The premature ageing of emerging market economies

Growth advantage over mature markets has halved and is set to disappear

Hung Tran

Labour productivity growth has recovered strongly from the early 1990s, but has recently shown signs of topping out © Reuters

The 2018 annus horribilis has put emerging market assets in a competitive situation: they are undervalued both historically (with equity price/earnings and price/book ratios below their 2000-18 averages and currencies undervalued) and relative to their mature market counterparts (especially offering higher real yields).

EM assets are still underweighted in global portfolios. As such, EMs are in a good cyclical position to recover when the global growth outlook stabilises, adjusting to the new normal of ongoing trade and political tensions.

Beyond this near-term view, however, the long-term case for diversifying into EM assets needs to be recalibrated, because many EM countries are faced with growing structural headwinds. Basically, they reflect a premature “ageing” of EM economies.

Most important is the ageing of many EM populations, albeit from a younger age structure than in mature markets. According to UN projections, the old age dependency ratio in EMs (65+ over the working age population) will rise from about 10 per cent at present to more than 22 per cent by 2050; the comparable increase in mature markets is from 28 per cent to 45 per cent.

In particular, except for India and Africa, EM labour force growth has slowed and actually declined in countries such as China (thanks to its one-child policy).beyondbricsEmerging markets guest forumbeyondbrics is a forum on emerging markets for contributors from the worlds of business, finance, politics, academia and the third sector. All views expressed are those of the author(s) and should not be taken as reflecting the views of the Financial Times.

In addition, productivity growth has shown signs of resuming its earlier trend of slowing since the 1960s after a recovery in the early 2000s. According to the IMF, for EMs excluding China, total factor productivity growth decelerated from about 2.5 per cent a year in the 1970s to minus 1 per cent in the early 1990s, then recovering to almost 1 per cent in the early 2010s before slowing down again.

Similarly, labour productivity growth recovered strongly from the early 1990s to more than 3 per cent, driven by a quickened pace of capital accumulation thanks to low financing costs, but has recently shown signs of topping out.

Besides factors such as reform and capital deepening, which can promote productivity growth, other factors exert a negative influence on long-term productivity performance — such as the premature deindustrialisation in many EMs and developing countries.

In recent decades, the share of manufacturing employment and value added in those economies has peaked and declined earlier in their development process and at lower levels of per capita income. This is in comparison with their own performance before the 1980s and especially relative to the experience of mature markets. To the extent that manufacturing activity and jobs tend to exhibit higher levels of productivity, the premature relative decline of manufacturing in favour of the service sector (which has grown to more than 53 per cent of GDP from 45 per cent in the 1990s) can dampen overall productivity growth.

Interestingly, modern technological changes can both help promote inclusive development in EMs (for example, in the case of the M-Pesa mobile payment system in Kenya) but also hinder their industrialisation efforts by emphasising trade in services and intangibles at the expense of manufacturing for export, which had been the main route for the industrialisation of the East Asian Tigers and China.

Such a shift into services, whose share of total exports rose from 17 per cent in 1979 to 24 per cent in 2017, can amplify the negative impact of rising protectionism on world merchandise trade, where EMs have a higher share (44 per cent) than in services (34 per cent). In addition, some major countries such as the US try to unwind global supply chains, preferring automation at home to (less) cheap labour overseas — thus also cutting back on trade in intermediate goods. Overall, a continued slowdown in world trade will weaken a key motor of growth for many EM countries.

Altogether, those trends combine to lower the EM potential growth rate. Indeed, after a growth spurt of more than 6 per cent a year in the first decade of the millennium — driven by a wave of reforms adopted after earlier financial crises in Latin America, Asia and Russia — EM growth has slowed to about 4.5 per cent at present.

In part, this reflects the exhaustion of the benefits of earlier reform measures — such as the adoption of more flexible exchange rates, inflation targeting, reserve accumulation and efforts to improve fiscal sustainability including some pension reform — while the pace of additional reform has stopped or even reversed as reform fatigue sets in. In the long run, according to the OECD, the potential growth rate of the Briics (Brazil, Russia, India, Indonesia, China and South Africa — accounting for most of EM GDP) is expected to slow further, converging to mature market trend growth of 2 per cent.

In other words, the growth advantage of more than 4 percentage points that EMs enjoyed over mature markets in the 2000-2010 period has narrowed to about 2 percentage points and will probably disappear in the long run.

