Is the golden age of emerging markets over?


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 opportunities.

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 Worldwide 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 future.

Antoine van Agtmael coined the term "emerging markets" while at the International Finance Corp., was the principal founder, chairman, and chief investment officer of Emerging Markets Management, and is the author of "The Emerging Markets Century."

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