Jeffrey E. Garten :
Long before the current market debacle, I was confronted with a fundamental question about emerging markets. As I was finishing off my course at the Yale School of Managment on “The Future of Global Finance” this past May, a student came up to me. “You have gone to great lengths to emphasize the role of emerging markets in a changing monetary system, ” he said, ” but everything I have been reading says that the era of the Brazils, the Indias, the Turkeys, the Indonesias as up-and-comers is history. Even China seems to have lost its luster. Have you been looking backwards and not forward?”
Standing at the podium and gathering my lecture notes, all I could muster in the moment was something about how important it was to separate the signal from the noise. There wasn’t enough time to elaborate, and later I felt my response was inexcusably lame. The last few weeks of escalating crisis for emerging-market countries started to make me feel that maybe the student was more correct than I had acknowledged. But the more I think about it, the more I am convinced that is it a mistake to think that the era of emerging markets is over. In fact, it is just in its early stages.
When commentators talk about emerging markets, they could be referring to a number of groupings. In 1995, for example, President Bill Clinton’s administration coined a term, “big emerging markets,” consisting of 10 countries that had large populations, large markets, and substantial influence in their regional neighborhoods. They were Mexico, Brazil, Argentina, Poland, Turkey, South Africa, India, China, Indonesia, and South Korea. In 1996, a Yale research team headed by historian Paul Kennedy published articles (and later a book) proposing that Washington give foreign-policy and economic priority in the developing world to nine “pivotal states” whose fates would be central to the problems of the 21st century: Indonesia, India, Turkey, South Africa, Brazil, Mexico, Egypt, Pakistan, and Algeria. (China was excluded because, for the Yale group’s purposes, it was considered a great power alongside Russia.)
Then, in 2001, Goldman Sachs, led by Jim O’Neill, then its senior research executive, published an analysis identifying four countries that would become global economic powers alongside the United States and Japan. They were labeled the BRICs: Brazil, Russia, India, and China. (Eventually South Africa was added.) Since the 1990s, however, much larger groupings encompassing countries such as Malaysia, Colombia, and Israel have been established by the United Nations, the IMF, the World Bank, Morgan Stanley, and other organizations, each list being used for different purposes, such as investment, social progress, etc. I fully agree with the Financial Times when, in early August, it described the emerging-market group as “one of the most powerful definitions in the world” and also a “capacious category” of “incongruous assets.”
This cacophony of so many competing definitions notwithstanding, virtually every category of emerging markets is now experiencing serious economic setbacks. But as my student implied, the problems are not just of the moment.
In July 2013, the Economist wrote, “The most dramatic, and disruptive, period of emerging-market growth the world has ever seen is coming to its close.” This past April, the Wall Street Journal paraphrased the IMF as stating, “Emerging markets are on course for the sixth consecutive year of falling growth rates, led by a faster-than-expected slowdown in China, a steep contraction in Russia and recession in Brazil.” In July, the IMF showed emerging markets’ collective growth decelerating from 5.0 percent in 2013 to 4.6 percent in 2014 to 4.2 percent this year. Well before the meltdown of the last several days, unemployment levels in emerging markets had been rising, and those countries’ currencies had hit 15-year lows – and that was before the Chinese devaluation of mid-August, which caused many other emerging-market currencies, such as the Indonesian rupiah and the Thai baht, to fall even further in order to maintain their competitiveness vis-à-vis the Chinese renminbi.
Emerging-market stock markets have been flat for the last six years and have given up all the comparative gains they made over stocks from developed countries. Private-sector debt in emerging markets has been soaring too. It is no wonder that outflows of funds from emerging markets have accelerated and exceeded $1 trillion in the last year. “The worry is that these problems are no longer contained within emerging market economies,” wrote Jonathan Wheatley and James Kynge of the Financial Times presciently as far back as June, “The dependable boost that the global economy has derived from the youthful dynamism of its developing countries for well over a decade … has recently become an outright drag.” They were correct, of course, as we are now seeing.
