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Emerging Markets


Emerging market economies (EMEs) have become the darlings of international investors and the focus of enormous attention in academic, media, and policy circles. M. Ayhan Kose and Eswar Prasad present the definitive account of the evolution of EMEs and use the lens of the global financial crisis to evaluate their strengths and weaknesses.

Led by a set of large and dynamic countries —including Brazil, China, India, and Russia —EMEs have become a dominant presence in the world ...

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Emerging market economies (EMEs) have become the darlings of international investors and the focus of enormous attention in academic, media, and policy circles. M. Ayhan Kose and Eswar Prasad present the definitive account of the evolution of EMEs and use the lens of the global financial crisis to evaluate their strengths and weaknesses.

Led by a set of large and dynamic countries —including Brazil, China, India, and Russia —EMEs have become a dominant presence in the world economy. They now account for a substantial share of world output and have been a major driver of global growth during the past decade. They are significant players in international trade and financial flows and are beginning to exert rising clout in global policy debates. However, the financial crisis of 2007–09 and the worldwide recession that followed cast a pall over the notion that EMEs had become self-reliant and "decoupled" from demand conditions in and financial flows from advanced countries.

Kose and Prasad, prominent experts on emerging market economies and globalization, draw on their extensive research to assess the resilience of EMEs in the face of the global financial crisis. Their analysis shows that EMEs, as a group, weathered the crisis much better than the advanced countries, and most of these economies have bounced back rapidly from the global recession. The authors track down the reasons for this resilience and explain why some countries in this group have done better than others. Based on this analysis, they draw lessons for the durability and sustainability of these economies' long-term growth. This book is important reading for anyone trying to anticipate the future growth of emerging markets or contemplating business opportunities in these economies.

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Product Details

  • ISBN-13: 9780815705642
  • Publisher: Brookings Institution Press
  • Publication date: 11/11/2010
  • Pages: 224
  • Product dimensions: 5.90 (w) x 9.00 (h) x 0.70 (d)

Meet the Author

Eswar Prasad holds the New Century Chair in International Economics. He is the Tolani Senior Professor of Trade Policy at Cornell University and a Research Associate at the National Bureau of Economic Research. He was previously head of the Financial Studies Division and the China Division at the IMF.

M. Ayhan Kose is assistant to the director in the International Monetary Fund's Research Department. He previously served as an economist for the United States and Canada desks of the IMF. He is the coeditor of the IMF Economic Review, the editor of the IMF Research Bulletin, and an executive editor of the Journal of Asian Economics.

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Read an Excerpt

Emerging Markets

Resilience and Growth amid Global Turmoil
By M. Ayhan Kose Eswar S. Prasad


All right reserved.

ISBN: 978-0-8157-0564-2

Chapter One

Changes in the World Economic Order: A Roadmap

Over the last two decades, emerging market economies (EMEs) have become a dominant presence in the world economy. They now account for a substantial share of world output and, with their rapid growth rates, have become a major driver of global growth during the past decade. Trade and financial linkages between advanced economies and EMEs have also become much stronger, speeding up the process of global integration.

The spectacular growth performance of EMEs in recent decades has attracted the most attention. As a group the EMEs have experienced far greater cumulative growth since 1960 than other developing countries and the advanced economies (figure 1-1). Excluding Brazil, China, and India—three of the most prominent large, dynamic economies—from the list of emerging markets makes the performance of this group look less spectacular, although it is still much better than that of the group of other developing countries. Other economic indicators provide a broader snapshot of the rising prominence of emerging markets in the world economic order (figure 1-2). While their shares of the world population and world labor force remained relatively stable from 1990 to 2008, the EMEs have now become more important on virtually every other economic dimension. The emerging markets' shares of world GDP, private consumption, investment, and trade nearly doubled in the space of less than two decades. The share of world foreign exchange reserves held by emerging markets jumped from about 20 percent in 1990 to nearly 75 percent in 2008.

These changes in the world economic order have prompted questions about the relevance of the conventional wisdom that when the U.S. economy sneezes the rest of the world catches a cold. The conventional wisdom came into question because emerging market growth continued to be strong despite relatively tepid growth in the advanced economies over the period 2003–07. A fierce debate got under way in 2006–07 about whether global business cycles were converging or whether cycles in emerging markets had started to diverge from fluctuations in advanced-country business cycles. Indeed, the notion was gaining ground that EMEs had become the main engines of global growth and that advanced countries had themselves become more dependent on demand from the fast-growing emerging markets.

