The Quest of a Generation: Sustaining Inclusive Growth

The following is an excellent excerpt from the book “THE ONLY GAME IN TOWN: Central Banks, Instability, and Avoiding the Next Collapse” by Mohamed A. El-Erian from Part III: “From the What to the So What” from Chapter 9: “The Quest of a Generation: Sustaining Inclusive Growth” on page 74 and I quote: “The advanced economies’ failure to grow nominal GDP has made life a lot more difficult for emerging countries–a phenomenon that accentuates not only their internal challenges but also the trials of navigating a global financial system that is inevitably distorted by the pursuit of unconventional policies and is periodically subject to discomforting bouts of financial instability.  Examples include the “taper tantrum” of May-June 2013, the U.S. Treasury “flash crash” in October 2014, the Swiss currency shock of January 2015, the volatility in German bond rates in May-June 2015, and the surprise China currency move in August 2015–all of which highlighted the combined impact of disorderly unwinds by levered traders, little appetite for risk taking among broker-dealers and other intermediaries, and a tendency for some end investors to head quickly to the door at the sign of trouble.

Brazilian and Indian officials have been particularly outspoken on this issue, and understandably so.  In the context of sluggish growth in the advanced world and only partial policy responses, their economies have been on the receiving end of volatile and disruptive capital flows whose major drivers have had a lot more to do with developments abroad than what is going on in these two economies.  It’s the issue of the “tourist dollar,” and it is an important and persistent one.  So let me explain it as I did in a presentation at the Peterson Institute for International Economics.

During periods of large capital flows induced by a combination of sluggish advanced economies, robust risk appetites, and highly stimulative central bank policies, emerging markets serve as destination for a huge pool of crossover funds, or what I refer to an tourist dollars.  Because these crossover funds have such large total assets under management, the flows they devote to emerging markets–while small for them–tend to be a multiple of those invested by more knowledgeable dedicated funds (what I refer to as the “locals”).  And their drivers have a different and more volatile mix.

Rather than “pulled” by a relatively deep understanding of country fundamentals, this type of capital is typically “pushed” there by the prospects of low returns in their more traditional habitats in the advanced world.

Instead of being associated with specialized vehicles, they tend to come from more general accounts typically managed against benchmarks dominated by advanced-country securities.  Searching for higher yields and/or greater possible price appreciation, their investment managers are “crossing over” into smaller (and typically off-benchmark) market segments.

Once they are invested, it doesn’t take long to observe that crossover flows lack the conviction and staying power of the dedicated funds.  As such, they often act as tourists rather than locals.

At the first sign of instability, they essentially tend to rush to the airport, looking to get out quickly; this can even occur when the initial source of instability has little to do with the emerging markets themselves (as was the case, for example, during the May-June 2013 “taper tantrum,” when financial markets in advanced countries were disrupted by a statement from Fed Chairman Bernanke indicating that the central bank could start reducing the support it was providing via QE programs).

Crossover tourist investors are usually inclined to stay in emerging market investment for only a limited amount of time.  They have a decisive home bias, and they tend to overreact to unanticipated news.

The resulting fluctuations in capital inflows and outflows have tended to overwhelm financial markets in the emerging world.  Remember, the flows are not driven primarily by individual country fundamentals.  Rather they are more the product of credit factories in the advanced world and central bank policies there.  And they are large relative to the absorptive capacity of the local financial system.

To my knowledge, no emerging economy has as yet found a robust policy approach for dealing with this challenge–but it is not for lack of trying.  As such, their growth performance has been subject to sizable headwinds.

Perhaps no one has been more vocal and lucid about these issues than Raghuram “Raghu” Rajan, the highly respected and insightful governor of India’s central bank.  With an impressive resume that includes a professorship at the University of Chicago, heading the IMF’s Research Department, and putting out an early warning about the financial crisis (and at the 2006 Jackson Hole conference, no less), he has introduced a breath of fresh air into the highest levels of the global policy dialogue.

