In my note last week I discussed why the world’s developed economies are facing a period of Japanese-style low growth, low inflation and ultra-low interest rates. The good news is that no such problem is facing the emerging world. The bad news is that it faces a separate set of growth challenges.
There are several strands to the “Japanification” of the developed world, but an important one is that productivity growth at the technological frontier has been extremely weak. As a consequence, economic growth in those countries at the frontier has also been weak. However, emerging markets do not sit at the technological frontier. GDP per head in most EMs is typically between 10% (India) and 50% (economies in Central & Eastern Europe) of that of the US. Growth in these economies is therefore determined by how quickly they catch up to the frontier – not by growth at the frontier itself.
Over the past couple of decades the pace of catch-up has been impressive. Emerging economies have been responsible for around two-thirds of global growth since 2000, and income levels have increased by an average of 6% a year. As a result, many now take for granted the idea that emerging economies grow much faster than developed economies.
However, the rapid growth recorded by EMs since 2000 is an historical anomaly. Average EM incomes fell relative to developed world incomes from the industrial revolution to the start of this century.
We’ve argued for a while that 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 with both other emerging economies and the developed world.
China was the most visible example of an economy liberalising and opening up, and its rapid investment-intensive model of growth 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 step-gain in EM productivity. But this has now faded. Economies can only open up once. Economic resources can only be shifted from the state to the private sector once. Tariffs can only be cut from double-digit rates to virtually nothing once.
Admittedly, some EMs have continued to liberalise in recent years. Under PM Modi, India is cleaning up its banking sector and easing rules around foreign direct investment. Brazil has just passed a historic pension reform bill. Mexico has liberalised parts of its economy. But these measures have generally been piecemeal. They lack the reach of the 1990s reforms and often fail to tackle the most important impediments to growth.
Meanwhile, China, which now accounts for 30% of EM GDP and 20% of global GDP, is facing a period of structurally weaker growth caused by increased misallocation of resource. We’ve argued that China’s growth rate will slow to just 2% by the end of the next decade. Add into the mix the fact that, in our view, the world has reached peak “globalisation” and now faces the very real risk of a period of “de-globalisation”, and the result is that emerging economies are now facing a period of much weaker growth.
As happened in the 1980s and 1990s, some EMs will continue to do relatively well. Despite its recent struggles, we suspect India will prove to be a relatively bright spot over the next decade. 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 much harder in the future. As we argued in a note last week, this year will be the first since 1999 in which incomes in the majority of EMs fail to converge with those in the US.
All told, we expect EM GDP growth to average around 3-4% over the next decade – down from an average of 6% between 2000 and 2015. Combine this with the fact that the creeping “Japanification” of the developed world and what’s left is a global picture of structurally lower growth, inflation and interest rates.
That doesn’t mean, of course, that growth won’t fluctuate within the cycle. Indeed, while we expect global growth to slow further over the next couple of quarters, we think it will bottom out around Q2 of next year and then edge up over the second half of 2020. However, the key point is that this recovery will come in the context of an environment of structurally weaker growth. Step back and the global economy remains gripped by a “Great Stagnation”.