Tuesday, November 20, 2012

Breakout Nations: In Pursuit of the Next Economic Miracles by Ruchir Sharma

Breakout Nations is ostensibly an investment guide, but it’s really a snapshot of the world economy, particularly the emerging markets and those that are on the verge of “breaking out” or achieving the next level of income.  (Although the term “emerging market” is used in different ways in different places, for the purposes of this book it refers to nations in which the average annual per capita income is less than $25,000.)

You cannot talk about this class of nations- or the global economy itself- without talking about China.  China itself is an emerging nation and has driven the growth of many of the others, particularly those that are dependent on commodity exports.  While the political posturing around China tends to veer to extremes- “China is eating our lunch!” or “China is about to implode!”- Sharma takes, appropriately, the middle path.  Much of the low-hanging fruit has been grabbed in China, and much of that is dependent on demographics: while China was able to add about 90 million workers between the ages of 35 and 54 to the workforce in the last decade, in this decade they will add closer to 5 million such workers.  The smaller workforce translates into higher wages and thus higher prices, and that will almost undoubtedly lead to a shrinking of demand for their manufactured goods.  In other words, growth rates of 8 percent or more are most likely a thing of the past.  However, Sharma is more bullish on China (at least compared to the bears) in part because while many of the easy gains have been realized, there is still a need to modernize its manufacturing infrastructure, and those are the kinds of investments the Chinese governments have been keen on.  China will most probably cool, but reducing to 6 or 7 percent annual growth is a less dire scenario than reducing to 4.

China’s economy has been driven by manufacturing and it’s increasing output has been dependent on commodities from other countries.  While there were fortunes to be made from commodities, the rule seems to hold that an economy highly dependent on them is more likely to overheat and then eventually crash than one that isn’t.  Russia and Brazil are good examples of a such; they are living large right now but don’t have a cushion to fall back on when demand inevitably recedes.  Of all of the commodity economies Sharma profiles, only Indonesia seems to know how to work the dynamics to its favor, possibly because they were burned by the cycle in The Fifties.

Manufacturing has been considered the smart way to grow an economy from one level to another, but it’s far from a silver bullet.  While Taiwan grew significantly because of its manufacturing output, its weakness is that it never made the transition from a destination for other nation’s factories to a nation that had its own industries.  Against the prevailing wisdom at the time, South Korea did make that transition, fostering corporations that built innovative products (and subsuming those that weren’t competitive in the market).  And while many of the largest South Korean companies are family-owned, they tend to be professionally managed.  Of all of the countries profiled in the book, South Korea is the one Sharma seems to be betting will be the breakout.

Perhaps surprisingly, Sharma is a little more bullish on Europe than most economists although he, like many others, argues that the inherent weakness of a shared currency like the euro is that it leaves individual nations unable to adjust when circumstances demand it.  However, while many nations in Europe are going through a downturn, Poland and the Czech Republic are quiet standouts, in large part because they have paid attention to the fundamentals of a good economy, including putting money away to make strategic public investments.  

One has to wonder how the leaders of the European Union feel about their treatment of Turkey’s entrance application several years ago.  Certainly, the Turkish are probably relieved that they were denied.  The energy released when the Turks lifted their ban on open displays of religious culture corresponded with a vigorous economic revival.  While certainly based on manufacturing, it is more dependent on domestic demand than other similar economies and has gone hand in hand with domestic investment in infrastructure (and education).  However, a potential weakness is that its domestic savings is relatively low- 20 percent compared with 50 percent in China.  Another potential weakness is that Prime Minister Recep Erdogan, while a cautious economic steward, has been in power for a decade and has indicated that he would like to remain so, albeit in a different role.  It remains to be seen whether he will be more like a Putin or Wen Jiabao.  Of course, as Sharma notes, the leader who can effectively manage a country’s finances can usually get away with almost anything politically.

If investments are bets, Sharma is hedging on India.  While the large population and cultural dynamism are now seen as strengths, India’s political system, rightly charged with corruption and cronyism, is what is holding it back.  While any student of Indian history is reluctant to give Churchill credit for any insights, he did have a point when he noted that “India” was as desriptive of a political or economic system as “Europe”.  Certainly we are seeing that now as modern Indians seem more engaged in local than national politics.  Also, India, like many of the other countries profiled in the book, has been guilty of believing its own public relations campaign and presuming that it will be the next China.  The extent to which the Indian government can implement policies to make it so- even if it’s at the expense of its traditional clients- will determine the extent to which they can make their advertising a reality.

If there is a problem that the global economy suffers from as a whole, it is an unwillingness to tolerate the kinds of recessions that punctuated our overall trend of growth for the last 150 years.  Indeed, the emerging market miracles are a direct result of the stimulus the United States implemented to smooth out the dotcom bust of 2000 and 2001.  The low interest rates did exactly as intended and increased money available for investment.  Unforeseen, however, was the extent to which that money would flow into foreign markets, which led to the booms in these nations.  Easy money was key to growth for some, but intelligent policies are necessary if those gains are going to be maintained or built upon.  Those well-positioned to do that are the ones who will break out.

While Sharma backed up almost all of his assertions with data and statistics, I was surprised that this didn’t have better footnotes.  In spite of the copious statistics, this was a compelling if not “easy” read.  Recommended for those who have been following current affairs.