Two episodes are particularly notable as they also illustrate how Governor Rajan’s peers in the central banking world have responded to remarks that put them on the defensive.

At a Brookings Institution conference in April 2014–one of the many that are organized around the Spring Meetings of the IMF and World Bank in Washington, D.C.–Governor Rajan warned about the adverse spillover effects on emerging countries of experimental advanced-country policies.  In doing so, he was not being especially outlandish, and he certainly was not the first to make these points.

Yet his remarks were enough to trigger quite a reaction from Chairman Bernanke, who was sitting in the audience, having left his position at the Fed earlier in the year and joined Brookings as a Distinguished Fellow in Residence.

Governor Rajan responded and, with the panel being broadcast via the Internet, the world had access to a rather unusual occurrence in the polite world of central banking: something close to a public argument between two highly regarded heads of central banks from different countries.

Chairman Bernanke reiterated the arguments advanced earlier by other advanced-country officials, which emphasize that the policies being pursued reflect the use of “domestic measures” to attain “domestic objectives,” that success in meeting these objectives would translate into higher growth that is good for everyone, and to the extent that there are negative spillovers on emerging economies, that it is up to the authorities there to deal with them through timely policy adjustments (something that we will come back to shortly).

The second episode was at the October 2014 Banque de France symposium mentioned at the start of this book.  Again on a panel, Governor Rajan made some remarkably thoughtful comments about the structural questions facing central banks and, more generally, the economies of the advanced world.  But rather than his comments serving as the basis of a much-needed discussion, he was politely sidestepped and labeled by the moderator of his panel as belonging to the “BIS brigade”–a reference to the work of the Bank for International Settlement, whose emphasis in recent years has been on the worrisome side effects of unconventional monetary policy, including distorting the link between markets and fundamentals while failing to provide a cure for inadequate growth.

Whether it is because the impact of large and volatile tourist flows is simply too big, to whether emerging economies are unable or unwilling to sufficiently adjust domestic policies, the effect has been to slow growth in the emerging world overall, so much so that this important part of the global economy is no longer a robust growth locomotive for the rest of the world–a role that it performed well after the 2008 financial crisis and that was instrumental for helping to lower the downside facing the advanced world.  Indeed, with most of the systemically important countries slowing (including China, India, and Turkey) or already in recession (such as Brazil and Russia), the emerging world has transitioned to become a drag on global growth.

In sum, the elusive advanced-economy quest for growth has morphed into a generalized growth deficit for the world as a whole.  In the process, the search for new growth engines has become harder, the stakes have gotten bigger, and the consequences have extended beyond economic and financial.  As we will see later in this book, they now also have important social, political, institutional, and geopolitical dimensions.

The overall reduction in emerging markets growth is not the only issue to note.  It has been accompanied by yet another complication–that of a growing gap in prospects, both among countries and across the populations of individual nations.

A few better-managed economies, such as India, are working hard to unleash pent-up growth drivers and surging ahead.  Other traditionally well-managed economies, like China, are trying to soft-land at lower growth rates while deepening their developmental maturation process.  Notwithstanding both internal and external headwinds, growth will become more inclusive in both these cases as it continues to pull people out of poverty, though not enough to avoid striking income and wealth inequalities.

Others, such as Brazil, find themselves facing the old-fashioned and troubling problem of stagflation, or that awful combination of low income growth and high inflation.  The application of the wrong policy mix to the challenges at hand is not only failing to promote growth, but is also leading to higher price increases that place ever greater pressure on the population, and especially the poor.  Their ability to reverse this situation is constrained by how this stagflationary situation fuels social discontent, and the resulting rise in the “misery index” (that is, the sum of the unemployment and inflation rates) complicates an already difficult political environment.

The next group, including countries such as Russia and Venezuela, are dealing with economic recession, even greater currency instability, and spreading financial disruptions–all of which damage business activity in a very basic sense.  As a simple but insightful example, witness Apple’s decision in December 2014 to suspend it sales in Russia as, according to the company, “extreme fluctuations in the value of the ruble” prompted a review of pricing policy and practices.

