June 10, 2021
Foreign Affairs: The Resurgence of the Rest
June 10, 2021
Foreign Affairs: The Resurgence of the Rest
June 10, 2021
Can Emerging Markets Find New Paths to Growth?
Reproduced by permission of FOREIGN AFFAIRS, May/June 2021.
After the turn of the millennium, it became commonplace to hear pundits say that the future belonged to the developing world. These countries were enjoying a run of spectacular growth. Between 2000 and the early 2010s, their share of global GDP more than doubled, from 17 percent to 35 percent. Their average incomes were rapidly catching up to those of developed nations. The share of the global population living on less than $2 a day was cut nearly in half, from 28 percent to 16 percent. Assuming the boom could last indefinitely, writers began to speak of the coming “emerging markets century,” but the phrase that best captured the Zeitgeist was “the rise of the rest.” This vision of a leveled planet, with poor countries growing faster than rich ones and catching up in terms of average income, appealed to anyone rooting for the underdog.
On Wall Street, analysts marketed Brazil, Russia, India, and China as the “BRICs,” suggesting rock-solid growth prospects. Copycats followed with acronyms such as “MINT” (Mexico, Indonesia, Nigeria, and Turkey) or nicknames such as “the tiger cubs” of Southeast Asia. Each label captured clusters of smaller and smaller emerging markets, all supposedly destined for prosperity. Some warned that it made no sense to lump together random countries this way. Brazil, for example, is a major exporter of iron ore and other commodities, whereas India is a major importer of commodities; they are developing on entirely different paths, and economic conditions that favor one can undermine the other. But it was a time of giddy optimism, and questions were out of style.
Then came the global financial crisis, which exposed the developing world’s boom as a freak event driven by a perfect storm of forces, including surging trade and capital flows and rising commodity prices. In the years that followed, many nations turned inward, nursing their own wounds and raising barriers to foreign money and imports. Trade and capital flows slowed. Commodity prices plunged. At the same time, the end of the postwar baby boom was starting to shrink the labor force in more and more countries.
Instead of booming again in the 2010s, half of all emerging economies grew more slowly than the United States and fell behind in average income. Their share of global GDP stagnated at around 35 percent. The biggest emerging economies, so recently hyped as future stars, began to fade. Skeptics spoofed the BRICs as a “Bloody Ridiculous Investment Concept.” By the time the COVID-19 pandemic hit, many developing countries were nearly broke. In 2020, more than 80 of them were forced to seek financial help from the International Monetary Fund (IMF).
For the most part, emerging economies had fallen off people’s radar, written off as lost causes by the global media and investors. But forecasters who mistakenly assumed a decade ago that the entire developing world could stay hot indefinitely were equally ill advised to assume it would stay cold forever. “The rest” were never likely to rise as a pack—or stagnate as a pack.
The 2020s now appear likely to unfold as a typical postwar decade, with some emerging economies falling, others rising, and a few standing out as genuine stars. A few will continue to rise to prosperity through the tried-and-true method of export manufacturing. But more are likely to be energized by forces unleashed during or accelerated by the pandemic: rising commodity prices, new economic reforms, and, most unexpectedly, the digital revolution.
Most emerging economies depend on commodity exports for growth, and global prices for those exports have already begun to rebound after declining throughout the 2010s. Financial distress caused by the pandemic is generating a widely overlooked wave of reform, which could boost growth in some developing countries. Finally, Internet businesses built with digital technology are spreading faster in developing nations than developed ones, which could also propel developing nations to grow faster in the future. None of these forces can boost growth indefinitely, or in all developing countries. But in various combinations, they are likely to put at least a few of these forgotten economies on a new miracle path.
THE END OF AN ERA
There was always reason to believe that emerging economies’ wildly successful run after 2000 would come to an end. In most decades after World War II, economic growth rates were similar in developed and developing nations. And since the population was growing faster in the developing world, the per capita income of most developing countries was falling behind that of the United States much of the time. Individual countries might leap forward for a decade or two, moving up one income class, but more often than not, they hit a crisis that set them back to where they started. Many developing countries have been following this pattern since record keeping began. Long-term success stories are celebrated as “miracles” because they are that rare.
Only a handful of countries have bucked these dominant trends. The IMF tracks 195 economies but counts only 39 as advanced. Most of these are Western countries that were already considered advanced at the end of World War II. But a few big economies did manage to sustain strong growth for decades, rising out of poverty and into the wealthy class, including Japan, Singapore, South Korea, and Taiwan.
