Emerging Market Recovery

Stephen DeAngelis

June 11, 2009

In a recent post entitled Crises and the “Next Big Thing”, I mentioned Austrian economist Joseph Schumpeter, who popularized the term “creative destruction” to describe the process of transformation that accompanies changes resulting from radical innovations or crises. Earlier this year, Washington Post op-ed columnist Robert J. Samuelson began a column by quoting Shumpeter [“American Capitalism Besieged,” 23 March 2009].

“Can capitalism survive? No. I do not think it can.” — Joseph Schumpeter, 1942

Samuelson notes that “the story of American capitalism is, among other things, a love-hate relationship. We go through cycles of self-congratulation, revulsion and revision.” The current economic downturn, of course, began the cycle that will take us through revulsion and revision. He continued by discussing his reference to Schumpeter.

“Schumpeter, one of the 20th century’s eminent economists, believed that capitalism sowed the seeds of its own destruction. Its chief virtue was long-term — the capacity to increase wealth and living standards. But short-term politics would fixate on its flaws — instability, unemployment, inequality. Capitalist prosperity also created an oppositional class of ‘intellectuals’ who would nurture popular discontents and disparage values (self-enrichment, risk-taking) necessary for economic success. Almost everything about Schumpeter’s diagnosis rings true, with the glaring exception of his conclusion. American capitalism has flourished despite being subjected to repeated restrictions by disgruntled legislators.”

Samuelson notes, for example, that the unbridled pursuit of profits has been subordinated by concerns about working conditions and the environment. It was Schumpeter’s failure to see how flexible and adaptable capitalism can be, Samuelson claims, that made his conclusion so wrong. Nevertheless, Samuelson concedes that “there is a thin line between ‘saving capitalism’ from itself and vindicating Schumpeter’s long-ago prediction.” Desmond Lachmond also believes the U.S. economy is teetering and that it looks more like an emerging market country than a developed one [“Welcome to America, the World’s Scariest Emerging Market,” Washington Post, 29 March 2009]. Lachmond is a fellow at the conservative American Enterprise Institute and he was previously chief emerging market strategist at Salomon Smith Barney and deputy director of the International Monetary Fund’s Policy and Review Department. Lachmond concludes his article this way:

“In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to ‘get their house in order’ — without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.”

Lachmond may be right. The Economist believes that “the biggest emerging economies will recover faster than America” [“Decoupling 2.0,” 23 May 2009 print issue].

“A year ago, many commentators—including this newspaper—argued that emerging economies had become more resilient to an American recession, thanks to their strong domestic markets and prudent macroeconomic policies. Naysayers claimed America’s weakness would fell the emerging world. Over the past six months the global slump seemed to prove the sceptics right. Emerging economies reeled and decoupling was ridiculed. Yet perhaps the idea was dismissed too soon.”

I have been supporting the notion that emerging markets are probably going to recover faster and provide better investment opportunities than more developed economies for some time. I moderated a panel on investing in Iraq at The Milken Institute’s Global Conference (see my post The Milken Institute Global Conference] and tonight I will appear on Fox Business News’ Cavuto show with Brian Sullivan at 6pm EDT to discuss the issue. The Economist notes that China’s economy has started to grow once again. “Fixed investment is growing at its fastest pace since 2006,” it reports, “and consumption is holding up well.” It notes that China’s growth rate could reach 8 percent this year and that the optimism over China’s growth has stirred optimism in other emerging market countries that are dependent on commodity prices. The magazine, however, tempers its optimism.

“Even the best performing countries will grow more slowly than they did between 2004 and 2007. Nor will the resilience be universal: eastern Europe’s indebted economies will suffer as global banks cut back, and emerging economies intertwined with America, such as Mexico, will continue to be hit hard. So will smaller, more trade-dependent countries. Decoupling 2.0 is a narrower phenomenon, confined to a few of the biggest, and least indebted, emerging economies. It is based on two under-appreciated facts: the biggest emerging economies are less dependent on American spending than commonly believed; and they have proven more able and willing to respond to economic weakness than many feared.”

The article concludes that even the best-positioned emerging market economies need to continue to reform.

“Government activism helps explain why the creditworthy big emerging economies can recover more quickly. But it cannot create long-term resilience. China’s rebound will only be sustained if the economy shifts further from state-sponsored investment to private consumption. That will require tough structural changes, from forcing state-owned firms to pay fatter dividends to a stronger social safety net. Other countries, notably India, must calibrate their government finances even more carefully. The idea of decoupling lives on, but that does not mean sustained prosperity in the big emerging economies is a foregone conclusion.”

