Emerging economies and the commodities bust: team up with the west

Pedro Sousa

Gone are the exciting days of growth story of the BRICS. Back then, it seemed that the West was done and the big emerging economies were going to be successful in a new era of economic, financial and geopolitical dominance. The financial system of the West played casino with the housing market, the Western taxpayer had to pay the bill, sovereign debt and the great recession arrived with a bang. Meanwhile, the big emerging markets were acting as the locomotive for global growth while the West was struggling. Capital poured into the BRICS and other emerging countries on an unprecedented scale and everyone wanted a share of the promised riches of the developing world.

Nowadays, emerging economies are in the news but for all the wrong reasons and are hurting badly. Among the BRICS, China is experiencing a sharp structural slowdown, South Africa is barely growing and experiencing a political crisis, Russia and Brazil are in recession, while India is the only one that is faring relatively well. Many other emerging economies have been suffering due to external factors and their own economic fragility. Unfortunately, emerging markets tend to be politically and economically unstable. Their leaders might have forgotten about this while riding the commodities boom.

Now, with the commodities bust, they find themselves in a difficult situation. Commodity prices have declined. Diminishing growth prospects for large emerging market economies such as China has led to a drop off in demand for imports, combined with abundant supply, creating downward pressure on most commodities’ prices. Agricultural commodities have also declined as the result of a record high harvest. Most severely, oil prices have collapsed due to lack of global aggregate demand and competition for market share. Linked to oil prices, natural gas and coal prices have also declined. As a result, emerging economies that rely heavily on oil exports, such as Venezuela, Russia and others, have suffered considerably, leading to devalued currencies and flight of foreign capital from their markets.

Adding to the Chinese slowdown and the oil market share competition, advanced economies are still suffering from the effects of the global financial crisis. Recession-hit, heavily indebted and scarred by the deleveraging process that saw the lower and middle classes pay for imposed fiscal austerity, consumers in Europe, Japan and North America have not used the windfall from cheaper energy to go on a spending spree. And advanced economies’ governments are failing to create a fiscal stimulus that would support a revival of growth. All of this provides a scenario for emerging economies that is starkly different from the positive growth story many were touting until relatively recently.

China

China is undergoing an attempted rebalancing from a manufacturing and export-led economy towards one focused on domestic consumption. This is a tough transition that has slowed Chinese growth. Growth inevitably slows as countries catch up with their more developed counterparts. Chinese leaders wish to enter a new phase of economic development that continues to promote growth, but on a greener, more sustainable footing. Their previous strategy focused on high investment in energy-intensive manufacturing and strong export performance.

With such high growth, China has become the second largest economy in the world. Its banking sector has assets equivalent to 40% of global GDP, its stock markets are worth $6 trillion and its bond market is valued at $7.5 trillion. Decades of fast growth were underpinned by overinvestment, too much borrowing and a reliance on selling products overseas. This process lifted more than half a billion people out of poverty but high inequality, pollution and congestion show that it came at a cost which underlines inadequate planning and preparation. The Chinese economy overheated and is now slowing down. The country has experienced financial imbalances and government has stepped in to avoid mass unemployment. Debt has increased substantially, with debt-to-GDP ratio soaring from 150% to nearly 260% over a decade. This economic slowdown has been a major drag on commodity exporters around the world, bringing economic and political pain to emerging economies that sell raw materials to China.

Other Emerging Economies

With Russia’s dependence on oil and uncertainty around oil prices, it could be a rough ride ahead. What we see in Russia is a classic emerging market crisis. Fuelled by the high oil price, capital rushed in. But the collapse in Chinese demand and falling oil price have resulted in a mad dash to get money out before Russia can start defaulting on its foreign creditors.

