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Business News/ Opinion / Online-views/  Back to basics in emerging markets
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Back to basics in emerging markets

Unlike East Asian economies, today's emerging markets cannot rely on exports as their engine of growth

Photo: Hemant Mishra/MintPremium
Photo: Hemant Mishra/Mint

Following 15 years of hype, a new conventional wisdom has taken hold: emerging markets are in deep trouble. Many analysts had extrapolated rapid growth in countries such as Brazil, Russia, Turkey and India into the indefinite future, calling them the new engines of the world economy. Now growth is down in almost all of them, and investors are pulling their money out—prompted in part by the expectation that the US Fed will raise interest rates in September. Their currencies have tumbled, while corruption scandals and other difficulties have overwhelmed the economic narrative in places like Brazil and Turkey.

With hindsight, it has become clear that there was, in fact, no coherent growth story for most emerging markets. Scratch the surface, and you found high growth rates driven not by productive transformation but by domestic demand, in turn fuelled by temporary commodity booms and unsustainable levels of public or, more often, private borrowing.

Yes, there are plenty of world-class firms in emerging markets, and the expansion of the middle-class is unmistakable. But only a tiny share of these economies’ labour is employed in productive firms, while informal, unproductive firms absorb the rest.

Compare this with the experience of the few countries that did emerge successfully, “graduating" to advanced-country status, and you can see the missing ingredient. South Korea and Taiwan grew on the back of rapid industrialization. As South Korean and Taiwanese peasants became factory workers, the economies of both countries—and, with a lag, their politics—were transformed. South Korea and Taiwan eventually became rich democracies.

By contrast, most of today’s emerging markets are deindustrializing prematurely. Services are not tradable to the same extent as manufactured goods, and for the most part don’t show the same technological dynamism. Services have proved to be a poor substitute to export-oriented industrialization so far.

But emerging markets do not deserve the doom-and-gloom treatment they are getting these days. The real lesson from the collapse of the emerging-market hype is the need to pay closer attention to growth fundamentals and see the diversity of circumstances among a group of economies needlessly lumped together.

For developing economies, the three key growth fundamentals are acquisition of skills and education by the workforce; improvement of institutions and governance; and structural transformation from low-productivity to high-productivity activities. East Asian-style rapid growth has typically required a heavy dose of structural transformation for a number of decades, with steady progress on education and institutions providing the longer-term underpinnings of convergence with advanced economies.

Unlike East Asian economies, today’s emerging markets cannot rely on export surpluses in manufacturing as their engine of structural transformation and growth. So, they are forced to rely more on the longer-term fundamentals of education and institutions. These do generate growth—and indeed are ultimately indispensable to it. But they generate 2-3% annual growth at best, not East Asia’s 7-8% rates.

Compare China and India. China grew by building factories and filling them with peasants who had little education, which generated an instant boost in productivity. India’s comparative advantage lies in relatively skill-intensive services—such as information technology—which can absorb no more than a tiny slice of the country’s largely unskilled labour force. It will take many decades for the average skill level in India to rise to the point that it can pull the economy’s overall productivity significantly higher. So, India’s medium-term growth potential lies well below China’s in recent decades. A boost in infrastructure spending and policy reforms can make a difference, but it cannot close the gap.

Being the tortoise rather than the hare in the growth race can be an advantage. Countries that rely on steady, economy-wide accumulation of skills and improved governance may not grow as fast, but they may be more stable, less prone to crises, and more likely to converge with advanced countries eventually.

China’s economic achievements are undeniable. But it remains an authoritarian country where the Communist Party retains its political monopoly. So, the challenges of political and institutional transformation are immeasurably greater than in India. The uncertainty that confronts a long-term investor in China is correspondingly higher.

Or compare Brazil with other emerging markets. Among these countries, Brazil has arguably taken the greatest hit recently. The corruption scandal surrounding the state-owned oil firm, Petrobras, has produced a crisis, with the currency tanking and growth halting.

Yet, Brazil’s political crisis demonstrates the country’s democratic maturity, and arguably is a sign of strength rather than weakness. The ability of prosecutors to investigate payment irregularities reaching into the highest ranks of Brazilian society and government without political interference—or the process turning into a witch hunt—would be exemplary in many advanced countries.

Cheap external finance, plentiful capital inflows and commodity booms helped hide many such shortcomings and fuelled 15 years of emerging-market growth. As the world economy generates stronger headwinds in the years ahead, it will become easier to distinguish countries that have truly strengthened their economic and political fundamentals from those that have coasted on false narratives and the tenuous strength of fickle investor sentiment.

©2015/PROJECT SYNDICATE

Dani Rodrik is professor of international political economy at Harvard’s John F. Kennedy School of Government.

Comments are welcome at theirview@livemint.com

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Published: 17 Aug 2015, 08:46 PM IST
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