Key Insights in The Rise And Fall of Nations

KEY INSIGHTS | ORIGINAL RESEARCH

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THE RISE AND FALL OF NATIONS |

RUCHIR SHARMA

The Four D’s

The world economy is fighting the friction generated by 4D’s. Deglobalization: international trade is now growing slower than the global economy for the first time in a generation, and cross border money flows have retreated to levels last seen a quarter century ago. Depopulation: since 2005, the working age population of the world has been growing at just 1 percent a year, half the rate of the previous 50 years. Deleveraging: the world has racked up $50 trillion in debt since 2008, more than it did in the years before the crisis and mainly driven by China, and only parts of the developed world have begun paying down the debt or “deleveraging”. De-democratization: many governments are trying to force feed the economy into growing faster, and 110 countries—more than half—have suffered some loss of freedom in the last 10 years.

The Age of Pessimism

The forces weighing on the global economy are real, but this is not an excuse to embrace fashionable pessimism. As economist Joseph Schumpeter warned, “pessimistic visions about anything usually strike the public as more erudite than optimistic ones.” It’s time to rethink success and every nation needs to downscale its ambitions. The fastest-growing economies are almost always the poorest ones, but even they need to be more realistic. In India’s income class, the definition of strong growth should come down from better than 7 percent to better than 5 percent, a standard that will reveal surprising success stories. For rich nations, the benchmark should come down from about 3 percent to 1.5 percent, which would help ease the gloom in the United States and Europe.

The Good, the Average and the Ugly

I use a system of 10 rules to rank theprospects of the world’s leading nations as “good, average or ugly,” an approach with a simple beauty. Even in pessimistic times, the rules will always reveal which nations are bestin class. Right now, the rules shows that China has among the ugliest prospects in the emerging world, in part because no other country is getting hit harder by the forces of depopulation, debt, and the deglobalization of trade and money flows. Yet the rules also reveal pockets of strength in economies that are far off the media radar, from the Philippines to Kenya, Bangladesh and Pakistan.


The Depopulation Bomb

It’s half the global slowdown story. Economic growth is broadly driven by populationplus productivity: more workers producing more output per hour. So if population growth slows, so does the economy, and global population growth has fallen by nearly half in the last decade, compared to its postwar average. My research shows that if a nation’s working age population is growing at less than 2 percent a year, then its economy will grow rapidly—faster than 6 percent a year—in just one out of four cases. In the 1980s, 17 of the largest 20 developing countries had a population growth rate that fast and now there are only two: Saudi Arabia and Nigeria. That means the world should expect fewer economic miracles in the years ahead. India falls into the next tier, with a working age population growth rate that is expected to average 1.5 percent over the next five years. That’s reasonably fast, but not in the miracle class.


Good Versus Bad Billionaires

Wealth inequality is exploding, provoking political revolts from South Korea to the United States. To track which countries are most vulnerable to these revolts, I use the yearly Forbes list to track the wealth of billionaires, the high-profile lightning rods for social unrest. First I calculate billionaire wealth as a share of GDP, to get a picture of their hold over the economy. Then I figure out how much of their wealth comes from inherited fortunes and corruption-prone industries like real estate or oil, which reveals the power of the “bad billionaires.” It is the rise of shady characters in these rent-seeking industries that is most likely to stir popular anger. I first started tracking billionaires in India around 2010, when the rise of crony capitalists was stirring a backlash against capitalism itself. Today billionaire wealth represents 14 percent of GDP, still well above the global average, but the bad billionaires are in retreat. Between 2010 and 2015 India saw one of the world’ssharpest gains in the clout of good billionaires, in industries like technology and pharmaceuticals: they saw their totalfortunes rise by 22 percentage points to 53 percent of total billionairewealth. These trends may have taken the edge off the anticorporate, antigrowthsentiment that gripped Delhi over the priordecade.

 

The Curse of the Cover Story
American journalists have a joke about the backward-looking nature of their profession,which is that by the time a story reaches the cover of Time, it’s already dead. To test for truth in this jest, I looked at every Time cover with an economic spin on a country or region, going back to 1980. If the cover was downbeat, the economy subsequently picked up speed 55 percent of the time. If the cover was upbeat, the economy slowed down 66 percent of the time. The curse of the cover is real. The point is not to disparage journalists, but to highlight the fact that they tend to follow mainstream forecasters, who typically predict that economies will keep moving in a straight line, and miss the big turning points. That explains why Time would ask whether this is “China’s Century, or India’s” in November 2011, the year when all the big emerging economies started to slow sharply. (Interestingly, the same test for The Economist magazine showed that, perhaps thanks to its contrarian worldview, its covers proved prescient more than half the time.) To avoid the curse, countries basking in the glow of media hype should start worrying and looking for ways to reform.

The Fall of The Rest

In 2010 many emerging nations were growing so fast, their average incomes were rapidly catching up to those of the United States. Hype for “the rise of the rest” hit a peak, which signaled a turn in the story. By last year, the average growth rate in emerging nations had fallen from a high of around 8 percent in 2010 to its long term average of 4 percent, and 2 percent excluding China. The United States was expanding faster than many of the big emerging countries, from Russia and Brazil to South Africa, where average incomes were in decline. This is perfectly normal. My research shows that in every decade before 2000, going back to 1960, the average income of most emerging nations fell relative to the United States. In Brazil, incomes rise and fall with prices for its major commodity exports, and the average income is the same, relative to US incomes, as it was a hundred years ago.