This potential growth slowdown puts the recent increase in EM debt in a more worrisome light. Debt has risen to a record amount of $71tn in the second quarter of 2018, according to IIF data. While government debt for EMs as a whole is relatively low at 48 per cent of GDP (compared with 109 per cent in mature markets) several countries such as Brazil and Hungary have high levels of government debt. More concerning is non-financial corporate sector debt, which at 95 per cent of GDP is higher than in mature markets (91 per cent).

Such high levels of outstanding debt, especially in light of rising financing costs, will make it more difficult for EM corporations to incur sufficient new debt to sustain investment and growth. This is particularly the case as it now takes more debt to produce the same amount of growth than before.

Moreover, the current EM debt burden will make it more difficult to fund and build up pension assets to provide for future retirees. Except for South Africa and Chile, most EM countries have very low levels of pension assets in funded and private pension schemes — less than 25 per cent of GDP, which is much less than countries such as the UK (77 per cent) and the US (118 per cent). This will put pressure on public “pay-as-you-go” pension systems in EM countries, especially if government deficits and debt cannot be brought under control.

Ultimately, failure to adequately provision for future retirees can create social tension, not conducive to growth.

In conclusion, the case for global investors especially pension funds to diversify into EM assets (younger population, higher growth and potentially superior return) is still reasonable for the foreseeable future. However, in the long run, this case depends critically on whether policymakers in EMs can implement appropriate policies to tackle the structural problems mentioned above, to improve productivity and foster inclusive growth.

In this race, some countries will do better than others. Hence, the key in EM investing is to be selective in picking country and stock exposures — and not treating EMs as a homogeneous bloc. After all, for 2018 the dispersal of US dollar-adjusted returns among different EM equity markets is much wider (48 percentage points, between minus 54 per cent in Argentina and minus 6 per cent in Russia) than between the MSCI World and EM indices (5 percentage points).

Hung Tran is former executive managing director of the Institute of International Finance and former deputy director of the IMF

What Should You Do About a Falling Stock Market? Nothing

If you had a perfect ability to predict how far the market would fall and when it would bottom out, it would make sense to move money in and out. But you do not.

By Neil Irwin

A nap can be a good strategy when the market nosedives. An investor getting some sleep at a private stock market gallery in Kuala Lumpur, Malaysia, in October. CreditCreditYam G-Jun/Associated Press

Millions of investors will receive year-end statements from their brokerages and retirement plan managers in the coming weeks, and the great majority of them will have unpleasant news: losses.

The S&P 500 finished the year down 6.2 percent, with the steepest declines recorded in the fourth quarter.

With Apple’s announcement of disappointing sales in China on Wednesday, the bad times for stocks continued in the first week of the new year. While most economic data has remained strong, there are some rumblings that 2019 may be quite a bit rougher than 2018. Corporate executives are becoming more pessimistic, according to surveys, and Americans are conducting Google searches for the word “recession” at the highest rate since the last one just ended in 2009.

If it all makes you want to flee — or at least shift your 401(k) into cash — that’s understandable. It’s also a bad idea. 
The sensible response to this unnerving series of developments is to do pretty much anything else. Read a book. Go for a walk. Take up knitting. Or just do nothing at all, like take a nap.

If you are a long-term investor (and any money you have tied up in the stock market should be intended for the long term to begin with), tumult like that of the last few months isn’t something that should cause panic. Rather, it’s the price you pay for enjoying returns that, over long time horizons, are likely to be substantially higher than those for cash or bonds.

That’s true if this episode turns out to be a false alarm for the overall economy, as is a distinct possibility. But it’s also true even if this does turn out to be the start of a prolonged period of economic and market distress — especially if you are still in the phase of your life of contributing to a retirement plan or otherwise accumulating savings.

Napping at a brokerage office in Beijing in October. Credit Jason Lee/Reuters

The recent pessimistic tone in markets is getting way ahead of the evidence. Nothing so far in either the economic data or the market indicators that most reliably predict economic swings suggests there will be anything worse than a modest slowdown in economic growth in 2019.

Businesses are still expanding and adding jobs. The yield on two-year Treasury bonds has fallen in the last three months, but it would have fallen a lot more if the bond market — which tends to be closely tied to the direction of the overall economy — had been predicting an imminent recession.
Moreover, an investor who moved money into cash now would be doing so just as the valuation of stocks was becoming more favorable — buying high and selling low, not the way great fortunes are made. That’s especially true when you factor in the drop in longer-term interest rates, which makes shares particularly appealing relative to bonds.

In early November, investing $100 in stocks would buy you about $4.64 worth of corporate earnings, versus the $3.21 in interest you would could receive by investing in 10-year Treasury bonds. Now, stocks offer $5.25, while bonds offer only $2.61.

