The shifting centre of gravity for global markets

The global economy’s centre of gravity is shifting before our eyes and financial advisers need to be ready to talk about the new risks and opportunities with their clients. Macquarie Bank's Craig Swanger explains.

When Galileo discovered the force of gravity in the 1600s, it is probably quite unlikely that he would have thought the theory would be used in relation to the global economy more than 400 years later.

Just as Galileo’s revelation set the wheels in motion for future scientific discoveries, today we are witnessing a profound new change of direction – this time, in global economic affairs.

The stuttering developed economies and growing developing economies are together shifting the global economic centre of gravity. This is creating new opportunities and risks for investors through what are commonly being referred to as the emerging markets.

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As research from the London School of Economics demonstrates, we can plot this changing centre of gravity.

In the 1980s, the global economic centre of gravity was somewhere in the Atlantic between the US and Europe.

More than 20 years later, and this would now be more accurately placed near Cairo and shifting eastwards, as the vast economies of the emerging markets such as India and China continue to grow. By 2050 this map will most likely be focusing on South-Western China.

A new economic vocabulary

Simultaneously, while the economic centre of gravity is shifting, so is the language we are using to describe these emerging economies.

From BRICs [Brazil, Russia, India and China] and MIST [Mexico, Indonesia, South Korea and Turkey], to CARBS [Canada, Australia, Russia, Brazil and South Africa] and CIVETS [Colombia, Indonesia, Vietnam, Egypt, Turkey, South Africa], a new vocabulary is emerging to capture this changing economic environment.

BRICs is perhaps the most common emerging market grouping currently in use, and incorporates two of the nations that are probably the most well recognised for tipping the balance – India and China.

A path well travelled

The path of rapid economic development has been far from uniform between nations. For centuries, global gross domestic product was dominated by population.

Multiply low productivity by a large enough population and a country will lead the world in economic size. Indeed, as recently as 1820, China’s economy was estimated to have been larger than Western Europe and the US combined.

The rapid and sustained development of the West saw economies with smaller populations such as Germany, the UK and the US vault ahead during the 19th and 20th centuries, as productivity advanced significantly.

Now, as emerging market nations start a similar economic development project, we see the rapid return of the most populous nations as leading economic powers – again, India and China.

Playing catch-up

It is all very well being able to identify the ‘new players’ on the pitch, but the real game challenge begins when it comes to thinking about how a relatively poor country is going to close the gap with more developed nations – how does it do it and how difficult is the process?

There are a variety of development models and historic examples provided by developed countries that were once considered poor.

Provided other factors are equal, poorer countries should grow more quickly than richer countries, because they can follow the lead of developed nations and achieve ‘catch-up growth’.

Japan’s Meiji period of industrial revolution (1868–1912) provides one such example of ‘catch-up growth’.

However, the most prominent current example is China.

There are some clear advantages that can be enjoyed by many emerging markets that make this game of catch-up a bit easier.

Developing countries have the ability to borrow the pre-existing know-how and skip to the latest technology, and are not constrained by outdated infrastructure, which requires expensive reinvestment or innovation to move forward.

Developing nations can also reap huge gains by simply moving the underemployed from agriculture to manufacturing, while developed nations – typically with a higher proportion of their workforce in the service sector – must innovate to enhance productivity from already high levels.

However, while these advantages may make the job of economic development sound easy, it is not all plain sailing.

Virtually all of these ‘advantages’ are a reflection of a very low starting point. Social, health and political issues often hold back or derail development.

Catch-up growth eventually reaches an inflection point, after which a difficult transition is required.

People power

Combine their large populations with industrialisation, urbanisation and increased consumption and you will easily understand why India and China are becoming today’s new leading economic powers.

The productivity improvements that result from converting a workforce from an agricultural to an industrial focus are accompanied by broader societal and infrastructure impacts.

As the population moves from country to city, the energy needs, infrastructure requirements and consumption patterns change.

China’s 48 per cent urbanisation rate is well below Western economies, which have rates closer to 80 per cent. Those making the move to cities are attracted by better job opportunities and higher incomes.

This urbanisation has also been associated with a rapid improvement to per capita income levels.

During the next 20 years, 600 million people around the world are expected to shift from low social economic status to the middle class. Of that number, half are in China.

We believe the vast size of the population making this transition will have a profound impact on global demand for many key resources, services and markets.

Rebalancing economies and portfolios?

As the world’s economy rebalances and shifts towards the emerging markets, investors are keen to understand the impact and, of course, the opportunities that are emerging for them.

History has provided a guide to economic development.

Developed economies have shown us the path and pitfalls faced by countries attempting to move from low to higher income status. This is not lost on those emerging economies, which enjoy several advantages in following the developed economies before them.

While many countries have been able to transition from low to middle income, relatively few have carried on to high income. It is evident that the relationship between economic growth and share market gains is not as simple as intuition would suggest.

Investors do not need to invest in emerging markets and their domestic assets to be able to invest in their growth.

They can invest in global sectors, such as resources, logistics and construction services which will benefit from urbanisation and industrialisation.

As consumption and spending patterns change, farmland, for example, also provides exposure to the benefits of the increased demand for food.

The Australian economy is relatively small, and just two sectors – finance and mining – make up nearly two-thirds of the Australian Securities Exchange index.

For this reason alone, access to investments in emerging markets can be an attractive proposition for Australian investors who are looking to tap into the growth opportunities of this new economic world order.

As we are all aware, with any new opportunity comes new risk, but just as Galileo’s experimentation led to new discoveries, this is no doubt an area which many investors will dip their toe into.

For financial advisers, this means being on hand to talk about the risks and opportunities with clients as they attempt to make their own investment discoveries.

Craig Swanger is Macquarie Bank’s executive director, banking and financial services group.