Who’s to blame for the emerging-market crisis?

By Felix Salmon
February 1, 2014
Paul Krugman and Dani Rodrik are out with dueling op-eds on the subject of the latest bout of financial-market craziness in places like Argentina and Turkey.

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Paul Krugman and Dani Rodrik are out with dueling op-eds (the latter written with Arvind Subramanian) on the subject of the latest bout of financial-market craziness in places like Argentina and Turkey. Both men have been following emerging-market crises for decades; both indeed, are world-class experts on such episodes. What’s more, both economists have a broadly left-liberal worldview: there’s no deep ideological or philosophical rift here. And yet the two seem diametrically opposed.

Here’s Krugman:

Turkey isn’t really the problem; neither are South Africa, Russia, Hungary, India, and whoever else is getting hit right now. The real problem is that the world’s wealthy economies — the United States, the euro area, and smaller players, too — have failed to deal with their own underlying weaknesses.

And here’s Rodrik:

Emerging markets aren’t hapless and undeserved victims; for the most part they are simply reaping what they sowed…

The fact is that the emerging economies’ troubles are domestically generated problems and not the fault of foreigners. The complaint of emerging-market countries seems a classic case of blaming outsiders for choices and actions that have been predominantly domestic.

Take a step back, and you’ll find a certain amount of agreement: both Krugman and Rodrik would accept that a large part of the story here is that the Fed’s QE program caused enormous amounts of cash to flow into the world’s emerging markets, thereby helping to inflate the markets which are currently crashing. What goes down must have gone up — and it’s easy to see where the inflows came from.

That said, neither Krugman nor Rodrik is blaming the Fed for causing the emerging-market bubble in the first place. The Fed had a (domestic) job to do, and did it; QE was part of that job, and the Fed simply can’t worry too much about potential unintended consequences on the other side of the planet when it’s setting US monetary policy.

The stories being told by both Krugman and Rodrik are consistent, then, with the “taper tantrum” theory of the current emerging-market crisis. Basically, emerging-market economies have become reliant on the constant flow of very cheap dollars being printed by the Fed; now that QE is coming to an end, they’re finding themselves in a real pickle.

Here, however, the two narratives diverge. Krugman, if I’m reading him right, is saying that if only US economic policy had worked better, we would have a much more vibrant economy, throwing off enormous amounts of cash which would more than make up for the taper. Employed Americans, along with fast-growing US companies, would naturally look to invest their money abroad, and the flows to emerging markets would remain healthy, thereby avoiding a crisis. Instead, we have too few employed Americans, we have overly cautious US companies, and the markets have come to the collective (and self-fulfilling) decision that the end of QE will mean the end of substantially all capital flows to emerging markets. The result is a “sudden stop” — and all sudden stops are extremely painful.

Rodrik, on the other hand, says that the current crisis is the emerging markets’ own fault, for opening themselves up to fickle and volatile capital flows in the first place. Worse, whenever these economies run into difficulty, they tend to respond by becoming even more open to international capital flows. This is a story which is bound to end in tears, no matter what the Fed does.

The two narratives aren’t entirely contradictory, but ultimately Rodrik’s is more important, and more correct. Sure, a healthier US economy might well have kept the money flowing to emerging markets for a bit longer. But as Krugman himself demonstrates, sudden stops in emerging markets can happen in any number of US economic environments, and for any number of reasons. The trick to preventing sudden stops isn’t to keep the money flowing: the trick to preventing sudden stops is to not make yourself susceptible to them in the first place. Here’s Rodrik:

Over the last five years in India, every episode of rupee pressure has provoked a relaxation of regulations on foreign inflows, which has rendered the economy vulnerable to the next rupee shock, which, in turn, provokes the next liberalization and so on. In Turkey, policy makers spun a tale of invulnerability to shocks and contagion even as the economy’s growth was driven by a flood of short-term capital inflows. China provides an instructive contrast. China has chosen to insulate itself from foreign capital and has correspondingly been less affected by the vagaries of Fed actions and the fickleness of foreign finance. Chinese policies aren’t blameless, but their economic insulation has afforded them the luxury of being the recipient of complaints rather than the distributor.

With the taper ending, we’re beginning to see markets start to become rather more discerning than they have been in recent years. No longer will money simply flow to anything and everything, be it gold or Turkish lira; instead, we’re beginning to see the return of volatility. Sometimes, as in the case of this week’s Facebook earnings report, that volatility is welcome. And sometimes, as we’re seeing in emerging markets, it isn’t — especially when the volatility looks as though it’s more a self-fulfilling caprice than a rational reaction to economic fundamentals.

Still, as Rodrik knows better than anybody, Turkey has real political and economic problems of its own: you don’t need to look to the Fed to find reasons for the current sell-off. Sometimes, small open economies are the blameless victims of forces outside their own control. This is not one of those times. They knew what they were doing, when they allowed the Fed’s liquidity to flood their economies. One day, the tide was going to start going out. That day has now arrived.


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If you own a car, it’s your fault.

The marginal economies grasped for the unaffordable good life: cars, TVs, suburbia … to get these things they competed with you for the means and now they have lost.

You won! Congratulations!