The generalized slowdown in growth is happening at a time when several economies have already used up some of the considerable resilience they had gained in the run-up to the 2008 global financial crisis–resilience that had served them and the global economy as well.

Having gone through their own internally generated debt and financial crises–and multiple times, including during Latin America’s lost decade of the 1980s, the 1994-95 Mexican tequila crisis, the 1997 Asian crisis, the 1998 Russian default, the 2001 Argentine default, and the 2002 Brazilian crisis–many emerging economies embarked on comprehensive “self-insurance” programs.  They involved various combinations of five key items that remain relevant today:

  • Building up large financial buffers in the form of ample international reserves;
  • Adopting more flexible exchange rates;
  • Reducing the currency mismatch between debt issuance and assets/revenues (or what is known by economists as the “original sin”);
  • Paying off some debt obligations and refinancing others on more favorable terms, including via longer maturities and lower interest rates; and
  • Embarking on institutional changes that render domestic economic management more responsible and responsive.

In other words, having suffered a series of small heart attacks, most emerging economies had embarked on a regime of more exercise, a healthier diet, and more regular checkups.  As such, when the big heart attack came–that associated with the 2008 global financial crisis, which originated in the United States–they were in a much better place to survive it.  They recovered quite quickly (and certainly faster than most people expected, and a lot better than their counterparts in the industrial world).

Since then, however, emerging markets have eaten into their resilience.  To use another analogy, this time from the auto world, they have found themselves on an unexpectedly long and bumpy journey, having to weather the potholes created both by the West and by their own actions, but doing so after using their spare tire and with many miles between service stations.

Financial cushions in the emerging world today are less robust due to lower international reserves and higher corporate debt, a significant portion of which is subject to currency mismatches, according to research by BIS staff.  Meanwhile, policymakers in too many economies seem distracted, either underestimating the challenges ahead or engaging in rather pointless blame games.

In addition to lower resilience, too many emerging economies have also become less agile, failing to transition to the next stages of responsible economic management, ones that involve more micro reforms–so-called second-generation structural reforms, which are technically more difficult to implement and tend to face stronger vested interests, yet are critical for sustaining growth and advancing the development process.

As a result, absent a strong recovery in the advanced world the lower growth performance of the emerging countries is unlikely to be corrected anytime soon.  Meanwhile, the more challenged the growth in the emerging world, the trickier the recovery among advanced economies.  All of which renders the global economy less dynamic and much more vulnerable to policy mistakes and market accidents.


“Mohamed el-Erian understands markets and economics, and he clearly and coolly articulates the forces that created the current global slowdown and the dangerous fork in the road that the world economy is approaching.  The road ahead cold lead to a perilous U-turn or more durable, inclusive growth.  The good news, as El-Erian convincingly argues, is that policymakers, businesses, and the rest of us still have our collective hands firmly on the wheel and can steer the economy in a better direction.”   –Alan Krueger, Bendheim Professor of Economics and Public Affairs at Princeton University


LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran


About tim074

I'm a retired dairy farmer that was a member of the National Farmer's Organization (NFO). Before going farming, I spent 4 years in the United States Air Force where I saved up enough money to get my down payment to go farming. I also enjoy writing and reading biographies and I write about myself as well as articles and excerpts I find interesting. I'm specifically interested in finances, particularly in the banking industry because if it wasn't for help from my local Community Bank, I never could have started farming which I was successful at. So, I'm real interested in the Small Business Administration and I know they are the ones creating jobs. I have been a member of Common Cause and am now a member of Public Citizen as well as AARP. I have, in the past, written over 150 articles on the Obama Blog ( and I'd like to tie these two sites together. I'm also on Twitter, MySpace and Facebook and find these outlets terrifically interesting particularly what many of these people did concerning the uprising in the Arab world. I believe this is a smaller world than we think it is and my goal is to try to bring people together to live in peace because management needs labor like labor needs management. Up to now, that hasn't been so easy to find.
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