One country whose name keeps popping up is Brazil. “Brazilian leaders and economists are relatively optimistic about the region’s largest economy. Brazil, they point out, has stable banks, high levels of reserves and sturdy domestic demand for products that keeps many businesses humming along” [“Brazil Sees Reason for Hope Amid Downturn,” by Joshua Partlow, Washington Post, 17 April 2009]. In an interesting twist, some analysts are now advising emerging market countries to look at ties with other emerging market countries (rather than strengthening ties with developed economies) as the best course of action out of the current recession [“S.E. Asia Faces Long-Term Trade Shift,” by Tim Johnston, Washington Post, 7 February 2009].

“Regional analysts say … that the present crisis is not just another cyclical downturn but is instead a structural realignment and that Southeast Asia’s export economies need to act quickly to adjust to a new reality in which American and European consumers will no longer be the main market. ‘We are geared towards selling what the U.S. and Europe want, not what Asians want. We need a readjustment,’ said Supavud Saicheua, the managing director of Phatra Securities in Bangkok. ‘In the long term, Asians have to consume more, and Europe and the U.S. have to consume less.’ … At one end of the spectrum will be countries such as Indonesia, the region’s largest economy. Economists say it is better off than most, thanks to its lower dependence on exports, particularly manufactured products. Economic growth, which was about 6 percent last year, is expected to slow to 4.5 percent this year. However, the country’s longer-term prospects are considered relatively healthy. At the other end is Singapore, which has seen domestic exports shrink and is already in recession.”

The point is that regionalization within globalization is likely to increase. As a result, supply lines are likely to change. Some supply lines will shorten, some will disappear, and new ones will emerge. African countries hope that some of those supply lines will include them. There have been some signs of improvement on the continent [“Keeping Africa’s Turnaround on Track,” by Ellen Johnson-Sirleaf, Washington Post, 9 April 2009].

“While international attention has been understandably focused on events in Darfur, Somalia and Zimbabwe, countries across the continent including Ghana, Tanzania, Mozambique and Liberia have been quietly turning around. Economic growth rates regularly exceed 5 percent in many nations. Since 2000, 34 million more African children are in school. More than 2 million Africans are on lifesaving HIV/AIDS medicines. Malaria deaths have been halved in Rwanda and Ethiopia, and the disease has been virtually eradicated in Zanzibar. Poverty rates are falling fast, from 58 to 51 percent across the continent in just six years, according to the World Bank. The key to this progress is stronger African leadership and more accountable governance. Today, more than 20 African countries are democracies, up from just three in the 1980s; they have competitive elections and improved human rights, and their news media are much freer. These efforts have been supported by increasingly effective development assistance from the United States and other partners.”

Even so, getting businesses to risk their scarce resources on investments in Africa is going to be difficult (see my post entitled Investing in Africa). Ms. Johnson-Sirleaf is president of Liberia. In order to keep Africa moving forward, she claims five additional steps are critical. They are:

“First, the G-20 pledge to provide the International Monetary Fund with new resources must be fulfilled, and the IMF needs to get those resources to countries quickly and without onerous conditions.

“Second, the World Bank and the African Development Bank must better leverage their resources; aggressively front-load support; and better target growth, jobs and safety-net programs. The International Finance Corp., the World Bank’s private-sector affiliate, must be especially creative in keeping private investment on track.

“Third, bilateral partners must build on their promises to increase aid and make it more effective by reducing bureaucratic delays, speeding disbursements and better aligning programs with African priorities.

“Fourth, export credit agencies must use their resources to attack risk and other barriers to trade finance, such as liquidity issues.

“Fifth, all countries must resist protectionist pressures so that trade can be the critical engine for restoring global growth.”

Ms. Johnson-Sirleaf is correct in assuming that “trade can be the critical engine for restoring global growth”; which brings us back to the Schumpeter quote cited at the beginning of this blog. I think Schumpeter was wrong. Capitalism will survive and it will help bring many emerging market countries out of poverty if they are willing to rid themselves of corruption and dependence on aid. Some countries simply have too few resources to ever be anything but wards of the international community — but they are not great in number. I remain optimistic that good investments can be made in emerging market economies and that those investments will make a huge difference in the lives of millions now living in poverty.