Sunday, 13 May 2012
Book Review: Breakout Nations by Ruchir Sharma
Credentials can’t come better than this. Ruchir Sharma, author of recent best-seller Breakout Nations, is head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management. A regular contributor to Wall Street Journal and Economic Times, Sharma is also a contributor editor for Newsweek. A man who travels often to various emerging nations for his work, Sharma has put forth a theory on how emerging markets will evolve in the foreseeable future. In the last decade all emerging markets grew (at varying rates of growth), but according to Sharma, it’s time to stop regarding all emerging markets through the same global lens. Each geography is different in various respects and not all the players are going to make through to the ranks of the developed world. There is no reason to believe China will continue growing at 8 or 9 percent, neither will India continue to move forward forever at 8 percent. Sharma gives even less of a chance for Brazil or Russia to breakout and make it to the league of developed nations.
The best thing about Breakout Nations is Sharma’s analyses based on his various observations as he takes his readers on a grand tour of various emerging markets. In addition to the usual suspects such as India, China, Russia and Brazil, he also goes to places such as Nigeria, Mexico and Turkey. China has built up infrastructure, but not all of it is in the right place nor is it always appropriate for China. Shanghai’s maglev train (short for magnetic levitation) which takes eight minutes to travel from Longyan Road to Pudong International Airport travels at 270 miles an hour and uses technology that is currently not used anywhere else in the world, is a case in point. After reaching the airport in eight minutes on the maglev, it takes longer to reach the terminal. The starting point - Longyan Road – is also in the middle of nowhere. A ticket on the maglev costs $8.00 and most people prefer to pay $1.50 for the metro. When Sharma took the maglev with a colleague, they were the only passengers on the train. Brazil on the other hand, is the exact opposite. It suffers from a lack of infrastructure. Its roads are so bad and so unreliable that ‘it costs more to truck soy from the plantations of Mato Grosso to the coast that it does to ship the soy from those ports to China.’ According to a 2011 newspaper report in a Rio paper (O Globo), in Brazil croissants are more expensive in Paris, haircuts cost more than they do in London, bike rentals are more expensive than in Amsterdam and movie tickets sell for more than they do in Madrid.
India’s high population and equally high growth rate was supposed to be a problem, but now it is considered to be a demographic dividend since India’s policy planner have taken the view that China’s high growth is be partly the result of a baby boom. ‘India’s confidence ignored the post-war experience of many countries in Africa and the Middle East, where a flood of young people into the labor market produced unemployment, unrest, and more mouths to feed. The conventional view is that India will be able to put all those people to work because of its relatively strong educational system, entrepreneurial zeal and strong links to the global economy. All of that is real, but India is already showing some of the warning signs of failed growth stories, including early-onset overconfidence. Most outsiders were just as confident before the recent signs of trouble. I put the probability of India continuing its journey as a breakout nation this decade at closer to 50 percent, owing to a whole series of risks that the Indian and foreign elites leave out of the picture, including bloated government, crony capitalism, falling turnover among the rich and powerful and a disturbing tendency of farmers to stay on the farm.’
India and Brazil have a lot in common, though one is a commodity exporter and the other a net-importer. Both are ‘high context’ societies, where ‘people are colorful, noisy, quick to make promises that cannot always be relied on, and a bit casual about meeting times and deadlines.’ This is in contrast with low context societies in the USA and Germany ‘in which people are individual oriented, care about privacy and are much more likely to stick to timeslines and their word.’ In a number of developing countries such as India, Brazil and South Africa, private enterprises have a tendency to look overseas. This is actually a sign of weakness since it means it is not easy to do business in the domestic market. Also, ‘if a country is generating too many billionaires to the size of its economy, it is off balance.’ India has more billionaires than China. Only the US, Russia and Germany have more billionaires than India. What’s worse, many of India’s billionaires have made their money through government patronage and unlike China, India’s billionaire list has a slow turnover.
Just as various emerging markets are different, each Indian state is different from others. Sharma says that foreign investors are slowly learning to look at India on the lines of the United States of Europe. Indian states in Central and North India like Bihar are fast catching up and have higher growth rates than the ones in the South. Sharma concludes that India has a good chance of being a breakout nation, a higher chance than the 50% Sharma gives China. ‘No other large economy has so many stars aligned in its favour, from its demographic profile to its entrepreneurial energy, and perhaps most important, an annual per capita income that is only one-fourth of China’s. But destiny can never be taken for granted. Indian policy makers cannot assume that demographics will triumph and that problems such as rising crony capitalism and increased welfare spending are just sideshows instead of major challenges. These are exactly the factors that have prematurely chocked growth in other emerging markets.'
Brazil may have lousy infrastructure, when compared with China, but its stock market is ‘hot’ unlike China’s. This is because Brazilian companies are forced to be disciplined on account of the high cost of borrowing and are highly profitable – hence the Brazilian stock market booms. In China, there is little fiscal discipline since the focus is on growth at any cost.
Mexico is a bigger oligopoly than even Brazil with a handful of families and companies controlling the economy. At one point, the richest country in Latin America, it has now been overtaken by Brazil and Chile. Mexico’s economy will find it hard, though not impossible, to breakout. Russia is another nation whose ascent is in doubt. A nation of extreme wealth and poverty, Russia’s per capita income is $13,000 p.a., which is way above that of China (just above $4000) and India ($1,400). However, Sharma calls Russia ‘an oil state which has lost its way’ and gives it even less of a breakout chance than China.
