Economics
BRICS

The Brazil Syndrome ... renowned economist Anders Åslund engages the views of Dani Rodrik, Nouriel Roubini, Joseph Stiglitz, and others on the growing turmoil in emerging markets.

Burgess COMMENTARY

Peter Burgess

The Brazil Syndrome

Slumping growth, if not outright contraction, in most of the world’s major emerging economies has been rightly attributed to China’s slowdown and plummeting commodity prices. But weak external conditions have also exposed profound governance failures – and not just in Brazil.

IMAGE Brazil storm Christ the Redeemer Yasuyoshi Chiba/AFP/Getty Images

WASHINGTON, DC –

Pity the world’s emerging markets: they are no longer flavor of the month, or indeed year, for international investors. You need only look at how investors have been fleeing Brazil amid rising economic uncertainty and political turmoil there. And Brazil is no outlier.

For most of this century – even after the shock of the global financial crisis in 2008 – emerging economies, led by China and India, grew at almost unprecedented rates. In the words of Jim O’Neill, who in 2001 cleverly condensed Brazil, Russia, India, and China into the BRICs acronym (the “s” later became upper case to include South Africa), these markets were no longer emerging – they had emerged.

Such bullishness, however, has practically vanished. China, the great emerging-market growth engine, may still be expanding at an impressive 6.5%-7% rate, but that is markedly lower than in the country’s boom years. Growth in other emerging economies has slowed as well, often dramatically, or even gone into reverse, hit hard by plummeting prices for oil and other commodity exports. Carmen Reinhart of Harvard’s Kennedy School of Government reckons the pain will continue.

Her Harvard colleague Dani Rodrik goes further, arguing that there was never a “coherent growth story for most emerging markets” in the first place. “Scratch the surface,” he says, “and you found high growth rates driven not by productive transformation but by domestic demand, in turn fueled by temporary commodity booms and unsustainable levels of public or, more often, private borrowing.”

Continuing credit expansion after the global financial crisis helped to prolong rapid growth, but not for long – and at a very high cost. As NYU’s Nouriel Roubini puts it: “Emerging markets are in serious trouble. They face global headwinds (China’s slowdown, the end of the commodity super cycle, the Fed’s exit from zero policy rates). Many are running…twin current-account and fiscal deficits, and confront rising inflation and slowing growth. Most have not implemented structural reforms to boost sagging potential growth. And currency weakness increases the real value of trillions of dollars of debt built up in the last decade.”

My own take is similar. Output in Brazil and Russia, for example, shrank by about 4% in 2015, and similar losses are likely this year. But, while the driving force of decline has been the collapse of commodity prices, the critical problem these countries (and other leading emerging markets) face is poor governance.

Shifting into the Slow Lane

Today’s growth obstacles should not obscure the considerable improvements that emerging economies made following the crises of the 1990s. Many built up large currency reserves and sovereign wealth funds. Most pursued prudent fiscal policies, leaving them with small public debts. And one of the greatest changes, the transition to flexible exchange rates, limited their foreign debts.

But these reforms were not enough to shelter them from deteriorating external conditions. Indeed, slowing growth in China and lower commodity prices are not emerging economies’ only worries. Kemal Derviş, a former administrator of the United Nations Development Program, writes that “the shift of many activities in both the services and manufacturing sectors from advanced economies to developing countries with lower wages” may be drawing to a close. The reason, Derviş argues, is that “a growing array of activities can be automated. So, whereas call centers used to be staffed mostly in low-wage countries, now the computer-robot that does most of the talking can be located in New York.”

Rodrik has a further concern, namely that “emerging markets are deindustrializing prematurely. Services are not tradable to the same extent as manufactured goods, and for the most part do not exhibit the same technological dynamism. As a result, services have proved to be a poor substitute to export-oriented industrialization so far.”