But most important, even if the economic road ahead really is as bumpy as some in markets seem to fear, you’re probably not going to be successful at timing those swings just right.

Of course, if you had a perfect ability to predict how far the market would fall and when it would bottom out, it would make sense to move money in and out. You do not.

There is a wide range of evidence that people are pitiful at timing the market. Even supposed investment experts lack that prescience.

Even if you turned out to be right about a continuing tumble in 2019, the great risk would be that whenever the rebound began, you would be caught out of position, unable to take advantage.

Suppose you were clever enough to recognize at the start of December 2007 that a major recession was about to take place, and you moved your money out of stocks. 
Yes, you would have saved yourself from steep losses in 2008 and early 2009. But you have to ask yourself: Would I have also had the courage to put money back in while the economy was still in horrendous shape in 2009, with double-digit unemployment and a banking system in tatters?

If not then, when would you have moved money back in? People who simply left their savings fully invested in the stock market in December 2007 have now made a 134 percent return on that money. Would you have done better than that, or would you have missed out on a big chunk of those gains out of the same caution that led you to pull money out of stocks to begin with?

People who did not panic in the fall of 2008 — the most panic-worthy time in most of our lifetimes — and kept putting their retirement funds into stocks did indeed incur steep losses over the ensuing months. But their newly invested funds were being put into stocks at the most favorable valuations in a generation, and thus enjoyed the full benefit of the rebound when it eventually came.

A truism of economic and financial cycles is that by the time it feels like the coast is clear and putting money into riskier investments is completely safe, the real money has already been made. People who looked at the economic chaos of early 2009 and stuck to their guns have ended up far better off than those who, convinced that a double-dip downturn was imminent, waited for years to get in.

This equation changes, of course, if we’re talking about money needed imminently as opposed to longer-term savings, such as for retirement. The economy looks stable now, but that could change — it’s still possible that markets and C.E.O.s know something about the future that isn’t clear in the data yet.

But that’s more of a fundamental argument about how your assets should be allocated. If an 18 percent drop in stocks is enough to cause you to change your entire investment strategy, that money shouldn’t have been in stocks to begin with.

The entire point of investing in stocks is that you get greater long-term expected returns in exchange for tolerating bigger ups and downs. Episodes like those of the last few weeks are, in effect, the price you pay for returns that are substantially higher than bonds or cash over longer periods.

Just as there are no free lunches, there are no excess returns without some volatility and risk.

As individual investors, we cannot control volatility. What we can control is our own mind-set and reaction, and the more level your head, the better your long-term results are likely to be.

Neil Irwin is a senior economics correspondent for The Upshot. He previously wrote for The Washington Post and is the author of “The Alchemists: Three Central Bankers and a World on Fire.”

Wall Street Firms Plan New Exchange to Challenge NYSE, Nasdaq

Morgan Stanley, Fidelity and Citadel Securities among backers of new ‘Members Exchange’

A launch would inject new competition into the heavily concentrated stock-exchange business.
A launch would inject new competition into the heavily concentrated stock-exchange business. Photo: brendan mcdermid/Reuters

A group of financial heavyweights including Morgan Stanley ,Fidelity Investments and Citadel Securities LLC plans to launch a new low-cost stock exchange to challenge the New York Stock Exchange and Nasdaq Inc., NDAQ -2.64%▲ the companies said.

The creation of the new venue, called Members Exchange or MEMX, comes after years of frustration among Wall Street brokers and traders with the fees charged by U.S. stock exchanges.

MEMX will be controlled by the nine banks, brokerages and high-frequency trading firms funding it, according to a news release viewed by The Wall Street Journal. Such an arrangement harks back to the era when exchanges were owned by their members, typically stockbrokers.

MEMX investors also include investment banks Bank of America Merrill Lynch and UBS AG UBS +0.35%▲ , high-speed trader Virtu Financial Inc. and retail brokers Charles Schwab Corp., E*Trade Financial Corp. and TD Ameritrade Holding Corp., according to the news release.

New York-based MEMX is set to make its plans public on Monday. Representatives of the investor group said they would seek to apply for exchange status with the Securities and Exchange Commission early this year. SEC approval for a new exchange is a drawn-out process that can take 12 months or longer, meaning it may be 2020 or later before MEMX is up and running.

A launch would inject new competition into the heavily concentrated stock-exchange business.

Today, all but one of the 13 active U.S. stock exchanges is owned by three corporations: NYSE parent Intercontinental Exchange Inc.,known as ICE for short, Nasdaq and Cboe Global Markets Inc. Between them they handle more than three-fifths of U.S. equities trading volumen.

