After the financial crisis, what does the future hold for emerging markets? Here, in two extracts from his new book, Uprising, George Magnus focuses on prospects for the Brics and less-hyped economies beyond—and predicts their impact on global trade
There is a strong conviction that we are all bystanders in an inevitable and world-changing shift in the structure of global power. The long-awaited decline of the West now seems to be in full swing. When president Barack Obama visited his opposite number, Hu Jintao, in Beijing in November 2009, many observers were struck by the symbolism of a battered and highly indebted US going to meet the leader of America's main geopolitical rival, and its most important creditor.
Historians and philosophers have wondered for a long time whether the world might one day change course, with the West in persistent decline and China—and maybe India—reverting to the position of global dominance they held for a couple of millennia. The debate is whether the financial and economic crisis is acting as a catalyst to speed up the process. What I call "Uprising" though, is more a questioning of the idea that the last two centuries of Euro- and US-centric history have been an aberration.
There is little question about the shift in economic power, which has broad significance. It is driving a realignment of political and national interests that is reshaping the world. Before the crisis the tensions between advanced and developing nations played second fiddle to the rising tide of global prosperity. It was assumed that, one way or another, global democracies would stick together somewhere under an American umbrella, while others would stand firm behind China. The crisis seems to have changed this perception because it has been seen as a failure of the type of capitalism and globalisation championed by the US over the last 25 years.
Political leaders in emerging markets have had important reservations in the past about the so-called Washington Consensus, which captured an approach to economic policy and structure, emphasising the primacy of markets, the minimisation of the role of the state in the economy and the intrusion of US-dominated international financial institutions into the sovereignty of nation states. Now the world seems to be splitting more between rich versus poor on matters such as trade, finance and climate change as opposed to along lines of political structure. Emerging-market democracies, such as India, Brazil, Turkey and South Africa identify increasingly as developing nations rather than democracies.
Many look to the Chinese model, not the tarnished US version, even if they retain respect for some of what the US stands for and have reservations about China's policies and its posturing about emerging market solidarity. There is no Bric or emerging market bloc as such and many emerging markets have competing national and geopolitical interests. China and India are rival continental powers and Brazil and India don't see eye-to-eye with China over exchange rates and several trade issues. Emerging markets may find themselves confronting the US and the West on a variety of topics with great ambivalence, but more chaotically than coherently.
As the financial crisis rumbled through the global economy, the Brics—and especially China—were already engaged in the scramble for access to energy and other natural resources in the Middle East, Africa and Latin America. In response to the crisis, they co-ordinated policy responses, placing the blame firmly on the US. They have become more vocal in the debate on how to reform and restructure global financial institutions and regulation and the role of the US dollar in global finance. They formed a united front at the Copenhagen climate summit in December 2009 and refused to accept the proposal that greenhouse gas emissions of poorer nations be capped at lower levels than those of Europe and the US. There is little question that the developing nations are now in a position to supplement their public reservations about US global capitalism with action, or at least a refusal to go along with a western agenda.
Yet the debate about the decline of the West and the rise of China and other emerging markets has reached feverish proportions. Such fever tends to blur sensibility and leads to muddled, and possibly dangerous, thinking. The West has had a fin de siècle moment, in which the driving economic powers of the last 30 years have broken down, or at least been compromised. Its reputation has suffered, too, for its claim to economic and financial leadership now looks tenuous at best. We should not underestimate the structural change or time needed to reboot our crisis-affected economies.
At the same time it would be dangerous to imagine that China and other emerging economies can carry on as before the crisis, in the mistaken belief that nothing has changed. There is little doubt that their economic outlook is potentially robust and many companies relish the prospect of tapping into the world's next billion consumers. Emerging markets might be the economic powerhouse of the next decades of the 21st century, but this is by no means inevitable.
Far too often, the trajectory of emerging markets is portrayed by protagonists in a naïve, linear fashion that doesn't accord to historical outcomes. Instead, the future is really about political economy, not economic forecasting or the models that drive confident assertions that the future has already arrived. History, politics and institutions all matter deeply to the future of emerging markets even though, in Einstein's parlance, they cannot be counted.
