Emerging-Market Risk and Reward

By Nouriel Roubini
Chairman of Roubini Global Economics and Professor at New York University's Stern School of Business.

One definition of an emerging-market economy is that its political risks are higher, and its policy credibility lower, than in advanced economies. After the financial crisis, when emerging-market economies continued to grow robustly, that definition seemed obsolete; now, with the recent turbulence in emerging economies driven in part by weaker economic-policy credibility and growing political uncertainty, it seems as relevant as ever.

Consider the so-called Fragile Five: India, Indonesia, Turkey, Brazil, and South Africa. All have in common not only economic and policy weaknesses (twin fiscal and current-account deficits, slowing growth and rising inflation, sluggish structural reforms), but also presidential or parliamentary elections this year. Many other emerging economies - Ukraine, Argentina, Venezuela, Russia, Hungary, Thailand, and Nigeria - also face significant political and/or social uncertainties and civil unrest.

And that list does not include the perilously unstable Middle East, where the Arab Spring in Libya and Egypt has become a winter of seething discontent; civil war rages in Syria and smolders in Yemen; and Iraq, Iran, Afghanistan, and Pakistan form a contiguous arc of volatility. Nor does it include Asia's geopolitical risks arising from the territorial disputes between China and many of its neighbors, including Japan, the Philippines, South Korea, and Vietnam.

According to the positive narrative about emerging markets, industrialization, urbanization, per capita income growth, and the rise of a middle-class consumer society were supposed to boost long-term economic and sociopolitical stability. But in many countries recently wracked by political unrest - Brazil, Chile, Turkey, India, Venezuela, Argentina, Russia, Ukraine, and Thailand - it is the urban middle classes that have been manning the barricades. Likewise, urban students and the middle classes spearheaded the Arab Spring, before losing authority to Islamist forces.

This is not a complete surprise: in many countries, working classes and rural farmers have benefited from per capita income increases and a broadening social safety net, while the middle classes feel the pinch from rising inflation, poor public services, corruption, and intrusive government. And now the middle classes tend to be more vocal and better politically organized than in the past, in large part because social media allow them to mobilize faster.

Not all of the recent political unrest is unwelcome; a lot of it may lead to better governance and greater commitment to growth-oriented economic policies. Among the Fragile Five, a change in government is likely in India and Indonesia.

But uncertainty abounds. In Indonesia, economic nationalism is on the rise, implying a risk that economic policy will follow an inward-looking course. In India, the opposition Bharatiya Janata Party's prime ministerial candidate, Narendra Modi, if elected, may or may not be able to implement at the national level the growth-oriented policies that he successfully implemented at the state level in Gujarat. Much will depend on whether he can shed his sectarian attitudes and become a truly inclusive leader.

By contrast, a change in government is unlikely in South Africa, Turkey, and Brazil. But the current rulers, if reelected, may shift policies. South African President Jacob Zuma has chosen a pro-business tycoon as his vice-presidential candidate and may move toward market-oriented reforms. Turkish Prime Minister Recep Tayyip Erdo?an cannot realize his dream of a presidential republic and will have to follow his opponents - including a large protest movement - to the secular center. And Brazilian President Dilma Rousseff may embrace more stable macroeconomic policies and accelerate structural reforms, including privatization.

Even in extremely fragile and risky cases, such as Argentina, Venezuela, and Ukraine, political and economic conditions have become so bad that - short of becoming failed states - the situation can only get better. Argentine President Cristina Fernández is a lame duck; and any of her potential successors will be more moderate. In Venezuela, President Nicolás Maduro is a weak leader who may eventually be unseated by a more centrist opposition. And Ukraine, having gotten rid of a kleptocratic thug, may stabilize under a Western-led economic revival program - that is, if the country can avoid civil war.

As for the Middle East, risks remain abundant, with a bumpy economic and political transition likely to take more than a decade. Even there, however, gradual stabilization will eventually lead to greater economic opportunities.

So, in most cases, there is reason to hope that electoral change and political upheaval will give rise to moderate governments whose commitment to market-oriented policies will steadily move their economies in the right direction.

Of course, the risks should not be discounted. Emerging economies today are more fragile and volatile than in the recent past. Structural reforms imply the need to pay short-term costs for longer-term benefits. State capitalism of the sort exemplified by China has strong support among policymakers in Russia, Venezuela, and Argentina, and even in Brazil, India, and South Africa. Resource nationalism is on the rise, as is a backlash against free trade and inward FDI. Indeed, rising income and wealth inequality in many emerging markets may eventually lead to a social and political backlash against liberalization and globalization.

That is why economic growth in emerging markets must be cohesive and reduce inequality. While market-oriented reforms are necessary, government has a key role to play in providing a social safety net for the poor; maintaining high-quality public services; investing in education, training, health care, infrastructure, and innovation; enforcing competition policies that constrain the power of economic and financial oligopolies; and ensuring genuine equality of opportunity for all.

Copyright: Project Syndicate


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