Moreover, the switch to flexible exchange rates over the last generation exposed emerging markets to the vicissitudes of advanced-country monetary policy and short-term financial flows. As Andrés Velasco, a former finance minister of Chile, pointed out last year: “Since the subprime crisis, ultra-low interest rates in the rich world have caused emerging-market firms to borrow like never before.” And the result? When market sentiment about emerging economies turned bearish, and the US raised interest rates in December, capital fled.

Broken BRICS

No country except the United States is as intensely scrutinized as China, the world’s second-largest economy, which is in the midst of shifting its growth model away from exports and toward household consumption and domestic services. But Keyu Jin of the London School of Economics reckons that “China’s problem is not that it is ‘in transition.’ It is that the state sector is choking the private sector.” Like many other China-watchers, she argues that “political reform” is essential. “If China is to avoid economic decline,” she says, it will have to overhaul its governance system – and the philosophy that underpins it – without triggering excessive social instability.”

To a longtime observer of reform efforts in Communist countries, that sounds – to borrow a phrase from the late Polish philosopher Leszek Kołakowski – like baking a snowball. Yet experts like Yale’s Stephen Roach remain sanguine that structural adjustment is on course and that China can avoid a hard economic landing. Governance, in Roach’s view, is not a problem. On the contrary, one-party rule and the legacy of the Soviet-style command economy are a source of strength: “Consistent with China’s long experience in central planning, it continues to excel at industrial reengineering,” he claims. Jin is similarly optimistic: “The good news is that China has a promising track record.”

The same cannot be said of the other BRICS countries, among which only India has maintained robust economic growth. In Brazil, for example, the ongoing political crisis surrounding President Dilma Rousseff’s impeachment, together with the massive corruption scandal engulfing the semi-public oil giant Petrobras, has clearly exacerbated the economic impact of weak global conditions. Moreover, according to Camila Villard Duran of the University of São Paulo, the move to impeach Rousseff over her management of fiscal policy “underscores the need to overhaul Brazil’s economic institutions.”

In Russia, meanwhile, a moribund economy, ravaged by low oil prices and Western sanctions, has given President Vladimir Putin no reason to alter the governance system. As long as that system succeeds in confining economic, political, and media power within a tight circle of Kremlin cronies, it serves the country’s leaders perfectly well.

With governance reform ruled out, Russia’s economic crisis is still at an early stage. The Kremlin has been forced to slash public spending, further weakening already-strained health-care and education systems – and thus jeopardizing Russia’s long-term growth prospects. The exiled Russian economist Sergei Guriev points out that the government is also planning to sell stakes in state-owned companies to boost revenues. But, with the stakes set to go to Putin’s top cronies, “Privatization 2.0” will produce neither large revenues nor much-needed efficiency gains.

Hope in Africa and the Middle East?

Over the past two decades, propelled by its commodity exports to China, Africa has emerged as the world’s new growth juggernaut (admittedly starting from a very low level). But now Africa’s exports have slumped, in tandem with China’s slowdown. As Kingsley Chiedu Moghalu, a former deputy governor of Nigeria’s central bank, agrees with Rodrik: “The heart of the matter is this: African countries mistook a commodity supercycle-fed boom for a sustainable economic transformation.”

Here, too, weak governance is aggravating the downturn. “Despite the spread of formal democracy on the continent” during the boom, Moghalu argues, “the nature of domestic politics in most African countries had hardly changed. Real leadership involves not just mobilizing citizens to vote for candidates, but also effective management, strategy, and execution of public policy.”

Meanwhile, five years after the “Arab Spring,” political stability – entirely absent in Libya and Syria – has been maintained in Jordan and Morocco and restored in Egypt and Tunisia. But growth in the Middle East and North Africa remains anemic. Despite substantial reforms to reduce the state’s economic role, Harvard’s Ishac Diwan argues that political interests have still prevailed since 2011. “With economic privileges doled out in a way that blocked the emergence of independent entrepreneurs, who could eventually challenge the autocrats’ control, favored firms were able to acquire virtual monopolies over entire liberalized economic sectors.”

