The crisis hits emerging markets

We are used to hearing that global growth is being driven by emerging markets. In the original Goldman Sachs study that coined the term “the BRICs”, it was estimated that by 2020 the BRICs would account for 49% of global GNP. In 2010, the figure was already 36%. Increasingly responsible for propping up the global economy, many believe that the future lies in emerging economies. When European leaders recently courted China as a possible buyer of troubled government bonds, the idea of emerging economies bailing out their erstwhile masters seemed complete.

The picture is in fact more nuanced for many different reasons. In an excellent recent study, Zaki Laïdi notes that the political demands of the BRICs are ambivalent: they defend national sovereignty in ways that prevents them from developing a shared political project of their own. In economic terms, the notion of a fundamental shift from the North America and Western Europe towards Brazil, China and India also needs to be nuanced.

The dependence of these emerging markets on the state of the economies in North America and in Western Europe is striking. In 2009 the world economy as a whole went through only a minor downturn, largely because of the offsetting growth in emerging markets. In 2010 and 2011, the picture has been rather different. Looking at growth rates across OECD and non-OECD countries, what is striking is how closely matched they are. The latter group consistently post higher growth rates but these rates rise and fall in line with growth in OECD countries.

This correlation in growth trends doesn’t mean the rich world is driving growth in emerging markets. But there are some powerful ways in which the problems in OECD economies have begun to feed through into emerging markets. Two channels in particular stand out. One is a fall in consumption in the US and Western Europe, resulting in a decline in demand for primary and secondary products exported out of emerging economies. On December 1^st, it was reported that China’s manufacturing sector contracted for the first time in almost three years. As the chart below shows, after a sharp downturn then upwards spike in the course of 2008, the rate of expansion of factory output in China has been declining steadily.

The second channel is via the withdrawal of foreign capital because of the pressure on Europe’s financial system. As banks reduce their exposures, those emerging economies dependent upon foreign bank lending are in difficulties. This exit of foreign capital and a declining demand for national currencies such as the Brazilian real or the Turkish lira is having inflationary consequences: as the currencies depreciate, the cost of imports rise, pushing up the general price level. This bites into the competitiveness of these economies as wage demands respond to higher living costs (NB. this is one reason Germany wants to avoid seeing the ECB stoke inflation in the Eurozone – it would undermine its ability to contain wage demands and thus challenge its own competitiveness model). According to the Basel-based Bank for International Settlements, emerging markets owe 3.4 trillion US dollars to European banks; 1.3 trillion US dollars of that is owed by Eastern European countries. According to The Economist, as European banks deleverage downward pressure will be placed on many emerging markets. This is particularly serious for those countries – like Turkey – who run large current account deficits. They are dependent upon foreign capital to manage these deficits.

What the figures imply for the role of the emerging markets in the global economy is far from clear. But the exposure of these economies to the events in North America and Western Europe is obvious. To declare the irrelevance of these two regions in the face of the rise of China or of India is to miss the extent to which growth in emerging markets is dependent upon OECD economies.