Growth In The Rearview Mirror

There is something amiss with a forest in which every tree grows to the sky. Yet few of us stopped to question the magical boom that hit virtually every country in the world, beginning in 2003. There was some skepticism about the housing-led growth spurt in the United States, but now it is increasingly apparent that the simultaneous acceleration from Brazil to India and even China was also rooted in a global credit bubble.

This is a particularly painful realization for the developing world, which came to believe that the

boom was testament to the power of globalization, increased urbanization and better macroeconomic policy management. While there is more than an element of truth in those arguments, it's hard to escape the conclusion that the growth leap was mainly due to easy access to cheap money.

The trend growth of developing economies showed a marked increase beginning in 2003, with the average rate doubling to 7.3 percent from 3.6 percent between 1980 and 2002. It was no coincidence that this levitation act got underway just when the U.S. housing sector started to boom. Following the tech bust in the preceding years, the U.S. Federal Reserve cut interest rates aggressively to engineer a new growth cycle.

But the Fed was not just setting U.S. interest rates—it was also determining the global price of money. Capital gushed into many developing countries, and the cost of capital went down universally. In a world of global capital flows it's difficult to run an independent monetary policy. Net capital flows to emerging markets rose to 7 percent of emerging markets' GDP during the 2003–07 period, up from an average of 4 percent from 1980 to 2002. As a result, equity and debt liabilities to foreign investors rose to more than $5 trillion by 2007, or 40 percent of the developing world's GDP, compared with 22 percent in 2002.

Given the easy availability of credit, companies in the developing world sought to fund ambitious growth plans with debt and equity capital from Western financial institutions. Last year was a bumper year, with $435 billion in new overseas syndicated loans, $150 billion in external corporate bonds issuances and $210 billion of foreign IPO money heading to emerging markets. The role of foreign capital flows in boosting economic growth goes beyond the raw numbers. Such flows also helped growth in a qualitative way by increasing domestic confidence regarding future growth prospects, spurring on the entrepreneurial spirit by providing the risk capital for large projects and bolstering exchange rates.