Brazil is in a somewhat similar position. After several years of strong growth and social policies that lifted millions out of poverty and helped to tackle inequality, Latin America’s biggest economy has brewed a dangerous cocktail of economic and political risks. The macroeconomic situation does not look good with falling commodity prices cutting deep through the economic fabric of country. Inflation is in double digits, expenditure is high and output is falling. The fiscal impact of falling commodity prices has turned out to be worse than expected for the Brazilian authorities and they are now struggling to cope with falling tax revenues. Politically, there is chaos which weighs further on Brazil’s economy. Dilma Rousseff is embroiled in an impeachment process that remains volatile, as corruption accusations have become endemic within Brazilian politics. The impeachment is based on allegations that she violated federal budget rules by using loans from state-owned banks to mask the size of the government’s budget deficit. Proceedings have begun but questions of its validity remain and it is likely the political crisis will continue, as will protests in the streets. Analysts see Brazil’s recession deepening and the economy shrinking even further this year.

India continues to grow, driven partly by its comparatively low-wage advantage. Given that workers’ rights are not likely to be a priority or be demanded in the country in the near future, India looks poised to continue to grow. Throughout the emerging market world, it is easy to find similar stories of economic and political hardships. South Africa, Venezuela, Argentina, Nigeria and many others are having serious problems dealing with the price collapse of commodities.

Oil 

Normally, when the oil price goes up, talk of global crisis begins. Similarly, when the oil price goes down, this is seen as good for the global economy. Consumers in oil-importing regions such as Europe receive an incentive to consume more. However, this seemingly positive scenario for the consumer is having a negative impact on the global economy due to lack of aggregate demand and market share competition that is oversupplying the Market.

Since 2014, the price of oil has been on a downward trajectory, which has taken the sector into a situation not seen for decades. In early 2016, the price of crude oil was more than 70% lower than in 2014. Comparing with the pre-financial crisis peak of 2008 the drop is even steeper. There are several factors that explain factors at play. On the demand side, Europe has been going through the Great Recession, China’s growth has slowed, and around the world vehicles are becoming more energy-efficient. On the supply side, we have the shale revolution of the US. It has nearly doubled domestic production over the last few years, which means it has reduced imports of foreign oil. Iran has returned to the international oil market after sanctions were lifted in early 2016 and there is the prospect of Libya returning if the political and security situation stabilizes. Russia, despite its economic problems, is managing to continue pumping at record levels. Canada’s oil production and exports have risen year after year. Last but not least, OPEC (the Organisation of Petroleum Exporting Countries) and its de facto leader, Saudi Arabia, have not cut production to shore up prices, due to market share competition. This is why supply has risen faster than demand.

What is happening on the supply side is abnormally fierce competition for market share. OPEC output has recently continued to grow as prices have fallen, unlike in some previous cycles. Oil supply has been strong, owing to record high output from OPEC members and some non-OPEC countries (e.g. US exports to the international market only resumed relatively recently). Iran, Venezuela, Ecuador and Algeria have all put pressure on OPEC to cut production. With increased competition Saudi Arabia may be happy to keep prices low for a while to make it uneconomical for other countries to develop further oil production. It does not seem willing to cut production in order to offset Iranian production entering the market over the next two years when higher-cost oil will die anyway. Venezuela, Ecuador, Russia and Nigeria are just a few petro-states suffering economic turbulence. With a further drop in oil prices, cutbacks in production are more likely, as oil companies pull out of existing and future projects. Companies like Shell, ExxonMobil, Total, Chevron, and BP are slashing their spending and postponing large projects.

The situation is unlikely to change in the coming years. Saudi Arabia has no intention to cut production and is the largest, most influential producer in the 13-member OPEC cartel. The Saudi government sees itself in a battle for market share with the rest of the world. And they want to see competition going out of business before they consider production cuts. They target high-priced Western oil producers as well as Russia and OPEC member states. Only when Saudi Arabia is comfortable with their market share would they consider cutting their own production to support prices. This position from Saudi Arabia is connected to the Kingdom’s strategy of wanting to end its reliance on oil with far-reaching reforms. The Saudis want to prepare for a post-petroleum era. This represents a huge shift for the world’s largest petroleum exporter, also the de facto leader of OPEC. The reform plan named Vision 2030 wishes to prepare the country for a future that is less dependent on falling oil revenue over the next decade and a half. Measures included in the plan are the creation of the world’s largest sovereign wealth fund, energy subsidies cuts, and privatization of the state-owned oil company Saudi Aramco, using proceeds from the sale to invest in a broader range of assets around the world.