The divergence argument is of course directly linked to the issue of the resilience of EMEs, as it implies that those economies have become less vulnerable to external shocks emanating from the advanced economies. A notable development over the last decade is that trade and financial linkages among EMEs have risen rapidly, with trade and financial flows among this group of countries accounting for a rising fraction of their respective overall cross-border flows. This has further enhanced the perception that EMEs have become less dependent on advanced economies and that business cycles among EMEs have become more correlated and simultaneously less closely linked to advanced-country cycles.

The global financial crisis has changed the direction of this debate and cast a shadow over the ability of the EMEs to insulate themselves from shocks in advanced countries. In particular, the problems in the financial systems of advanced countries rapidly spread to a number of EMEs during the last quarter of 2008 and the first half of 2009, disrupted their asset markets, and stunted their short-term growth prospects. As the global financial crisis has vividly shown, financial markets around the world are now closely tied together, and shocks in one part of the global financial system can and often do have large and immediate effects on other parts. Moreover, the crisis has been a bitter reminder that, for all their benefits, deeper trade and financial linkages can serve as a mechanism for magnifying shocks and intensifying their effects on the real side of a nation's economy.

As a significant fraction of EMEs followed the advanced countries into recession, the crisis called into question the notion of greater resilience of EMEs to advanced-country shocks. This was not altogether a surprising outcome, as past episodes of business cycles suggest that deep and highly synchronized recessions in advanced countries tend to have large spillovers to the EMEs. Remarkably, however, the majority of EMEs bounced back briskly from the global recession since mid-2009 and as a group have weathered the crisis much better than the advanced economies. There is of course significant variation in the degree of resilience displayed by different groups of emerging markets. For instance, the Asian emerging markets, especially China and India, have done far better than the economies of emerging Europe. Nevertheless, the core fundamentals of the EMEs suggest that most of these countries have the potential to generate sustained high growth over the long term, so the shift in the locus of global growth from the advanced economies to the EMEs is likely to persist.

These developments call for a deeper analysis of the implications of shifts in the global economic structure. Does economic theory provide clear guidance about how rising integration within and between groups of countries should affect business cycle synchronicity? In fact different theoretical models highlight two opposing effects of rising trade integration. Rising trade interdependence ought to increase cross-border demand spillovers and increase business cycle synchronization, as measured by correlation of growth rates of output (gross domestic product), across countries. On the other hand, if rising trade linkages lead to greater specialization of production, then fluctuations in output could become less correlated as countries become more exposed to industry-specific shocks. There are similar contrasting effects of financial integration on output correlations; it magnifies potential shock spillovers, but this might be offset by greater industrial specialization if countries can use financial markets to smooth consumption relative to the resulting country-specific income risk. In short, the overall net effect of rising within- and between-group trade and financial integration is hard to pin down in a theoretical model.

A country's level of development also plays a role in determining the nature of the transmission mechanism. Trade and financial integration could help low-income developing economies to diversify their production base as integration gives them access to foreign finance for investment projects as well as access to larger foreign markets. It is only at higher per capita income levels that the specialization effect dominates the diversification effect of greater integration.

We discuss these mechanisms and the associated literature in more detail later in the book, but the main implication is that the net effects of trade and financial integration on within- and between-group correlations of business cycles can only be resolved empirically. Another implication is that the level of development may have a bearing on how integration affects a country's business cycle synchronicity with the rest of the world, suggesting the need for a breakdown of country groups not by region but by level of development.

Against this background of ambiguous predictions from theory, the objective of this book is to provide a systematic empirical analysis of the changes in the nature of cyclical linkages between the advanced economies and the EMEs in order to analyze the resilience of the latter group to global economic and financial developments. We focus on four specific questions: First, how have the trade and financial linkages between the advanced countries and EMEs evolved in recent decades? Second, what are the implications of the dramatic changes in international linkages for the dynamics of cyclical spillovers between the advanced countries and EMEs? Third, how (and through which channels of transmission) has the latest global financial crisis impacted the short-term macroeconomic stability and long-term growth prospects of the EMEs? Finally, what are the policy implications of these changes for emerging markets and advanced countries?

The book is organized as follows. In chapter 2 we provide an extensive survey of the empirical and theoretical literature on the cyclical implications of rising global trade and financial linkages for the transmission and synchronicity of business cycles, with specific attention to the vulnerability and resilience of EMEs to developments in advanced countries. It turns out that there are few conclusive theoretical implications about how greater global integration should affect business cycle correlations, leaving this to be resolved empirically.

