauro Guillen, a management professor at Wharton to talk about what’s happening in emerging economies.  Thanks for joining us.

Mauro F. Guillen:  Thank you for having me.

Knowledge@Wharton:  Can you discuss what’s been happening very recently in emerging economies?  A lot of money has been flowing out.  Their growth rates look like they’re slowing down.  I realize it is hard to generalize, but it is happening to many countries, perhaps for different reasons.  One of the explanations for this – at least the partial explanation – is that the Fed’s so-called tapering off, is a worry because that may mean the U.S. interest rates would go up and look relatively more interesting than the returns that investors are getting on their so-called hot money in these emerging economies.  So it’s about these financial flows rather than foreign direct investments in bricks and mortar and that sort of thing.

Mauro F. Guillen:  You’re absolutely right.  The fact that investors are anticipating that the Federal Reserve will change its policy in the near future is obviously putting some pressure on those short-term hot money flows right into emerging economies, and people of course don’t want to be caught in the middle of all of this. They tend to move their money to where it can get the highest possible yield. I think that’s a very important background factor. I don’t think it’s the only one.  What we see in many emerging economies, speaking broadly about them, is that the current model of growth is becoming exhausted, which has been, in many of these emerging economies, export-led. So we’ve seen very little progress in most of these countries — China, India, Brazil — in terms of the development of a domestic market that would compensate for slower growth in terms of exports. There’s been some progress, but not enough to essentially keep the economy going at a very fast pace, which is what happened throughout the last few years.  We shouldn’t forget that it is remarkable that even during the 2008, 2009 and 2010 financial crisis, emerging economies continued growing as they did. But now, they’re at a crossroads. This comes at a very bad moment, when there is also political turmoil in several of them. There are street protests in many of these economies, Brazil most recently. There’s rising income inequality, which also adds to the problems. And, more broadly, there are bubbles. There’s clearly a real estate bubble in several of the markets in Brazil. There’s clearly a real estate bubble in several areas in China, or perhaps all over the country, and so on. So there are many imbalances that have been building up in several markets over the last 10 years of rapid growth.And then, as you can imagine of course, just to make things even worse, the banking system, always suffers from the buildup of these bubbles. We’re starting to see in some of these markets, that the percentage of non-performing loans is starting to increase in bad assets on the balance sheets of banks. So yes, we are at a crossroads, there’s a lot of uncertainty, and I think right now, I guess one of the biggest problems for emerging economies is that neither the U.S. nor Europe, which are traditionally the most important export markets, are growing that much. So this comes at a bad moment. It comes at a bad moment for everybody.

Knowledge@Wharton:  U.S. GDP growth was just upgraded from 1.7% to 2.5% for the second quarter.  So that’s one hopeful sign. Who knows what will happen in Japan? There is an effort there to crank up the economy in ways that haven’t been done in the last 20 years or so, during the so called “lost decades.” And Europe is struggling with just its nose above the water. So is there perhaps a grand shift, even if it’s a mild one happening, where the emerging economies — which had been carrying the world economy, or at least preventing something worse than what happened — are now passing the baton to the developed countries?

Mauro F. Guillen:  Right, exactly.  The baton seems to be passing, not perhaps fast enough, because the U.S., as you just said, is enjoying a little bit faster growth, but not the kind of growth that we would like to have here in order to reduce unemployment. And then in Europe, of course, it’s just not enough. So yes, this is much better from the point of view of emerging economies than the situation a year ago or two years ago, but I think the big question mark, is whether it’s big enough. And I think it is very clear that all of the debate about the development of the domestic market, domestic consumption market in BRICS, in Mexico, now has become very relevant. I don’t think that these economies can continue enjoying high growth rates, let’s say into the next five or ten or 15 years unless the domestic markets in these countries become so much more important — in other words that they switch away from an export-led model of growth to one that is more balanced between exports and domestic consumption.

Knowledge@Wharton:  Which of the emerging economies would you worry about the most under the circumstances you’ve been talking about?

Mauro F. Guillen:  Well, I think there are reasons to be worried in each of the large emerging economies.  I think Brazil probably right now stands out as being the biggest underperformer. Brazil was growing at 6%-7%-8% just a few years ago. And now it’s barely growing. We see over there, many of these tensions and the overheating. I worry about Brazil also because Brazil is more vulnerable than the others. It is highly dependent on the hot money that has been coming into the country to cover the deficit that they have in their current account with their relationship in terms of trade and other kinds of flows.  Brazil, in spite of being a major export power, is still a country that imports more than what it exports. They need money, capital flows, to come in and bridge the gap. So I worry about Brazil. And I think I worry about Brazil also because Brazil is 40% of Latin America. If something bad happens in Brazil, then that’s going to have a big impact on the region. But having said that, I think there’s plenty to worry about in China these days and also in India. India, with all of its poverty and all of the need for more growth, is now very clearly under performing as well. I don’t worry that much about Russia, quite frankly. I think Russia is, to a very large extent, shielded from much of this because it is an economy that generates enough export earnings. It is an economy that has such vast natural wealth that unless they grossly mismanage it, they will probably weather any kind of storm.

Knowledge@Wharton:  What about places like Indonesia and Thailand, those kinds of countries?  As China goes, so go those countries? Is that what is most likely to happen?

Mauro F. Guillen:  Well, that’s part of it, but more importantly is the U.S. and Europe because those are the most important export markets. Thailand, Indonesia, Vietnam and Malaysia; these are countries that very much depend on the U.S. market and also European markets for their exports. Now having said that, I think they have one advantage, which is that I don’t think you are seeing in those economies the kinds of bubbles that have emerged in places like Brazil or China.

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