Left Out in Latin America

Rousseff’s fate may be a dramatic instance of a broader trend, which Shlomo Ben-Ami, a former Israeli foreign minister, calls the “end of a cycle of left-wing hegemony in much of Latin America.” Rousseff’s political demise follows the “crushing defeat of the long-ruling Chavista government in Venezuela’s recent parliamentary election, together with the end of 12 years of Peronist rule in Argentina.” Significantly, because these changes were triggered by economic pressures, they mark “a measured transition toward political pragmatism,” rather than “an ideologically-driven sea change.”

Equally encouraging, there is now genuine popular mobilization against corruption. Luis Alberto Moreno, President of the Inter-American Development Bank, raises an important issue: “As corruption scandals rattle Latin America, many observers are asking if the region will ever shake off its legacy of weak institutions. I believe the answer is yes.”

After the return to democratic rule in the 1980s and 1990s, many Latin American countries have, indeed, been strengthening their political systems’ checks and balances, and so – according to Moreno – are finally raising the quality of governance. Perhaps Brazil’s Petrobras scandal, like Italy’s anti-corruption prosecutions of the early 1990s, will spur a political house cleaning. But the opposite could also happen. As Velasco has observed, “Populism often thrives when the legitimacy of political institutions declines.”

But then there is Venezuela, arguably the world’s worst example of economic mismanagement, with its plummeting output and soaring inflation. Ricardo Hausmann, the director of Harvard’s Center for International Development (and Venezuela’s former minister of planning), lists “four fundamental ingredients of such man-made disasters: repression of the market, suppression of information, systematic persecution of dissent, and attribution of blame for the disaster to the victims.” Hausmann, whose criticism has prompted Venezuela’s president to threaten him with criminal charges, calls for “restoration of the market mechanism” to “prevent a humanitarian catastrophe.”

More immediate cheer for financial markets may come from Argentina, following last November’s election defeat of the populists in power since the sovereign default in 2002. Yet Martin Guzman and Joseph Stiglitz worry that if center-right President Mauricio Macri “is not careful, Argentina could face a balance-of-payments crisis, owing to deteriorating external conditions and macroeconomic mismanagement, especially since 2011.” Of course, macroeconomic mismanagement is precisely the reason why Macri won. Rather originally, Guzman and Stiglitz praise late President Néstor Kirchner as a master of economic policy – and regret that his widow, whom Macri succeeded as President, was not up to his standard.

Reasons to Be Fearful

Latin America today includes both the world’s most promising emerging economies and some of its most troubled, whereas the region that causes the most concern remains, along with the greater Middle East, the former Soviet Union. Russia is hardly the only ex-Soviet state with a rent-seeking regime that is running out of rents. As former Economist editor Bill Emmott notes, “Central Asia’s oil-producing dictatorships, including Azerbaijan, have been among the countries hardest hit by the drop in prices.” Emmott singles out Azerbaijan, Kazakhstan, and Turkmenistan as autocracies likely to harbor the next dictator to be overthrown.

Of course, the same could be true of Venezuela, and sweeping political change may come to democratic Nigeria as well, not to mention Brazil and South Africa. (Ukraine, many of whose troubles stem from Russian aggression, is perhaps a special case of combined economic and political crisis – which is no comfort to its citizens.)

In a sense, all of the major emerging markets – with the revealing exception of India, where economic growth is not dependent on commodity exports – are reliving the lesson of the 2008 global financial crisis. As Warren Buffett famously summed it up: “Only when the tide goes out do you discover who’s been swimming naked.” For much of the last generation, buoyant commodity prices served as a fig leaf for emerging markets’ profound governance failures. Now the fig leaf has been stripped away, and their leaders must face the beach.

Photo of Anders Åslund ANDERS ÅSLUND Anders Åslund is a senior fellow at the Atlantic Council in Washington, DC, and the author, most recently, of Ukraine: What Went Wrong and How to Fix It.