System Shock: The submergence of emerging markets

•  ANDRES VELASCO

UNITED NATIONS: It was an off-the-record, online conversation about the state of the world. Nobel laureates, former government officials, and hedge-fund managers held forth on geoeconomics, warfare, artificial intelligence, green investments, how to avoid the next pandemic, and other lofty topics. But here’s what struck me: two hours into the discussion, no one had yet uttered the phrase “emerging markets.”

China came up, of course, but only in relation to what might happen to Taiwan if Donald Trump returns to the White House. India’s alleged growth miracle last year went unmentioned. Turkey was mentioned only in the context of Middle East politics. South Africa? Nope. Brazil? Remind me: where exactly is Brazil?

What a contrast to the mood only a few years ago. I remember a dinner at the annual World Bank/International Monetary Fund meeting, during which a half-dozen European finance ministers stared into their salads and feigned patience as a minor official from the People’s Bank of China received all the questions from the assembled investors. Back then, everyone wanted to talk about emerging markets. Their growth kept the world economy afloat when the economies of rich countries tanked in 2008-09 and again in 2020.

No more. Today, the fortunes of the world economy depend on the fortunes of the US economy, with perennial under-performers Japan and Europe stuck in unglamorous supporting roles. Emerging markets are footnotes at best.

One of the few “iron laws” we economists can utter with confidence is: the richer the country, the lower its average growth rate. So, you might have expected the Chinas, Indonesias, Turkeys, and Brazils of this world to move from center stage, because they had grown richer and were now growing more slowly. Economists call this “convergence.”

But that is not what is happening. Middle-income economies are slowing long before they have become high-income economies. The culprit, for the most part, is bad domestic policies.

China is the most obvious example. When forced to choose between economics and the Communist Party, President Xi Jinping always chooses the party. And that is not because political stability is essential for continued growth. On the contrary, it is because continued growth might create challenges (real or imagined) to Xi’s control.

A place where one must worry about email being read, phone calls tracked, and a walk in the park surveilled is not a place where the world’s investors want to put their billions. Yes, Chinese researchers are quite advanced in some aspects of AI. But the AI financial feeding frenzy is happening in Silicon Valley, not Beijing.

India merits special attention. When I was in New Delhi late last year, the frothiness typical of a bull market was in the air. Official claims that the economy was growing at 7% and more during the third quarter surely contributed to the bullish atmosphere, which continues.

But there are at least two glitches with that happy story. First, the growth numbers are not believable, as Ashoka Mody has convincingly argued. Second, Prime Minister Narendra Modi is slowly but surely weakening Indian democracy’s secular and liberal foundations. The latest example was the massive spectacle, presided over by Modi, of the consecration of the Ram Temple in Ayodhya on the site where Hindu militants razed a mosque in 1992, provoking riots that left 2,000 people dead.

Another lesson economists repeat with reasonable certainty is that doing away with equal protection under the law is not good for long-term investment and growth. That lesson is becoming increasingly relevant for India.

You will not find a compelling growth story in Latin America’s two largest emerging markets, Brazil and Mexico, either. Poland, once the star performer in Central and Eastern Europe, barely grew at all in 2023. Indonesia and the Philippines have both been expanding at a respectable 5% clip, but in both countries, growth is expected to decline, highlighting the difference between short-term macroeconomic management, which has improved in most emerging markets, and a long-term growth strategy, where most get a failing grade.

Yes, there are exceptions to this rule, but even they point to the overall departure from the spend-and-print fiscal and monetary policies of decades past. Until its election in May 2023, Turkey was still experimenting with the bizarre idea that fighting inflation requires cutting interest rates. But, after he secured another term in office, President Recep Tayyip Erdogan appointed a serious finance minister, and the country turned toward common-sense policies. Predictably, equity prices soared.

In Brazil, Finance Minister Fernando Haddad has struggled to meet his ambitious fiscal targets. But the very fact that President Luiz Inácio Lula da Silva, whose foreign policy (think Russia-Ukraine) has been abominable, should allow Haddad to entertain ambitious fiscal targets is an improvement. Under President Javier Milei, even Argentina is trying to cut its fiscal deficit, though he may lack the votes in Congress needed to get the job done.

Independent central banks have made a huge difference, acting early and with the necessary strength to fight inflation, even when confronted with populist presidents (as in Brazil, Colombia, Mexico, and South Africa). In the recent inflationary cycle, the larger Latin American economies began to tighten monetary policy a year before the United States did. They are now well into the easing phase, with inflation (mostly) under control.

So, the larger emerging markets can expect mediocre growth and stagnant real wages, not spectacular debt crises. Convergence to high-income status now hangs in the balance.

It is fashionable to say that the world has been getting less equal. In fact, while the US or the United Kingdom may have become less equal, the world as a whole has become vastly more equal, as rapid growth in China, India, and other emerging economies pulled billions out of poverty. That welcome trend will be in danger if emerging markets enter a sustained slowdown, as now seems likely.