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The Emerging Markets’ Century

Saturday, August 28, 2010

Whereas public debt levels in many major industrialized countries will soon exceed 100 percent of GDP, those in the major emerging market economies generally range between 40 to 50 percent of GDP.

A profound, yet little noted, change is occurring in the global economy. It is the relative strengthening of the public finances of the major emerging market economies compared to the crumbling public finances of industrialized countries. This change will likely accelerate the tendency already very much in evidence in recent years for the emerging market countries to gain relative importance in the global economy. It is also likely to carry with it profound political implications for international relations between those countries and those in the G-7.

Earlier this year, Bill Gross, head of Pacific Investment Management Co., the world’s largest bond fund, published a highly disturbing chart that he labeled “The Ring of Fire.” The chart vividly encapsulated how dramatically compromised the public finances of all too many major industrialized countries have become. It did so by highlighting the toxic combination of high public debt and high budget deficit levels across a wide array of major industrialized countries. The most striking feature of the chart: it underlined that not only were the public finances of Japan, Greece, and Italy all on unsustainable paths, but so too were the public finances of France, Spain, the United Kingdom, and the United States.

Lachman_RingOfFire

Sadly, “The Ring of Fire” chart suggests that lackluster economic growth performance in the industrialized countries is likely in the years ahead, since one has to expect that, over the course of the economic cycle, high budget deficit levels will be associated with higher interest rates as industrialized country governments compete with their private sectors for a limited pool of available financing. One would also expect that high public debt levels will undermine private-sector confidence as both households and companies come to fear the prospect of future distortive taxes to deal with compromised public finances.

Yet a further reason for concern that compromised industrialized public finances will lead to lackluster growth is that these poor finances are occurring across a wide array of countries. As the Financial Times’ Martin Wolf keeps reminding us, a synchronized attempt by these countries to address those poor public finances by higher taxes and deep public spending cuts could result in insufficient global aggregate demand. This would be particularly problematic when the industrialized countries’ economic recovery remains so feeble and when these economies are still burdened with troubled banking systems.

At the same time that poor public finances are clouding the industrialized economies’ economic prospects, a very different picture characterizes the major emerging market economies. Indeed, an extension of “The Ring of Fire” chart to the emerging market economies reveals that growth in these economies will likely be supported by relatively sound public finances. It is striking in that, whereas public debt levels in many major industrialized countries are headed to soon exceed 100 percent of GDP, those in the major emerging market economies, with the notable exception of India, generally range between 40 to 50 percent of gross domestic product. And, with relatively small budget deficits in those countries, there is every reason to expect that their public debt levels will remain at healthy levels.

Lachman_Chart

Already in the decade before the 2008–2009 economic crisis, a number of factors favored considerably faster economic growth in the emerging market economies than in the industrialized countries. In contrast to the slow-growing and aging populations in the industrialized countries, emerging market economies are characterized by younger and faster growing populations. At the same time, savings rates in non-Japan Asia have considerably exceeded those in the G-7, while the emerging market economies are taking full advantage of the potential to grow rapidly through simply catching up technologically to the industrialized countries.

In the years immediately ahead, one must expect that the emerging market economies will retain many of the advantages that have favored their rapid growth in the recent past. There is now every reason to expect that these advantages will be amplified by the sounder public finances that characterize the emerging market economies. And there is also every reason to expect that, as they become even more important in the global economy, the emerging markets will become increasingly more vocal in pressing their case for their representation in international economic organizations like the International Monetary Fund to more fairly reflect their relative importance.

Desmond Lachman is a resident fellow at the American Enterprise Institute.

FURTHER READING: Lachman discussed the Federal Reserve “Dropping the Ball During the Only Game in Town,” the “Greek Tragedy Could Have Multiple Acts,” “Maybe Milton Was Right about the Euro,” and “Dipping and Deflating” in the economy. He's argued against “An Ill-Timed Call for Fed Tightening” and predicted “Storm Clouds Ahead for President Obama.”

Image by Darren Wamboldt/Bergman Group.

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