Now that the long bull run in emerging market equities has gone into reverse, the question has to be asked. Was it all hot air? The answer is yes only in the limited sense that most of the surge since the start of the last decade was driven by a change in valuation basis and by investment bankerly hype. Yet the underlying economic story remains largely intact, even if central banks in emerging markets are fighting a difficult battle with inflation and geopolitical risk has re-surfaced.
On a recent trip to Asia I read two excellent and complementary books on emerging markets by Ayhan Kose and Eswar Prasad*, both formerly of the International Monetary Fund, and by George Magnus**, an adviser to UBS. Both broadly agree that the shift in the locus of global growth from the advanced to the emerging market economies will continue, while noting the remarkable resilience shown by such economies as India and China in the financial crisis. Yet both take a nuanced view of the policy challenges that these countries face.
Mr Magnus in particular argues that those who believe China’s rise is pre-ordained in the light of crude extrapolations of past economic growth rates fail to grasp the importance of institutional structures. The rule of law, contracts, property rights, neutral courts are, he rightly says, crucial to the sustained accumulation of capital over generations, which is the source of lasting economic strength and power. On this score there remains considerable uncertainty about China’s future trajectory vis a vis the supposedly ailing US.