1 Emerging Market response to Developed Countries over recent periods of US recessions and crises: What changed? Regan Deonanan University of Notre Dame Thursday, 23 rd June, 2011

2 Why 2007 US crisis of particular concern to Macroeconomists? Three large facts: Global nature of this US ‘recession’ Largest downturn since Great Depression Macroeconomic models did not predict it Implication: Contrary to previous belief, we still don’t know how to prevent them

3 Purpose of my research How do we prevent developing countries from being so affected by global crises? Need to understand what’s different about the 2007 crisis and why

4 Definitions Emerging markets (EMs) – countries in the process of rapid growth Examples: BRIC, Indonesia, Mexico, Poland Developed countries (DCs) – countries with high level of development Examples: Canada, France, Germany, Italy, Japan, UK, US (G7) US recessions/crisis: 1981, 1990, 2001, 2007

5 Big picture from the data: Pair-wise correlations of rgdp growth between EMs and DCs

6 Main point from graph EM growth became highly synchronized with DC growth/shocks in moving from 2001 to 2007 period – why?

7 Framework of empirical methodology Assumptions: DC fluctuations are the most important drivers of EM growth rates EMs do not influence DC behavior EM growth = US shock + Other DC shock + Prior EM growth + EM shocks

8 Intuition behind empirical methodology What’s driving this recent change in EM response? Size of shocks from DCs Structural change within EM economy What is the nature of the structural change? Trade related Financially related

9 Results: Size shocks or structural change?

10 Results: Ranking by level of structural change 1. LATVIA 2. LITHUANIA 3. ESTONIA 4. RUSSIA 5. SLOVAKIA 6. ROMANIA 7. MALAYSIA 8. KOREA 9. MEXICO 10. ARGENTINA 11. THAILAND 12. PERU 13. TURKEY 14. JORDAN 15. CZECHOSLOVAKIA 16. BRAZIL 17. CHILE 18. HUNDURAS 19. POLAND 20. SOUTH AFRICA 21. MOROCCO 22. COLUMBIA 23. INDONESIA 24. ISRAEL

11 Overall results Structural change within EM economies played a greater role in explaining the change in behavior observed This structural change was particularly oriented towards the US This structural change left EMs more vulnerable to the US through trade and not through financial channels

12 Takeaway: EM response to DCs over various US recessions/crises– what changed? Whenever the US economy goes down we can expect EM economies to also go down at the same time

13 Implications Important from portfolio diversification viewpoint If investing in EMs for high growth - fine If motive for investing in EMs is balancing risk from investments in DCs, need to look to other countries Important from macroeconomic stabilization viewpoint As we seek to diversify our economies by going after EMs, need to ensure we develop relationships with other developing countries as a means of insuring away aggregate risk

14 Diversification and opportunities for growth of region International investors will now be looking beyond EMs for investment opportunities Natural progression will be to Frontier Markets, some of which can be found here in our region (eg. Jamaica, T&T) Making Caribbean region for financially attractive has the potential, more than ever before, to bring in much needed investment