Global Growth Trends and Emerging Markets

The OECD’s recent report on the long-term growth potential of the global economy  (Link) provides valuable insights on prospects for investing in emerging markets.  Any such exercise on long-term forecasting is fraught with difficulties, as it combines relatively certain variables (population growth and ageing, fiscal sustainability, the catch-up of emerging economies) with complicated assumptions (eg. globalization, technological development) and relies heavily on the extrapolation of the status quo. Nevertheless, the report provides a practical view on medium to long-term prospects for emerging market countries that can be useful in evaluating investment opportunities.

The first chart below shows the expected growth rate of the global economy.  OECD’s economists  expect a significant slowdown in global growth, from 3.7% to 2.7% over the next decade. This assumes steady 2% growth in the OECD, but a sharp slowdown in BRIICS (Brazil, Russia, India, Indonesia, China and South Africa), from 5.5% in 2017 to 3.6% in 2030. The slowdown in BRIICS comes  mainly from much  lower growth in China.

The following chart shows the impact of the expected slowdown in China on the dynamics of global output. China has been the main driver of global growth since 2006, and its contribution to global growth peaked at nearly 50% in 2010 during its massive debt-fueled fiscal expansion which it conducted in response to the global financial crisis. By 2030 China is expected to contribute only 30% of global GDP growth, no more than the  OECD’s share, and it is expected to fall further after that. However, the rapid rise of India will partially compensate for China’s decline, so that if we look at China and India together – a hypothetical “Chindia” – we see that over 60% of global growth will continue to come from these two economies through the middle of the next decade. Over half of global growth will continue to come from “Chindia” for the next 25 years.

 

In fact, as shown in the next two charts, China’s share of global output, will peak over the next ten years. While the OECD’s share of global output will decline from 55% to 47%, China’s share of global output will rise from the current 23% to around 27% by 2030 and then stabilize around that level. This is because China is moving up the technology frontier at a time when the ageing of the population will impact the size of the workforce.   India will take the helm from China to become the main driver of global growth. It faces an entirely different situation than China because it lies very low on the technology frontier and has enormous room to grow its workforce through urbanization and the incorporation of women in the workforce.   “Chindia’s” share of global output will rise from 31% to 40% by 2030 and equal the OECD by 2040.

 

The rise of China and India, and also Indonesia to a lesser degree, are shifting the center of gravity of the world’s economic activity towards Asia. This cause a “remoteness” effect detrimental to countries that are far from Asia. Countries that for past decades have benefited from being near the all-important U.S. consumer market will now bear a remoteness cost with regards to their role in Asia. The chart below shows the winners and losers from this effect.

 

Finally, the OECD decomposes the structure of GDP per capita growth for the past two decades, the proximate future (2018-30) and the long term (2030-60), showing the contributions from labor, capital, working age population and active workforce. The data shows that China’s past growth has come mainly from labor efficiency (migrants moving from farm to factory) and to a lesser degree from more active workers. All of these growth factors for China are declining decade by decade, with a growing negative effect from labor supply. It is interesting to note that by 2030, China’s GDP per capita growth will be only slightly higher that that of the United States while total GDP growth may actually be lower in China because of worse demographics.

The OECD data also illustrates that relatively few emerging markets will maintain a significant growth premium for the next decade (China, India, Indonesia, Turkey); most will have  GDP per capita growth not to different than the U.S. with similar demographic trends (Latin America and South Africa); and Russia has a significantly worse growth profile. These growth profiles need to be incorporated into valuations.

Conclusions

  • For the next ten years and well beyond global growth will be driven by “Chindia.” Given that well over half of global growth will come from these two countries and this may be sustained for an extended period of time creating very large compounding effects, it would seem foolhardy for emerging market investors to not focus most of their attention on these two markets.
  • Over the next decade and beyond,  the world’s center of economic activity will continue to move to Asia. This creates important proximity benefits for countries within the region or with close ties (eg., southeast asia, northeast Asia, Australia, Iran) and remoteness costs to distant nations (eg., Latin America)
  • India will increasingly drive growth. As China increasingly competes with developed economies its growth will slow.
  • Concerns that China will dominate the world economy are probably misplaced. It is likely to become the largest economy in the world over the next 10-15 years but this will be at at time when growth has slowed substantially due to demographic pressures. Also, China’s authoritarian model is likely to create impediments to growth as it becomes more prosperous.
  • Many emerging market countries need to implement reforms to boost their growth profiles. Brazil is a good example of a country that can significantly improve its growth profile through market-friendly reforms.

Macro Watch:

  • Long View scenario for global growth (OECD)
  • Brazil: The first global domino tips (Alhambra Partners)
  • Europe is working on alternative to SWIFT (Zero Hedge)
  • BOE’s Haldane take on Institutions and Development (BOE)
  • Emerging vulnerabilities in emerging economies  (Project Syndicate)

India Watch

  • 70% of rail tickets booked on smartphones (Mumbai Mirror)
  • Buffett invests in India payments platform (WSJ)
  • India’s growing clean air lobby (BNEF)

China Watch:

  • China is bracing for a new cold war (AXIOS)
  • China’s long term growth will slip below the U.S. (Bloomberg)
  • China’s greater bay area (FT)
  • What does a Chinese suerpower look like? ( Bloomberg)
  • The rise of China’s super-cities (HSBC)
  • China’s urban clusters fuel growth (Project Syndicate)

China Technology Watch

  • China’s authoritarian data strategy (MIT Tech Review)
  • China leads in CRISPR embryo editing (Wired)
  • China’s EV start-ups forced to seek state partners (QZ)

EM Investor Watch

  • Emerging markets are no bargains ( WSJ )
  • Par for the course in EM (Bloomberg)
  • Brazil’s health catastrophe in the making (The Lancet)
  • The burden of disease in Russia (The Lancet)
  • Brazil’s nostalgia for dictatorship (NYT)
  • Turkey’s problem is not going away (Bloomberg)

Tech Watch

  • Tesla; software and disruption (Ben Evans)
  • EV sales are ramping up (Bloomberg
  • China and Japan agree to EV charging standard (Nikkei)

Investing