In memory of Dr. Andreas Höfert

The exaggerated rumors of “the demise of the rest”

On my desk sits the November/December 2012 issue of Foreign Affairs, which bears a sobering title: “The demise of the rest: How the BRICs are crumbling and why economic convergence is a myth.” With the US still on the verge of the fiscal cliff, and Europe embarking on what will likely be a decade of troubled stagnation, is the last region standing now also falling apart?

Ruchir Sharma, head of Emerging Markets and Global Macro at Morgan Stanley, argues in the title article that “international economic convergence is a myth.” Although “[t]he most talked-about global economic trend in recent years has been ’the rise of the rest,’ with Brazil, Russia, India and China leading the charge... Few countries can sustain unusually fast growth for a decade, and even fewer, for more than that. Now that the boom years are over, the BRICs are crumbling; the international order will change less than expected.”

Sounds pretty frightening, doesn’t it? In fact, if this were true, with Europe, Japan and the US pretty much in the doldrums, we would be facing no less than 10 years of worldwide stagnation or recession. Welcome back to the Great Depression. Let’s just hope that the current decade will not end like the 1930s did. As an economist, it is an occupational hazard that I am usually strolling much more on the gloomy side of the street than on the sunny side. However, when it comes to the “rise of the rest,” I have a quite strong opinion - and one which is far less dark than that of my colleague.

I am not an emerging market specialist, so I asked two of my prominent UBS colleagues and experts in the field, Jorge Mariscal, Chief Investment Officer Emerging Markets, and Costa Vayenas, Head of Emerging Market Research at CIO Research, to share their impressions on this article. Both of them make it pretty clear right at the beginning: Like me, they see the BRIC concept as little more than a marketing gimmick. It reduces the whole emerging market space to only four large countries, which clearly cannot encompass all that is happening there. Over the last decade, we have stressed the fact that there are other emerging markets which may not be as large, but are at least equally investable. These include Indonesia, Mexico, South Africa and Turkey, to pick out just a few G20 names.

Sharma also uses the concept of convergence in a misleading - if not incorrect - way. He says that the hype has been about “the economies of many developing countries swiftly converging with those of their more developed peers” - but no one serious has actually made that claim, nor that the “major players in the developing world... [are] catching up to or even surpassing their counterparts in the developed world.” In fact, Sharma confuses the nominal GDP of the emerging market countries - which, taken as a whole, could well exceed that of the developed countries at some point - with GDP per capita. Closing this gap should prove much more difficult, and is still a long way off. All the standard models have always shown US GDP per capita remaining well above China’s for decades to come, and I do not see any serious challenges to this claim.

Sharma also ignores the growth prospects of developed economies, which at this stage do not appear particularly exciting. Given their heavy indebtedness, it is doubtful that they will experience higher growth rates than the emerging markets, which have much healthier balance sheets. So even if growth in emerging markets were to slow down substantially, it would still most likely remain above that of developed economies and this in itself means catching up.

Ultimately, and most importantly for investors, long-term asset returns are not concerned with whether emerging economies will reach developed economies on a per-capita basis, but whether they will offer better growth opportunities as they continue to converge.