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By Christine Lagarde

I would like to share with you my views on a key 21st century issue—the growing importance of emerging market economies. And by growing importance, I mean for the global economy- for you and me.

To get started on this topic, let us consider all the possible connections with emerging markets in the first 30 minutes of your day:

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Let’s assume it is 7:00 am, and the alarm goes off on your Chinese-made smartphone. (Ok, let’s say it is 9:00 am—perhaps you have had a long night behind you!). On the way to the shower, you send a WhatsApp message to your TA. WhatsApp, of course, was co-founded by a Ukrainian computer engineer.

A few minutes later, your roommate has also woken up. With a third of UMD graduate students being international students, there is a good chance that she may be facetiming with relatives in India. At 9:15 am, you are facing a really tough choice—between strong coffee from Kenya and a milder variety out of Colombia. You switch on your Bluetooth speaker—made in Malaysia—to listen to the news.

Overnight, global stock markets were rattled by the latest Chinese economic data—which has put a dent in your mom’s 401(k) savings plan, and you worry about Spring Break in Mexico.

Luckily, as you head out to a field trip in a Zip Car made in Korea, you realize that low oil demand and strong supply from emerging markets have also brought down gas prices! As you contemplate these first minutes of your day, you realize that the center of economic gravity has been slowly shifting.

Yes, the United States is still the most important economy in the world, but New York, Chicago, and L.A. have gotten company, from Beijing to Brasilia, from Moscow to Mumbai, and from Jakarta to Johannesburg.

Emerging and developing economies are home to 85 percent of the world’s population—6 billion people. These 85 percent matter to the global economy more than ever, and they matter to you more than ever—because of strong linkages through trade, finance, economics, geopolitics, and personal connections that you experience every day.

A New Partnership for Growth

As a group, emerging and developing economies now account for almost 60 percent of global GDP, up from just under half only a decade ago. They contributed more than 80 percent of global growth since the 2008 financial crisis, helping to save many jobs in advanced economies, too. And they have been the main driver behind the significant reduction in global poverty.

China alone has lifted more than 600 million people out of poverty over the past three decades. After years of success, however, emerging markets—as a group—are now facing a new, harsh reality. Growth rates are down, capital flows have reversed, and medium-term prospects have deteriorated sharply.

Last year, for example, emerging markets saw an estimated $531 billion in net capital outflows, compared with $48 billion in net inflows in 2014.

In the short term, the softening of growth, the scale of capital outflows, as well as the recent stock market declines are cause for concern.

Furthermore, on current IMF forecasts, emerging and developing economies will converge to advanced economy income levels at less than two-thirds the pace we had predicted just a decade ago.

This means that millions of poor people are finding it more difficult to get ahead. And members of the newly created middle classes are finding their expectations unfulfilled.

This is bad not only for emerging markets themselves, but also for the advanced world that has come to rely on emerging markets as destinations for investment and as customers for its products.
It also carries with it the risk of rising inequality, protectionism, and populism.

This is why we need what I call a new “partnership for growth”. Both emerging and advanced economies need to play their part to promote faster and more sustainable convergence.
With this in mind, I would like to address three questions:

First, what are the key challenges facing emerging markets and what are the interlinkages between emerging and advanced economies? Second, how can we forge a new partnership for growth?

Key challenges

China has embarked on an ambitious rebalancing of its economy—from industry to services, from exports to domestic markets, and from investment to consumption. It is also moving towards a more market-oriented financial system. These reforms are a necessary process that, in the long run, will lead to more sustainable growth and benefit both China and the world.

However, it will lead to slower growth, and this slowdown creates spillover effects—through trade and lower demand for commodities, and amplified by financial markets. Second—declining commodity prices. Oil and metals prices have fallen by around two-thirds from their most recent peaks, and are likely to stay low for quite some time. As a result, many commodity-exporting emerging economies are under severe stress, and some currencies have already seen very large depreciations.

The Federal Reserve has raised interest rates in response to a strengthening U.S economy, while other advanced economies have not raised interest rates, or have gone in the opposite direction.
This has contributed to a rise of the U.S. dollar—putting considerable strain on those emerging market companies that took on large amounts of US dollar-denominated debt, especially in the energy sector. This means that anybody who holds an exposure to such companies, whether banks or governments, may be vulnerable to losses.

