Emerging economies as saviours ?

OVER the past two years, industrial countries have experienced bouts of severe financial instability. Currently, they are wrestling with widening sovereign-debt problems and high unemployment. Yet emerging economies (EEs), once considered more vulnerable, have been remarkably resilient. With growth returning to pre-2008 breakout levels, the performance of China, India, and Brazil is an important engine of expansion for today's global economy.

High growth and financial stability in EEs are helping to facilitate the massive adjustment facing industrial countries. But that growth has significant longer-term implications. If the current pattern is sustained, the global economy will be permanently transformed. Specifically, not much more than a decade is needed for the share of global GDP generated by developing economies to pass the 50% mark when measured in market prices.

So it is important to know whether this breakout growth phase is sustainable. The answer comes in two parts. One depends on EEs' ability to manage their own success; the other relates to the extent to which the global economy can accommodate this success. The answer to the first question is reassuring; the answer to the second is not. While still able to exploit the scope for catch-up growth, EEs must undertake continuous, rapid, and at times difficult structural change, along with a parallel process of reform and institution building. With government policy remaining on course, we should expect a gradual strengthening of endogenous domestic growth drivers in EEs, anchored by an expanding middle class. Combined with higher trade among them, their future is one of reduced dependence on industrial-country demand, though not a complete decoupling.

Distribution as well as growth matter. EEs still need to manage better their growing domestic tensions, which reflect rising income inequality and uneven access to basic services. A failure on this front would derail their strengthening domestic and regional growth dynamics. This's better understood today, with distributional aspects of growth strategy being firmly placed on EEs' policy agendas.

While EEs can deal with the slowdown in industrial countries, the financial-sector transmission mechanism is more challenging. Today's low interest-rate environment is causing a flood of financial flows to EEs, raising the risk of inflation and asset bubbles. The hiccups in western banks have served to disrupt the availability of trade credits, and, if amplified, could destabilise local banks.

These risks are real. Fortunately, several EEs continue to have cushions and shock absorbers. Having entered the 2008-09 crisis with sound initial conditions, they are nowhere near exhausting their fiscal and financial flexibility — and hence their capacity to respond to future shocks. Overall, EEs are well placed to continue to navigate successfully a world rendered unstable by crises in industrial countries. Yet, again, the decoupling is not complete. A favourable outcome requires industrial countries' ability and willingness to accommodate the growing prominence of EEs. The risks here are significant.

The flow of knowledge, finance, and technology that underpins sustained high growth rates in EEs is closely linked to an open, rule-based, and globalised economy. Yet this global construct comes under pressure in an environment in which advanced countries have stubbornly high unemployment and bouts of financial volatility. Hence, such continued openness cannot be taken for granted. Political and policy narratives are becoming more domestic and narrow, while the global agenda and the pursuit of collective common interests are having greater difficulty being heard. These challenges will grow.

Managing an increasingly complex set of transnational connections is an even bigger challenge in a multi-speed world that is being turned upside down. Such a world needs better global governance, as well as overdue institutional reforms that give EEs proper voice in global institutions. In the absence of such changes, the global economy may bounce from one crisis to another without a firm hand on the rudder to establish an overall sense of direction. The result is what economists call Nash equilibria, or a series of suboptimal and only quasi-cooperative outcomes. Where does all this leave us? EEs will be called on to play an even larger role in a multi-speed global economy characterised by protracted rehabilitation of over-extended balance sheets in industrial countries. Left to their own devices, they are up to the task. But they do not operate in a vacuum. EEs' ability to provide the growth lubrication that facilitates adjustment in industrial countries is also a function of the latter countries' willingness to accommodate tectonic shifts in the operation and governance of the global economy.

Let us hope that these global issues receive the attention they require.