What drives emerging markets growth?
04 November 2016
Economic growth in the emerging and developing economies has been relatively disappointing again this year, with the IMF expecting growth of only around 4% – considerably below the 2000-2015 average of 5.8%. But why has this slowdown happened and will it continue?
We think there are several factors driving this slowdown such as adverse global conditions, the slowdown in China and the marked decline in commodity prices since 2014. With commodity prices expected to remain well below 2014 levels, despite some recovery since early 2016, and Chinese growth rates projected to keep falling gradually over time, emerging market growth is expected to remain more subdued over the next 5 years than in the first decade and a half of this century.
To explore this further, however, it is useful to look in more detail at what was driving growth during this earlier ‘golden era’ for emerging markets. To do this we used a standard growth model in which initial GDP per capita, investment, government debt and education levels were the key explanatory variables for real GDP per capita growth between 2000 and 2015 in emerging market and developing countries. We then augmented the model with primary commodity exports as a percentage of GDP.
As the table below indicates, we found that all these variables had a statistically significant impact on growth. Our model explains around 40% of the variation in real GDP per capita growth across countries, which is pretty good for a simple cross-sectional regression of this kind.
Key features of our results are as follows:
- Initial GDP per capita: in line with past studies we find a significant negative relationship between initial average income levels in an economy and subsequent GDP per capita growth; this reflects the fact that, other things being equal, a low initial level of economic development provides more opportunities for catch-up with higher income countries by making use of their technologies and ideas.
- Investment: capital investment (as a share of GDP) has been a particularly significant driver of growth since 2000, as can be seen from the chart below. A one percentage point increase in investment as a percentage of GDP is associated (on average) with an increase of 0.15 percentage points in annual average real GDP per capita growth. Investment can raise economic growth by supporting infrastructure development in key areas like energy and transport, boosting technological progress and so increasing productivity.
Figure 2: Relationship between investment and real GDP per capita growth, 2000-15
- Education: we find that secondary school enrolment has also been a driver of growth, with a one percentage point increase in enrolment associated with a rise in real GDP per capita growth of 0.05 percentage points. While this is a smaller impact than for investment, the benefits from education are more likely to accrue over longer periods of time as better educated school leavers enter the workforce.
- Government debt: we find a negative relationship between government debt and growth, but the impact is of a relatively smaller magnitude compared to the other variables in the model. High levels of debt can make governments vulnerable to financial and currency crises, particularly if these involve heavy borrowing from overseas, and so tend to be associated with greater macroeconomic instability, higher inflation and slower long-term growth on average.
- Commodity exports: strong demand and many years of high commodity prices for most of the past 15 years had a positive impact on growth in emerging markets, but the magnitude of this effect was relatively small and it has gone into reverse recently as described above.
Our results therefore indicate that, on average, commodity exports have not been a key driver of growth across the emerging markets, though we found the effect was stronger and more positive in the 2000-5 period and less significant after that. Yet, for some of the largest commodity exporters, such as Russia, Saudi Arabia and Brazil, the impact is likely to be greater than our results suggest. Low commodity prices look set to continue and this could pose challenges for some of the major commodity exporters, but our results suggest that low commodity prices alone will not be enough to constrain overall emerging market growth in the long run.
In summary, emerging market growth is determined by a multitude of factors but investment, education and macroeconomic stability are critical. We will explore these issues further in the next edition of our World in 2050 report, due out in February 2017, which will use a forward-looking version of the model developed here that also allows for more country-specific influences on growth.
Looking forward, emerging economies need to place an emphasis on diversifying their economies, investing in productivity-enhancing infrastructure and, as we argued in our recent Young Workers report, equipping their people with the skills needed to thrive in an increasingly competitive global digital economy. Emerging markets that do this should continue to thrive in the long run.