The strength of emerging markets – still the main theme of 2008

One of the major themes of 2008 will be the continued growth of emerging and developing markets. It has been characterized as the decoupling investment story. This growth theme has not been believed by many investors either for the long or short-run. Past history states that the direction of the US and the policies of the developed economies will determine the fate of the emerging market but times have changed. The old rules and assumptions applied to emerging markets currently do not seem to apply. The new emerging market world is characterized by four conditions:
1. Growth decoupled from United States
2. Sustainable high growth rates
3. Current account surplus positions
4. Growth independent of foreign aid

All four of these conditions are unusual. It has been the lack of these conditions which have been the key arguments for avoiding emerging markets, yet the current environment have made all of the old assumptions are faulty.

Growth can be had without the United States being a leader. The rise of the middle class in many of these countries have allowed for internal growth. The strong demand for commodities has also pushed up the growth rate for emerging markets. The lack of capital expenditures in commodities have lead to higher prices which provide cash flow for new capital investments by these countries.

Growth can be sustained at relatively high level and not just something that is a short-term phenomenon. First, and foremost the education and infrastructure developments mean that many emerged countries have the environment to sustain growth. Second, the commodity boom is not something that will not be short-lived.

Current account surplus can occur with emerging markets. The restructure of balance sheets with better fiscal management mans that cash flows from exports have allowed many emerging market countries to have better current account situations. The variables that were used to measure the potential for currency crisis are all pointed in the right direction.

The last assumption that developing countries can have sustainable growth without foreign aid is probably the most engrained in Western though yet it is the premise that is most problematic especially after Reading William Easterly’s The White Man’s Burden: Why the West’s Effort to Aid the Rest Have Done so Much Ill and so Little Good. The developed world may not be needed to help these countries because they have found a means of obtaining economic independence or just do better when left to their own devices for finding an economic structure that works.

William Easterly, who has also written The Elusive Quest for Growth, may be one of the most insightful researchers on economic development and growth. Certainly, he is one that is most willing to confront conventional thought. This willingness to question convention through thoughtful gathering evidence makes him essential to thinking about growth and development. His premise is there are planners, who represent the traditional thought of dealing emerging markets and searchers who are the agents of change who look for viable solutions. Easterly destroys the underlying assumption for all aid based on the big push. The big push argument has driven all World Bank, IMF, and Western aid in general. For growth to be sustained in developing countries requires large amount of aid to get countries jump started on a high growth trajectory. Without this aid, growth will only be sustained at low levels. A careful review of research as well as his experiences at the World Bank has him conclude that the countries do not need a big push. They do need the rule of law, property rights, governments that will not steal from the people, and aid that is targeted to specific goals which are measurable. High growth has been in those countries where the market structure allows individuals to creatively find solutions to specific problems. Market structure is necessary to finding good economic solutions.

The change in the market structure may be the most important factor that will allow developing economies to stand on their own and be decoupled from the developed economies and the current crisis. Of course, we are talking about the long-run and not just the current cycle.