Five years ago, the future for emerging markets seemed set fair. Globalization was driving much of the world’s manufacturing to them, as Western companies sought optimal global supply chains. All they needed to do was avoid selecting lunatic Marxist or Islamist dictators as leaders. Yet the future has changed; globalization is in retreat, though it’s not yet clear how far the retreat will go. However, that does not mean that emerging markets are condemned to long-term penury.

By economic theory, the free movement of goods, people and capital is economically an unalloyed good. By David Ricardo’s Doctrine of Comparative Advantage, every country should produce the goods and services for which it is most fitted. Labor should move worldwide to where it has the greatest expected remuneration, and capital should seek advantages worldwide, taking account of risks and potential rewards in every national environment.

It appeared around 1995-96 that modern communications and the Internet had for the first time enabled companies to source globally, while the fall of Communism a few years earlier had opened up the remaining new potential sources and markets. The Ricardian dream seemed about to become reality and the world was finally becoming globalized. There would naturally be a dampening effect on Western living standards as new emerging market sources of supply came onstream, but that effect should surely be temporary, and by Ricardo’s theorem, every country in the world would be very much richer once the process had played out.

The emerging markets themselves would not in general initially be well managed. However, in a fully free global market, the influx of investment and increase in living standards would tend to improve the behavior of the country concerned. Countries whose governments wasted money on boondoggles, indulged in excessive corruption, or harassed their entrepreneurial classes would rapidly fall behind their more virtuous neighbors, and so public pressure would force their governments to straighten up and fly right.

This did not happen, largely because a world with large meddling governments is not a free market. First, international central banks have kept interest rates artificially low since 1995. This has made it artificially easy to finance assets in emerging markets, creating a huge pool of hot money and reducing risk premia between interest rates in emerging markets and rates in developed markets. Essentially, outsourcing has been artificially subsidized. Then the Internet and modern telecommunications came upon us so rapidly that the world economy could not adapt to so large a change quickly enough, and so pathological behaviors were created, which prevented the globalized market from operating as it should.