Back to the future for emerging markets
The economic gains of emerging markets (EMs) seen in the noughties continue to inflate growth expectations today, despite the longer historical record indicating much slower progress.
There is a distinct whiff of the 1980s in the air. People don slim-fit jeans and carrot trousers, inflation is approaching double digits, and the world is once again splintering into ideological blocks. Remember ’the end of history‘ and ’the world is flat‘? No longer.
EMs are no exception, with the era that brought us the acronym BRICs now seeming a distant memory. You don’t have to look as far as Russia, which has become altogether un-investable: even China, India and Brazil have lost their shine.
The chart above shows the growth premium of EMs over developed markets (DMs). It has fallen markedly from the 2009 peak, but this is just a return to normality. The noughties, which were characterised by China’s WTO accession and the commodity super cycle, were the outlier.
Converging, but slowly
The GDP per capita of EMs does converge with that of DMs, but at a slow pace. At the pace observed since 1960, it would take 170 years for the median EM to reach half US GDP per capita, about the level Korea is at today. Latin America’s GDP per capita growth has been particularly slow, rising from 12% of the US level in 1962 to only 15% today.
Combining extrapolations of relative GDP per capita with OECD demographic projections gives a glimpse of how the world might look in 2050 – not that different from today. Based on these projections, EMs’ share of world output would rise to 46%, from 38% in 2020. Demographics would account for a quarter of the increase. The top five economies would be the US, China, Japan, India and Germany, with India the only – if noteworthy – addition.
A case of overoptimism?
This is not conventional wisdom, by the way. For many forecasters the noughties are still the frame of reference, leading to convergence speeds that are wildly at odds with the longer historical record (see the chart above). The OECD, for example, projects the share of global output attributable to EMs to rise to 57% and Indonesia to become the fourth-largest economy by 2050.
What are the implications for investors? EM equity markets have underperformed DMs for years. The cheap valuations relative to developed markets partially reflect the decline in the EM growth premium. And, with the growth premium only back to normal, we believe investors cannot bank on huge relative equity gains in the years to come.