These Asian miracles all used the same strategy to catch up to the West: they built themselves into export-manufacturing powerhouses. By bringing in revenue from all over the world, exports boosted growth to rates that would have been impossible to sustain in a domestic market alone. The problem today is that it is increasingly difficult for developing countries to rise the way the Asian miracles did.
The role of manufacturing in the global economy is shrinking. As robots replace humans on the factory floor, fewer assembly lines can produce the same amount of goods. Simultaneously, consumers sated with household goods are shifting to spending on more services. Exports have also begun to play less of a part in the global economy, as the free-market impulses of globalization give way to the protectionist instincts of deglobalization. This is the root of the pessimism engulfing the developing world. Where will the growth come from?
Those doubts are, like the hype that preceded them, overdone. Just because the most successful of the old growth models—export manufacturing—is fading doesn’t mean developing countries won’t find ways to rise from the ashes of the global pandemic.
Although manufacturing has historically been the surest path to prosperity, it is an increasingly narrow one. These days, only a few countries benefit, as producers, seeking lower wages and shorter supply lines, move their factories out of China. For now, the handful of winners are concentrated in eastern Europe and Southeast Asia.
The IMF has a complex and partly subjective definition of “advanced economies,” but one thing those economies have in common today is an average annual income of at least $17,000. The last large economies to break that barrier were the manufacturing giants South Korea and Taiwan, back in the late 1990s. And the next major country to make that leap is likely to be another export manufacturer: Poland.
In recent years, Poland has gotten a lot of attention for the right-wing populist drift of its political culture but little for its extraordinarily steady economic success. After completing its transition from communism to democracy in 1991, Poland embarked on more than a quarter century of rapid growth, averaging more than four percent per year, unbroken by even a single year of negative growth. By the eve of the pandemic, that unusually long run had increased the average Polish income tenfold, to nearly $16,000—close to the threshold of the advanced class.
The secret to Poland’s success has been manufacturing. New export producers have risen all along its western border, including in Gdansk and Krakow, which are less populous than Warsaw but geographically well positioned to serve richer European markets. Many of those producers began as startups launched by Polish entrepreneurs who openly admire U.S. capitalism and were animated by disdain for their Soviet communist past. Others are manufacturing plants established by foreign multinationals, producing everything from light bulbs to car parts.
Poland is the biggest player in the widening manufacturing hot zone of eastern Europe, but not the only one. Today, Hungary and Romania are also within striking distance of the advanced income level. Candidates are also rising in Southeast Asia, including Indonesia, Thailand, and Vietnam. The Asian contenders tend to be a bit behind the eastern European countries, with average incomes below $10,000, but they also tend to be growing faster.
The most impressive case is Vietnam. Analysts first began speaking of Vietnam as “the next China” during the boom that began around 2000, and the country is now mobilizing for manufacturing-led growth as perhaps only a one-party, authoritarian state can. With the government urging the population of 96 million to follow COVID-19 protocols over loudspeakers and through mass texts, Vietnam has achieved one of the world’s lowest death rates. Following brief and mild lockdowns, it was the fastest-growing economy of 2020.
Vietnam’s breakout has been a long time in the making. During their boom years, the original Asian miracles produced annual export growth close to 20 percent—nearly double the average for other emerging economies. Vietnam has sustained a similar pace for three decades. Even as global trade slumped in the 2010s, Vietnam’s exports grew by 16 percent a year, by far the fastest rate in the world and three times as fast as the average for emerging economies. Over the last five years, no country has increased its share of global exports more than Vietnam has. Like all Asian miracles in their early years did, Vietnam invests heavily in new roads, ports, and railways; it now gets higher World Bank grades for the quality of its infrastructure than any other developing nation at a similar stage of development.
Perhaps the greatest achievement of the original Asian miracles was that they managed to grow the pie while sharing it more broadly, reducing inequality. Vietnam is starting to draw attention for the same reason. The average income in Vietnam is nearly 30 times as high as it was in 1990 and has risen to almost $3,000 per person. Vietnam’s workforce is unusually healthy, well educated, and well nourished for a low-income country. A 2020 IMF study praised Vietnam for investing heavily in the economy while reducing poverty and “leaving no one behind.”
