One comes out of the IMF/World Bank annual meetings in Washington DC realizing how much the world economic landscape has changed over the last several years. The rise of emerging markets, called “third-world countries” only a couple of decades ago, has been nothing short of spectacular. Benefiting from sound macroeconomic management, a supportive external environment and high commodity prices, these countries have managed to move to the center stage of the world economy, amid the failure of the mature or big industrialized countries to face up to their challenges. These challenges have ranged from growing fiscal and trade imbalances in the US, to lagging bold and crucial structural changes in the EU that would, among other things, render its labor markets more flexible and hence, more capable of generating potential growth rates, to finally a Japan that has yet to generate domestically-driven growth and emerge from a decade long suboptimal growth.
Of course, the positive factors that have helped emerging markets’ upward move as a global economic power were not accidental but rather the combination of well taught policy lessons, policy responses in mature markets, and some luck. The policy lessons were accumulated after a series of currency and debt crises that rocked the emerging markets from Mexico (1994) to Asia (1997) to Russia (1998) to Brazil (1999) to Argentina (2001), leaving policy makers in these countries and other emerging markets with the realization that sound and prudent fiscal and monetary management of the economy are necessary conditions for sustainable high-paced growth. Meanwhile, the collapse of the dotcom bubble in 2001 prompted an unprecedented easing by the Fed, creating one of the cheapest credit cycles, which in turn led to liquidity abundance and hence higher emerging markets asset-prices be it in stocks, bonds or even real estate. The third supporting factor, i.e. the increase in oil and other commodity prices, is a combination of a bit of luck and a reflection of strong global demand.
Two developments over the last couple of years have particularly underlined this shift in economic status and the emergence of a new world economic paradigm. The first was last year, when the big four emerging markets (Brazil, Russia, India and China) contributed all together more than 50% to the global growth rate. In other words, of the 5.4% growth rate that the world achieved in 2006, more than 2.7% were generated in the four large emerging markets. The second development came in this year (2007), as China is set to be the largest single contributor to world GDP growth, beating both the US and the EU. In other words, of the 5.2% world growth rate expected for 2007, China alone is contributing 0.9% while the US and the EU are contributing each less than 0.8%. These are major shifts in the global economic conditions, underlining the facts that the engine of world growth is no longer the US, or even the EU, but rather emerging markets.
The vulnerability bias and not just economic relevance seems to have changed. The US sub-prime mortgage debacle and its consequences on the money and credit markets globally, was indeed the first global credit crisis in a long time that breaks in a mature rather than an emerging market. After a series of emerging market crises in the 90s propagated to world markets, jacking up interest rates and causing jitters in world stocks, the last episode of massive write-offs, tight credit conditions, and volatile stock markets has actually originated in the US market where easy credit conditions over the last several years have encouraged over-lenient lending and speculative investments whose reversals are just starting to materialize. Even more surprising has been the resilience of emerging markets to the global financial distress, as evidenced by their debt and stock markets which continued to rise in value as mature debt and stock markets declined.
Skeptics are very careful about declaring “the end of history” (a term coined by American historian Francis Fukuyama upon the collapse of the Soviet Union) of the world economy, and even highlight emerging market vulnerabilities that would make them unshielded from a severe meltdown of global financial markets. We do not completely disagree with such skeptics, and though we are not ready to declare the end of economic history ourselves, we are surely prepared to recognize the start of a new chapter.