A decade ago, it became fashionable to proclaim that emerging market economies had "decoupled" from the global economy and were forging ahead inexorably under their own steam. Then came the great crash of 2008 and another idea took hold: that emerging nations were the locomotives that would haul the rest of the world out of recession.
Today, that notion looks as fanciful as the earlier one. Instead of advancing boldly toward a bright new tomorrow, emerging countries face economic storm clouds on every front: sharply slowing growth -- and in some cases stagnation -- weak exports, heavy debt, capital flight, depreciating currencies, shrinking foreign exchange reserves and loss of confidence among international investors.
Increasingly, the talk is of a deepening "crisis" in emerging markets that threatens to drag the rest of the world down with it. Dominic Rossi, chief investment officer of Fidelity, a mutual fund group that manages more than $5 trillion of assets worldwide, warned recently that the crisis would unleash a powerful deflationary wave, engulfing advanced as well as developing economies.
The fall from grace of the emerging economies has occurred with dramatic speed and scale. Just as striking is how closely the woes besetting them today resemble those that have hampered Western economies since 2008 -- problems up-and-coming nations were then widely believed to have escaped.
Their reversal of fortunes is partly due to the weakness of the global economic cycle, exacerbated by expectations of an imminent rise in U.S. interest rates that has led capital to flee emerging markets in search of higher returns. However, many of their troubles have much deeper roots and will not be quickly or easily solved.
The two biggest problems are China and debt. Many emerging economies, especially large exporters of energy and raw materials, owe much of their past growth to demand from China. Its apparently insatiable appetite made it the biggest consumer of many commodities and enriched countries that produced them. However, their heavy dependence on China has become a liability as its domestic demand has dried up, sending commodity prices crashing.
That is unlikely to change soon. Overinvestment in boom times has created a huge overhang of mining capacity worldwide, while low-cost production of shale oil and gas is set to limit future rises in energy prices and turn the U.S. into the "swing producer" that determines global market trends.
China, meanwhile, is struggling to re-engineer a perilously obsolete economic model based on massive capital investment in property, manufacturing and infrastructure. If it succeeds, its future growth will be built on domestic consumption and knowledge-intensive and services industries, not on pouring concrete, rolling steel and building heavy industrial plants.
Of course, cheaper energy and commodities have made harder times easier to bear for countries that consume, rather than produce, them -- though not by enough to prevent a slowdown in their growth rates.
Vast sums squandered
The emerging market economies' other big problem is debt. Though levels are still lower than in many advanced nations, they have risen fast. The McKinsey Global Institute says emerging countries have accounted for almost half the growth in global debt since 2007. Their total borrowing stood at $49 trillion at the end of 2013.
Some of that money has doubtless been for productive investment and other useful purposes. But much has not. In China, where total debt has quadrupled to more than 280% of gross domestic product since 2007, vast sums have been squandered on unsold property, surplus industrial capacity, "highways to nowhere" and other vanity projects -- not to mention embezzlement and fraud. Much of the money may never be repaid, piling up problems ahead for the banks that lent it and their state owners.
When the 2008 financial crisis erupted, some commentators blamed it on a flood of cheap money created by a savings glut in Asia. Now the tables have turned brutally as ultraloose Western monetary policies have fueled a borrowing binge in Asia and elsewhere. Complacency, irrational exuberance and poor policies followed. As the U.S. moves closer to tightening monetary policy, bills are starting to come due. And they are not just financial and economic.
In some emerging markets, such as Malaysia and Brazil, political cracks are appearing as governments are shaken by corruption scandals. In Turkey, the increasingly autocratic leanings of President Recep Tayyip Erdogan are straining the country's youthful democratic institutions. These are ominous signs for countries that will need stable and purposeful governments to steer them through rough economic waters ahead.
How can emerging economies regain their lost vigor? The first step is to recognize that they can no longer count on the engines that have powered much of their growth in the past: U.S. and European consumption, the commodities supercycle, Chinese demand and rising debt. Now they will have to shoulder more responsibility for generating their own prosperity.
A priority should be to restore productivity growth -- the bedrock of rising living standards -- which has flagged almost everywhere in recent years. That is a complex task, requiring actions on many fronts, from education and training to infrastructure and fiscal policy. The key will be pushing through structural reforms that bulldoze obstacles to growth, allocate resources more efficiently, make markets work better and promote competition.
We have been here before. Starting in the 1980s, a vast wave of reforms swept the industrialized and developing world, ushering in globalization and a lengthy period of global economic growth. However, by the early 2000s, reforms had petered out almost everywhere. Now, led by China and India, emerging-market governments are realizing that renewed reforms are essential to their economic future -- and, in China's case, to continued Communist Party rule.
Powerful vested interests
However, things are off to a slow start. In India, hopes that Prime Minister Narendra Modi's government would push through radical and much-needed economic liberalization have so far been unfulfilled. In China, President Xi Jinping's bold reform program, unveiled two years ago, is still making heavy weather, despite his rapid accumulation -- and ruthless exercise -- of personal power.
In both countries, powerful vested interests that profit from the status quo have mounted strong resistance to change. But even if they can be overcome, other challenges loom. One of the biggest is to develop strong institutions and redefine the functions of the state. That is particularly important in countries at risk of falling into the "middle-income trap," the no man's land between developing and advanced status, in which many once fast-growing economies flounder and stagnate.
While cheap and abundant labor and capital can power the early stages of economic development, other ingredients are needed to make the leap to high-income status. Innovation, creativity and brainpower all become critical. So, too, do robust property rights, sanctity of contract and efficient and effective regulation of markets, particularly financial ones. These are the vital ingredients needed to provide positive economic incentives and ensure fair play.
All these things require sound laws and rules and effective enforcement by institutions that command trust. In countries where governments have intervened energetically in the economy, that will mean switching from active player to the role of independent referee, presiding over institutions that are independent of political meddling, and acting in the overall public interest.
In many countries, all this will involve a profound cultural change and take time to put in place, just as it did in advanced economies. In China, the challenge will be especially big; not just because of the country's size and diversity but because its rulers are pursuing profoundly contradictory objectives.
On the one hand, they have pledged to give a "decisive role" to market forces in allocating economic resources. On the other hand, they are insisting on maintaining absolute control over the economy, while simultaneously cracking down steadily harder on political freedom, transparency and dissent. Trying to marry these different agendas has produced some messy results, notably the botched handling of exchange rate policy and panicky official efforts to shore up stock markets. The Communist Party's carefully cultivated reputation for competence has suffered as a consequence.
Whether China can square the circle and get its economy back on the rails will be fascinating to watch, as will the efforts of other emerging markets to overcome their troubles and set new growth paths. The tests they now face are the toughest since the 1997 Asian financial crisis. Much hangs on their ability to match up to them -- not just for their own futures but for the rest of the world as well.
Guy de Jonquieres is a senior fellow at the European Centre for International Political Economy, a Brussels-based think tank, and formerly a journalist with the Financial Times.