Javier Guzmán Calafell: A growth reset for emerging markets
Remarks by Mr Javier Guzmán Calafell, Deputy Governor of the Bank of Mexico, at the
"2016 Astana Economic Forum", Flagship Session on "A growth reset for emerging markets",
hosted by the Government of the Republic of Kazakhstan, the Economic Research Institute
(Kazakhstan), the Reinventing Bretton-Woods Committee and ISPG/International Strategy
Partners Group. Astana, Kazakhstan, 25 May 2016.
* * *
The views expressed in this document are strictly personal.
First of all let me say I am very honored to participate in this session of the 2016 Astana
Economic Forum. I would like at the outset to express my gratitude to the organizers for the
invitation to speak at this event.
During the years preceding the global financial crisis, Emerging Market Economies (EMEs)
showed a remarkable performance, with the pace of GDP growth increasing in the period
2000-2007 to nearly 7 percent per year, a sharp contrast with the figures of 3.3 and
3.7 percent observed during the eighties and nineties, respectively. Naturally, this had
important consequences for the composition of the world economy. Thus, the share of EMEs
in global output (in PPP-adjusted terms) increased from 43 percent in 2000 to around one
half by 2007. Moreover, this accelerated growth in EMEs had a significant impact on the
wellbeing of these economies' populations, as their nominal GDP per capita (also in
PPPadjusted terms) rose by nearly 70 percent during that period, thus narrowing the gap with
respect to the advanced economies (AEs).1 Naturally, this performance supported the
expectation of a much faster convergence between the two groups of economies.
Following the economic difficulties deriving from the global financial crisis of 2008-2009, the
risk of an abrupt end to this process arose. Nonetheless, EMEs displayed resilience to this
shock, and even though their output growth decelerated in 2009, the outcome was far better
than the outright contraction observed in the AEs. Moreover, the subsequent rebound in
economic activity fed the expectation that EMEs could again perform as strongly as they had
prior to the crisis, and hence resume the increase in income per capita towards AE levels.
Unfortunately, the pace of economic activity in EMEs has been on a downward path since
2011, and 2016 could well mark the sixth consecutive year of declining output growth in
these economies. Even if the expectation of a slight increase in EMEs GDP growth for this
year materializes, the differential vis-à-vis the AEs would still narrow to levels not seen since
the early 2000s. It is important to emphasize that the recent performance has so far only
slowed, but not reversed or even stopped, the global convergence process. However, the
persistent deceleration of EMEs over a time span of several years, and its generalization
across countries and regions, certainly raise important concerns.
Not surprisingly, these developments have given rise to a lot of debate on the possible
factors behind them. Many observers have stressed the role of external conditions. In
particular, the rate of expansion in the AEs has remained since 2011 significantly below its
pre-crisis long-run average (1.6 percent in 2011-2015 vs 2.8 percent in 1980-2007). In
addition, the volume of global trade of both goods and services has decelerated sharply in
recent years, as its growth rate during 2011-2015 (3.9 percent annual average) fell well
below its pre-crisis long-term average (6 percent in 1980-2007). Also, the terms of trade for
the EMEs have severely deteriorated since mid-2014, essentially due to the fall that
commodity prices, especially oil, have displayed. Lastly, capital flows to EMEs have not only
declined, but are significantly more volatile with respect to previous years.
How important are external conditions for economic growth in EMEs? The IMF has recently
attempted to answer this question, on the basis of a study for 16 of the largest emerging
market economies, accounting for a large share of the group's output and spanning a broad
spectrum of economic and structural characteristics.2 The conclusion is that external factors
(including, but not limited to, growth in the AEs) contribute as much as or more than other
factors in explaining deviations from estimated average growth during the period 1998-2013.
Irrespective of the precise figures, it is unquestionable that external factors have played a
decisive role in EMEs growth performance in recent years. However, I am of the view that
the main challenge for this group of countries in coming years is of a domestic, not of an
external, nature.
In this respect, it is worth to consider the following.
First, the above-mentioned IMF study finds considerable differences across time and
countries. In particular, it notes that internal factors contributed more to deviations from
estimated growth during the slowdown observed after the global financial crisis. Other
studies reach a similar conclusion. For instance, according to research carried out by World
Bank staff, although the recent EMEs slowdown was driven initially by external forces,
domestic factors have increasingly weighed on growth.3 In fact, this study estimates that the
growth slowdown in EMEs since 2011 has predominantly reflected slowing total factor
productivity (TFP) growth. The significant decline in TFP growth in EMEs in recent years has
also been stressed by other analysts.4
Furthermore, the evolution of economic growth in EMEs in coming years will be affected by
demographic trends. Since 2010, working-age population growth has slowed from pre-crisis
rates in all EME regions. In addition to the resulting slowdown of labor market inputs, this
may adversely affect innovation, productivity growth and savings.5
Second, a substantial recovery of the world economy in coming years is still out of sight.
