Emerging Markets, Hitting a Wall
By TYLER COWEN
A GROWTH slowdown in the so-called BRICS nations — Brazil, Russia, India, China and South Africa — could be impeding the expansion of the global economy. That’s serious enough, and indeed we are seeing unrest in Brazil over stagnant living standards. Yet a graver problem may be lurking behind the headlines — namely, that sustained, meteoric growth in emerging economies may no longer be possible.
The disconcerting truth is that the great “age of industrialization” may be behind us, a possibility that has been outlined most forcefully by the economist Dani Rodrik, who is leaving Harvard for Princeton next month. And evidence for this view is coming from at least four directions:
THE RISE OF AUTOMATION First, machines can perform more and more functions in manufacturing, and sometimes even in services. That makes it harder to compete via low wages.
Say you run a company in a developed nation and have been automating many of its processes. Because your total bill for employee wages would be low, why not choose the proximity and familiarity of investing in labor in or near your home country? This change would help the jobs picture in the United States and probably countries like Mexico, but could hurt many other lower-wage nations.
GLOBAL SUPPLY SOURCES Supply chains are now scattered across many countries. Think of the old development model as a nation, such as South Korea, trying to build a nearly complete domestic supply chain for its automobile and other industries. The newer model is more distributed, as reflected by the iPhone, with the bounty from the investment spread across many locations, including the Philippines, Taiwan and mainland China. As for cars, Thailand has courted automobile factories with success, but the parts usually come from outside the country and the benefits for the Thai economy are limited.
Richard Baldwin, professor of international economics at the Graduate Institute in Geneva, refers to the internationalization of the supply chain as “globalization’s second unbundling.” He sees the new world as one of “development enclaves,” in which parts of countries will stand out as advanced or wealthy, without fundamentally transforming the entire economy.
WIDER ECONOMIC GAPS Another barrier is the difficulty of sustaining a cultural vision for catching up economically. South Korea was a poor nation in the 1960s, and its economic rise required sacrifices from millions of people in work hours, savings and investment in education. But within 20 years or so, one could see that South Korea would most likely join the ranks of economically developed nations. Indeed it has, so these sacrifices yielded satisfaction within a reasonable time. Many of today’s poorer nations seem to be more than 20 years away from competing with the global leaders, which are now themselves more advanced, and that slower and longer path to the top may discourage some countries from even trying.
AGING POPULATIONS Finally, many lower-income countries will be old before they are rich. China’s population, for example, is aging rapidly, given the government’s one-child policy and the decline in birthrates that accompanies rising income. It is less well known that fertility rates in much of the Middle East and North Africa are also falling rapidly. In Iran, for example, it is now estimated at 1.86 per woman, which over time would mean that families are not replenishing themselves. And shrinking and older populations, of course, limit future economic growth.
BY no means do these arguments mean that the living standards of poorer nations must stagnate. A country can improve the lot of at least some of its citizens by selling services, as seen in the relative prosperity of Bangalore, India, which, among other activities, runs call centers and sells many programming services online. Many African nations are marketing their resource wealth, and may also improve productivity in local agriculture. Virtually all poor nations eventually benefit from the innovations of wealthy nations, which they often receive at much lower prices, as seen with cellphones and medications, for example.
So the chances for progress remain, but those poorer nations might never “become like us.” There was something special about the 20th-century mix of widespread, well-paying manufacturing jobs, which enabled the rise of a middle class that would take significant control of government, through its roles as voters and taxpayers. Those manufacturing jobs also created strong incentives for many people to pursue traditional education, whether in Toronto or Tokyo.
The best guess is that the idea of economic catch-up has changed, which means that politics in developing nations could change, too. Just as inequality in income and wealth has been rising in the United States, newly growing nations find themselves in a more stratified world, without developing their own strong egalitarian histories to undergird political institutions or economic expectations. Many of the wealthy may produce their public goods — like secure streets and clean, beautiful parks — in gated communities.
In some countries, there may be a de facto “rule by consent” from abroad — if, for instance, you are an African working in a Chinese-owned mine and living in a company town, while receiving your vaccines from a Western nonprofit organization. Those phenomena might not fit our current notions of national pride very well — and might mean further splits within developing nations.
Indeed, the future path of developing countries could be much different from that of recent, high-growth success stories. The next set of emerging-market winners, for example, may retain very large pockets of poverty. And as the expectation of a single, common path for economic development fades, governments may need to rethink what they can accomplish — and how.
In any case, we should be prepared for the possibility that, while Seoul now looks a fair amount like Los Angeles, perhaps La Paz, Accra and Dhaka will never look much like Seoul.
