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What's going on in emerging markets (EM)? After decades of economic growth, some of the EM countries, such as Brazil, Russia, India and China, are experiencing progressive deceleration or economic stagnation. Sure, there are outside factors at play, such as weak growth in the economies of major trading partners, particularly the Eurozone and Japan. A greater concern for most investors is, however, whether the recent weakness of EM economies reflects more fundamental structural problems that would prevent a reacceleration of their economic growth over the longer term.
In most cases, the current weakness in EM economies is due to the type of structural issues that have proven difficult to resolve in most cases throughout history. Structural reforms require a broad-based pro-reform political coalition that can overcome the inevitable backlash from entrenched interest groups benefitting from the status quo. In most cases, reform groups fail at this task. Without reforms, economic growth will weaken and financial instability and political acrimony may ensue. Indeed, some countries have become caught in the so-called middle-income trap that prevents their economies from converging with more advanced economies.
Reform sometimes has a better chance of success when a country is mired in a severe and/or prolonged economic crisis, which may motivate the population to support a break from the status quo.
Even when a country does manage to implement major reforms, it should not rest on its laurels, however. Reforms must not lose momentum once economic growth resumes, an error many South American nations made after the 1960s.

Argentina, Brazil, and other countries that have pursued trade protectionism, import substitution and the infant industry model of economic development since the 1950s have periodically enjoyed rapid growth, but have not been able to sustain it over the long term. These nations have ended up with uncompetitive manufacturing sectors and over-reliance on raw material exports, which condemns their economies to frequent boom-bust cycles. The only solution is sustained reform that fosters efficiency and international competitiveness, key elements of which are lifting trade barriers and empowering the private sector to rise to the challenge.
EMs that have sustained structural reform more consistently, such as Hong Kong, Taiwan, South Korea and Singapore, have benefitted handsomely by achieving very elevated standards of living. To be sure, the countries that have achieved rapid economic expansion since the end of World War II have all benefited greatly from postwar international agreements that spurred globalization and international technology transfer and facilitated foreign direct investment. But the EMs that have benefited most from globalization are the ones that have implemented progressively deeper economic reforms, such as in China, South Korea and Taiwan.
Any economy growing at a super-charged rate will eventually experience progressive deceleration as the population becomes more affluent and its income per capita approaches convergence with advanced economies. Such convergence has been very rare since World War II, more or less limited to a small number of countries in Europe and the Far East. Failure to sustain reform over the long term remains the primary reason for the failure of many EMs to overcome the middle-income trap.
Farid Abolfathi is senior director, economics and country risk, at IHS
Posted February 4, 2015


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