Why emerging markets confound the pessimists

Remember this time last year, when it was fashionable to predict that 2014 would be a pretty bad year for emerging markets?  Didn’t really happen, did it? Now I hear analysts saying the crisis they’d been counting on has only been postponed. It’ll happen next year instead. It’s possible, but I wouldn’t bet on it.

In this discussion, one crucial fact is both obvious and always forgotten: The so-called emerging markets are all quite different. They don’t move in unison. Take the impact of cheaper oil. Just as in the advanced economies, it’s good news for some (the equivalent, in effect, of a tax cut) and bad news for others (the equivalent of a cut in income). It’s unhelpful to generalize. Many of the world’s star performers in 2014 were emerging-market economies. The same will be true in 2015.

The fallacy of agglomeration is compounded by a failure to grasp relative scales. Taken together, the two errors give a completely distorted picture of global activity.

The slowing of China’s expansion is a constant theme these days. Fine, but remember that China will be a $10 trillion economy by the end of 2014, and that during the course of this year’s slowdown, it added roughly $1 trillion to world output. In terms of purchasing power parity, China is now about as big as the U.S. Therefore, growing at a “disappointing” 7.0-7.5 percent, it will add more than twice as much to global output next year as the U.S. added in 2014.

Yet the median financial commentator is excited about the U.S. and downbeat about China. What am I missing?

In current-dollar terms, China’s economy is now more than twice the size of Japan’s. Again, investors seem disproportionately energized about the lesser case. Japan would have to grow at a rate in excess of 10 percent to make a bigger contribution to global output than China. China is bigger than Germany, France and Italy combined: The biggest euro economies would need to grow by more than 7 percent to rival its addition to global activity.

Though lagging far behind China, India is becoming a globally significant economy as well — about the same size as Italy, or three-quarters the size of the U.K. economy in current-dollar terms. Adjusted for purchasing power, its addition to global output will far exceed theirs in 2014.

In fact, despite the general mood of despondency, growth in global output will come in this year at about the average for the decade to date — 3.3 percent. Granted, that’s down from 3.9 percent between 2001 and 2010, but it’s about the same as in each of the two decades before that. The main thing is, U.S. growth isn’t the only thing driving the pattern.

Financial markets seem to give a better sense of the underlying dynamics than you’d get from gauging the mood of analysts. “Slowing” China has seen its Shanghai benchmark index rise by more than 25 percent so far this year. The Shenzhen index, which probably gives a better representation of the modern sector of China’s economy, is up about 35 percent. That’s roughly the same as the rise in India’s main stock market index. Indonesia is up close to 20 percent, and Turkey 25 percent. A number of other stock markets have done a lot better than those in the advanced economies. Not so much a crisis, when you look at those numbers; more a pretty stellar year.

So is 2015 the year it all unravels? The now-traditional end-of-year prediction calls for a steep rise in U.S. bond yields. If that happened, then emerging-market economies with growing current-account deficits and a correspondingly heavy dependence on imported capital might struggle. But bear in mind two offsetting factors.

First, some of the economies seen as most at risk in this scenario — including India and Indonesia — are big energy importers and will benefit from cheaper oil.

Second, advanced-economy central banks have limited latitude — and in some cases, none — to tighten monetary policy and raise long-term yields.

In Japan and the euro area, further easing seems likelier than any tightening of monetary conditions. The U.S. has halted its quantitative easing program but will be in no hurry to advance its schedule for monetary tightening. There’s little prospect yet that the Federal Reserve will put the bonds it has bought back into the market. And it won’t see higher global bond yields as serving U.S. interests. U.S. exporters, after all, need customers.

It’s enough to make you think the crisis may be postponed yet again.

Published in collaboration with Breugel

Author: Jim O’Neill is a Visiting Research Fellow at Bruegel.

Image: Skyline of Mandaluyong City, Metro Manila. REUTERS/Cheryl Ravelo.