The “Expectation Revolution” Is Rattling Chile, Turkey and Brazil
Kemal Dervis is Vice-President and Director for Global Economy and Development at the Brookings Institution. He has been Minister of Economic Affairs of Turkey and Executive Head of the United Nations Development Programme.
WASHINGTON—The world economy is entering 2014 with signals still mixed, but becoming more positive for the short run.
There has been some good news. In 2013 the American economy grew faster than what consensus projections had foreseen. China slowed down a little in the middle of the year, but picked up later.
In Europe, the UK finally started to come out of its recession and growth returned even to the Eurozone, although very slowly. Worries about widespread emerging market difficulties that appeared in the aftermath of the US Fed’s tentative signal of likely tapering in May, dissipated as the Fed later made it clear that any tapering would be very gradual. On December 18th this very gradual and cautious approach was confirmed at the last meeting chaired by Ben Bernanke. In contrast to what happened in May, markets around the world reacted positively. I think it has become clear that a gradual normalization of US monetary policy will indeed take place and, also, that this normalization in itself will not create a major problem for either the advanced or the emerging economies.
Looking ahead from the point of view of the emerging and developing economies, therefore, we should not overestimate the short term problem that slowly rising interest rates and gradually declining liquidity may generate. “Slow” and “gradual” are the key words here. Abrupt changes could still prove disastrous. It is unlikely, however, that the monetary authorities of the advanced economies will allow any sudden changes, and they still have the means to ensure gradualism, particularly if they cooperate. A potential crisis that everyone talks about and tries to simulate well in advance, usually does not become a crisis. This does not mean that a few specific countries with very high current account deficits and low reserves to short term foreign debt ratios could not get into serious trouble.
There are other, more structural problems, however, that emerging countries will have to face, and these are widespread. These new challenges are the result of the rapid social changes of the past two decades. They are also the product of the social media revolution of recent years.
The rapid growth of the last two decades has led to the emergence of a sizeable and yet still vulnerable middle or “near-middle” class in countries such as China, India, Brazil, Turkey, Chile and many others. Hundreds of millions have been able to escape poverty and enter the modern consumer age.
Cars, small apartments, I-Pads and I-Phones, even a quick holiday away from home, have become more than just a dream. Yet incomes are still low and many households have been able to attain these “middle class” products only by getting into debt. As public sector debt has mostly declined, private credit card use and medium term mortgages have increased rapidly.
Somewhat paradoxically, greater macroeconomic stability and less sovereign debt worries have encouraged private borrowing. But the ensuing debt is sustainable for households only if their disposable income continues to rise rapidly. For a household that has experienced 6 percent annual income growth for several years and that has increased its debt to disposal income ratio from 10 percent to 40 or 50 percent, a slowdown of income growth to, say, 2 percent a year, could lead to serious hardship, by increasing the debt service to income ratio in a way that would force consumption cut-backs, despite still growing income. If real interest rates rise, the problem is aggravated.
The political economy of many emerging countries is such that social stability requires continued rapid growth. In many countries a slowdown, even if modest by historical standards, could create debt sustainability issues in the household sector, with wider impact on the financial sectors. The phenomenon is made more serious and pressing by an “expectation revolution,” fueled by modern communication technology and the potential for mass mobilization made possible by the same technology.
Societies where inequality of wealth and income are particularly high, seem particularly vulnerable to mass mobilizations of the type we saw in 2013 in countries as diverse as Chile, Brazil, and Turkey, three countries with some of the highest Gini coefficients (a summary measure of inequality at a given point in time) in the world. Each of these three countries is very different, but in each case the young and parts of the aspiring new middle classes were in the streets asking for respect, greater equality, less corruption and a greater say in their own lives. In the two giants, India and China, it is also clear that as long as growth is very rapid, social tensions and the expectations of the young can be managed. If and when growth slows down by two or three percentage points, disappointment and discontent are likely to develop rapidly.
That is why big challenges lie ahead for the emerging economies. To avoid serious social and political pressures, growth has to be not only rapid, but broad based and equitable, in the sense that if there are steep income increases for some accompanying rapid growth, they must be perceived as deserved by effort and job creation, and not due to exploitation of rents or political favors.
I do believe that growth can continue to be rapid, provided it is spurred by a new wave of reforms focusing on skill upgrading, a transparent and more efficient public administration and renewed emphasis on building infrastructure for the knowledge economy of the 21st century. I do not believe that the potential for “catch up” growth is anywhere near exhausted, even though it may not be as easy to achieve it as it was at a time when traditional manufacturing was the main channel of increasing productivity.
There will be plenty of opportunities to move closer to “best practice” technology across all sectors of an economy, including “internal” catch up with less efficient firms moving towards the efficiency levels of high productivity firms within large emerging economies. Moreover, the line between what we call manufacturing and what we call services will continue to become increasingly blurred.
GDP growth itself will not be enough, however. It will have to be sufficiently employment generating and sufficiently well distributed across citizens and regions of a country to respond to the strong expectations of the aspiring new generations. With new communications technology and incomes no longer just at subsistence levels, come new awareness and new demands for empowerment and equity.
Emerging countries will have to channel this strong drive for increased and shared prosperity into positive energy that helps build institutions, confidence in the future and high savings and investment rates. Those where domestic governance succeeds in doing so will be able to thrive. Others may face stormy waters.