Despite Russia, all is not lost in Eastern Europe which has a couple of sweet spots. The Czech Republic, which was a leading industrial nation in the 1920 and Poland are doing well. Hungary which was doing well has slipped up.
Sharma is highly appreciative of Turkey’s achievements after the Erdogan regime came to power. Though despised by many secular and modern Turks for their Islamic values and backwardness, Recep Tayyip Erdogan’s AKP has brought stability to Turkey, along with greater inclusiveness. Masses once excluded on account of their religious values now play a leading role in the economy. Erdogan has taken the middle ground on many issues and some of Turkey’s former elites have also come to appreciate the stability he has brought. After consolidating its hold on power, the AKP started using Putin-like tactics, but Sharma suggests that ‘Erdogan would prefer to be seen as a Turkish avatar of Lee Kuan Yew.' In stark contrast to Turkey is Malaysia which is yet to cast off the shadow of Mahathir Mohammad. Of the former Tiger economies, Malaysia is one which hasn’t recovered from the 1998 crisis which affected all the South-East Asian countries. Unlike Indonesia which addressed the issues which caused those problems, Mahathir Mohammed blamed malicious foreign speculators for the crisis. As a result, Malaysia has slid backwards.
Indonesia on the other hand is a commodity based economy which has not suffered on account of its income from commodities. Sharma calls it the best run large commodity economy where foreigners find it easy to do business. In the 1960s, the Philippines was a regional leader, but now it is a laggard with a few family owned conglomerates dominating the markets. However, its new President Benigno Aquino III seems to be a good leader who is ‘delegating power to competent technocrats and seems to understand what needs to be done to get the lights back on.’ Thailand too has suffered a number of downturns, but the new Prime Minister Yingluck Shinawatra offers hope.
Sharma calls South Korea the gold medallist among breakout nations, mainly because it has, in addition to developing its infrastructure, it developed global brands. This is unlike Taiwan which has stuck with manufacturing components for western companies and has little bargaining power over pricing since the manufacturing can be done anywhere else. South Korea too has a number of problems. For example, its service sector is underdeveloped. In case the two Koreas manage to reunify, South Korea would gain even more since it is in a position to utilise the disciplined workers of North Korea.
South Africa is another resource-rich nation, which after showing some promise after the end of apartheid, slipped into a state of inertia. A cappuccino economy (a white layer on top of black coffee with some dark chocolate sprinkled on top), South Africa has been moving towards a welfare state before it can afford it. In this respect it is similar to Brazil. In South Africa, wages rise faster than inflation. This coupled with powerful unions and a strong currency has resulted in deindustrialization. Again like Brazil, many South African businesses are very profitable but they look to foreign countries to expand and make profits. Many enterprises are still state owned and hence there are no cheap airfares to South Africa.
Sharma also examines a handful of countries he classifies as the Fourth World of Frontier Economies. These are countries where the rule of law has a limited franchise and where just as profits are high, so is the possibility of making a loss. All Gulf States fall into this category. So do countries like Nigeria and many African countries some of which show promise. Sri Lanka is also classified as a Frontier economy, one which is reaping its peace dividend. I feel that Sri Lanka ought to have been classified as a breakout nation rather than a frontier economy. As Sharma himself admits, even during the bleak days of the civil war, its economy grew at the rate of five percent.
Sharma tells us that ‘the richer a country is, the harder it is to grow national wealth at a rapid pace’ Another interesting rule promulgated by Sharma is that a country should ideally have more than one big city. The second city should have a population of atleast one-third to half that of the first city. Brazil has Sao Paulo and Rio de Janeiro, Korea has Seoul and Busan, Indonesia has Jakarta and Surabaya, but Thailand has only Bangkok, which has ten times as many people and the next largest city. This, according to Sharma, is a bad sign.
Is dictatorship better than democracy for emerging nations? Sharma suggests that rather than the actual system in place, what matters is the quality of the politicians. For example, Vietnam’s system is similar to that of China, but on account of inferior management, Vietnam does not show any sign of being a breakout nation despite a small flicker of hope in the middle of the last decade.
Sharma predicts that commodity prices are bound to fall. There was a time when many believed that the US Federal Reserve had mastered the art of making the economy go up without the occasional recession – it was thought that the boom-bust cycle was a thing of the past. Now with the benefit of hindsight, we know that it is not the case. Similarly, there are some who feel that commodity prices can only go up, that China will keep growing at the rate of nine percent forever. ‘Commodity.com is driven by fear and a total lack of faith in human progress: fear of rising phalanx of emerging nations with an insatiable demand led by China, of predictions that the world is running out of oil and farmland, coupled with a lack of faith in the human capacity to devise answers, to find alternatives to oil or ways to make agricultural land more productive. It’s a Malthusian vision of struggle and scarcity: of prices driven up by falling supplies and wages pushed down by foreign companies.’ The hype about commodities 'has created a new industry that turns commodities into financial products that can be traded like stocks. Oil, wheat and platinum used to be sold primarily as raw materials, and now they are sold largely as speculative investments. Copper is piling up in bonded warehouses not because the owners plan to use it to make wire, but because speculators are sitting on it ......'
What will be the result when commodity prices crash? Will it lead to a global crash? Sharma argues that it will not. Also, Sharma feels that when China’s economy slows down, it will not come to a shuddering halt. Do please read this amazing book for Sharma’s rationale for his conclusions.