In chapter 3 we present the details of our database, which covers the main advanced economies and emerging markets along with a large group of other developing economies. The latter group includes low-income countries that are typically less integrated into the world economy. In chapter 4 we study the changes in global growth dynamics and focus on the evolution of the size distribution of different groups of countries and the dynamics of sectoral output over time. This allows us to characterize the rising importance of EMEs in the world economy and also to examine how the internal structures of these economies have shifted over time.

Building on this analysis, in chapters 5 and 6 we examine changes in global trade and financial linkages in recent decades. We document how EMEs have become major players in global trade and finance due to rapid economic growth fueled by the dramatic changes in their sectoral structures and the extent of their integration into the global economy. We also provide an analysis of changes in the composition and direction of trade and financial flows of emerging markets, both among themselves and with other groups of economies.

In chapter 7 we study the impact of the rapid increase in global linkages on the volatility of business cycles. Given that volatility is a key analytical component for a study of the resilience of EMEs, this chapter presents a baseline for evaluating the impact of globalization on business cycle fluctuations. We analyze the evolving nature of the dynamics of volatility of output, consumption, and investment across groups of countries and over time.

In chapter 8 we examine the degree of business cycle comovement among and between advanced economies and EMEs. We also consider the changes in the extent of comovement during the global financial crisis using the latest available data. We separately examine the comovement of real and financial variables using aggregate as well as sectoral data in order to provide a more complete picture of cross-country comovement. One striking result is that comovement of fluctuations in financial markets has considerably outpaced those in real variables such as GDP.

In chapter 9 we undertake a formal statistical analysis of the degree of comovement to examine whether economic fluctuations among and between the two groups of countries have changed over time. Our empirical analysis is based on state-of-the-art econometric models that allow us to flexibly capture the dynamic transmission and propagation of different types of shocks across countries. Interestingly, we find that business cycle comovement has become stronger within the groups of EMEs and advanced economies but slightly weaker between these two groups. This novel result provides some backing for the notion that EMEs are decoupling from the advanced economies, although our evidence is suggestive rather than conclusive.

In addition to the aggregate analysis, we also study the nature of business cycle spillovers among emerging markets in specific regions such as Asia and Latin America. The increasingly prominent role of Asian economies, especially China and India, is particularly relevant to the debates about the decoupling and resilience of EMEs, which have focused on the ability of this region to insulate itself from a slowdown in advanced economies during the global financial crisis. Contrasting the spillover effects in different regions allows us to explore the mechanisms by which countries may be more or less insulated from global shocks, even if they have similar levels of integration with the global economy.

In chapter 10 we characterize business cycle dynamics around recessions in EMEs. One of our objectives is to study the resilience of these countries during the global financial crisis. Since a number of emerging market countries experienced recessions because of the crisis, a natural first step is to review the main characteristics of these episodes. We also provide a brief analysis of the behavior of key real and financial aggregates in emerging markets around these periods, contrasting these patterns with those for advanced economies. In addition, we examine the implications of recessions accompanied by financial crises. That analysis provides a baseline for evaluating the performance of key EMEs during this crisis.

In chapter 11, we investigate in more detail the impact of the global financial crisis on EMEs. Considering the unique nature of the crisis, we first provide a metric to examine the cost of the crisis and compare this cost with that of previous episodes. We then provide a bird's-eye view of how the EMEs in different regions were affected by the crisis. In chapter 12 we undertake detailed case studies of two groups of EMEs—those in Asia and those in Europe—that displayed strikingly different degrees of resilience to the global financial crisis. China and India, in particular, weathered the crisis with just a small stutter in their growth rates, while EMEs in Eastern Europe suffered deep recessions during 2008–09 and are experiencing weak and uncertain recoveries. These regional case studies set the stage for a discussion in chapter 13 of the factors underlying the resilience of emerging markets as a group and also the differences in the degree of resilience of different groups of EMEs.

We conclude the book in chapter 14 with a summary of our findings and a discussion of their implications for the design of macroeconomic policies for emerging markets, advanced countries, and the global economy. Our analysis points to a number of interesting avenues for future research, which we also summarize in the concluding chapter.

Chapter Two

Rising Global Linkages and International Business Cycles: What Do We Know?

This chapter provides an overview of the literature about the implications of global trade and financial linkages for the properties of business cycles in advanced countries and EMEs. We first pre sent a brief summary of theoretical arguments and empirical evidence about how greater trade and financial linkages could influence the volatility and synchronization of business cycles. We then turn our attention to empirical studies analyzing various aspects of cyclical linkages between advanced countries and EMEs.