To illustrate this point another way, several of the most important emerging markets have faltered severely, not just because of economic policies but also because of political deterioration. In China, stock market and currency turbulence have raised serious questions about whether the Middle Kingdom is in for much harder times, whether the heyday of rapid growth is over, whether its fundamental economic and political model is seriously flawed, and, indeed, whether its top officials are up to the challenge. In Brazil, a broad corruption scandal and accusations that the government has illegally manipulated its fiscal accounts have not only helped stall the economy – actually it just entered into a recession – but threaten to create political turmoil of a kind not seen since the transition to democracy from military rule in the 1980s. In India, the hope accompanying the election of Prime Minister Narendra Modi has been deflated by parliamentary gridlock over essential reforms. In Russia, plummeting oil prices and Western sanctions have pulverized the economy. In Turkey, political stalemate created by a dictatorial president, a massive refugee problem, and escalating military involvement with Syria have cast a serious pall over necessary reforms. In Indonesia, the economy has slowed to levels not seen since 2009, and a new president seems unable to move critical legislation to reverse the trend. The list goes on.
Why have emerging markets proved to be so disappointing? For starters, there was excessive exuberance in the 1990s concerning the idea that a post-Cold War new world order would emerge quickly and that China, India, and Brazil were in the vanguard.
Concretely, that took the form of too many projections that were straight-lined from the outsized performance of emerging markets over several years during that decade. Such extrapolation is always ill-advised, but to make matters worse, the starting point for these projections was based on a period that included a phenomenal business expansion in the United States, exceptional optimism regarding the economy in the European Union, and China’s takeoff after a half-century of stagnation, including its voracious appetite for the commodities that so many other emerging markets exported.
The mid-to-late 1990s was also a high-water mark of globalization, with global trade and investment flows across borders growing at extremely fast rates. In retrospect, many projections just assumed that the highly positive global economic conditions would continue and that relatively easy policy reforms in emerging markets such as tariff reductions would be followed by much more difficult ones, such as liberalization of restrictive labor practices.
Then, from 2008 to 2009, a massive financial crisis that began in the United States rocked the global economy and has interrupted global financial connectedness for the last six years. Exceedingly low interest rates in the world’s advanced countries and the cheap capital those rates spawned allowed emerging-market governments and their private sectors to go on a borrowing spree. Mounting nationalism and xenophobia in Europe cast an additional pall over the future of globalization. A slowdown in China’s appetite for commodities and raw materials rocked emerging-market exporters such as Indonesia and Brazil. Tumbling oil prices caused severe slowdowns in countries such as Russia and Venezuela. No one foresaw this set of circumstances, nor could they have, but assuming only sunny skies was a horrible mistake. In 2014, Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management, minced no words when he wrote about those who had been overly optimistic about emerging-market performance: “Forecasters assumed that recent trends would continue indefinitely and that hot economies would stay hot, ignoring the inherently cyclical nature of both political and economic development. Euphoria overcame sound judgment – a process that has doomed economic forecasting for as long as experts have been doing it.”
Excessive expectations have also been evident in forecasters’ assumptions about political development in emerging markets. Western prognosticators seemed to have forgotten that politics in the emerging world were every bit as complex as they were in the United States, Europe, or Japan. Particularly in the United States, but not exclusively there, there was a pervasive hypothesis that if growth rates in emerging markets were strong, all else would follow: Democratic governance would evolve quickly, and deep-seated corruption would be extinguished because a rising middle class would demand it. The workforce would acquire the skills and education it would need because knowledge would be easily transferable in an ever borderless world. In fact, the long, hard road to political reform and the obstacles to establishing effective, transparent government administration were seriously underestimated.
(To be continued)
(Jeffrey E. Garten teaches courses on globalization at the Yale School of Management, where he was formerly dean. He was previously undersecretary of commerce for international trade in U.S. President Bill Clinton’s administration and a managing director of the Blackstone Group).