Unfortunately, most emerging economies depend greatly not on exporting manufactured goods but on exporting oil, soybeans, metals, and other raw materials. And so their fortunes are whipsawed by the rise and fall of global prices for these commodities. Historically, commodity prices have followed a predictable cycle of long booms and long busts, which have left prices essentially flat in inflation-adjusted terms since records began in 1850.
No wonder so many emerging economies get stuck in the developing stage. “The rise of the rest” was a writerly translation of “mass convergence,” jargon for the period when virtually all emerging economies were growing fast enough to see their average incomes catch up to, or converge with, that of the leading developed nation, the United States. The average incomes of converging nations have tracked commodity prices for decades, rising rapidly together in the 1970s, falling together in the 1980s and 1990s, rising together again after 2000, and then slipping backward in the 2010s.
So, like commodity prices, the fortunes of major commodity exporters tend to go nowhere in the long run. The average income of Brazil, a diverse exporter of oil, soybeans, and other commodities, is no higher today relative to the United States’ average income than it was in 1850. South Africa, another diverse exporter, has fallen behind in relative terms over the same period. Of the 18 largest oil-exporting countries for which data are available, 17 are no richer today in relative terms than they were in the year they discovered oil. (Only Oman has managed to break out.)
Why are commodities a less reliable path to growth than manufacturing? The export revenue is less steady. Digging stuff out of the ground requires less innovation than manufacturing goods and therefore generates little or no gains in productivity, which is the real key to durable increases in prosperity. And the so-called curse of commodities is real: commodity price booms often breed corruption, as officials vie for a piece of the windfall profits rather than focusing on long-term budget and investment discipline. Thus, commodity-driven economies tend to not only grow erratically but also suffer from high levels of corruption and its equally destructive companion, high levels of wealth inequality.
Nonetheless, after falling in the 2010s, global commodity prices started to turn upward late last year, and there are many reasons to believe this revival can endure. One is the weakening dollar. Prices for commodities such as oil and steel are denominated in dollars, so a weakening dollar leads, almost by definition, to a rise in commodity prices. And the U.S. Federal Reserve’s massive printing of dollars, aimed at easing the economic pain of the pandemic, is already weakening the dollar. More than 20 percent of the U.S. dollars in circulation were printed in 2020.
The political winds also favor commodity exporters. With China recently having committed to net-zero emissions by 2060 and the United States under the Biden administration likely to follow suit, countries representing more than half of global GDP will have made this pledge. This campaign will lift economies that export metals necessary for green electrification programs. Among the main beneficiaries will be platinum exporters, such as South Africa and Russia, and copper producers, such as Chile and Peru. A sunny and unusually windy climate also makes Chile a potentially major supplier of renewable power and of green hydrogen fuel—the kind produced using renewable power.
With more infusions of stimulus already in the pipeline everywhere from China to the United States, government spending will keep fueling demand, including demand for commodities. Much of China’s COVID-19-induced stimulus spending is going to new infrastructure projects, boosting demand for building materials. Record-low mortgage rates are driving housing booms from Germany to the United States, with a similar effect on demand for construction materials. Many countries are also sharply increasing social benefits, which go to lower-income families—those most likely to spend the additional income, further lifting consumer demand and prices of raw materials.
At the same time, weak prices over the last decade greatly reduced new investment, leaving supplies of commodities tight. Whether the post-pandemic recovery lasts or not, rising demand will collide with low supply to push prices up—and not only for environmentally friendly commodities. Oil could get a similar lift, following a period when low prices forced many oil fields to shut down.
To be clear, rising prices will not be enough to generate rapid, sustained growth for all commodity exporters. Many will be held back by incompetent or corrupt leaders, bloated bureaucracies, or other factors. Still, some will enjoy a good run. A diversified exporter such as Brazil is likely to benefit from the general rise in prices. And its growth could last at least as long as the revival of commodity prices does.
As the United States and other developed countries spend massively on stimulus to ease the pain of failing businesses and shelter-at-home orders, they are ignoring or explaining away the likely consequences of their spending. Rising deficits and debt will drag down productivity and therefore economic growth. But developing countries are moving in the opposite direction: unable or unwilling to borrow and spend, they are encouraging painful productivity-boosting reforms, which will spur growth.
