Emerging Financial Markets
1. Growth and Prosperity
Prof. J.P. Mei
R
V-Violence
AL- Incorrect Politically
AC-Adults only, Very
Challenging
2
Economic Growth:
A Millennial Perspective

0-1000: Almost no growth, 0.01%

1000-1500: Almost no growth, sign of life 0.15%

1500-1820: Doubling the growth rate 0.32%

1820-1870: Tripling the growth rate 0.93%

1870-1913: Golden age 2.11%

1913-1950: Set back 1.85%

1950-1973: Recovery & boom 4.91%

1973-1998: Another Golden age 3.01%
Three Key Drivers
 Conquest
or settlement of relatively
empty areas of fertile land, new
resources, transfer of population, crops
and livestock
 International
trade and capital
movement
 Technology
and institutional innovation
Historical Roulette

3000 BC, Kingdom of Egypt

2500 BC, The Greek Civilization

2000 BC, Shang Dynasty in China

500 BC, The Roman Empire

Middle Ages: China, Aztec in Mexico and the
Incas of Peru

1500 AD, Spanish Adventurers

1600-1800, The Netherlands

1700-1900 AD, British Empire

1900 AD - ?, The United States of America
3000 BC, Kingdom of Egypt
500 BC, The Roman Empire
Key Questions
Why
the small Netherlands once
dominated the world?
Why New York won the world
series of Capitalism?
What is the key ingredient of
economic growth?
Tulip Mania: The First Speculative
Bubble in the World
1800
1668
1600
Price (Guilders)
1400
1200
1000
800
600
400
200
0
64
Jan 1637
37.5
Feb 1637
Time
1642
Tulip Mania: The First Speculative
Bubble in the World
 The
Flow of foreign
capital
 The first stock
exchange in the world
 Development of
options, futures, and
banking institutions
 International lending
Why New York?
•In 1770, Foreign import:
•Philadelphia: 47,000 tons; Boston: 38,000 tons
•Charleston: 27,000 tons; New York: 25,000 tons
•But, New York had a unique history
•Money driven, not religion
•It was a trading post, speaking 18 different
languages even with 1000 population
• Became a financial center after independence
•The development of Erie canel
•Center for trading railroad stocks
The Man Who Made it Happen
•What to do with Junk continentals?
=2.5 cents?
•Federal tax system
•Refund national debt, both foreign
and domestic
•Central bank
•The fight with Jefferson
•Establish Bank of New York
•Introduced securities for federal,
state, bank, insurance companies
•A windfall for Wall Street
Free Market & Monopoly