In Brazil, a Reminder of Emerging-Market Risks
By TIM GRAY
THE protests in Brazil last month were the latest vivid reminder of the perils of investing in emerging markets. Tens of thousands of demonstrators thronged the streets of São Paulo, Rio de Janeiro and other cities, incited partly by a rising cost of living and a slowing economy. Cars burned. Tear gas billowed. And the Brazilian stock market sank.
Yet Brazil was one of the investment darlings of the last decade — the “B” in the ballyhooed BRIC quartet that also included Russia, India and China. Brazil’s economy at times grew at a rate of more than 5 percent a year. Most years, its stock market rose by double digits — in 2009, it returned more than 100 percent. Millions of people moved from poverty into the middle class, and Brazilian companies, like the oil driller Petrobras and the mining concern Vale, attained international prominence.
So far this decade, though, the Brazilian stock market has been a bust. It has dropped by a cumulative 25.3 percent over the last three years, and it has dragged Latin America stock mutual funds down with it. In the first half of 2013, Latin America funds tracked by Morningstar lost almost 17 percent, on average. Over the last three years through June, they lost 4.6 percent a year, annualized. But over the much longer term, they have still fared the best among emerging-market regional funds tracked by Morningstar, returning 16.7 percent, annualized, over the last decade.
“Brazil needs to grow,” said Will Landers, manager of the BlackRock Latin America fund. “It has to deliver a G.D.P. growth rate above 2.5 percent, or investors are going to stay away.” Growth sagged in 2012, with gross domestic product increasing less than 1 percent.
As the bellwether for South American bourses, Brazil has had problems that affect investors in the entire region. Brazilian stocks account for nearly 60 percent of the MSCI Emerging Markets Latin America index and thus the same amount of passively managed funds, like the iShares MSCI Emerging Markets Latin America exchange-traded fund, that track the index. “You’re going to be investing in Brazil if you run a Latin America fund,” said Andres Calderon, manager of the Natixis Hansberger Emerging Latin America fund. Brazilian stocks recently made up about two-thirds of the assets of both Mr. Calderon’s and Mr. Landers’s funds.
Add in Mexico, the region’s other big economy, and Latin America funds can end up looking like concentrated bets on a couple of countries. Mexican companies recently accounted for 25 percent of the MSCI index, 22 percent of the BlackRock fund’s assets and 22 percent of the Natixis fund’s assets. The remaining countries in the MSCI index are Chile, Colombia and Peru.
Actively managed funds can typically hunt more broadly for investments than in just those five countries. BlackRock’s fund, for example, recently held shares of Copa Airlines in Panama.
But the relatively small size of economies and stock markets in Chile, Colombia and Peru can prevent them from adding much oomph to big portfolios. With a G.D.P. of about $250 billion, Chile’s economy is roughly equal to Minnesota’s, while Peru’s is akin to Oregon’s.
Still, portfolio managers see promise in this trio, particularly Peru. “Peru is the highest-growth country in Latin America,” said Luis Carrillo, lead manager of the J.P. Morgan Latin America fund. “It’s growing at Chinese rates — 7 to 8 percent annual G.D.P. growth for six or seven years. The government has learned that growth is the best way to bring people out of poverty.”
Peru’s stock market remains nascent, without the diversity of companies typical of a mature market. “So far, it’s made up mainly of mining and metals companies, so it’s more of a play on commodities,” said Luiz Ribeiro, São Paulo-based manager of the DWS Latin America Equity fund. But domestic consumption is growing, and that should soon yield the kinds of consumer companies that Mr. Ribeiro and other managers say represent the future for stock investing in Latin America.
Managers of Latin America funds often caution that the region and its markets, for all of their promise, remain volatile — as recent events in Brazil have shown.
Thus Adam J. Kutas, manager of the Fidelity Latin America fund, suggests a fund like his should account for no more than 5 percent to 10 percent of a typical diversified portfolio. “These are markets that are earlier in their growth phase than the U.S. or Europe,” Mr. Kutas said. “They can add a lot of enhanced return, but you have to be comfortable with the risk.”
Some commentators recommend even greater conservatism. David Snowball, publisher of the Mutual Fund Observer, an online newsletter, said that most retail investors might be better off staying away from any fund aimed at a single emerging region. “You want to invest where you have a comparative advantage — better contacts or better information,” he said. Most retail investors have neither the contacts nor the expertise to determine whether they should overweight Latin American stocks as compared with, say, those of Asia or Eastern Europe, he said. Instead, he advised, they should stick with broadly diversified offerings.
Mr. Kutas took a different view, noting that a growing number of people in the United States do have firsthand Latin America knowledge. Many have roots and family in the region, travel there regularly and speak Spanish or Portuguese.
“If you do have a personal connection, that can help you understand the risk you’re taking on,” he said. “And if you want to invest in the region you come from or participate in the opportunities you see there, a Latin America fund is one way to do it.”
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