This is a familiar pattern. Many developing countries push for economic reforms only when forced to in a crisis. They then fritter away the gains during the ensuing boom and fall back into financial trouble. The bigger the crisis, the greater the incentive to reform. A silver lining of COVID-19, then, is that it represents the biggest incentive to reform in decades.
China is a classic case. In 2008 and 2009, Beijing spent so heavily that its massive stimulus program was praised for supposedly saving the world. But China’s growth slowed in subsequent years, weighed down by debt. This time, facing the COVID-19 pandemic and a sluggish economy, China has spent less heavily, particularly relative to the United States, as have many others in its class. On average, big emerging economies are spending nine percent of GDP—roughly one-fourth the median of developed countries—on stimulus to fight the pandemic.
Instead, they are pushing for reform. Much attention has been paid to Beijing’s new focus on self-reliance and its efforts to build its own technology supply chain, invulnerable to U.S. sanctions. Yet last summer, the Chinese leadership also announced plans to strengthen property rights, facilitate the free flow of capital and labor, allow flexible price adjustments, and encourage competition in ways that would let productive companies thrive and unproductive ones fail. Less dead wood could boost growth.
Reform is also in the offing in India. When Prime Minister Narendra Modi came to power, in 2014, he was touted as a radical reformer, but for the most part, he has only tinkered at the edges. Lately, however, Modi’s government has started to take decisive steps to address lagging economic growth, including cutting corporate taxes. After the pandemic hit last year, it took controversial actions to open up the labor and agricultural markets, and it is now battling in the Supreme Court to see those changes through.
It’s hard to know which types of reforms will have the biggest economic impact, or any impact at all. But anyone who has traveled to certain developing countries has seen how even a single reform-minded leader with ambition can fire up consumer confidence—and it has been years since reform plans looked this ambitious. Consider Indonesia. In recent years, the country streamlined the paperwork for hiring foreign workers and set up a one-stop shop that processes new business licenses in three hours. In 2020, it topped all of that when its parliament, over the protests of unions, passed a bill to boost investment and create jobs through a sweeping reduction in red tape, labor laws, and corporate taxes.
It is striking to see other change-averse states sticking to reforms that were controversial before the pandemic and are even more so now. Brazil, for example, is pushing ahead with an overhaul of its cripplingly expensive pension system. It aims to cut spending by more than $140 billion over ten years, in part by raising the retirement age for both men and women. And in traditionally insular Saudi Arabia, the government is granting new rights to foreigners, including the right to own 100 percent of publicly traded companies in a variety of sectors, including health and education, and the right to obtain (for a hefty fee) permanent residency permits, which include the legal authority to purchase property.
For all the recent focus on the U.S. election, politics matters more in emerging economies, where relatively weak institutions mean that a single leader can have a much greater impact on policies and growth. The reforms that China, India, Indonesia, Brazil, and Saudi Arabia are undertaking represent attempts to solidify national finances and open the economy to market forces. So far, all these campaigns are being pushed by incumbent leaders. What happens next depends on how long the pandemic lasts and how many governments it topples.
After the financial crises that hit emerging markets in the late 1990s, new leaders rose to power with a strong popular mandate for change. In Brazil, Russia, South Korea, and Turkey, those leaders at least initially proved to be reformers: they lowered debt and deficits, welcomed foreign investors, and helped set the stage for the developing world’s boom. South Korean President Kim Dae-jung, who served from 1998 to 2003, implemented the most far-reaching reforms, which is one reason South Korea has continued to advance more steadily than the other members of this group and most other emerging economies. If the pandemic brings to power a new generation of reformers, some with a transformative impact, it would not be the first time.
THE DIGITAL REVOLUTION
So far, only export manufacturing has demonstrated the capacity to sustain almost double-digit rates of economic growth, at least in an elite few countries. But the digital revolution, by rapidly widening the reach of online shopping, banking, entertainment, and new business services to previously unserved markets, offers the promise of a new development miracle. It is not likely to generate growth as fast as manufacturing could, because in most countries, digital services are rising as local industries, with no added boost from exports. But it can simultaneously and sustainably transform domestic economies across the developing world, not just in a handful of countries.
Digital services can grow explosively across the greenfield that is the developing world. Many consumers there have little access or attachment to an old fixed-line world of brick-and-mortar shops, banks, and theaters, and they are thus quick to adopt the latest digital services. In China, the prototypical case, the new digital economy is already growing fast enough to compensate for the decline of aging rust-belt industries.
