BRICs as the Emerging (Decoupled) Leaders
Prior to the global financial crisis, there was a virulent debate over the concept of decoupling, the idea that the performance of some sectors of the global economy are not correlated with that of others.
The main paradigm of decoupling was around a group known as the BRICs - Brazil, Russia, India and China. These economies, it was argued, would continue to grow even if the established global economies – the United States and Europe – faced declining economic growth or even recession.
The main thrust of the argument regarding why these economies were becoming independent of the US was that domestic aggregate demand was becoming relatively more important to their economic growth than foreign trade and investment. Another reason was that trade and investment flows between these countries as well as other emerging economies was rising, meaning that demand for goods and services in the US and Europe were becoming less important.
The BRICs economies shared important features, including large populations, high real rates of economic growth, and rapidly developing infrastructure. However, these economies have major differences. Brazil and Russia are major exporters of natural resources, while China and India are importers. Moreover, these countries have varied trade and investment partners.
A Global Crisis, but Recovery is Strictly Regional
At the onset of the global financial crisis, many analysts viewed the crisis itself as proof that the decoupling theory was patently false. The crisis began in the US, spreading to Europe, and then to the entire world. How could one argue that there was such thing as decoupling given these events? However, almost a year after the crisis began, clear evidence is emerging that certain parts of the world are recovering faster than others, in large part because these economies seem to be less affected by events in the United States and Europe.
The best proxy for short run economic performance is stock market indices. The efficient markets hypothesis can be generally accurate in the sense that stock market performance reflects investor expectations about future economic performance, even if it does not reflect actual future economic performance.
Looking at global equities markets during 2009, we see that all of the ten best performing equity markets in 2009 are emerging markets. All four of the BRICs nations are represented in the top 10, and Asia and Latin America dominate the top 10, with only one of the ten not being from one of these two regions. None are from Europe or North America.
Clearly, if judged by the performance of their equity markets this year, Asian and Latin American economies have shone this year, and the traditional powers of Western Europe, the United States and Japan have all performed very poorly.
A Shift in Thinking for Global Investors
If one accepts this data as an indication that decoupling has indeed occurred, what does it mean for global investors? First, it could signal the beginning of a shift in what is considered a safe-haven investment. Under a scenario of correlated global economic performance, the United States is the clear safe-haven, because it is the most advanced economy in world, and all returns are correlated with its returns. In a decoupled world, an investor’s safest play is to diversify – that is, to invest in the traditional economies, and to invest in the BRICs and other emerging economies whose performance may not be correlated with that of the United States and Europe. Evidence that this diversification is taking place is already emerging.
If global investment flows come to reflect this “decoupled” analysis, it will mean the US’ dominant global economic position will begin to recede. Ever since Bretton Woods, the United States has been able to run consistent budget and trade deficits because the world was willing to hold dollars without question. In a decoupled world, this may no longer be the case.
Second, a decoupled world will mean the end of the dominance of the dollar. If holding US assets is no longer the default investment decision, then holding dollars is no longer the default currency position. A basket of diversified safe haven investments will require a similarly weighted currency position in order to manage currency risk exposure.
Finally, a decoupled world will lead to more difficulty in reaching global consensus on trade and investment rules. If the performance of all economies depends on the performance of all others, then cooperation is an appealing strategy. If, however, some countries come to see their own performance is independent of, or negatively correlated with that of others, then consensus on global rules and standards will become much more difficult.
Evidence of this problem has already emerged during the Doha round of WTO discussions, and more recent changes in the structure of global economic meetings is a further indication that new interest groups are forming. Most importantly, the meeting of the BRICs heads of state, marks a critical moment. It signals that these leaders view their interests as tied to one another’s in a manner that is independent of their ties with other large economies.
In summary, the stark divergence in the economic performance of Asian and Latin American economies, compared with that of the traditional powers in Europe and the United States since the beginning of 2009 indicates that the world may be entering a new economic era in which globalization is tempered by starkly divergent regional interests.
Mohammed Sadek Alsulaiman - An economist who is currently Senior Manager for Private Equity and Real Estate at the National Investment Funds Company and a Board Member of the Young Arab Leaders, UAE Chapter