Is China the next Japan?
When it comes to China in the world economy today, it is important to consider its situation compared with Japan, some 30 years ago. Just as Japan was feted as the new superpower in the 1980s and came to a stickier end than anyone could then imagine, so there are some troublesome parallels with China today. The way things are going, China may be creating a comparable type of bubble in its economy and asset markets. Puncturing the bubble quickly may be distressing, and compromise the exchange rate system, but it would be more manageable and consistent with longer-term stability than doing so too late.
The legacy of financial crises is uncertain. Sometimes they are the catalyst for much-needed reforms that improve the functioning of the financial system and the economy for a generation. Sometimes they leave lasting scars and unfinished business that return as crisis in the near future. Japan's financial crisis in the 1990s never resulted in radical restructuring of the banking sector, or structural reform. The 1990s are often called Japan's "lost decade", because the failure to restructure and reform led to a long period of economic stagnation, soaring public debt and price deflation. Yet 2010 marks the start of a third lost decade.
For all the plaudits heaped on China for its strong and successful response to the crisis, the country's credit policies bear close monitoring. The amount of credit as a share of GDP was about 160 per cent before the crisis, far higher than other Brics and several Asian emerging markets. By the end of 2010, it may reach 200 per cent. That would be close to Japan's level in 1991, and not too far away from the US in 2007. Sino-euphoria is having its day, but the combination of a credit and an investment boom is obscuring the causes of possible instability that lurk on the horizon.
The parallels between Japan and China today might seem far-fetched. China is not an advanced economic nation with an already sophisticated infrastructure and financial system and a high level of income per head. When Japan built its infamous "bridges to nowhere" in the 1990s as a way of cushioning the slump in the economy, the charge was that the expenditures used taxpayers' money to finance non-commercial and pointless public projects. Even if there is waste and inefficiency in China's public works programmes, it should be able to get far more "bang for its buck" in building modern infrastructure to support an economy of 1.3 billion people.
In the wake of the crisis China accelerated its high-speed rail development, vowing to increase the passenger network by a third to almost 10,000 miles over the next 10 years. The core of this project is the country's most expensive ever engineering project, namely to build a tunnel to cut in half the train time from Beijing to Shanghai. On paper, this type of capital investment should boost local economies, add to workers' incomes and generate lasting improvements in productivity. It may take longer than expected for the payback from such infrastructure projects, but it's hard to argue that such investment is money wasted.
But it's wrong to dismiss the parallels with Japan out of hand. Like Japan, China's strength in the global economy is not measured as well by GDP as it is by its enormous exports and by the accompanying explosion in its capital exports and foreign assets. Like Japan, China's massive net creditor status gives it the opportunity to extend its influence through foreign and commercial policies, and to use its loans and aid as a bargaining chip with countries and global institutions. In China's case it also allows a build-up in military and naval capabilities.
Like Japan, China has a large excess of savings over investment that can be traced to high levels of household savings and rising levels of corporate savings. The resulting external surpluses in China are larger than Japan's ever were. Tinkering with policies doesn't help to address the circularity of a structural problem. A controlled and undervalued exchange rate exacerbates the imbalance between (relatively backward) domestic and (high-profile) external demand. It sustains trade competitiveness and export growth, and enriches large export companies, which channel their profits into higher investment to enhance export capacity. The outcome assures persistent high levels of domestic savings, high external surpluses, and the export of financial capital.
There was no consensus in Japan to allow the yen to increase in value, and to use the stronger currency as an agent to turn the economy's focus away from an over-reliance on exports and the corporate and investment structures that supported them. The lack of such consensus meant that Japan could not co-operate adequately with the US in addressing the causes of economic and trade disputes, and contributed in no small measure to the financial policies that were to prove its undoing. The worry is that China is heading the same way.
George Magnus is senior economic adviser at UBS. Uprising: Will emerging markets shape or shake the world economy? is published by Wiley in November, price £19.99
