Ignore emerging market economies at your peril

Over the past decade, the emerging market economies have been the primary source of world economic growth, and they now account for around one half of the global economy. This has to make their more recent economic slowing and darkening economic prospects of considerable concern to global economic policymakers.

This would seem to be particularly the case considering that the emerging market economic slowdown has been occurring not at a time of global monetary policy tightening but rather at a time when the world’s major central banks have been shifting to an easier monetary policy stance.

{mosads}There can be little doubt that output is now falling in a number of smaller emerging market economies, including Argentina, Iran, Turkey and Venezuela. Nor can there be much doubt that the economic prospects in these countries will all too likely worsen meaningfully in the months ahead.

Indeed, the Iranian and Venezuelan economies are already on the verge of collapse, as the U.S. substantially tightens its economic sanctions on these two countries. Meanwhile, political considerations in both Argentina and Turkey make it unlikely that these two countries will be able to defuse their currency crises any time soon.

October elections in Argentina are darkening that country’s economic outlook by raising the prospect that the reform-minded government of President Mauricio Macri will be replaced by an anti-market Peronist-style government. At the same time, the forthcoming rerun of the Istanbul local election is encouraging populist economic policies in Turkey that are hardly inspiring investor confidence.

Of very much more concern for the world economic outlook, however, is the slowing in economic growth and the worsening of economic prospects in China and Brazil, the world’s second and seventh largest economies, respectively.

Already before the worsening in U.S.-China trade relations, the Chinese economy was slowing down to a 6 to 6.5 percent growth rate — its slowest rate in over a decade. It was doing so as the Chinese government was trying to rebalance China’s excessively investment-dependent economy and wean it from an over-reliance on rapid credit growth.

With the recent intensification of U.S.-China trade tensions, even that slower growth would now appear difficult for China to attain. Equally troubling is the seeming hardening of positions on the trade issue for political reasons in both China and the United States, making an early resolution of the dispute unlikely.

Meanwhile, in Latin America’s largest economy, earlier hopes that the new Brazilian government would revitalize that country’s economy is giving way to fears that the country might again be relapsing into an economic recession. Worse yet, signs that the new Brazilian government lacks the coherence or the support in Congress to address the country’s serious public finance challenge, or to reform its pension system, is leading to a loss of investor confidence and to a substantial weakening in Brazil’s currency.

U.S. policymakers would make a grave mistake to dismiss the emerging market economies’ diminishing economic prospects as an event occurring abroad with little likely impact on the U.S. economy.

While it is true that the U.S. economy is unlikely to be hurt by the emerging market economies through the trade channel, the same cannot be said of the financial market channel. If global financial markets were to get roiled by the spillover of slower emerging market economic growth to the Asian and European economies, it is all too likely that the U.S. economy would feel the effects of that market turbulence. It might do so in very much the same way as the European and Asian economies were hit in September 2008 by the financial market fallout from the Lehman bankruptcy in the United States.  

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.