Developed & Emerging Markets – Where Do They Stand?

Ever since the term, BRIC (Brazil, Russia, India & China) was created in 2002 by Goldman Sachs, the story of global growth has been emerging markets. Russia was driven by oil and Brazil by commodities, China and India were driven by demographic dividends in their immense populations. However, things have changed in the past three years.

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In 2008, the Lehman crisis put the developed markets in a precarious condition. Debt soared, liquidity tightened, growth collapsed and the global GDP trend shifted out of the developed markets and into the emerging markets. As the share of emerging markets started rising, the share of developed markets started falling. In 2009, emerging markets accounted for 35% of global GDP, while developed markets accounts for 42%. In 2013, emerging markets accounted for 48% and developed markets accounted for 32%.

While the U.S. grappled with low inflation and the EU was occupied with the problem in Greece, things took a sharp shift in favor of developed markets. There was clearly a lot of pressure on emerging markets. As liquidity dried up in U.S. markets, commodity producers suffered. The oil and commodity slowdown just made it all worse. In 2015, the share of emerging markets in the global GDP was down to 34%, but the share of developed markets finally increased to 43%.

I think that this trend is going to become more pronounced in favor of developed markets in 2016. India, China and Mexico will still be the fastest growing economies. However, other emerging markets are going to pay a price for the fall in China’s growth. The US, Canada, UK, Japan and Germany will most likely grow by 2%.

As the US creates record jobs, the EU gets growth back, Russia and Brazil will probably suffer from the weak commodity prices and bad policy decisions. That means that between the slowing of China and negative growth from Brazil and Russia, the emerging markets are going to have a rough year. 2016 may be the year that developed markets get back on track.

What do you predict will happen?

The Chinese Economy Will Turn Around

The Chinese economy has had an incredibly difficult year. Between the dramatic sell-off in the Shanghai stock exchange and their weakening GDP numbers, it has just been a constant flow of bad news from China. There has also been some negative statistics that are fueling concerns that China’s legendary success of pushing over 300 million people out of poverty over the last 30 years is coming to an end.

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Besides economic troubles, China has also been facing pollution and other environmental challenges. A World Bank Study actually states that only 1 percent of China’s 560 million city dwellers breathe safe air. There is also a looming property bubble and the fact that their country de-prioritizes democratic principles, but let’s keep the focus of this to economics.

By some estimates, China’s GDP growth rates are hovering below the minimum 7 percent per annum that is required to double per capital incomes in one generation. However, there are factors that suggest a rebound is about to occur. Public policymakers are planning to further cut interest rates, encourage bank lending by reducing the reserve requirement and increase public investment.

China is managing the three main drivers of growth – capital, labor and productivity in a way that supports long-term prospects. The relaxing of the one child policy back in October was quite a surprise. It was originally introduced in 1979 to slow the population growth rate – it is estimated to have prevented around 400 million births. Now, 90 million couples are eligible to have two children.

The country also has plans to increase the number of cities with a population of 1 million from around 10 today to 221, as well as the cities with 10 million people from 5 to 8 by 2025. A more urban population is the key piece of their strategy to move from an investment led, export based economy toward a consumption based urbanized growth. This will help the Chinese avoid a middle-income trap.

A lot is at stake. Over the past few decades, China has become a major and main trading partner and source of foreign direct investment for developed and developing countries. They are the largest foreign lender to the U.S. government and the biggest source of foreign direct investment to Australia, as well as the largest trading partner and source of infrastructure for emerging countries such as Brazil and South Africa.

Needless to say, China has an enormous vested interest in avoiding an economic slump.

Consequences of China’s Two-Child Policy

China’s announcement that is will end its decades long one child policy is exciting news for married couples who want to have two children. However, what about unmarried women? China still makes it almost impossible for most single women to have a child.

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Single women that do not have a “reproduction permit” form the government are denied birth certificates for their children. If they do have a child anyway, the child will not receive a hukou, the official household registration. This means that their child will have trouble gaining admission to school and accessing affordable healthcare. The single mother will also get a “social maintenance fee” for violating family planning policies, which is quite expensive – $13,000.

Many women have taken to social media to voice their opinions proclaiming, “Single women with an education and a high income should immigrate to another country.” In face, some single women have already begun travelling abroad to freeze their eggs because China bans single women from using assisted reproductive technology. In July, a famous movie star of China, Xu Jinglei at 41, told a Chinese magazine that she flew to the United States to freeze her eggs. Amazingly, many came out to support Xu’s choice on Weibo.

It is not surprising that China chose to end its one-child policy in hopes to alleviate some of its demographic challenges, which I wrote about in a previous post. Their population pressures come from the institution of the policy in 1980, which has caused a rapidly aging population, shrinking work force, falling birth rates and an extreme sex ratio imbalance – there are roughly 116 boys born for every 100 girls.

