Emerging markets: will the economic catch-up continue? (2024)

Article tagsEconomyTradeGlobalCountry Analysis

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• Emerging markets outperformed developed economies in the two decades prior to the covid-19 pandemic.
• Deteriorating global economic conditions will limit emerging markets’ near-term growth prospects, but we still forecast that they will expand more rapidly than developed economies in the longer term. Most emerging economies in Asia are set to grow by 2-3% per year in 2022-50; by contrast, growth in the US and much of western Europe will average only about 1-2%.
• Many fast-growing emerging markets have investment climates that are difficult to navigate, but investors often appear willing to put up with the inconvenience of difficult operating conditions in exchange for natural resources, efficiency gains, or the potential rewards that come with a large domestic market.
• Some sectors will be particularly important in driving growth in emerging markets. The expansion of non-traditional financial services, investment in technology and innovation, and a move up the value chain in manufacturing are all likely to feature on the policy agenda of fast-growing emerging markets.

In the two decades before the pandemic emerging markets largely outperformed developed markets. Rapid growth resulted in an increase in emerging markets’ share of global GDP, largely at the expense ofwestern Europe. Results in Asian emerging markets were particularly striking; even aside from China’s (and, to a lesser extent, India’s) meteoric rise, countries like South Korea and Indonesia consistently outperformed.

There is no single explanation as to why emerging markets as a group experienced such strong growth. The factors driving China’s expansion—growth of resource-intensive manufacturing and exports, facilitated by favourable dynamics (specifically a huge pool of low-cost labour)—were very different to India, where growth was mainly fuelled by services. Growth in Latin America tended to be explained either by developing low-cost manufacturing exports that served the North American market, or by exporting commodities to China. In central and eastern Europe, large-scale expansion of the EU in the mid-2000s meant that these economies became integrated into western European supply chains, supporting stronger export-led growth.

Will the catch-up story continue?

Emerging markets face a number of challenges that will make it more difficult for these economies to outperform developed economies in the near term.The most acute threat comes from the tightening of global monetary policy, which will make it more difficult to attract investors to domestic debt markets while also making it more expensive to service existing debt—doubly so for those economies that borrowed in US dollars, given that currency’s current strengthening. At the same time soaring global commodity prices are putting pressure on natural-resource-poor emerging markets (many of which already run current-account deficits). This impact is aggravated by shakier investor sentiment, which is weakening financial inflows at a time when they are needed more. The fact that food tends to account for a much larger share of the consumer price basket in emerging markets is further exacerbating the impact of skyrocketing prices for grains and vegetable oils.

Notwithstanding these challenges, we expect real GDP growth to remain stronger in emerging markets than in developed economies in 2022-26. We forecast average annual growth in the OECD of 1.8%, compared with 3.9% in non-OECD economies. By region, Asian growth will remain firmest (Association of South-East Asian Nationscountries alone are forecast to grow by an average of 4.7% per year in 2022-26), although the pace of expansion in the Middle East and North Africa will also be strong (averaging 3.4% per year). Growth in Latin America, however, will remain lacklustre, at 2.2% per year.

In the longer term, catch-up by emerging markets is likely to continue. Growth in emerging markets is forecast to slow, but continue to outpace the expansion in developed economies. Most emerging economies in Asia are set to grow by 2-3% per year in 2022-50; by contrast, we forecast that the pace of growth will average just 1-2% per year in the US and in much of western Europe.

What will drive catch-up?

Long-term growth is driven by three main factors: demographics (labour force productivity), investment (accumulation of capital stock) and technological advancements (which help to drive total factor productivity—TFP). Emerging markets have traditionally had a clear demographic advantage, with younger populations, giving them scope to catch up with developed markets. However,over time, emerging markets’ demographics will start to become less favourable (in some, such as China, this is already evident), meaning that growth will increasingly have to come from productivity gains. This makes factors such as the business environment, the security situation and issues such as corruption also important in terms of affecting TFP, and thus affecting growth in emerging markets.

In reality many of the fastest-growing emerging markets have investment climates that are difficult to navigate. Market size and related opportunities will also remain important, with investors often willing to put up with difficult operating conditions in exchange for the big potential returns that come from successful investment in countries with large domestic markets or major efficiency gains (for example, in low-cost manufacturing). The aforementioned constraining factors are also likely to hamper potential GDP growth, implying thatfast-growing emerging markets would be able to expand even more rapidly if they made greater progress on improving their investment climates.

Which sectors matter?

Although there is no one-size-fits-all explanation as to why fast-growing emerging markets have performed particularly well, some sectors will be more important in determining which economies grow rapidly in the coming years. Rapid expansion of non-traditional forms of financial services will provide innovative solutions in markets that have long been underserved by banks. New payment methods, some pioneered by fintech firms, will drive the proliferation of digital transfer channels between individuals, firms and governments.

Investment in technology will also help to drive growth in emerging markets, through the adoption of digital technology and artificial intelligence (AI). Emerging markets that focus on upgrading physical infrastructure in order to expedite the adoption of fifth-generation (5G) technology, for example, will be better placed to take advantage of these developments. In many of these economies, governments are dovetailing these efforts with a drive towards moving up the value chain in manufacturing production. In the past emerging markets have tended to focus on low-wage reassembly work, but the more successful ones are now shifting towards the production of more complex (and profitable) goods.

Wed, 12th Oct 2022Article tagsEconomyTradeGlobalCountry Analysis