Shares of ICE sank 2.9% on Monday morning, while the broader S&P 500 index was little changed. Nasdaq and Cboe fell 2.8% and 1.9%, respectively.

Despite its prominent backers, there is no guarantee that MEMX will succeed. New exchanges often struggle to attract trading activity away from established markets. IEX Group Inc., a startup that was founded in 2012 and now runs the only independent exchange not owned by the big three, handles 2.5% of U.S. equities trading volume.

But brokers looking to save costs could be drawn to MEMX’s low fees. ICE, Nasdaq and Cboe have faced criticism for raising fees for services such as the data feeds that brokers use to monitor moves in stock prices. The three big exchange groups say their prices are fair.

“We think with the right team we could run an exchange at a fraction of the cost of what the incumbents are offering,” said Virtu Chief Executive Officer Douglas Cifu. MEMX hasn’t yet said how much its fees will be.

The involvement of Citadel Securities and Virtu could benefit the project if they become big buyers and sellers of shares on MEMX. The firms are the country’s two biggest stock traders, each handling around 20% of U.S. equities volume.

However, their involvement could also prompt some skepticism because many investors still view high-speed traders warily. Critics such as “Flash Boys” author Michael Lewis have accused ultrafast traders of exploiting ordinary investors. The firms reject these allegations.

Jamil Nazarali, global head of business development for Citadel Securities, said MEMX’s design would ensure it represents a broad cross-section of the stock market, from retail investors to banks to electronic traders. “A lot of past exchange startups focused on one group of participants or another,” he said. “This exchange is for everyone.”

MEMX raised $70 million in its initial funding round and expects to bring other investors on board later, people familiar with the situation said.

The planned announcement comes at a time when the big three exchange groups are facing increased scrutiny from regulators. In September, a Democratic commissioner at the SEC, Robert J. Jackson Jr., said in a speech that “the SEC has stood on the sidelines while enormous market power has become concentrated in just a few players.” In October, the SEC ruled against NYSE and Nasdaq in a long-running dispute over data fees, in a decision that may restrain exchanges’ ability to keep increasing such fees in the future. NYSE and Nasdaq are appealing the decision in federal court.

Despite being member-owned, MEMX will still be a for-profit company. Exchanges throughout much of the 20th century were nonprofit organizations.

U.S. stock exchanges abandoned their old model starting in the 1990s. The NYSE, which traces its history to a pact signed by two dozen stockbrokers in 1792, only converted into a publicly traded, for-profit corporation in 2006.

Brazil Finds More Than a Friend in Israel

The leaders of the two countries have made headlines recently for their budding friendship. But there’s more than a bromance driving their countries together.

By Allison Fedirka        


The friendly relationship between Israeli Prime Minister Benjamin Netanyahu and Brazil’s new president, Jair Bolsonaro, made headlines at the end of 2018. This “budding brotherhood,” as they’ve called it, started when Bolsonaro, then the president-elect, announced plans to move Brazil’s embassy in Israel from Tel Aviv to Jerusalem. Though he has since revised that promise, relations between the two countries continue to flourish. Netanyahu even attended Bolsonaro’s inauguration Jan. 1, becoming the first sitting Israeli prime minister to visit Brazil. More than a bromance, the close ties between the two leaders are a testament to their countries’ foreign policy strategies.

Back to Normal

Alignment with Israel, while often framed as a new development, is a return to form for Brazil. In the late 1940s, Brazil supported the creation of an Israeli state and was among the first countries to recognize the Israeli government. Ties between the two grew closer during Brazil’s military dictatorship, from 1964 to 1985, as they cooperated in areas such as security and nuclear energy. The relationship continued through the 1990s; in fact, Brazilian President Fernando Henrique Cardoso received several awards from Israel, including an honorary doctorate from the Hebrew University of Jerusalem, while in office. It was only when Luiz Inacio Lula da Silva took power in Brasilia in 2003 that Brazil-Israel relations became strained. Diverging from Cardoso’s neoliberal economic policies, da Silva espoused more direct government control of the economy and ushered in a populist era of government in Brazil.

Changes in foreign policy accompanied the economic shifts: Brasilia turned against the United States – and, by extension, against Israel. Brazil formally recognized the Palestinian state, according to the 1967 border, in 2010. Even then, its relationship with Israel persisted. In 2010, Brazil also ratified the free trade agreement that the Common Market of the South, a regional trade bloc better known as Mercosur, had struck with Israel three years earlier. And despite its decision to recognize Palestine, Brazil never upgraded its diplomatic mission there to embassy status. The moves didn’t exactly please Israel, but neither did they derail its relations with Brazil.