Many Chinese feminists have said that they don’t want to marry at all, but are still doing it because they want to have a child and the obstacles for single mothers are so insurmountable. Rather than giving women increased reproductive freedom, many feminists believe that the new “two-child policy” will actually put even more pressure on women through unforeseen ways. For example, there will be increased gender discrimination in hiring as employers factor in the time female job applicants take off from work to have two babies instead of one now.

It is very interesting that China is both forcing women not to have children, but also to have children at the same time – what is the right thing to do? How do you think that China can solve their demographic problem?

How Chinese Companies Win the Customer

China’s greatest success has been in industries that are very customer-focused such as household appliances (39 pdownloadercent global revenue), Internet software (15 percent) and smart phones (10 percent). In these sectors, the majority of the growth is from local market sales – the size of China makes domestic leaders, global leaders.

Based on the enormous size of the Chinese consumer market, appliance makers like Haier and Internet companies like Tencent, Alibaba and Baidu have grown to be world leaders. However, the Chinese consumer market is also quickly moving. The disposable income of its consumers has risen by 10 percent every year for over a decade and now 85 million households have joined the consuming class. In the Chinese market, innovations are rapidly scaled up and commercialized. So, Chinese companies have learned how to adapt global products by tweaking designs and better addressing the consumer needs. A new generation of Chinese entrepreneurs have been solving consumer problems in a unique way – the Chinese way.

China has a highly fragmented retail industry and this harshly limits decent choices for consumers if they are outside of major cities. However, Chinese entrepreneurs saw this as an opportunity and build a world-leading e-commerce industry, Alibaba. It has grown to be the world’s largest online market place based on the value of the merchandise sold – $349 billion last year. Further innovations by Alibaba is Alipay, a payments system and Ali Finance which helps to finance small scale suppliers that don’t have a traditional banking system.

Rethink Business Models

Chinese entrepreneurs greatest flair has been inventing business models. To understand, I’ll let you know that in most parts of the world, 60 to 90 percent of revenue for online businesses comes from advertising. In China, this is not the case; their advertising industry is actually only about a quarter the size of the US industry. Chinese companies needed to create new business models to monetize the web traffic. One company, Tencent generates 90 percent of its revenue from online games, sales of virtual items on social platforms and e-commerce. The result? The average revenue per use is $16 compared to Facebook’s $10.download (1)

Cheaper, but Better

China is known for creating products for about half of what other countries charged, but only at about 80 percent of the quality. With the rise of a wealthy class in China, now they have to create cheaper, but better products to win their consumers. A Beijing-based market phone maker, Ziaomi has become one of the world’s most successful startups. Xiaomi phones usually cost half of what top products of global brands cost for the same and even better hardware features. How do they do it? Ziaomi has achieved this by embracing business model innovations like online only sales and risk sharing with supplier. Now, Xiaomi is the largest smart phone player in China and is preparing to enter foreign markets.

No, U.S. Stocks Aren’t Going to Crash

There has been an image of the Wall Street’s iconic bull lying on its side floating around the Internet. However, this is actually far from the truth. U.S. stocks would need to diver down over 20% from peak levels and stay down for quite a while until considered a bear market. After the big stock market sell-off, the S&P 500 is only down 12.5% from its all-time high – that is not even enough for a 10% correction. It is easy for us to begin to worry when the majority of the trading screen is in red, but there is actually a strong case being made that stocks will only go up from here. Wall Street experts think that the S&P 500 will end around 2,100 – which is a lot higher from where the market currently is, but also means that stocks will have a small gain by the end of the year.

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There are a few reasons why U.S. stocks will remain bullish. Let me outline them.

Right now, the U.S. economy is in pretty good shape, not close to a recession, which is when bear markets usually occur. The U.S. economy should grow almost 2% this year and unemployment numbers are down below to prior the Great Recession.

Sure, China’s economic slowdown is a little frightful and many think it will create widespread effects. True, China is the center of this global sell off, but only 2% of U.S. revenue from the entire S&P 500 come from China – a tiny amount. So, there is no need to worry about China.

Corporate earnings may be a little ugly, but this is only the first time since 2008. The only real industry that is struggling is oil. The price of a barrel of oil has fallen from over $100 last year to under $40 this year. However, healthcare and technology industries are still going strong.

One fatal mistake that could be made that would definitely tank U.S. stocks is by raising interest rates too early. However, Federal chairwoman, Janet Yellen said that there do not plan to raise interest rates until the economy is strong enough. Will the raise happen in September? December? Or even 2016? We will have to see.

Some believe that even after the pullback, stocks are still too expensive. However, the S&P 500 is trader just over 16 times forward earnings and the average for the past decade has been around 14. So, it is a little high, but not where it was at 18.