Some analysts have expressed concern about the possibility of chronic low growth in the
advanced economies, be it as a result of factors on the demand (a long-lasting excess of
saving over investment pulling down growth, inflation and real interest rates) or supply
(ageing and low productivity growth among them) sides.6 Regardless of whether or not these
fears prove valid, it will be, in all likelihood, a long time before we see again rates of growth in
the AEs similar to those observed before the global financial crisis.
It is also important to note that the transition to a new consumption-services based economic
model in China, coupled with the nature of other challenges currently faced by its economy
2
See International Monetary Fund (2014): "On the Receiving End? External Conditions and Emerging Market
Growth Before, During, and After the Global Financial Crisis", Chapter 4 of World Economic Outlook, April.
3
See Didier, Tatiana et al. (2015): "Slowdown in Emerging Markets: Rough Patch or Prolonged Weakness?",
World Bank Group Policy Research Note, December.
4
See for instance International Monetary Fund (2015): "Where Are We Headed? Perspectives on Potential
Output", Chapter 3 of World Economic Outlook, April.
5
See Didier, Tatiana et al. (2015): "Slowdown in Emerging Markets: Rough Patch or Prolonged Weakness?",
World Bank Group Policy Research Note, p. 29, December.
6
See, for instance, Blanchard, Olivier et al. (2015): "Inflation and Activity - Two Explorations and their Monetary
Policy Implications", IMF Working Paper No. 15/230, November; as well as the chapters by Lawrence
Summers ("Reflections on the 'New Secular Stagnation Hypothesis'") and Robert Gordon ("The Turtle's
Progress: Secular Stagnation Meets the Headwinds"), among others, in Teulings, Coen and Richard Baldwin
(2014): "Secular Stagnation: Facts, Causes and Cures", a VoxEU.org eBook.
(high levels of debt, overcapacity and financial fragility, among others) are already affecting
this country's growth potential.
In this context, it is hardly surprising that, after recording last year their sharpest decline
since 2009, the terms of trade of goods and services for the EMEs as a group are projected
to continue falling, although at gradually moderating rates, throughout 2021.7 Furthermore,
the perspective of a normalization of monetary policy in the United States and the overall
situation of uncertainty in international financial markets point to the continuation of
challenging external financing conditions for several years to come.
To sum up, both the nature of the recent deceleration of economic growth in EMEs, and the
structural transformation of the external environment these countries are facing, underline
the need to reinforce the internal sources of growth. In other words, without disregarding the
importance of international economic cooperation, the fundamental challenge is domestic,
not external.
What should EMEs do to meet this objective?
The first requirement is of course to ensure macroeconomic stability. This is not an area of
much controversy. The empirical evidence shows clearly the benefits of strong public
finances, low inflation and in general a solid macroeconomic environment for the
achievement of sustained and adequate rates of economic growth. However, implementation
has proved to be a more challenging issue, as we continue to see high fiscal and current
account imbalances, as well as excessive debt levels, in a number of EMEs. The reasons
are varied: inadequate diagnoses, external shocks, restrictions of a political nature, improper
timing of policy implementation, poor coordination of different policy instruments, and so on.
In fact, macroeconomic policy slippages explain partly the poor economic growth results
observed in several EMEs in the last years. A frequent recommendation for these countries
is to use fiscal and monetary stimulus, whenever this is feasible, to support growth. But the
fact is that most of them lack the room to implement expansionary demand management
policies under present circumstances.
As stressed by the experience of the global financial crisis, financial stability is a second
requirement to lay the basis for sustained growth. The standard recommendation here is the
use of macroprudential policies, with simultaneous and coordinated efforts at the
macroeconomic and microprudential levels. To this, one must add the need to ensure the
availability of more and better statistics, an appropriate analytical capacity and the creation of
a suitable institutional framework. Although the international community has devoted a lot of
energy to enhance our understanding of the policy framework needed to ensure financial
stability, we still have many theoretical and empirical gaps in this field. Under these
circumstances, the safest approach seems to be to adhere as closely as possible to the state
of knowledge, with proper consideration of domestic conditions and an emphasis on
prudence.
The third crucial requirement to foster growth in EMEs is structural reform. Indeed, the
deceleration of TFP growth in recent years and the relevance of this factor in explaining the
lower rates of economic activity in EMEs, clearly point to the need for action on the supply
side. The crucial role of structural reform is underlined when taking into consideration that
many EMEs face the risk of falling into a "middle-income trap".8 At lower levels of
development, the availability of a substantial amount of underutilized resources and easy
productivity gains (stemming for instance from importing foreign technologies or mobilizing
resources from agriculture to manufacturing) allow the achievement of high rates of
economic growth. As the opportunities brought about by starting from behind dilute with
increased levels of income, potential growth declines.
