MARCH 2008 :: COVER STORY : INTERNATIONAL

Shot Felt 'Round the World
When the U.S. Economy Hurts, Emerging Economies Share the Pain

Today's global economic crunch was made in America. But despite hopes to the contrary, the pain will be shared by developing nations world-wide.

Developing economies-where 85% of the world's population lives-are maturing and are far less fragile than they were a decade ago. But they aren't strong enough to escape the pain of a slowdown in the industrialized world or self-sufficient enough to sustain global growth on their own.

Many emerging markets rely on exports to rich countries. And while local sources of economic growth have taken root in China and elsewhere, they aren't enough to keep developing countries from slowing if their export engines sputter.

For years, economists have been debating whether the developing world is robust enough to "decouple" from the U.S. economy, and motor ahead even when the powerhouse U.S. economy softens. For now, at least, the answer appears to be no.

"No country can decouple from the U.S.," says Kamal Nath, India's trade minister. "The question is the impact."

$9.5 Trillion in Spending

American consumers hold far greater sway over the world economy's fate than consumers in any other country: They spent about $9.5 trillion last year-nearly six times as much as the more than two billion Chinese and Indian consumers combined, says Stephen Roach, chairman of Morgan Stanley in Asia.

In Thailand, shoe exports are already cooling and some apparel factories have closed. In China, furniture makers are facing weaker sales. Hua Chao Art & Furniture in Zhongshan says exports to the U.S. fell about 17% in 2007 compared with the previous year, in part because of the U.S. housing bust. "Production may shrink and jobs may be cut accordingly," says a sales manager at the company.

"One has to remember that the U.S. remains the dominant economy globally," says Ifzal Ali, chief economist of the Asian Development Bank in the Philippines. To argue that emerging-market economic growth can be sustained without the U.S. is "quite a stretch and can be quite misleading," he says.

The U.S, after all, accounts for 22.5% of the world economy, according to the latest World Bank estimates. Japan, along with Germany, France, Italy, Spain and the United Kingdom, account for an additional 23.6%.

That isn't to say emerging markets are headed for disaster. China, by far the largest emerging economy, is still on track to grow strongly in 2008. Chinese demand, in turn, should help sustain the economies of resource-rich countries in Latin America, Africa and Southeast Asia. Economists at the big mining company Rio Tinto predict that commodity prices will remain at historically high levels for a long time to come because of China, which accounted for between 60% and 90% of the increase in world demand for steel, aluminum and copper between 2000 and 2006.

Emerging-market spending on infrastructure also is likely to continue. China's latest five-year plan calls for more than $100 billion in railway construction, including a $22 billion Beijing-to-Shanghai high-speed railway. Russia, India and oil-rich Middle Eastern countries are nearly as ambitious.

The trend benefits multinational companies such as Caterpillar and General Electric. Emerging markets "never totally decoupled" from the economies of richer countries, GE Chairman Jeff Immelt says, but are "becoming increasingly decoupled." GE is betting on continued strong demand for its aircraft engines from Latin American airlines, and for its electricity-generation equipment in India, South Africa and other places with "power shortages everywhere," he says.

Indeed, emerging economies have found ways to cushion the blow when the U.S. market collapses. In the late 1990s, several emerging markets ran out of foreign reserves and defaulted on their debts. In the decade since, some have built up huge cash reserves to support their economies in times of crisis. Brazil sits on a cushion of $185 billion. Russia has stored some of the country's oil revenues in a fund valued at $160 billion. In all, emerging markets have an estimated $4.1 trillion in central-bank reserves.

"This time we have something of a vaccine when the U.S. sneezes," says Claudio X. Gonzalez, chairman of paper company Kimberly-Clark's Mexican subsidiary, referring to Mexico's estimated $7 billion on hand from oil-export revenues, a recent sale of toll roads, and other sources. "This extra money won't entirely free us from the effects of a U.S. slowdown, but it should help."

Emerging markets-the term applies to what once were known as developing countries or the Third World-historically have been the weak links of the global economy. Many suffered from poverty, economic mismanagement, corruption and fickle international investors.

A lot has changed. Living standards in a handful of Asian economies-South Korea, Singapore, Hong Kong-have risen to the level of some European countries. Even excluding those success stories, emerging markets have been growing at better than a 7% pace over the past few years, double the rate of big industrialized countries, according to the International Monetary Fund.

Not Immune

But emerging markets aren't immune if demand for imports falters in the U.S. and Europe and fails to revive in Japan.

Many emerging markets depend more than ever on exports. In Asia excluding Japan, exports accounted for about 55% of gross domestic product in 2007, compared with slightly less than 40% in 2001, the last U.S. recession period, according to Lehman Brothers. "The set of countries that is trying to grow on exports is still quite large, and they're not all going to be able to," says Simon Johnson, chief economist at the International Monetary Fund.

Taiwan, Singapore and South Korea are particularly exposed to U.S. consumers, because they are major suppliers of semiconductors and high-tech goods Americans snap up. Singapore's economy contracted for the first time in four years during the fourth quarter of 2007, largely because of slowing exports.

In Thailand, several apparel-related businesses have closed. Shoe exporters say demand growth, running at double-digit-percentage increases in early 2007, has been cut in half, in part because of a strong local currency.

"It's been a bit slow" lately, says Thamrong Tritiprasert, chairman of the footwear committee of the Federation of Thai Industries, a manufacturing association. But 2008 should be strong, he says, in part because Thailand is expanding to other markets, including Europe. "Even when there's a recession, people are still buying shoes," he says.

Signs of a Slowdown

The most successful economies in Europe's former communist bloc have likewise staked their futures on trade with rich countries.

Slovakia has become the Detroit of Europe, thanks to massive factory building in recent years by foreign car makers, including Volkswagen and South Korea's Kia Motor. Slovakia's exports, dominated by cars, are equivalent to 70% of GDP, and surging car production has pushed economic growth above 8% in the past two years. But most customers are in Western Europe, where consumer spending was already retreating late last year.

Mexico is particularly vulnerable to a U.S. slowdown, because some 23% of its annual economic output comes from exports to the U.S. Shipments of finished cars to the U.S. last year fell 60,000 units to 1.2 million, though to date Mexico has offset those declines with increased sales to other parts of the world.

Mexico's exports of manpower are also under threat. The U.S. housing slump has led to the loss of some 100,000 construction jobs, many filled by illegal immigrants. That has dramatically slowed the growth of money sent back home by migrants. After nearly quadrupling to $24 billion in 2006 from $6.6 billion in 2000, remittances sent back to Mexico grew perhaps 3% last year, according to the Inter-American Development Bank. That is the slowest rate of growth in more than 20 years.

Many emerging markets had hoped to reduce reliance on U.S. and European consumers by boosting domestic spending. Yet while consumer expenditures have increased in many places, they haven't kept pace with other sources of growth.

Consumer spending now makes up a smaller percentage of economic activity in China, Brazil and India than in the early 1990s, according to data from forecasting firm Global Insight. In China, consumer spending now accounts for about 35% of the economy, compared with 46% in 1990-and more than 70% currently in the U.S.

In Thailand, hopeful developers have built or renovated ultra-high-end malls throughout the central business district. One, called "Siam Paragon," includes a Ferrari showroom and luxury fashion boutiques.

Yet staff say most big-ticket items are purchased by foreign tourists or expatriates. At an Adidas boutique in one of the malls, sales agent Jiraporn Duangchisin says sales are down some 70% over the past few months.

"I don't know where all the people have gone," she says.