Buttonwood Agreement on 4/21/1792
outside 68 Wall Street

Self Governing and regulating => set
its own rules and devise its own
procedures => most free market in the
world. But not always in public
interests.
The Definition Of Emerging Markets
•The IFC Definition: Income less than $9,000
•21% GDP, 85% Population, 76% Area, And 11%
Market Capitalization in the World (1995)
•Higher growth rates & high mean returns in many
countries
•Time Taken to Double Per capita Output (10 years
but unstable)
3
The Emerging Markets
S h a re o f W o rld P o p u la tio n , 1 9 9 6
S ha re o f W o rld G D P , 1 9 9 6
E m erging
19%
D e v e lo p e d
16%
D ev eloped
81%
S h a re o f W o rld E q u ity m a rk e t C a p ita liz a tio n
E m e rg in g
9%
D e v e lo p e d
91%
E m e rg in g
84%
Annual Real GDP Growth1987-1996
1 2 .0 %
9 .9 %
1 0 .0 %
8 .5 %
7 .7 %
8 .0 %
6 .0 %
5 .1 %
4 .0 %
3 .1 %
3 .0 %
2 .3 %
2 .0 %
0 .0 %
C h in a
T ig er C u b s F ou r T ig e rs
In d ia
L atin
A m e ric a
Jap an
U n ite d
S tates
Annual Real GDP Growth1997-2001
9.0%
8.0%
7.7%
7.0%
6.0%
5.1%
5.0%
4.4%
4.0%
3.7%
3.0%
2.6%
2.0%
1.1%
1.0%
0.7%
0.0%
China
India
4 Tigers
US
Latin America
Tiger Cubs
Japan
Average Annual Returns for the
Twelve Years Ended December 1998
Source: International Finance Corporation. Returns include capital gains and dividends.
A rgentina
27.0%
C hile
25.4%
G reece
23.5%
M exico
19.1%
H ong K ong
17.1%
US
16.6%
T aiw an
15.8%
B razil
10.4%
8.9%
S ingapore
T hailand
5.1%
M alaysia
K orea
-5.0%
2.1%
-1.3%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
Average Annual Dollar Returns 1999-2002
Source: International Finance Corporation. Returns include capital gains and dividends.
Argentina
Singapore
Greece
Taiwan
US
Hong Kong
Brazil
Chile
Malaysia
Mexico
Korea
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
T a b le . P R O D U C T IV IT Y G R O W T H
T im e T ake n to D o ub le P er-cap ita O utp ut (S e lected periods)
C o u n tr y
P e rio d
Y e a rs
C h in a
1977-19 87
10
S o u th k o re a
1966-19 77
11
B ra zil
1961-19 79
19
T u rk e y
1857-18 77
20
Ja p a n
1855-19 19
34
U .S .
1839-18 86
48
U .K .
1780-18 38
59
S ources: F or U .K ., C rafts 1981 ; for Japan, M oddison , for oth ers, W orld B ank data
The Lucas Growth Model: The
Puzzles of Economics Growth
Why growths differ across
countries? (India vs. China)
Why
growths do not always
translate to stock (investment)
returns? (Korea)
Why
capital flow is so small?
Privatization and Incentives
 Studies
have shown a high correlation between
economic freedom and growth.
 Privatization
of SOEs leads to great improvement
in efficiency and profits.
 Low
Tax Rates provide more incentives for
entrepreneurs.
 Free
trade and market opening allows
multinationals to leverage their strength,
outsourcing production, and expand their
markets.
4
Effective Corporate Tax Rates
Data Source: Goldman Sachs
Japan
US
China
Thailand
Singapore
Hong Kong
0%
10%
20%
30%
40%
50%
60%
An Educated And Low Cost Labor Pool
 Low
Literacy Rates Make Training
Less Costly.
 Young
 Cost
and Energetic
Of Labor Is Low
 Technology
Leap-frog Allows for
Dramatic Improvement in Efficiency.
5
Bulge Bra ck
Asian countries, % of population aged 25-59
(source: Higgins and Williamson; * represents forecast)
1990-1992
2005*
2025*
55
50
45
40
35
30
25
Indonesia
Malaysia
Thailand
Bangladesh
Pakistan
W o r ld L a b o r C o sts in U .S . D o lla r s p e r H o u r
M a n u fa c tu rin g S e c to r
G erm an y
Ja p a n
F ra n c e
U n ite d S ta te s
Ita ly
C anada
B rita in
S p a in
S o u th K o re a
S in g a p o re
T a iw a n
H ong K ong
B ra z il
C h ile
P o la n d
A r g e n tin a
M a la ysia
M e x ic o
C zech
R u ssia
T h a ila n d
In d o n e s ia
C h in a
In d ia
1995
C o st (U S $ )
1997
C o st (U S $ )
3 1 .8 8
2 3 .6 6
1 9 .3 4
1 7 .2 0
1 6 .4 8
1 6 .0 3
1 3 .7 7
1 2 .7 0
7 .4 0
7 .2 8
5 .8 2
4 .8 2
4 .2 8
3 .6 3
2 .0 9
1 .6 7
1 .5 9
1 .5 1
1 .3 0
0 .6 0
0 .4 6
0 .3 0
0 .2 5
0 .2 5
2 7 .8 0
1 9 .0 8
1 6 .9 1
1 8 .1 7
1 5 .8 1
1 6 .2 4
1 4 .0 8
n /a
4 .2 9
7 .0 5
4 .9 8
5 .3 1
n /a
n /a
n /a
n /a
1 .8 1
n /a
n /a
n /a
0 .3 9
0 .2 2
0 .3 3
0 .2 6
S o urc e : M o rg a n S t a n le y R e se a rc h (E nd o f Y e a r E st im a t e s)
Domestic Savings And Foreign
Capital Flow (FDI)
 People
are thrifty (high saving rates) in many
markets. But high domestic savings can not fully
cushion the flow of foreign capital.
 FDI
flows have increased rapidly.
 Equity
flows are rising but not steady.
 The
composition of capital flows are more
healthy (more private than public flows) but there
is a problem of duration mismatch.
6
Foreign Investment
$140
$120
$100
$80
EQUITY
FDI
$60
$40
$20
$86
87
88
89
90
91
92
93
94
95
96
97
6
Economic Impact On Developed Countries
 Raising
demand of baby boomers in EM
vs. falling demand in many western
countries
 Rising
demand for western technology
 Badly
needed infrastructure projects
create huge demand for capital and
expertise.
7
Comparison of Population Growth
Data Source: United Nations
Over the last five years, Japan’s population grew only at a miniscule 0.2% a year. In comparison,
the population of other Asian grew at much higher rates, with some growing at over 2% a year.
3.0%
2.5%
Population Growth
2.0%
1.5%
Series1
1.0%
0.5%
0.0%
Japan
U.S.
China
Thailand
Indonesia
Mexico
Brazil
Hong Kong
India
Malaysia
Annual GDP Growth Projection 2000-2025
Data Source: “Asia’s Bright Future” (Steven Radlelet and
Jeffrey Sachs ), United Nations, and Financial Times
8.0%
7.0%
7.0%
6.7%
6.3%
6.0%
5.3%
5.0%
4.4%
4.5%
4.2%
4.1%
4.0%
3.0%
2.2%
2.0%
1.0%
0.0%
China
Indonesia
Malaysia
Thailand
Hong
Kong
South
Korea
Singapore
Taiwan
Japan
What can go wrong
 Paul
Krugman: Little TFP increase.
 Past
Success has little persistence (Brazil & Korea).
 Excessive
public and private borrowing increase the
risk of financial crisis.
 Currency
instability resulted from week financial
system.
 Overbuilding
of production capacity leads to low
returns. (Real estate speculation)
 Strong
special interest groups can block badly
needed reform.
8
Will Asia Follow Japan’s Fate?






Population growth create
demand
Still in catch-up mood
Low taxes create strong
incentive
Valuation reasonable before
the crash (The bubble was
small)
Weak currency boost
competitiveness
Good fiscal and monetary
condition




Weak legal
institutions
New
development
strategy
Market panic
US market
crash
9
Dramatic Improvement in Current Account
15.0Population

growth create demand
Still in catch-up mood
Low taxes create strong incentive
Small family business (except
Korea)
Valuation reasonable before the
crash (The bubble was small)
Weak currency boost
competitiveness
Good fiscal and monetary condition
12.0
11.7
10.0
Current Account as % of GDP

9.4
5.0

3.9
3.7
1996
1998
0.0

Thailand
Korea
Malaysia
Indonesia
Philippines
-3.4
-5.0

-5.1
-8.0
-10.0
-4.9
-5.0
Lessons from History
 Speculation
helps accumulate capital
and encourages risk taking and capital
flow
 Diversity is key to emergence
 Democracy helps trickling down
 TFP is key to long-term success (not
growth, not investment)
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