Unfortunately, the efforts of structural reform in EMEs stagnated in recent years. To some
extent, this is a result of the high rates of economic growth observed in this period. In view of
the dynamism displayed by their economies, the authorities of many emerging market
countries saw little need for economic reform. Thus, notwithstanding the opportunity provided
by a favorable external environment, they did not carry out the structural measures needed
to increase productivity and the potential for growth. The global financial crisis may have
even worsened the situation, as one of its side effects has been a reversal in the reform
effort in a number of areas, with only a few countries announcing comprehensive reform
plans, China, India and Mexico among them.9
Naturally, this situation has to change if economic growth in EMEs is to continue at a
reasonable pace. Reform priorities vary from one country to another, and therefore it is not
possible to recommend specific measures that may be applicable on a generalized basis.
However, on the basis of the international experience, a few general principles can be
underlined:
• Economic reforms that reduce barriers to the efficient functioning of markets, fuel
competition, stimulate innovation and the adoption of new technologies, and
encourage the accumulation of human and physical capital, including infrastructure,
are associated with higher productivity growth.
• Policy reforms may have non-linear effects related to the quality of political and
economic institutions. Therefore, a broad range of institutional factors need to be
taken into consideration in a process of reform.
• Reforms in different areas interact. These synergies must be taken into account to
maximize the impact on productivity growth.
• A proper transition to a greater influence of market forces, and therefore an
adequate sequencing of reforms, is critical for the success of these efforts.
• The drivers of productivity growth may vary along the development path. The
"middle-income trap" hypothesis points to different policy requirements at different
levels of development.
• Approval of long-ranging reforms may take a long time, among other reasons
because of obstacles of a political nature. Also, the impact of reforms on productivity
will normally be slow. As a result, the payoff of an early move in this direction will be
usually very high.
To conclude, let me say a few words about the recent efforts of structural reform in Mexico,
as my country's experience can provide some additional insight on the intricacies of this
issue. During the period 1990-2011, Mexico's economy recorded an average annual rate of
growth of around 2.8 percent, too low for the country's needs. In the presence of a
demographic dividend, the main factors behind this performance were a relatively low
investment rate and, particularly, a negative contribution to growth of total factor productivity.
As a response to this situation, the Mexican authorities embarked since late 2012 on a
farreaching structural reform effort, aimed at increasing the economy's growth potential. The
reform package encompassed a wide range of sectors, as well as a significant strengthening
of the institutional setting.
The structural reform measures are still under implementation, and the full gains from this
transformation will take a long time to materialize. However, some results are readily visible. I
would like to highlight in particular the evolution of inflation. As of the first half of May, the
annual inflation rate in Mexico stood at 2.5 percent, below the 3 percent target. As a matter
of fact, we have been observing figures consecutively under the target since May 2015, an
unprecedented achievement. This is of course the result of many factors, the implementation
of strong macroeconomic policies the most prominent among them. But structural reform has
also played a major role in these developments. For instance, the competition brought about
by reform in the telecommunications sector has resulted in significantly lower prices for these
products, with beneficial effects on inflation.10 This has also been supported by a reduction in
electricity prices, partly the result of reform in the energy sector.
The recent performance of economic growth in Mexico is also worth noting. During the years
before the eruption of the financial crisis (2000 to 2007), the Mexican economy showed an
average annual rate of growth of around 2.7 percent. The figure for 2011 to 2015 is similar
(2.8 percent), notwithstanding the fact that the rate of GDP growth of our main trading
partner, the United States, fell by 0.6 percentage points between these two periods,11 and
that the economy was hit by a number of other external shocks, including a sharp decline in
oil prices. It is also worth noting that Mexico is one of the few EMEs where a deceleration of
growth is not observed during the two periods under consideration. Although it would be very
difficult to isolate the different determinants of this performance, there is clearly a possibility
that the structural reform process begun in 2012, is one of the factors behind the resilience of
the Mexican economy's rate of growth to the difficult external environment.
All in all, on the basis of an adequate macroeconomic management and a comprehensive
package of structural reform, in a context of financial stability, the Mexican economy has
been able to successfully weather the turbulent times of recent years. The task, however, is
not complete yet. To start with, the role of the reforms in setting the economy's pace over the
long term is heavily dependent on their adequate implementation. Furthermore, structural
reform is a dynamic process and therefore additional measures may be needed. Finally, it is
also important to remember that, as in the case of other EMEs, the country's macroeconomic
position and financial stability are still subject to challenges, particularly in what is likely to
remain an uncertain and volatile external environment.