The West

The economic and political story that comes from Western countries is worrying. We are witnessing a lack of aggregate demand that results from the “austerity at all costs” mantra dominant in developed countries, coupled with rising income and wealth inequality in recent decades. High levels of private and public debt are constraining growth-enhancing capital spending, which fell after the global financial crisis and has not since recovered to pre-crisis levels. This means productivity growth has slowed. Rising income and wealth inequality is increasingly unacceptable for both social and political reasons, and it deeply damages economic growth. As income is redistributed from labour to capital, it flows from those who have a higher marginal propensity to spend, low and middle-income households, to those who have a higher marginal propensity to save, high-income households and corporations. Those at the top spend far less than those at the bottom, so that as money moves up, demand goes down. Growth is therefore sluggish within Western economies.

After the global financial crisis of 2008, a deleveraging process was initiated. Many countries had to bailout the finance sector due to systemic risk, putting their sovereign debt position at risk. Austerity was imposed, the great recession began. Private and public spending were cut to reduce high debts and deficits. Thus we are likely to remain in “secular stagnation”. Politically, this does not bring good things, as history has shown us. Increasing inequality, a scarring effect of unemployment, underemployment and job precarity, and a sense of insecurity due to recent terrorist attacks have created a populist backlash against trade, globalization, migration, and technological innovation. The US faces an extremely volatile presidential election, the UK and the European Union are now dealing with the thunderstorm that is Brexit, right-wing parties are gaining visibility in Eurozone countries and Japan is on the edge of outright economic contraction.

Emerging Economies Should Team Up With The West, Not Fight It

With advanced economies going through tough times, and with capital pouring in, emerging economies managed to lift millions of people out of poverty and give rise to new middle classes. This feat should be celebrated. For every person that has been given a chance to get healthcare or access to higher education that leads to a dignified job, this has been a life changing achievement. And that is true for country. Yet emerging countries failed to 1) prepare their economies for a commodities bust and 2) contribute to the creation of a multipolar order.

Nowadays, with the commodities bust, emerging economies are going through tough times. Most emerging economies failed to take advantage of the commodity price boom to create a diversified economy and the last thing the global economy needs is division. The North vs South, “Us vs Them” rhetoric was counterproductive and fueled an ill-advised ambition to challenge, rather than work and cooperate with advanced economies. Being anti-West is counterproductive and ultimately detrimental to economic growth and wellbeing of emerging markets. Ultimately, the same cooperative attitude has to also be present in Western countries. It takes two to tango. In the current multipolar economic disorder, this is harmful for shared prosperity as it further incentivizes a dangerous race to the bottom. A race to the bottom that disregards hard fought global rules, principles, and multilateral progress. At a time when international vision and collective action is urgently required – and inevitable, given the interconnected global economy we live in – emerging economies need to be constructive and cooperative for the benefit of all.

Putting aside the unlikely event of a new source of demand for commodities appearing, emerging economies will not see the same levels of growth in the next five to 10 years as they did in the previous decade. This time around, emerging economies should look beyond sectors vulnerable to boom and bust cycles and shoot for the next stages of development by promoting economic diversification, top-class universal education and training, well-regulated and liquid capital markets, properly functioning tax systems, trusted and effective public and private institutions, universal healthcare, innovation and entrepreneurship, protection of workers’ rights, civil rights and liberties, the rule of law and strong democratic governing institutions. Unfortunately, these are not yet the characteristics of many emerging markets. But they do represent the ambitions of their people. To achieve this, there is a need to synchronize the global economy. Like advanced economies, the BRICS should follow through on their G20 commitments, to work closely with all members, and consolidate the G20’s role as the premier forum for global financial and economic cooperation.

Pedro Sousa – Economista mestre pela Universidade de Minho, editor do blog Econ Plus

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