It’s been a good 10-year run for fast-growing emerging markets. But now many of them face severe economic imbalances and slowing growth built up during the go-go years. Those structural flaws could be papered over in good times, but they have finally undermined sustainable strong growth, and the cracks are starting to show. In this video interview, Wharton management professor Mauro F. Guillen discusses how formerly hot emerging market countries are passing the growth engine baton back to developed countries.

An edited transcript of the conversation appears below.

Knowledge at Wharton: Can you discuss what’s been happening in emerging economies? A lot of money has been flowing out. Their growth rates look like they’re slowing. It’s hard to generalize, but it is happening in a lot of countries, perhaps for different reasons. And one of the explanations for this is that the Fed’s so-called tapering off is a worry because that may mean that U.S. interest rates would go up and look relatively more interesting than the returns that investors are getting on their so-called hot money in these emerging economies. So it’s about these financial flows rather than foreign direct investments in bricks and mortar and that sort of thing.

Guillen: You’re absolutely right. The fact that investors are anticipating that the Federal Reserve will change its policy in the near future is obviously putting some pressure on those short-term hot money flows into emerging economies, and people of course don’t want to be caught in the middle. And they tend to move their money to where it can get the highest possible yield. I think that’s a very important background factor. I don’t think it’s the only one.

“What we see in many emerging economies, speaking broadly, is that the current model of growth is becoming exhausted, which has been, in many of these emerging economies, export-led.” –Mauro F. Guillen

What we see in many emerging economies, speaking broadly, is that the current model of growth is becoming exhausted, which has been, in many of these emerging economies, export-led. So we’ve seen very little progress in most of these countries — China, India, Brazil — in terms of the development of a domestic market that would compensate for slower growth in terms of exports. There’s been some progress, but not enough to essentially keep the economy going at a very fast pace, which is what happened throughout the last few years.

We shouldn’t forget [how] remarkable [it is] that even during the 2008, 2009 and 2010 financial crisis, emerging economies continued growing as they did. But now they’re at a crossroads. And this comes at a very bad moment, when there is also political turmoil in several of these countries. There are street protests in many of these economies, Brazil most recently. There’s rising income inequality, which also adds to the problems. And, more broadly, there are bubbles. There’s clearly a real estate bubble in several of the markets in Brazil. There’s clearly a real estate bubble in several areas in China, or perhaps all over the country, and so on. So there are many imbalances that have been building up in several markets over the last 10 years of rapid growth.

Just to make things even worse, the banking system always, always suffers from the build up of these bubbles. And we’re beginning to see in some of these markets that the percentage of non-performing loans is starting to increase in bad assets on the balance sheets of banks. So yes, we are at a crossroads, there’s a lot of uncertainty, and one of the biggest problems for emerging economies is that neither the U.S. nor Europe, which are traditionally the most important export markets, are growing that much. So this comes at a bad moment. It comes at a bad moment for everybody.

Knowledge at Wharton: U.S. GDP growth was upgraded from 1.7% to 2.5% for the second quarter [at an annualized rate]. So that’s one hopeful sign. Who knows what will happen in Japan? There is an effort there to crank up the economy in ways that haven’t been done in the last 20 years or so, during the so called “lost decades.” And Europe is struggling with just its nose above the water. So is there perhaps a grand shift, even if it’s a mild one, where the emerging economies — which had been carrying the world economy, or at least preventing something worse than what happened — are now passing the baton to the developed countries?

Guillen: Right, exactly. The baton seems to be passing, not perhaps fast enough, because the U.S., as you just said, is enjoying a little bit faster growth, but not the kind of growth that we would like to have here in order to reduce unemployment. And then in Europe, of course, it’s just not enough. So this is much better from the point of view of emerging economies than the situation a year ago or two years ago, but I think the big question mark is whether it’s big enough. And I think it is very clear that all of the debate about the development of the domestic market, domestic consumption market in BRIC [countries (Brazil, Russia, India and China)], in Mexico, now has become very relevant. I don’t think that these economies can continue enjoying high growth rates, let’s say into the next five or 10 or 15 years unless the domestic markets in these countries become so much more important — in other words that they switch away from an export-led model of growth to one that is more balanced between exports and domestic consumption.

Knowledge at Wharton: Which of the emerging economies would you worry about the most under the circumstances you’ve been talking about?

Guillen: Well, I think there are reasons to be worried in each of the large emerging economies. I think Brazil probably right now stands out as being the biggest underperformer. Brazil was growing at 6%-7%-8% just a few years ago. And now it’s barely growing. We see over there many of these tensions and the overheating. I worry about Brazil also because Brazil is more vulnerable than the others because it is highly dependent on the hot money that has been coming into the country to cover the deficit that they have in their current account with their relationship in terms of trade and other kinds of flows.

“I don’t think that these economies can continue enjoying high growth rates, let’s say into the next five or 10 or 15 years, unless the domestic markets in these countries become so much more important ….” –Mauro F. Guillen

Brazil, in spite of being a major export power, is still a country that imports more than what it exports. They need money, capital flows, to come in and bridge the gap. So I worry about Brazil. And I think I worry about Brazil also because Brazil is 40% of Latin America. If something bad happens in Brazil, then that’s going to have a big impact on the region.

But having said that, I think there’s plenty to worry about in China these days and also in India. India, with all of its poverty and all of the need for more growth, is now very clearly under performing as well. I don’t worry that much about Russia, quite frankly. I think Russia is, to a very large extent, shielded from much of this because it is an economy that generates enough export earnings. It is an economy that has such natural wealth that unless they grossly mismanage it, they will probably weather any kind of storm.

Knowledge at Wharton: What about places like Indonesia and Thailand, those kinds of countries? As China goes, so go those countries? Is that what is most likely to happen?

Guillen: Well, that’s part of it, but more important is the U.S. and Europe because those are the most important export markets. Thailand, Indonesia, Vietnam and Malaysia; these are countries that very much depend on the U.S. market and also European markets for their exports. Now having said that, I think they have one advantage, which is that I don’t think you are seeing in those economies the kinds of bubbles that have emerged in places like Brazil or China.