In fact, the spectacular rise of a parallel Internet universe, dominated not by U.S. search and social media giants but by Chinese rivals such as Alibaba and Tencent, is perhaps the main reason China is still growing faster than—and on track to catch up with—the United States. Already, China is a leader, if not the leader, in digital technologies from robotics to artificial intelligence.
Already, copycats of U.S. and Chinese Internet companies are providing search, shopping, and other services, and gaining momentum, everywhere from Asia to South America and Africa. Catering to local tastes and languages, these regional Internet giants are rapidly expanding consumer access to finance, shopping, travel, and other services, while also greatly increasing productivity.
According to the World Bank, the average cost of starting a business has not changed since 2003 in developed economies, whereas in developing economies, it has fallen from 50 percent more than the average annual income to 60 percent less. Much of this improvement stems from the fact that entrepreneurs in developing countries can now launch a business—from landing a loan to taking payments from customers—on the increasingly ubiquitous smartphone.
Surprisingly, the digital revolution is as advanced in developing countries as in developed ones, or even more so—and it is spreading faster. Although no large developing countries are among the world’s 30 richest countries in terms of per capita income, 15 are in the top 30 in terms of the share of economic output that comes from digital revenue (which includes revenue from e-commerce, e-media, and e-services of all kinds). China, Indonesia, Colombia, Chile, and India are all near the top. These economies are already more digitized than most of their developed rivals.
And in all of them, digital revenue is growing much faster than the overall economy—in Colombia, Indonesia, and Turkey, more than seven percentage points faster than GDP. In Southeast Asia, digital technology is outrunning both the forecasts and the hype. Since 2016, Google has teamed up with Singapore’s sovereign wealth fund to report on the digital economy in Southeast Asia. The first report expected digital revenue to quadruple, to $200 billion, by 2025, but the latest one has upped the 2025 forecast to $300 billion.
No developed economy is getting nearly as large a lift from digital industries. Robotic waiters, drone delivery services, and digital cash are already far more common in China than in the United States. A homegrown version of Amazon is rapidly becoming the dominant e-commerce platform in Poland. Google is building the newest models of its Pixel smartphone in Vietnam, where e-commerce is growing at an annual rate of 40 percent. Lagos and Nairobi are rising fast as the financial-technology capitals of Africa, and some of their leading entrepreneurs are explicitly aiming to raise the region’s “digital GDP” by widening access to Internet financing.
A NEW MIRACLE
The celebration and hype that just a decade ago swirled around hot emerging markets are not likely to return. Shrinking populations, rising debt, and declining trade and capital flows are slowing growth in all economies, developed and developing. As late as 2010, the hottest emerging economies were still growing at a rate close to ten percent a year, a pace that will be all but impossible to sustain in a world burdened by depopulation, debt, and deglobalization. But emerging economies also won’t need to grow that fast to catch up with the West, whose economies are slowing as well. Even five percent growth could generate new miracles when the average growth rate in developed countries has fallen to two percent or less.
The idea of mass convergence captured so many imaginations because it sketched a new arc for humanity, with fewer failing economies, less poverty and suffering, and more investment opportunities in emerging economies. From socialists at Berkeley to capitalists on Wall Street, everyone could buy into this vision of the future.
Instead, the U.S. economy’s rise in the 2010s, led by a small group of giant technology firms, left a world more grossly out of balance and arguably more unfair than ever. Today, the United States accounts for about a quarter of global GDP, and after sucking up the lion’s share of investment dollars for the last ten years, it also accounts for 57 percent of the value of global stock markets. The leading emerging markets account for more than a third of global GDP but only nearly 14 percent of the value of global stock markets.
But money tends to follow economic growth, and gaps this extreme between economic output and financial gains tend to rebalance themselves over time. In fact, since late 2020, investors from around the world have been returning to emerging markets, which is another reason to believe that the coming decade could be a good one for some of these countries. And if those investments help boost the average growth rate of emerging economies by even one percentage point over the next decade, that would lift an additional 200 million people, now surviving on less than $2 a day, above the poverty line. The 2020s may not offer a new arc for humanity, but it will still be a good decade for the underdogs.
RUCHIR SHARMA is Chief Global Strategist at Morgan Stanley Investment Management and the author of The Ten Rules of Successful Nations.
This article was originally published in the May/June 2021 issue of Foreign Affairs Magazine and on ForeignAffairs.com.
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