Why emerging market leaders should read Thomas Piketty

Why emerging market leaders should read Thomas Piketty

Thomas Piketty brought the debate over wealth inequality into the limelight in the US and Europe, but it could have an even larger impact on emerging and frontier markets.

Six months ago, it would be hard to imagine a book like Thomas Piketty’s Capital in the Twenty-first Century becoming a bestseller in the US and Europe. With its 700 pages peppered with charts and tables, it does not fit the mold of a bestseller. Regardless, it has dominated the political and economic debate in the developed world. Its core message, that wealth inequality is increasing and has a crippling effect on the economy, has rung true with the left-wing and drawn ire from many others.

Piketty’s research, just like where it has had the largest political impact, focuses entirely on developed countries. But when compared to emerging and frontier markets, the inequality in developed economies is relatively small. The issues brought up by Piketty loom much larger over the economies of China, Thailand, and Brazil than they do in the US, France, or Japan.

The implications of Capital in the Twenty-first Century for emerging and frontier markets cannot be understated. These countries will be global growth drivers for the next generation. Their ability to adapt to growing middle classes, a need for better institutions, and increased world power will have an impact on growth and wealth far from their shores. Piketty’s points are issues that investors in developed economies must be intimately acquainted with. In fact, many of these issues are already occurring.

Political unrest

A handful of the more promising emerging and frontier markets are at best democracies in name only. This has left the door open to policies that enrich the politically well-connected and ignore the majority of the population. Many of these economies have grown at a rate of upwards of 10% annually, but poor or self-rewarding policies raise doubts about that growth’s longevity – not least due to civil unrest.

Thailand’s recent coup – the third removal of democratically elected governments in 15 years – is perhaps the most vivid example. Thaksin Shinawatra’s party has been elected with strong base of the rural poor, who largely work in subsistence agriculture, with a focus on economic development and infrastructure spending. These policies threatened the benefits that the urban middle and upper class, as well as the influential military, reaped from the political system as it was.

Hong Kong is another recent example. The debate over expanding suffrage across to all residents of the island has sparked mass protests by pro-democracy campaigners. In a telling moment, the Hong Kong offices of the Big Four accounting firms placed a large advertisement in three Hong Kong newspapers warning against the disruption to markets that increased democratization could cause. The Big Four represent the portion of population with the greatest wealth, and recognize that more vibrant democracy could very well threaten the privileged position they have enjoyed historically in Hong Kong.

Untapped growth potential

Piketty’s arguments make a strong connection between wealth and capital: The wealth inherited by the lucky few allow for investment in business, capital, and financial resources. The growth in emerging and frontier markets over the last 20 years would not have been possible without that wealth, but because only a select few had the resources to make those investments the gains are concentrated in the already wealthy populations of emerging markets. While globalization and growth have increased incomes of entire populations in high growth countries like China, as Andrew Sheng and Xiao Geng argue, the gains of the top 1% are much larger.

Allowing the general population to access a larger share of the emerging and frontier markets’ wealth would lead to faster growth, which should be more steady and consistent as well. The argument holds whether analyzing these economies from the demand-driven or supply-driven outlook. Having access to more wealth and the returns to that wealth will allow for more domestic spending, increasing demand, jobs and the viability of local industry. On the supply side, the returns on capital in the hands of the general population will increase productivity and lower the price of goods for the entire country.

This stimulative effect would be welcome in emerging and frontier markets whose economies have faltered in the last year. In developing stronger domestic markets, emerging markets will be less susceptible to the impact of developed markets shocks, like the ones that the Federal Reserve’s taper caused. Unfortunately, taking advantage of these returns is logistically difficult.

An IMF report on equality, growth and wealth redistribution concludes that redistribution generally does not have a negative impact on growth, especially in more unequal countries. The authors argue that the poor can be better off and the aggregate can be better off. But the redistribution has to come from somewhere, and that is where the practical difficulties lie. The most influential members of society are the ones who lose the most in paving the way for faster growth. Not only would they lose ground in relation to the rest of the population, but there would be competition for business opportunities that previously went uncontested.

This is what fuels the political conflict and will continue to be a source of uncertainty. Those who have already gained from the last two decades’ growth in emerging markets have an incentive to remain the beneficiaries for future decades. They also have the most experience in dealing with foreign investors and markets. Piketty’s arguments are central to the discussion of the future of emerging and frontier markets, even more so than in the US and Europe. The question going forward is whether Piketty’s recommendation for a global wealth tax will help or hurt these economies – and whether they will have an impact on wealth distribution in these markets.

Categories: Economics, International

About Author

Alex Christensen

Alex is an Editor at Global Risk Insights, who also currently works in investment research. His work on political risk and economic policy has appeared in many forums, including Business Insider, Seeking Alpha, Oilprice.com & The Emerging Market Investors Association. He holds a Master’s in Economics from the London School of Economics and BA from Washington University in St. Louis.