Emerging markets will be key to world growth

What happens in emerging markets matters, as they account for more than half of world GDP, said Bank of Thailand Governor Prasarn Trairatvorakul in a speech to Harvard Kennedy School on Monday. The Harvard alumni’s speech, “From Here to There: Economic Transition in Emerging Markets”, focused on emerging markets, of which declining economic growth has been the talk of the town. The following are excerpts from his speech.

 

Since the early 2000s, when Jim O’Neill at Goldman Sachs coined the acronym BRIC for Brazil, Russia, India and China, emerging markets have powered global economic growth. By mid-2009, these economies were growing 7 percentage points faster than the G7 economies and contributed around two-thirds of world output growth.

Ultimately, growth depends primarily on what happens at home. External conditions alternately provide headwinds or tailwinds, but the ability to counter or take advantage of these shifts is determined by domestic capabilities.Endowment of resources, such as land and labour, could be the most fundamental domestic factor. Yet, he argues that the long-run prosperity of nations is not bound by their endowments. Holland is Europe’s largest tomato exporter. Despite little sunshine, the Dutch can produce 70 kilos of tomatoes per year in a square metre of temperature controlled greenhouse, while Greek and other Mediterranean growers get approximately 7 kilos through traditional open-air plantations. 

Natural and geographical constraints can be overcome. Japan and Singapore spring to mind as countries that have made much of their limited resources. 

In Thailand the average worker in the manufacturing sector is roughly 10 times more productive than those in agriculture. Yet, the latter employs about 40 per cent of our workforce compared to 15 per cent in manufacturing. It is easy to see that simply moving workers from agriculture to industry can lift our income tremendously. In fact, this was one of the key drivers of Thailand’s growth in the 20 years prior to the 1997 crisis. During this time, the share of employment in agriculture fell by a third, releasing workers to the more productive manufacturing and service sectors. Thailand’s experience is typical of many others in Asia.

Emerging-market countries’ sustaining growth going forward hinges on the continuation of this process of change and upgrading. For Asia, industrialising the agriculture sector through the adoption of modern methods and the development of agribusinesses will be a key source of productivity growth. Similarly, the composition of the service sector, which is quite large, has to shift from low-productivity activities to modern, high value-added services.

Countries that have achieved sustained growth are those that are better at removing the bottlenecks that impede such transformation. This typically requires a number of key fundamental capabilities, such as macro-economic stability, the rule of law, good education, strict enforcement of contracts, a competent bureaucracy, good governance and low tolerance of corruption. These are often encapsulated under the rubric of strong institutions. One can think of institutions as the set of rules and norms that both governs the incentives of economic agents as well as constrains their behaviour. Good institutions encourage growth, bad institutions stifle it. Entrepreneurship, a critical driver of structural change, relies heavily on the institutional environment. 

This does not mean that a country needs to achieve comprehensive institutional development before growth can occur. “Big bang” institutional reform is typically unfeasible. But eventually, the growth process has to evolve to be sustained. At this point, weak institutions will hamper growth. A strong legal system and enforcement of property rights, for example, won’t boost innovation much if the education system fails to produce a skilled workforce. A highly educated workforce cannot contribute meaningfully if macro-economic stability is lacking. Good macro policy will make little difference if corruption is rampant. The individual institutional elements complement each other in such a way that the whole is greater than the sum.

But how do we achieve institutional change? Why do some countries manage to improve their fundamental capabilities while others languish? This is the heart of the matter. It is not hard to spot bad institutions. It is another issue entirely to make change happen. In this regard, policy prescriptions that call for “growth enhancing structural reforms” or “strong institutions” alone is partial at best. That’s like saying that if you want to get fit, you should exercise. Good advice, but not very useful.

A practical reform strategy must be based on a ground-level perspective of how institutional change happens. Policy can then be tailored to maximise the chance of success. So how does institutional change happen? Structural reforms create winners and losers. The winners are often diffused and dispersed. Conversely, the losers are often easily identifiable, powerful and well organised. Institutional change must go up against vested interests. 

The fact is, institutional reform is highly contingent. It depends upon events transpiring in a particular way at critical junctures. This is shaped by the prevailing political economy context and social attitudes, as well as luck. There was nothing inevitable in Deng Xiaoping’s rise to power in China in the late 1970s, which was the key pivotal moment that set China towards economic reforms that bolstered the role of market forces. The set of events that transpired were highly contingent on the outcome of a power struggle between remnants of the Cultural Revolution leadership, namely the Gang of Four, and more reform-minded members of the Communist Party. 

Countries must seek to make the most of these windows of opportunities to build reform momentum. Successful policies will be those that are mindful of a country’s history and leverage on prevailing political economy contexts. The long-run performance of countries hinges critically on this because the outcomes of institutional change tend to be highly persistent. How rules and norms evolve depends heavily on what they are today. Thus, institutional development often follows a virtuous circle, such as in South Korea, or a vicious spiral, as in the case of Zimbabwe.

There is an enormous amount of heterogeneity among emerging market economies. Where a country stands in terms of its history and readiness for institutional change will distinguish those that are just experiencing a temporary deceleration from those that might be facing more of a structural slowdown. The destinies of emerging markets are not strictly bound to each other. Some will succeed, and a few may not. It is not useful to lump countries together into one group or under one catchy acronym or another. Each country needs to be analysed as an individual story.

Emerging-market countries are at a critical juncture. Much has been accomplished, and much potential remains. This is the key transition point. How successfully a nation manages this transition will depend primarily on domestic factors. Specifically, its ability to instigate structural change and implement institutional reforms. I believe that big strides can be achieved if we can push through our individual glass ceilings. But I am also realistic that realising this potential and coordinating societies on the good outcome will be enormously challenging.

To move forward, there needs to be a collective change of attitudes and mindsets – particularly towards things like corruption, good governance and consideration for the public good. Here there is good news and bad news. On the positive side, mindsets and attitudes are things within our control. The bad news is that changing attitudes and mindsets is perhaps one of the most difficult things to do. As Leo Tolstoy once wrote, “Everyone thinks of changing the world, but no one thinks of changing himself.”