When you take a look at all of this, you’ll see that this really isn’t a trigger for a major downturn in the U.S. stock market and in the long term, this correction is a good thing.

The Creation of the “World Bank Rival”

China’s new financial organization, Asian Infrastructure Investment Bank (A.I.I.B.) has simultaneously sparked tension and gained momentum and support. The opposition seems to hail primarily from the United States, citing concerns that the AIIB could undermine the World Bank, and possibly spur poor oversight and minimally governed financial practices. Just last month, the largest economies in Europe- France, Germany and Italy, announced their desire to become founding members of AIIB. This decision followed closely behind the United Kingdom, whose decision to join drew public admonishment from the White House, which is not recognized as common behavior. More than 50 countries have now signed on to join the AIIB initiative.

Launched in October 2014, the AIIB has the potential to trigger economic growth for China. Xi Jinping, China’s president and Communist Party Chief, initially proposed funding to poor Asian countries for infrastructure projects. And though this is a part of what the ADB and World Bank already provide, there is an enormous infrastructure gap. According to a 2010 report published by The Asian Development Bank Institute (ADB), Asia will need to invest as much as $8 trillion into its infrastructure in order to see a continuation in economic development over the next ten years. For China, this would mean much needed investments towards improving their environment, which impacts the country’s health conditions, as well as increasing macroeconomic stability and trade expansion. Resources available within the confines of existing international financial institutions simply aren’t enough to help bridge the gap.

World Bank president, Jim Yong Kim has welcomed the chance to collaborate with AIIB, stating, “The decisions we make this year, and the alliances we form in the years ahead, will help determine whether we have a chance to reach our goal of ending extreme poverty in just 15 years.” Kim sees great potential to be forces in economic development for emerging markets, through co-funding projects and working together towards the same financial goals for the global economy. There are also talks of a development institution, amongst the BRICS developing nations (Brazil, Russia, India, China and South Africa), however there is a struggle to reach a decision about how fund it and subsequently manage it.

Jim Yong Kim, the World Bank president, suggested the bank and the AIIB could co-finance infrastructure projects or work on regional integration. Photograph: Nicholas Kamm/AFP/Getty

Jim Yong Kim, the World Bank president, suggested the bank and the AIIB could co-finance infrastructure projects or work on regional integration. Photograph: Nicholas Kamm/AFP/Getty

The unwavering lobbying by the United States, against the AIIB could prove to be ineffective and even have a negative long-term impact on trade. What is becoming clear to many is that the multilateral system at work to fight against poverty, while perpetuating sustainable global economic growth is of great benefit to all nations. And while the United States, along with few others, raise questions of concern and even reason for cautious acceptance, they are losing credibility and possibly turning the eyes upon themselves.

The question still remains, is it genuine concern over safeguarding, meeting standards and regulation or is it more about the loss of power, governance and leadership?

Pollution in China is More Than a Public Health Threat

In March 2013, Premier Li Keqiang declared “war on pollution” but one year later, 90% of China’s biggest cities still fail to meet air quality standards. Granted that this still an improvement over last year, but it’s clear that they have a very long way to go before air quality in areas like Shanghai and Beijing become safe places to live and work. The pollution isn’t just a problem for public health reasons, but also its economic health.

In order to protect its ailing citizens and decrease the amount of pollution in the air, state regulators have been ordering the closure of most “offending enterprises”, according to The Economist. Combined with the economic slowdown in China, those who have been laid off due to these closures have a difficult time finding new jobs to support their families. Foreign companies that operate within China are also having difficulty recruiting senior executives from abroad because of the failing air quality. Most companies have had to offer a “hardship bonus” to those they hire as compensation for living in these conditions.

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Let’s pause for a moment and take a look at what exactly the air quality is like and how it’s measured. The Air Quality Index (AQI) is measured based on the presence and levels of particulates, sulfur dioxide, carbon monoxide, and nitrogen dioxide in the air (to name a few). This could range anywhere between 0 and 500. The World Health Organization considers an AQI of 25 to be considered safe. But for many urban areas in China, the AQI could be anywhere between 100 and 500; sometimes more. Exposure to such levels after extended periods of time are known to cause both cardiovascular and respiratory diseases. In fact, it’s been shown to decrease life expectancy by 5.5 years.

According to an MIT study, published in the journal Global Environmental Change, there was an estimated $112 Billion lost in 2005 due to “lost labor and an increased need for health care.” The long-term effect on the health of China’s citizens puts a strain on the economy that cannot be undone overnight. The “war on pollution” is not a war that will be over anytime soon. But with determination and (most importantly) cooperation it’s a battle than can be won. We can hope that in time, improved conditions in China’s urban landscape will lead to additional economic growth.