Author: Paweł Kowalewski

Economist, works at NBP, specialises in monetary policy issues and FX markets

The brief history of emerging economies

KOWALEWSKI Krótka historia gospodarek wschodzących JAMNIK

It is difficult to provide an assessment of the changes taking place in emerging economies. Their share in the global economy has increased and their markets have become more heterogeneous, but many structural reforms have not been completed.

The year 2018 was marked, among other things, by the turbulences in emerging economies. That is why it’s worth reflecting on the condition of these countries and the progress that they have made.

When the World Bank’s economist Antoine van Agtmael came up with the concept of emerging markets in 1981, he probably wasn’t expecting how staggeringly popular that term would eventually get. In fact, Agtmael’s only goal was to avoid referring to these markets using the unfortunate term “third world countries”, which had acquired a negative connotation.

Times are changing, emerging economies themselves are changing, but the term invented by Agtmael is still very popular. When analyzing the markets in these countries, it is difficult to leave aside an analysis of their economies.

The biggest paradox of the Agtmael concept is that it does not contain a precise definition or the criteria that a country has to fulfil in order to be included in the group of emerging markets. Such definitions were offered by others, though. It has been said that “emerging markets are those from which one cannot emerge in an emergency”. This definition is attributed by some to James Cross, the deceased deputy governor of the South African Reserve Bank.

However, we there is no need to refer to this definition in order to capture the essence of emerging markets. These are markets that are supposed to emerge on the horizon, which can be understood as the periphery of the world economy. The problem, however, is that most of these economies behave as if they didn’t really want to emerge from the periphery.

Has there been any change?

Agtmael was lucky when he introduced his term into circulation, because a year later, in 1982, a debt crisis broke out, the effects of which posed a serious threat to the entire international monetary system. It is no wonder that the new concept quickly gained enormous popularity. Agtmael was fortunate: his term took on the features of timelessness. Jim O’Neill from Goldman Sachs, who invented the acronym describing selected emerging economies, BRIC, wasn’t so lucky. For some time it even eclipsed the popularity of the term “emerging markets”. After all, who hasn’t heard about the famous BRICs? However, the popularity of the BRIC acronym is currently decreasing, and the term “emerging markets” is coming back into favor.

Over 36 years have passed since Agtmael introduced his concept. That is long enough to reflect on how the economies described by this term have changed.

It is not possible to answer the above question in an unambiguous manner. On the one hand, there are many arguments in support of the thesis that these economies have changed beyond recognition, and that — more importantly — this change is irreversible. On the other hand, there are also arguments that make it relatively easy to refute that claim.

Increasingly far away

Let’s therefore begin by describing the positive changes that have taken place in emerging countries. First of all, the share of these economies in the global economy has increased. It has now exceeded the share of developed economies for more than a decade — measured, of course, according to the purchasing power parity. Many of the emerging markets are now exhibiting greater resilience to economic shocks. The abandonment of the fixed exchange rate formula, in most cases, has had a significant effect. In many of the countries described, there has been a substantial increase in foreign exchange reserves.

In the past, most of these economies had a hard time trying to defend themselves against the so-called contagion effect. Today, it is no longer impossible to escape this phenomenon. It’s worth noting that in the second half of the 1990s Poland was a positive exception in this respect. Over time the markets in question have become much more heterogeneous. Thus far, the current financial crisis in Argentina and the political uncertainty in Brazil have not translated into the valuation of Peruvian or Colombian assets. The still uncertain situation in Indonesia does not matter much for what is happening in the other countries of Southeast Asia. It would certainly be possible to find several other examples to justify this thesis.

It should be noted, however, that — referring to the analysis of GDP per capita — the achievements of emerging economies have not been particularly impressive. This is because their growing share in the global economy went hand in hand with their much faster demographic growth. Thus, instead of decreasing, the distance from developed countries has actually increased.

China has left other emerging nations far behind

One could still have many objections to the way in which structural reforms are carried out in emerging economies. And this doesn’t only apply to the macroeconomic level. It’s worth mentioning such phenomena as the fight against corruption or the development of corporate governance. Insufficient progress in these areas is a source of frequent crises. In 2018, the investors most frequently focused their attention on the developments in Turkey and Argentina. This does not mean, however, that the situation on other markets was calm. It’s enough to mention countries such as India, Mexico or even Brazil in this regard.

One interesting case is Argentina, because in spite of the many bitter memories concerning cooperation with the IMF, it is still following the received recommendations. This adherence to “mainstream economics” is the reason why many experts still predict the imminent political death of the incumbent president.

However, not all countries are following the path taken by Argentina. This may be due to the fact that their leaders have been able — at least for the time being — to exploit the bankruptcy of “mainstream economics” in the late 1990s more effectively than Cristina Fernandez de Kirchner, who was the predecessor of Argentine’s president Mauricio Macri.

It’s enough to look at the example of Russia and Turkey. It will not be an exaggeration to state that in the case of both Presidents: Vladimir Putin and Recep Erdogan, the path to power was paved by the currency crises in these countries, which occurred in 1998 and 2001, respectively. Meanwhile, the ostracism of Western states against both leaders after 2013, regardless of the reasons, only seems to strengthen them.

Despite the enormous efforts to quantify the criteria of belonging to the group of emerging markets, the definition of this group is still a matter of convention. If only due to a single question: can the Chinese market still be included among emerging markets? The answer is seemingly affirmative, but on the other hand, the answer to the question of whether China can still be treated as an emerging economy is much less obvious. Therefore, while in 2001 the idea of putting China and Brazil in a single group of countries still seemed reasonable, today it is not. It is all the more inappropriate to mention BRICS with the inclusion of South Africa. One thing is certain: the presence of China in the group of emerging economies heavily distorts the results of analyses of the macroeconomic situation in the group as a whole.

Everything depends on the United States

Another exception to the generally negative trends are the countries of Central and Southeast Europe (CSE), which have made tremendous progress over the past quarter of a century. But are they representative of the entire group of emerging economies? Already in 2001, Ricardo Hausmann from Harvard University pointed out that the other emerging markets were looking enviously at CSE and the help that this part of Europe was receiving from the much wealthier western part of the continent.

Finally, we face the question of the overall assessment of the changes taking place in emerging economies. In other words: whether positive or negative changes prevail. In an attempt to answer this question, one should refer to one additional criterion: the vulnerability of emerging markets to the policy pursued by the US Federal Reserve System.

Let us recall that both the debt crises and the series of crises in the second half of the 1990s were the result of monetary policy tightening carried out by the Fed. The relatively long period of stability in emerging markets — especially at the turn of the first and second decade of the current century — was largely due to the fact that the Fed not only wasn’t tightening its policy, but was actually loosening it on an unprecedented scale with the mass asset purchases in the years 2008-2014.

The Fed has now been tightening its monetary policy since 2015. However, the real test for emerging economies was not the moment when this tightening started. For many economies the moment of truth came in May 2013, when the Fed announced that it would reduce the rate of the quantitative easing carried out since 2008 (the so-called tapering).

The Fed’s announcement of a reduction in the scale of asset purchases resulted in a significant outflow of capital from many emerging markets. In some economies this phenomenon was deepened by their own macroeconomic problems, and in particular by high external and fiscal imbalances. At that time, the affected countries included Brazil, India, Indonesia, Turkey and South Africa.

Therefore, it is of secondary importance whether Agmael was lucky or not when he came up with his term for the described markets. There are many signs that some countries simply aren’t able to leave the peripheries of the global economy. That is why we will keep hearing about emerging markets for a long time to come.

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