Are emerging markets (EMs) still the engine of global growth, or are they a busted flush? It’s a question that has investors scratching their heads, but the answer will also have profound implications for the global economy. After all, EMs now account for over 60 percent of global GDP.
The good news is that the immediate outlook appears to be brightening. Despite concerns about the spillovers to emerging economies from the Fed tightening its monetary policy and the threat of greater trade protection in the U.S. under President Trump, the latest data suggest that economic conditions in EMs are improving.
{mosads}At Capital Economics, we use our proprietary GDP Trackers to provide a real-time view on growth. These show that EM growth has accelerated steadily since mid-2016 and is now running at a three-year high of just 4 percent, year-on-year.
Admittedly, there are some clouds on the horizon. In particular, we expect China’s recovery to peter out over the course of this year as policy support is withdrawn. If we are right, the effects will be felt elsewhere in Asia and among producers of industrial commodities too. But the prospects for other large emerging economies are improving.
India’s economy is getting back on its feet after the disruption caused by the government’s efforts at “de-monetisation”, and there are signs that Brazil and Russia are starting to turn the corner following deep recessions. Having consistently surprised on the downside since 2015, it is very possible that both economies now surprise on the upside.
The net result is that we expect EM growth to continue at a steady if unspectacular rate of around 4 percent, year-on-year, over the course of 2017 and 2018.
So all is well? Not quite. The rapid rise of emerging economies since 2000 means that many now take for granted the idea that they typically grow much faster than their counterparts in the developed world.
In fact, our analysis shows that the past 15 years is the only period since at least 1950 that has delivered sustained EM outperformance, whether in aggregate or per capita terms. Average EM incomes fell continually relative to developed world incomes from the industrial revolution to the start of this century.
The much faster growth after 2000 owed less to a lasting break in EM performance than to a number of one-off factors that provided a temporary boost. Policymakers across the emerging world adopted more market-friendly policies in the 1990s and 2000s, and the spread of technology allowed rapid integration both with other emerging economies and with the developed world.
China was the most visible example of an economy opening up, and its rapid investment-intensive growth further helped other EMs by lifting commodity prices. But most of the emerging world, from Latin America to the former Soviet Bloc, followed a similar path.
The result was a surge in productivity growth across the emerging world. But this has now faded as the step gains in EM productivity could not be repeated. Economies can only open up once. There are no major EMs left to integrate with the world.
Meanwhile, demographic trends are turning less favourable too. Working-age populations are still rising in most places but the rate of growth is slowing almost everywhere. Other things equal, slower workforce growth will shave almost 1 percentage point off aggregate EM growth over the coming 15 years compared with the last 15.
As happened in the 1980s and 1990s, some EMs will continue to do well. But rapid catch-up growth will return to being the exception rather than the norm. Indeed, increasing automation and use of robots in industry may make the sort of labour-intensive, manufacturing-led catch-up growth that the most successful EMs followed in the past harder to follow in future.
The upshot is that while we are less concerned about EM growth over a one-to-two year horizon, the outlook over a five-to-ten year horizon is more challenging than many still seem to expect. Most analysts still think that EM growth will return to a “trend” rate of around 5 percent or so at some point toward the end of this decade.
In contrast, we think it will get stuck at somewhere around 3.5-4.0 percent and could fall much lower if China’s government continues to delay much-needed structural reform.
This may not sound like much, but the difference slower EM growth will make to the shape of the global economy over coming decades will be profound. By 2030, the gap in EM output in our forecast compared to that of the IMF’s is about the size of the U.S. economy today. In a globalized world, the effects will be felt both in the pockets of EM workers and in the returns of global investors.
Neil Shearing is chief emerging markets economist at Capital Economics, the leading macroeconomic research company.
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