Theoretical Implications

Theoretical models have different implications about how global integration should affect volatility of output and other macroeconomic aggregates. The same is true for comovement of different macro variables. We review the literature on each of these separately.

Volatility and Synchronization of Output in Theory

There is no consistent theoretical prediction across different models about how trade and financial linkages affect output volatility. The effects of trade and financial integration depend, in different models, on the level of development, the nature of the shocks, and the pattern of specialization.

International trade linkages generate both demand- and supply-side spillovers across countries, which can increase the degree of business cycle comovement. For example, on the demand side an investment or consumption boom in one country can generate increased demand for imports, boosting economies abroad. On the supply side a positive shock to output in tradable goods leads to lower prices; hence, imported inputs for other countries become cheaper.

However, both classical and "new" trade theories imply that increased trade linkages lead to increased specialization. How does increased specialization affect the degree of comovement? The answer depends on the nature of specialization (intraindustry versus interindustry) and the types of shocks (common versus country-specific). If stronger trade linkages are associated with increased interindustry specialization across countries, then the impact of increased trade depends on the nature of shocks. If industry-specific shocks are more important in driving business cycles, then international business cycle comovement is expected to decrease. If common shocks, which might be associated with changes in demand or with supply conditions, are more dominant than industry-specific shocks, then this would lead to a higher degree of business cycle comovement (Frankel and Rose, 1998).


Excerpted from Emerging Markets by M. Ayhan Kose Eswar S. Prasad Copyright © 2010 by THE BROOKINGS INSTITUTION. Excerpted by permission of BROOKINGS INSTITUTION PRESS. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

Acknowledgments xi

Introduction xiii

1 Changes in the World Economic Order: A Roadmap 1

2 Rising Global Linkages and International Business Cycles: What Do We Know? 9

Theoretical Implications 9

Empirical Evidence 12

Changing Nature of Shocks and Linkages 16

Linkages between Advanced Countries and Emerging Markets 17

Summary 21

3 Setting the Stage 23

Country Groups 25

Time Periods 26

4 Shifting Dynamics of Global GDP and Growth 29

Distribution of World GDP 29

Distribution of World Growth 31

Evolution of Sectoral Growth Dynamics 37

Summary 38

5 Global Trade Linkages 41

Sectoral Composition of Output and Trade 43

Geography of Trade Linkages 45

6 Global Financial Linkages 53

Growth of Financial Linkages 54

Growth and Risk-Sharing Benefits 57

Geography of Financial Linkages 61

7 Business Cycle Volatility 67

Evolution of Volatility 67

Volatility and Growth 70

Summary 73

8 Comovement of Business Cycles and Financial Markets 75

Output Correlations across Groups 75

Output Correlations within Groups 78

Comovement across Financial Markets 79

Summary 84

9 Exploring the Sources of Business Cycle Comovement 85

Database and Methodology 86

Business Cycle Comovement, 1960-2008 87

Evolution of Business Cycle Comovement, 1960-84 and 1985-2008 92

Summary 100

10 Macroeconomics of Recessions and Financial Crises 105

Database and Methodology 106

Basic Features of Recessions 107

Dynamics of Recessions 112

Recessions and Financial Crises 115

Summary 118

11 Emerging Markets during the Global Financial Crisis 119

How Costly Was the Crisis? 120

How Did Emerging Markets Fare during the Crisis? 124

Survey of Explanations for the Performance of EMEs 126

12 The Good and the Ugly: Emerging Asia and Emerging Europe 129

Asian Emerging Markets 130

Emerging Markets of Eastern Europe 147

13 What Explains the Resilience of Emerging Markets? 161

Less Dependence on Foreign Finance and a Shift away from External Debt Denominated in Foreign Currency 161

Large Buffers of Foreign Exchange Reserves 162

Greater Trade Linkages among EMEs 163

More Diversification in EME Production and Exports 163

Separation of EMEs' Business Cycles from Advanced Economies' Business Cycles 164

Better Macroeconomic Policies, Including Flexible Exchange Rates, in Emerging Markets 164

Rising per Capita Incomes and a Burgeoning Middle Class 165

14 Conclusions and Policy Implications 167

Implications for EMEs 168

Implications for the Advanced Economies 170

Implications for the Global Economy 171

Implications for Future Research 172

Appendix: List of Countries and Country Groups 175

References 183

Index 197

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