hankyoreh

Jayati Ghosh

The idea that the rise of emerging economies like China and India in the early twenty-first century would usher in a boom for the global economy was nothing more than “euphoria,” a noted scholar claims.

The argument from Jayati Ghosh, a professor at India‘s Jawaharlal Nehru University, came during her keynote speech at the sixth Hankyoreh Asia Future Forum held at the Sheraton Grande Walkerhill hotel in Seoul on Oct. 28-29.

Ghosh is a world-renowned development economist who has focused mainly on the economies of emerging and developing countries.

The emerging markets are currently stumbling, as various indicators show. Economic forecast numbers released by the International Monetary Fund (IMF) early this month suggested economic growth rates for emerging economies as a whole would be worse this year than last. Emerging economic growth rates have been in decline for the past five years, in contrast with advanced economies like the US that have shown some signs of slight improvement.

The emerging economies are also losing funds. As recently as last year, there was a net influx of capital accounts, but most analysts predict outflows will exceed inflows this year.

“This would be the first time in the last twenty years that there has been a net outflow of emerging economy capital accounts,” Ghosh said. “And those capital outflows stand a strong chance of accelerating if a US interest rate hike becomes a reality.”

So what happened? In the wake of the 2008 global financial crisis, it was the emerging economies that helped sustain global economic growth while the advanced economies were reeling. Many touted the prospects of the so-called “BRICs” -- Brazil, Russia, India, and China -- which were seen as large both in scale and in growth potential. Numerous BRICs-linked financial investment fund products emerged domestically and abroad, and net capital inflows reached the level of US$500 billion a year.

But now Brazil and Russia are facing their own economic downturns. Chinese Premier Li Keqiang appeared to be bracing for a growth rate decline this year when he recently said the seven percent projected economic growth rate was never set in stone.

In the words of Hyman Minsky, the economist who explained economic cycles in terms of the expansion and contraction of credit supplies, the emerging economies have slipped rapidly from “euphoria” to “revulsion.” The interesting question is how economies with such a relative lack of experience with capitalism became so quickly exposed to financial risks and instability.

This is the area that Ghosh explores. Understanding the crisis currently facing the emerging economies requires a dissection of the nature of “expectations” channeled onto them early on, she claims.

South Korea’s own experience suggests that some early capital accumulation is necessary if underdeveloped countries are to achieve economic development. Funds are typically introduced from overseas for that purpose. In the South Korean case, overseas aid and foreign loans were used to build economic and social infrastructure such as roads and railways, which were then used as the groundwork for economic growth.

But the funds that have poured into emerging markets since the 2000s have been of a different nature. Instead of being used for direct investment in factory building, they have stayed chiefly in the financial sector, where they have been used to generate profits from the rate of return differences between different assets and countries, Ghosh says.

Much of the money that has gone into emerging economies has indeed been invested in the real economy. But even there, the goal has been to produce financial profits rather than to reflect the daily needs (effective demand) of people. It is no coincidence that the emerging economies have all recently been going through bubble-dependent booms in their real estate, asset, and/or securities markets, albeit at different times. The asset bubble in emerging economies was also an important factor shoring up the global economy amid the downtown for the advanced economies after the 2008 crisis.

Ghosh argues that attention should be paid to the environmental factors that allowed funds to flow so freely into emerging economies when they weren‘t paying off in the advanced economies. The phenomenon was boosted externally by an unprecedented trend of “financial globalization,” and institutionally by capital account liberalization that opened capital markets widely to foreign investors, she says.

Various financial liberalization measures combined to utterly change the nature of economies in emerging countries, including South Korea. Many companies now opt to pursue easy profits through financial methods rather than hiring large numbers of people to make products. For individual investors, the rational choice at a time when a global recession has hurt rates of return on real sector investment has been to venture into financial areas. And with finance specializing by nature in the brokering of funds, financial development has served to boost economic efficiency and reduce risk.

But rapid financialization has spurred growing debt for families and corporations, which lurks as a major potential risk in emerging economies like South Korea. Clear limits also exist to debt-driven emerging economies at a time when real growth is unsupported. Instead of being a product of increased economic efficiency and growth, debt is now something that economic growth actually depends upon -- a phenomenon Ghosh calls “debt-driven growth.”

Another frequent occurrence when an economy is skewed too heavily toward the financial side is for foreign funds to suddenly pull out in response to some outside shock. In other words, emerging economies are inevitably left more vulnerable to such shocks. This, according to Ghosh, is the root of the current “emerging economy threat” to the global economy.

“There is no future for emerging economies that attempt to grow in this way,” she declared.

“The important thing for emerging economies is to lay the groundwork for sustained growth by redesigning the economic production structure around high value-added industries,” she added.

According to Ghosh, it is the ongoing financialization of emerging economies over the past decade or so, and the resulting temporary growth, that are having the effect of eroding long-term growth potential.

By Kim Gong-hoi, researcher at the Hankyoreh Economy & Society Research Institute

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