Structural divergences in emerging markets: Where are they headed next?
We expect potential growth to diverge across major emerging markets (EMs) because of both demographic and productivity trends. Demographics are shifting from generally growth-supportive to much more country- and region-specific. In countries with favorable demographics, growth is likely to accelerate. East Asia has ageing – in some cases, shrinking – workforces and populations. Latin America, Central Europe and the Former Soviet Union are transitioning rapidly in the same direction. South Asia is in a demographic sweet spot now and for the next few decades, which Africa is poised to enjoy for several decades.
Source: OECD, Macrobond, Invesco. Annual data as at 14 June 2023.
Note: Potential growth is an estimate of the rate that an economy can grow in a balanced manner, without excessive imbalances such as high inflation, and in the case of most EM countries, excessive fiscal or current account imbalances, which can cause financial crises, usually in the form of debt, currency and banking crises, often simultaneously. Source: OECD, Macrobond, Invesco. Annual data as at 14 June 2023.
Productivity growth is central to economic catch-up and financial outperformance. It can offset an ageing population, boost a demographic dividend, and improve workforce shortage. In our view, accelerating productivity growth hinges on an adaptable labor market, corporate sector and enabling environment for investment and commerce. These factors would help economies to make the most of the Fourth Industrial Revolution.
Real GDP growth has two key ingredients – demographics and productivity growth. Demographics, it is often said, is destiny but in our view, policy choices can make as much or more difference in practice. EMs have often had sizeable, rapidly growing, and young populations and yet failed to catch-up to the developed world. Examples include the large Latin American economies, China and India before their market liberalizations, and South Africa today.
Conversely, some rapidly ageing EMs have generated very high, sustained growth which enabled them to catch up to the developed markets (DMs). Some EMs are continuing this trend, with considerable convergence in capital asset prices and risk premiums, across bonds, stocks, and real estate, as well as labor incomes. Stand-out cases are South Korea, Central and Eastern Europe and the Baltics. These regions have made the most of economic integration with larger, richer trading partners, especially in the US and EU.
In a world where trade barriers and investment restrictions are rising, this route to growth and convergence is very likely to be more limited, in our view. To catch-up, EMs striving for the technological frontier need policies to offset constraints. This will allow EMs to catch-up from international integration and substitute for global scale and competition to generate profits, learning-by-doing and exploit competitive advantages, such as lower labor costs.
A world of industrial policies and demographic shifts also implies pressures on fiscal budgets and labor markets. We believe the best performers will be those countries which will generate internal competition and innovation while maintaining access to regional and global markets. Economic alignments with geographically or geopolitically compatible larger richer economies should help in this regard. India, Vietnam, Mexico, Central Europe stand out as strong contenders on this basis. Southeast Asia could also continue to benefit from access to markets and partners in the region, including China, Korea, and Japan as well as the US. For South America and Sub-Saharan Africa, the potential of natural resources, dynamic populations and entrepreneurialism should be highly supportive but could be constrained by the “resource curse” of windfall profits, rent-seeking, and relatively volatile economic cycles.
Investment risks
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