In addition to these challenges, the emerging world is also facing increasing geopolitical and environmental risks. Think of the Syrian refugee crisis that is directly affecting countries such as Turkey, Lebanon, and Jordan, which are hosting millions of displaced people.

Think of the impact of climate change on food prices, political stability, and people’s health, particularly in Sub-Saharan Africa and southern Asia. By 2030 it is expected that more than 98 percent of deaths related to climate change will occur in developing countries.

Spillovers and Spillbacks

All this matters to advanced economies—because of what we at the IMF call spillovers and spillbacks. What does that mean? It means a two-way street of unintended knock-on effects—with actions in one country spilling over to others, which in turn creates a negative feedback, or spillback effect, on the country that started the process. Emerging markets have reached a size where such effects are big enough to be noticed everywhere.

Last August, global financial markets were rattled by China’s announcement of a new exchange rate arrangement. And at the beginning of this year, another stock market plunge in Shanghai made global investors hit the “sell” button. More broadly, weaker corporate fundamentals in emerging markets can also trigger financial spillovers to the rest of the world.5 So, watch those balance sheets!

Global trade has slowed down dramatically in recent years, partly because of China’s economic slowdown. This matters to all of us—not only because trade has historically been a major driver of growth, jobs, and prosperity, but also because trade between emerging and advanced economies now exceeds trade among advanced economies.

Adding it all up, our estimates show that a slowdown of one percent in the emerging world would reduce growth in advanced countries by about 0.2 percentage points. This may not sound like much, but in fact would be a significant blow to those advanced countries that are already struggling with what I have called a “new mediocre” of low growth and high unemployment.

There are also environmental spillovers. Over the next 15 years, we may be looking at up to $90 trillion in global infrastructure investment, mostly in emerging and developing economies that will see a massive increase in urbanization. Just think about the risk if this investment is done in the wrong way—for example, if it locks in carbon-intensive energy and transportation structures in these mega-cities. This could radically affect the quality of life on the planet—for all of us. So the message is: emerging and advanced economies depend on each other, and the world depends on their collaboration. How can the two sides do more to make it work?

It takes two to grow.The idea is that strong policy actions by emerging and advanced economies can be a win-win for both. A win-win for the global economy.

What is it that both emerging and advanced economies can do?

There are no easy answers here. Both need to address the underlying economic issues that are fundamental to boost potential growth and promote the sustainable income convergence that I talked about earlier.

First, foster more and better innovation—by removing barriers to competition, cutting red tape, enhancing the mobility of labor, and investing more in education and research. This would unleash entrepreneurial energy and help attract private investment in ideas that are new, surprising, and useful.

This would also strengthen the role of public research institutions, such as the University of Maryland. Remember that all the technologies that make your phone “smart” have benefited from state funding—the internet, wireless networks, GPS, microelectronics, and touch screens.Private companies like Apple put it all together—brilliantly—but they would not have had the incentives and financial muscle to do it all by themselves!

Second—facilitate a greater sharing of technology between the advanced economies and their emerging peers. This would, for example, require finding a better balance between intellectual property protection and technology dissemination. Emerging economies would need to rethink their approach to patent protection. At the same time, we should ask whether ideas in advanced economies are, in some cases, too strongly protected. There has been an active global debate on these issues, including on pharmaceuticals and medical treatments.

Another way to facilitate the sharing of technology and know-how is foreign direct investment. FDI into emerging and developing economies, as a share of GDP, is now well below what it was in 2000-06. Our global forecasts predict it will fall even further by the end of the decade. So we need greater efforts to remove unnecessary barriers to FDI, and to replace hot money with longer-term investment.

Likewise, we need to promote technology sharing by promoting trade reforms. For at least three decades before the 2008 financial crisis, global trade regularly grew at twice the rate of the global economy. It is now expanding at, or below, the rate of the global economy. Aside from the China effect, this is because of the slowdown in trade liberalization in recent years. So we need greater efforts to open up global trade systems and promote trade integration through regional and multilateral agreements. Finally—both advanced and emerging market countries need to complete and implement the global regulatory reform agenda—which is essential to create a more resilient global financial system.

Editor: a slightly edited speech by International Monetary Fund Managing Director, at the University of Maryland, on February 4, 2016

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