The strength of developing markets – the main theme of 2008

One of the major themes of 2008 will be the continuing growth of emerging and developing markets. This growth theme still has skeptics; however, the old rules and assumptions applied to developing markets do not seem to apply. The new emerging market world is characterized by four conditions.

1. Sustained high growth rates
2. Growth decoupled from United States
3. Growth independent of foreign aid
4. Current account surplus positions

All four of these conditions are counter to what many have expected. Unsustainable independent growth conditions have been the key arguments for avoiding emerging markets, yet the current economic environment for many countries suggests that all of the old assumptions are faulty.

Growth can occur without the United States being a growth leader. Of course, the reason for the high growth may be that the liquidity has been moving from the developed countries to emerging markets. Growth in the United States has slowed, but liquidity has still grown as measured by the decline in real interest rates. Liquidity increases should continue throughout 2008 even if there is a slowdown in rate cuts. The liquidity issue is more tied to the credit risk taking and not the availability of funds. Trade flows have moved away from the US, so emerging markets are less dependent on the growth direction of the US.

Growth can be sustained at relatively high level for a number of years and not just something that is a short-term phenomenon because the market structures for many of these economies have changed. Current account surpluses are also sustainable for emerging markets because there have not been currency adjustments as would be expected if the foreign exchange markets were freer. Of course, the sustained increases in commodity prices have helped many countries which are more dependent on raw material exports.

Nevertheless, the assumption that developing countries can have sustainable growth without foreign aid is probably the most ingrained in Western thought. Yet, we are seeing many countries start to develop strong growth without aid packages. Countries which have been the bets performers have also been independent of large aid packages. This independent development is having a profound effect on global growth. It is also the premise that is most problematic with many Western economic thinkers.

I found 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 one of the most important books in 2007 which influenced my thinking concerning developing and emerging markets.

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 someone most willing to confront conventional thought. This willingness to question development orthodoxy through thoughtful gathering of evidence makes him essential to thinking about growth and development.

His premise is that there two schools of thought to development. There are planners, who represent the traditional thought of dealing with emerging markets. Planners believe that growth can be fostered through strong and active intervention in developing countries. More aid is always better than less aid. If we provide enough aid to a country, it will grow. There are also searchers who are the agents of change who look for viable solutions to growth based on the circumstances of the country environment. More aid is not always good. It can be detrimental to development if it is wasted and used unproductively.

Easterly destroys the underlying assumption for aid based on the big push theory. The big push argument has driven all World Bank, IMF, and Western aid in general. For growth to be sustained in developing countries there is required large sums 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 Easterly conclude that countries often do not need a big push. Countries do need the rule of law, strong well-defined property rights based on past precedent, governments that will not steal from the people, and aid that is targeted to specific goals which are measurable. High growth has occurred in those countries where the market structure allows individuals to creatively find solutions to specific problems. A good market structure is necessary to finding good economic solutions.

We are seeing those countries that have followed the outline of Easterly flourishing while those that have not have continued to languish. If the market structure allows for entrepreneurship and innovation, there is growth.