Bolsonaro wants to reverse course from the populist policies of Brazil’s recent history. To that end, he’s pledged to roll back government interference in the economy and to reach out once more to the developed countries da Silva eschewed in a bid to promote industrialization and growth among fellow developing economies. And Bolsonaro’s market reforms, like those of his predecessors, will come with foreign policy changes. Where da Silva looked to other countries in the Southern Hemisphere – namely states in South America and Africa, as well as China – for support and cooperation, the new Brazilian president is turning back toward wealthier northern states like the U.S., countries in Northern Europe and, of course, Israel. 


Areas of Mutual Interest

For Israel, meanwhile, Bolsonaro’s interest is well-timed. Israel, a relatively small country, depends on trade and collaboration with other states to keep its economy humming. Surrounded as it is by rivals, however, it must look beyond the Middle East to find suitable partners. Latin America is a natural choice. The region’s many developing markets and trade potential make it an attractive destination for Israel, which, according to the latest World Bank figures, derives 30 percent of gross domestic product from exports. South America remains a largely untapped market for Israel, and it boasts a wealth of natural resources and numerous opportunities for investment, technology development and military modernization. Over the past couple years, Netanyahu has paid official visits to Colombia, Argentina and Chile, along with several countries in Central America. But Brazil is a standout in the region. Not only does it have a $1.93 trillion economy – the world’s ninth-largest, by the World Bank’s most recent data – but it also has recently pulled itself out of recession. Now that Bolsonaro has taken office, promises of deregulation and more open markets have made Brazil even more enticing.

The focus on economic ties in Latin America is something of a departure for Israel. Throughout the 1970s and 1980s, Israel built its relationships with regional states, including Guatemala, Nicaragua, Honduras, Argentina and Colombia, on military backing and support for various armed groups. Its ties with Brazil and nearby countries today are broader in scope by comparison. Nevertheless, military equipment still has a role to play in the partnerships.

In Brazil’s case, technology transfer and development are the priority. Brazil began talks with Israel in March 2018 to acquire and exchange scientific and defense technologies, an arrangement that would at once satisfy Israel’s desire to export military goods and services, its area of expertise, and Brazil’s need to acquire more advanced technology. The two also have reached nascent agreements over defense technology, such as missiles, radar and high-tech surveillance cameras, that could help modernize Brazil’s military and law enforcement. (Some recent Brazilian governments have shied away from making these kinds of deals, but Bolsonaro, a champion of the military and security forces, will welcome them.) Space exploration and satellites are other points of mutual interest. Brazil can benefit from Israel’s know-how on the subject, while Israel takes advantage of Brazil’s strategic launch sites near the equator.

Along with defense, water scarcity is an issue where Israel’s knowledge and experience will come in handy for Brazil. Israel is a global leader in irrigation technology, including drip watering, desalination and extracting moisture from the air. Innovation in the field has enabled it to overcome arid and desert conditions to sustain agriculture, and that ingenuity could be invaluable for Brazil. The South American country’s semi-arid Northeast region is currently in the throes of a yearslong drought that has hurt local economies and populations that rely on rainfall for their agricultural activities. The Brazilian government historically has taken an ad hoc approach to addressing these problems, for example by trucking in large volumes of water to alleviate droughts. Working with Israel, Brazil could devise a longer-term strategy to mitigate the effects of uneven rainfall and lay the necessary groundwork to keep developing the Northeast. The Brazilian Senate unveiled plans for such an initiative early last year, and the topic will be a priority when Bolsonaro visits Israel, as he is expected to do in the first quarter of this year.

A Pragmatic Partnership

For all that renewed cooperation has to offer Brazil and Israel in the economic and tactical spheres, from a political standpoint, the gains are modest. Aligning with Israel will help Brazil ingratiate itself with the United States, while giving Israel more diplomatic support – an asset for a country surrounded by enemies and frequently subject to scrutiny, if not censure, on the international stage. Other than that, though, neither side has much political capital to offer the other. Its shift toward Israel, in fact, has prompted speculation that Brazil would lose allies in the Arab world. But as Netanyahu works to normalize relations with Arab countries in response to Iran’s growing influence in the Middle East, the risks of a diplomatic backlash will diminish for Brazil.

The growing partnership between Israel and Brazil is a pragmatic one, based on complementary needs and priorities. These needs – whether economic, military or environmental – are driving the two countries together, Brazil in its quest to develop its economy and assume greater influence in global affairs, and Israel in its effort to find new overseas markets to boost its economy.