Posted by econundertow | Report as abusive

Well, well, well. The article conveniently ignores the fact that US is the reserve currency and countries invest in UST. Would any one invest in a company with a reckless management involved in making reckless decisions ? I suspect, most will not. Why is it any different for UST ? A company has an obligation to its shareholders and must reap maximum returns to its shareholders. Why is it any different for countries in UST ? The monetary policy in US only inflates the debt away. Sure, US has a right to its monetary policy but is it ahead of its shareholders ? For a country which apparently practices capitalism, ( after bail outs capitalism is a myth ) the answer here should be NO.

Posted by AmanTelli | Report as abusive

This seems to be somewhat sloppy. The QE program exists to to help ‘ease’ the cash-flow deficiencies of the American economy for the banking/investing sector, with the vague hope that it will spread out into the wider economy and stimulate more activity etc. etc. Instead it seems that the money has been kept within the tight circle of the upper reaches of the financial markets, and used (in part) to generate profits from currency trading around the world; the current ‘panic’ stems from those moneys pulling out of those markets in search of other, perhaps more stable profits – as investment money will do. This is the fault of the Fed? Or of those countries who attracted the investment in the first place?

There does not seem to be a currently viable theory of economic activity that fully explains – or models – the impact of short-term greed upon the large-scale flows of capital, probably because it is difficult to model psychology, even though it has such a large impact upon behavior; I imagine we have to turn to politics for that…

Posted by daveinoak | Report as abusive

Well, Krugman followed up that op-ed with some blog posts that were more explicitly critical of bad policy in the affected economies.

http://krugman.blogs.nytimes.com/2014/02  /01/macroeconomic-populism-returns/

I don’t think there’s all that much daylight between him and Rodrik, or much of the rest of the left-econ-blogosphere.

Posted by Auros | Report as abusive

It is of Turkey as France. PK has a fully coherent and relevant global vision. But when he supported the candidacy of Hollande he was not in the field to find that the campaign promises of that Mr. Normal were only nonsense. Hence his so violent reaction when Hollande recognizes the failure of his rhetoric.
Holland would have been elected without PK and I don’t blame him either. But we must accept that the knowledge of local parameters can’t be easily integrated into an overall vision.

Posted by jlesalvignol | Report as abusive

Krugman: “The real problem is that the world’s wealthy economies . . . have failed to deal with their own underlying weaknesses. Most obviously, faced with a private sector that wants to save too much and invest too little, we have pursued austerity policies that deepen the forces of depression.”

Krugman doesn’t believe there should ever be cyclical downturns when governments can engage in deficit spending to counteract “demand shortfalls.” [But why attribute the problem to "demand shortfall" instead of, say, "supply excess"?]

Krugman’s advice is: Do everything possible to maintain asset prices. Put the monetary pedal to the metal to drive GDP growth, reduce unemployment, etc.

But Krugmans critics’ have always argued: We had an unsustainable bubble in PCE as a % of GDP that must deflate. Or does Krugman think the PCE could go thru its recent highs?

http://advisorperspectives.com/dshort/ch arts/index.html?indicators/PCE-percent-o f-GDP.gif

Posted by dedalus | Report as abusive

both agree also that the fundamentals these emerging markets are not that bad. But Krugman uses also the secular stagnation theory, which takes a larger and complicated path to explain these short term fluctuations in the emerging markets. Rodrik is setting foot on much firmer grounds to explain the problems on these emerging markets.

Posted by gonzaloalberto | Report as abusive

So, let me see if I get it. You don’t have an awful lot of money. Somebody offers you lots for little work. Do you (a) accept, knowing that it comes from a fickle rich guy that tomorrow may stop paying you? Or (b) refuse?

I can’t say I’m all that surprised that emerging markets, in the whole, accepted.

On the other hand, the fickle rich guy assuming that if he suddenly stops paying his staff, it will have no consequences at all, might just be wrong…

Posted by Doly | Report as abusive

It’s like saying that home owners knew what they were buying and knew their finances (what they could afford in terms of mortgages), then why blame the banks for the subprime crisis. By that logic, aren’t homeowners the ones to blame for the housing crisis and why then save them (prevent foreclosures)?

Clearly, it’s not that straightforward. There needs to be more coordination in terms of global monetary policy especially today when global economy so interconnected. There are smaller economies that are very dependent on larger economies that can easily get washed by flood of money. Just like easy credit caused the financial crisis, easy money is partly to blame for what’s going on with emerging markets.

Posted by Manish123 | Report as abusive

I understood the basic thrust of Krugman’s argument as being that, if the developed economies had not pursued austerity with such determination, we might have growing economies that could tolerate positive real interest rates for government and corporate debt. Then, investable funds thrown off by those economies wouldn’t rush to developing countries because there would be decent investment opportunities in the developed world. And the developing economies wouldn’t be at such risk of sudden flight. Have I missed something?

Posted by historystudent | Report as abusive

Two morons duking it out without understanding the obvious trigger. A trigger that has been discussed a great deal in the financial media. It is the taper and reduction of cheap Fed liquidity that is pulling money out of these emerging markets. It was predicted this would happen and it is happening. That’s not to say the emerging markets wouldn’t be having problems anyway but we’re seeing concerted chaos in these emerging markets because of the Fed’s QE and zero interest rate policies. Policies that chumps like Krugman support.

Posted by Mirry | Report as abusive

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