Emerging Markets in 2017: Trends To Watch

Trends Across Emerging Markets: Three To Watch In 2017

Emerging market economies pack a serious economic punch, but will they fire on all cylinders in 2017?

At my research organization, The Conference Board, we project emerging markets to grow at a dismal 3.6% in 2017. Just above half the long-term average growth rate they achieved since 2000. With these economies collectively comprising 55% of the world’s GDP in 2016, how they perform will go a long way in setting the pace at which the global economy grows. Several factors could alter the growth path of emerging markets in 2017 and beyond. Without question, the following three warrant serious attentionI.

Interest Rates

A hike in the Federal Reserve interest rate will strengthen the US dollar. But as a result, the depreciation in emerging market currencies will make their imports more expensive. Not only will this effect inflation, it also will hamper their ability to produce and export goods, production of which requires imported intermediate goods/raw materials. According to OECD the import content of export – the amount of imported raw material used in the production of exported goods and services – in the seven large emerging economies (i.e. the BRIC plus Indonesia, Mexico and Turkey) spanned from 10 to 30% in 2011.

The rate hike, and the resulting increase in the return over investment in the U.S., will also lead to a return of capital from emerging markets back to the U.S. The lower foreign investment could affect economic growth in countries that rely significantly on foreign investment.

The increasing value of the dollar will affect commodity exporting countries.

If commodities are traded in US dollars, the real revenue earned by these countries will be lower, thus disturbing their balance of payments and ultimately their growth

II. Trade Tumbles

Since the 2000s, a major factor energizing emerging economies has been their integration into the global economy. For them, the door to trade opened wide and fast. Emerging market trade now constitutes more than half of global trade. Nevertheless, global trade growth has nosedived in recent years, particularly after 2011.

Recent research also suggests global import intensity in the post-2000 years was driven strongly by international production fragmentation, which has stalled since 2011. This might reflect the increasing ability of countries to produce upstream products for domestic use or increases in trade restrictions. As such, the growth of trade looks unlikely to increase in the year ahead. Upcoming potential trade restrictions by the U.S will only further slowdown momentum.

Also contributing to the reduction in growth of global trade volume is falling commodity prices.

It constrains the ability of commodity exporting countries to import from economies like China. Within China, the change in the structure of production and consumption favoring less trade-intensive services has reduced its import intensity. Thus, the overall reduction in the import intensity within emerging market economies also has contributed to the trade slowdown.

Lastly, advanced economies face a looming and serious labor shortage problem, which might increase pressure for more automation and digitization of production processes. There is evidence that low-wage jobs are and will remain vulnerable to technological substitution. Given the increasing wage pressure in emerging economies, this might then reduce the off-shoring of low and middle-skill jobs. This would be a secondary effect, and hence will likely hamper future trade growth.

III. Productivity Putters

Labor productivity growth drove the remarkable growth surge in emerging market economies. Yet, most emerging market economies still lag on that front and thus have significant potential to catch up; their relative productivity pales compared to advanced economies.

For instance, today’s labor productivity levels in China and India, respectively, clock in at 1/5^th and 1/7^th of the United States’. Moreover, these economies have experienced declines in labor productivity growth in recent years. When you consider the likely decline in trade, which I detailed in trend #2, continuation of weak productivity growth looks more and more likely.

For some emerging markets, the chance to catch up in productivity moves farther out of reach by the day.

Consider China. The country is shifting away from an investment-manufacturing-export dependence model to more domestic consumption of goods and e-services. This transition looks all but certain to slow down the brakes.

But in places like China, a return to investment-led growth in productivity is unlikely to push up productivity. To energize and sustain productivity growth, emerging market must look to equipping their populations with new and necessary skills. Many of these economies face severe skill challenges; even more worrying, they continue leaving these challenges on the back burner.

If some emerging markets fail to regain robust productivity growth, they will likely fall into the ‘middle income trap’ phenomenon that has impacted several fast growing Asian economies.

The Bottom Line

The current global environment is not conducive for higher growth in emerging market economies. In the wake of declining global trade, eroding productivity potential, and the foreign investment possibly moving elsewhere, what can help change course? The enactment of policies strengthening domestic demand and easing supply-side bottlenecks would go a long way. Yet that remains a huge challenge.

Abdul A Erumban is a senior economist with The Conference Board. He is based in Brussels, Belgium.