Emerging markets have performed amazingly well over the last seven years. They have outperformed the advanced industrialized countries in terms of economic growth, debt-to-GDP ratios, and countercyclical fiscal policy.  Many now receive better assessments by rating agencies and financial markets than some of the advanced economies.

As 2012 begins, however, emerging markets may be due for a correction, triggered by a new wave of “risk off” behavior among investors. Will China experience a hard landing? Will a decline in commodity prices hit Latin America? Will the sovereign-debt woes of the European periphery spread to neighbors such as Turkey in a new “Aegean crisis”?

Engorged by large capital inflows, some emerging market countries were in an overheated state a year ago. It is unlikely that the rapid economic growth and high trade deficits that Turkey has experienced in recent years can be sustained. Likewise, high GDP growth rates in Brazil and Argentina over the same period could soon reverse, particularly if global commodity prices fall - not a remote prospect if the Chinese economy falters or global real interest rates were to rise this year. China, for its part, could land hard as its real-estate bubble deflates and the country’s banks are forced to work off their bad loans.

The World Bank has now downgraded economic forecasts for developing countries in 2012 (Global Economic Prospects, Jan.18, 2012).    Brazil’s economic growth, for example, came to a halt in the third quarter of 2011 and is forecast at only 3.4 percent in 2012 …well below the rapid 2010 growth rate of 7.5 percent.  Reflecting a sharp slowdown in the second half of the year in India, South Asia is coming off of a torrid six years, including 9.1 percent growth in 2010.  Regional growth is projected to ease further to 5.8 percent in 2012.

But will economic slowdown turn to financial crash?   Three possible lines of argument support the worry that emerging markets’ performance are fated to suffer dramatically in 2012: empirical, literary, and causal. Each line of argument is admittedly tentative.

The empirical argument is just historically based numerology: emerging-market crises seem to come in 15-year cycles. The international debt crisis surfaced in Mexico in mid-1982, and then spread to the rest of Latin America and beyond. The East Asian crisis erupted 15 years later, in Thailand in mid-1997, and then spread to the rest of the region and beyond. We are now another 15 years down the road. So is 2012 the time for the third round of emerging markets crises?

The hypothesis of regular boom-bust cycles is supported by a long-standing scholarly literature, such as the writings of Carmen Reinhart. But I would appeal to an even older source: the Old Testament - in particular, the story of Joseph, who was called upon by the Pharaoh to interpret a dream about seven fat cows followed by seven skinny cows.

Joseph prophesied that there would come seven years of plenty, with abundant harvests from an overflowing Nile, followed by seven lean years, with famine resulting from drought. His forecast turned out to be accurate. Fortunately the Pharaoh had empowered his technocratic official (Joseph) to save grain in the seven years of plenty, building up sufficient stockpiles to save the Egyptian people from starvation during the bad years. That is a valuable lesson for today’s government officials in industrialized and developing countries alike.

For emerging markets, the first phase of seven years of plentiful capital flows occurred in 1975-1981, with the recycling of petrodollars in the form of loans to developing countries.  The international debt crisis that began in Mexico in 1982 was the catalyst for the seven lean years, known in Latin America as the “lost decade.” The turnaround year, 1989, was marked by the first issue of Brady bonds, which helped write down the debt overhang and put a line under the crisis.

The second cycle of seven fat years was the period of record capital flows to emerging markets in 1990-1996.  Following the 1997 “sudden stop” in East Asia came seven years of capital drought. The third cycle of inflows, often identified as a “carry trade,” came in 2004-2011 and persisted even through the global financial crisis. If history repeats itself, it is now time for a third sudden stop of capital flows to emerging markets.

Are a couple of data points and a biblical parable enough to take the hypothesis of a 15-year cycle seriously?  We need some sort of causal theory that could explain such periodicity to international capital flows.

Here is a possibility: 15 years is how long it takes for individual loan officers and hedge-fund traders to be promoted out of their jobs. Today’s young crop of asset pickers knows that there was a crisis in Turkey in 2001, but they did not experience it first hand. They think that perhaps this time is different.  

If emerging markets crash in 2012, remember where you heard it first - in ancient Egypt.

[This article was published in Project Syndicate, which holds the copyright.]

         My last blog post listed some policies and institutions with which various small countries around the world have had success — innovations that might be worthy of emulation by others.  Of course there are plenty of other examples of policies and institutions that have been tried and that are to be avoided.    The area of agricultural policy is rife with them.   Many start with a confused invoking of the need for “food security.”

          The recent run-up in wheat prices is a good example.   Robert Paarlberg wrote an excellent column in the Financial Times recently, titled “How grain markets sow the spikes they fear.”   Grain producing countries point to the high volatility of prices on world markets and the need for food security when imposing taxes on exports of their own grain supplies, or outright bans, as Russia did in July.    The motive, of course, is to keep grain affordable for domestic consumers.  But the effect of such export controls is precisely to cause the price rise that is feared, because it removes some net supply from the world market.    (The same could be said when grain importing countries react to high prices by enacting price controls, because that adds some net demand to the world market.)   

            The current run-up in grain prices is reminiscent of the even higher spike in food prices in 2008.   As Paarlberg argues, many of the other explanations that were put forward for that episode don’t fit this time.   The importance of export controls is now clearer.

            In 2008 Argentina imposed export tariffs to prevent its grain farmers from taking advantage of high world prices.   (This case seemed particularly irrational in that, unlike the usual case, the strongest political pressures came from the growers, not the consumers.)    At the same time, on the other side of the world, India put on export controls to prevent its rice farmers from selling their product on world markets to take advantage of high rice prices.   Controls imposed by Argentina, India, and others were important contributing factors to the global spike in food prices.

            Are governments indeed being completely irrational?   The commodities we are talking about are staples in the consumption of ordinary households.   For simplicity, let’s assume it is an absolute constraint that governments cannot allow grain prices to go above a certain threshold.    Perhaps there will be riots in the streets otherwise.  In this case might it make sense to put on export controls when the price threatens to go above that level?   One can see the motivation in the short run.   But, thinking in the long run, across complete cycles, controls are not a good answer.  

            One can imagine various sensible long-term policies that might assure that this constraint is not violated, such as stockpiling, although in practice many policies sold as “food security” are not in fact applied in a sensible way.

            One solution may be for major countries that are active in the market for wheat or rice to get together and agree not to impose controls.   The result would be to stabilize prices: no more alternation of price spikes and price collapses.  Each country could then rely more on the world market to cover shortfalls than it can now, when trade is made less dependable by the threat of controls by others.   The case of rice controls was nailed in a paper on food security written last year by two students in Harvard’s MPAID program (Masters in International Development), Naoko Koyama Blanc and Diva Singh.  In their model, it can indeed under certain conditions be rational for India to follow the practice of imposing controls when the price goes up, under a regime where volatility is high because others impose controls.  But it would be more rational for India to negotiate a no-controls regime with other countries, because under that regime volatility would be lower, the controls would not be needed, and everyone would be better off.