When emerging-market governments get popular, an economic crisis could be right around the corner.
This is the finding from a new paper published by Christoph Trebesch, Helios Herrera, and Guillermo L. Ordoñez on the economic policy site voxEU.
“Our main finding is that ‘political booms’, defined as an increase in government popularity, precede financial crises in emerging markets,” the authors write. “The public’s opinion of the current government improves significantly in the run-up to a country’s financial crash. Interestingly, however, political booms only predict financial crises in emerging markets, not in advanced economies.”
The authors looked at economic crises in emerging markets such as South Korea, Russia, Indonesia, and the Philippines, which all faced economic turmoil in the late 1990s when the value of several Asian currencies fell rapidly.
The popularity of these governments grew precipitously ahead of these financial crises, but in advanced economies like the U.S., Japan, and the U.K., government popularity actually declined ahead of a financial crisis.
This chart shows the disparity in government popularity in these economies ahead of financial crises.
One of the main reasons that this phenomenon seems unique to emerging markets is that EM governments are actually less popular than their emerging-market counterparts, making it difficult for them to regulate or rein in nascent credit or speculative bubbles.
The authors find, “
emerging markets may be more prone to crises than advanced economies because their governments have on average lower reputation, and because in emerging markets there is higher uncertainty about the quality of political leaders. Governments in emerging markets have more to gain by riding the popularity benefits of a credit boom.”
The authors note that the two most common predictors of financial crises are credit booms and an increase in capital flows. But for emerging markets, a popular government could amplify potential financial risks.
“The two predictors jointly have much higher explanatory power than separately,” the authors write. “[A]n emerging market which experienced a political and credit boom at the same time is much more likely to suffer a crisis than a country experiencing only one of them.”