Emerging markets will struggle to escape secular stagnation

Developed market economies, bloated and solipsistic as they are, hog as much attention as they can in the field of global economics. Currently they are dominating a debate about an apparent slowdown in long-term rates of growth, which generally goes under the name of "secular stagnation".

Yet, as the International Monetary Fund and others have warned, the phenomenon of slowing trend growth stretches across emerging markets too - if anything even more so. The causes may be different, but the challenge of reversing the unwelcome development is no less difficult. Not only that, but the unusual pattern of the slowdown must surely raise some questions about how durable it is.

In a recent, much-read, analysis, the IMF says that "secular" or trend growth has fallen across the developed markets from 2.25 per cent before the crisis to 1.6 per cent over the next five years, with an even sharper fall among EM countries. Having risen in the decade before the crisis to 7.2 per year - and the rise was in EM countries as a whole, not just China - trend growth since 2008 has slid to 6.5 per cent and is expected to drop over the next five years to 5.2 per cent.

Although some argue that the problem in the advanced economies is the slowing of technological innovation, the debate there has generally homed in on a demand-side rather than a supply-side explanation. Pessimists such as Lawrence Summers, the former US Treasury secretary and White House chief economic adviser, argue that the long-term real rate of interest has fallen such that monetary policy, which it is hard to loosen below the "zero lower bound" of interest rates at nil, cannot be eased enough to bring the economy back into equilibrium.

Hardly anyone believes the same for emerging markets. With the exception of one or two countries such as the Czech Republic and Israel, EM interest rates generally have considerable space to fall and, in any case, higher rates of trend growth and inflation mean that negative real interest rates can be achieved more easily without going below zero.

However, what emerging markets do apparently face - and some argue that they share this problem with advanced economies - is a slowdown in trend growth apparently related to a deceleration in the pace of technological advance and the ability to implement it.

According to the IMF, the pattern of secular slowdown in EMs has been quite different from that in the rich countries. While the latter appeared to be flagging even before the global financial crisis hit in 2008, emerging economies actually accelerated in the decade before the crisis and only hit stronger headwinds thereafter.

There is something a little puzzling about this conclusion. The weakening since the crisis seems to have resulted not from lower labour supply or investment but from a slowdown in total factor productivity - the ratio of output to all inputs - which aims to capture how well economies absorb and deploy technologies.

Few would doubt that reforms to promote faster growth in EMs have been sporadic and unimpressive since the long boom began in the early 2000s. But it seems a little odd that productivity improved rapidly nonetheless in the years before the crisis and slowed across the emerging market world thereafter. True, a prolonged cyclical downturn can itself reduce trend growth by the scarring effects of unemployment and bankruptcies. Yet the EMs in general did relatively well surviving the ravages of the crisis, and grew strongly in the five or six years following.

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It is true that trend growth tends to slow the more that countries approach the technology frontier and their expansions decelerate to match that of the rich economies. But emerging markets have started to slow at much lower levels of per capita GDP than rich economies. Moreover, poorer countries within the EM world have slowed just as richer ones have.

Since TFP is notoriously difficult to calculate, it may well be the case that the slowdown in trend is more apparent than real. Still, it would be intensely foolish to assume that the problem will go away on its own - especially since EMs have some undeniable growth problems still to come, particularly the shrinking of the workforce as a share of the population thanks to demographic transition. In China's case in particular, investment-to-capital ratios are likely to decline as the economy shifts away from exports and investment and towards consumption.

For emerging market governments, then, there seems little alternative than to continue to try to tinker with their economies to promote growth. For advanced economies, the wisdom of attempting structural reform at a time that growth is low and inflation nil or negative is questionable, if it provokes uncertainty that reduces confidence and demand. For emerging markets that have monetary and fiscal room to compensate for such an effect, that caveat is much weaker.

None of these problems is new. Economists have been worrying over the middle-income trap of economies slowing at relatively low rates of per capita GDP for a long time, and various solutions to increasing productivity have been mooted. But they have been given a new urgency by the apparent confirmation that the trend slowdown is real, that it stretches across the emerging market world, and that - just to give advanced economies a final look-in - that it is taking place amid a global deceleration of output in the medium term.

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