Slowdown in Emerging Markets: Not Just a Hiccup

IMF Blog, June 26, 2014

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Emerging market economies experienced strong growth in 2000-12, averaging 4¾ percent per year.
In the last two to three years (prior to June 26, 2014), growth in most emerging markets has been cooling off, in some cases quite rapidly.
The key question: is the recent slowdown transitory (a hiccup) or a sign of a more chronic condition?

Employment increases and accumulation of capital (buildings and machinery) remain the main drivers of growth.
- Together they explain 3 percentage points of annual GDP growth in 2000–12.
Improvements in total factor productivity explain 1 ¾ percentage points of annual GDP growth in 2000–12.
The pickup in economic activity in the 2000s compared to the 1990s is solely explained by higher total factor productivity.
Total factor productivity, after previous declines in Latin America and the Middle East and North Africa, is now on the rise across emerging market regions.
Productivity improvements reflect both cyclical upsides during good times and structural (permanent) factors such as:
- Reallocation of inputs to more productive sectors.
- Gains from past reforms (deregulation, trade liberalization, financial liberalization).

External factors account for a considerable part of the recent slowdown; domestic factors also play a role.
On average, cyclical and structural factors are equally important in explaining the growth slowdown in emerging markets over the last few years.
Implication:
- The cyclical component implies some slowdown may reverse once advanced-economy growth picks up.
- The structural component implies a more permanent reduction in potential growth for some countries.

Estimates of potential growth rates in emerging markets for the next 3-4 years are 3½ percent.
This implies growth would be on average 1¼ percentage points lower than in the 2000s.
Factors explaining the anticipated slowdown in potential growth:
- Expected moderation in investment (growth of the physical capital stock) as global interest rates rise and commodity prices stabilize.
- Natural constraints such as population aging limiting the contribution of labor.
- The need to slow growth in countries that allowed external and financial imbalances to build, in order to address balance-sheet risks.

Policymakers in emerging markets should place renewed emphasis on structural reforms to raise productivity, which despite recent improvements remains relatively low compared to advanced economies.
Structural reforms can include measures tailored to country circumstances (referenced IMF work discusses tailored structural reforms).
Two possible country-level responses:
- In some countries, transitioning to a slower potential growth rate may be desirable if it yields more sustainable and balanced growth.
- In other countries, the slowdown can be an opportunity to reevaluate policies and undertake structural reforms to restore stronger growth, income convergence, and rising living standards.

Source: Slowdown in Emerging Markets: Not Just a Hiccup — Evridiki Tsounta, Kalpana Kochhar, June 26, 2014.

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