 

Why Democracies Outrun Authoritarian Regimes In The Long Haul

The rise of China convinced many people that autocracies have an advantage in generating strong economic growth. To test that faith, I looked at all the postwar booms and found 60 in authoritarian countriesand 64 in democratic countries. Moreover, authoritarian regimes are much more likely to grow in extremely fast or slow spurts, with wild swings between the two extremes. Since 1950, there have been 138 cases in which a country grew very slowly for a decade, and 100 of those slumps struck under an authoritarian government. The worst boom-bust swings came under notorious dictators like the Assad’s of Syria, but a similar authoritarian roller coaster effect has disrupted nations like Brazil in the late 1960s. In the post crisis era, pockets of people in many troubled nations, from Russia to India,have looked to a strong hand to restore prosperity, but they should beware what they wish for. China’s steady economic success under authoritarian rule story was the exception, not the rule.

 

The Point of No Return

Though many economistshave looked for it, and some claim to have found it, there is no holy grail, no one key that foretells a nation’s future. The single most reliable indicator I have found is a negative one, which signals a warning when the debts of private households and companies has grown more than 40 percentage points faster than GDP over a five-year period. Over the past 50 years, every nation that passed that point of no returnwent on to suffer a serious economic slowdown. In recent years, many emerging nations have been rapidly running up debts, while the private sector in the United States and other wealthy countries were cutting back. This is a complete reversal of the state of the world before 2008. But only one emerging country has passed the point of no return: China. India, by contrast, is suffering from the opposite problem: one of the biggest obstacles to faster growth is anemic credit growth, due to a sclerotic system in which state banks control 75 percent of all loans, more than double the emerging world average.

 

The Second City Rule

For large countries, I track the geographic balance of economic growth by monitoring the rise of second cities, with populations of more than a million. In the small class of mega-nations, China is beating India hands down. China has nineteen cities that have quadrupled in size over the last three decades to more than a million people, compared to just two in India. China’s include the southern industrial boomtowns of Dongguan and Shenzhen, with more than 7 million. India’s areMallapuram andKollam in Kerala state, with barely over a million, and they passed that mark due largely to a redrawingof the local administrative map in 2011.

Of course, one reason for China’s lead is that its economy has grownmuch faster than India’s, and industrialization encourages urbanization.But even with that caveat in mind, India has also done less todevelop and much to discourage the rise of second cities, reserving prime urban real estate for civil servant enclaves like Lutyens Delhi, and cramping development with outdated building and zoning codes. Smaller cities struggle to grow, andwhen rural Indians do move to urban areas, they tend to choose themegacities with more than ten million people: Mumbai, Delhi,Kolkata, and Bangalore. In fact 17 percent of India’s population lives in such megacities, compared to 12 percent of China’s. If China is developing as a nation of boom cities, India is aland of creaking megacities, surrounded by small towns and not enoughvibrant second cities.

 

The Curse of The Second Term

 

Economic reform is most likely under bold new leaders, but even the best reformers grow stale and start to run out of ideas, the popularity to implement them, or both. The markets sense this process of decay, and tend to turn on leaders over time. Over the past 25 years in the major emerging democracies sixteen presidents and prime ministers have lasted two or more terms in office, including Vladimir Putin of Russia and Manmohan Singh. The stock markets in these countries beat the emerging world average by 16 percent in the leaders’ first terms, but delivered just average returns in the second terms. This is strong confirmation of what is known in the United States as “the curse” of the second term, since many of these leaders started out as economic reformers but lost momentum in their second term.Some of the weakest second term results came under RecepTayyip Erdogan in Turkey,where the stock market lagged behind the emerging-world averageby 18 percent during his second term, from 2007 to 2011; and Singh in India, which lagged by 6 percent during hissecond term from 2009 to 2014.

 

Good Vs. Bad Binges

A nation is most likely to rise when it is investing heavily in new businesses and creating jobs, but not all investment spending binges are created equal. India is like the Soviet Union in this respect, a nation that invested heavily—more than 30 percent of GDP—for many years, but got little out of all that spending, because so much of it was misdirected by the state.

It may sound odd to speak of good binges, but even if these binges end in a crash, the country doesn’t wake up with a hangover. It finds itself stronger, with new canals or rail lines or fiber optic cables or factories, which will help the economy grow when it recovers. The best binges unfold when companies funnel money into technology, infrastructure, and especially manufacturing, a particular weakness in India, where even incense sticks are now manufactured mostly in Vietnam. The worst hit when the money goes into real estate or oil and other commodity industries, which tend to push up prices but leave nothing of productive value behind.

 

Cheap is Good

One of the most striking signs of collapsing growth in emerging nations is how cheap their currencies feel now. While the rupee has fallen against the dollar, other emerging currencies outside of China feel even cheaper. Rio hotel rooms that went for $1,000 a night just a few years ago can now be had for $200. At world-class restaurants in Johannesburg, a three course meal is $30. In Moscow, businesses chauffeur guests around in Toyotas, because they can no longer afford Mercedes. These are symptoms of the downturn, but also signals of potential recovery, because cheap currencies attract investment and promote exports. The trick is knowing how to read the signals, and I show readers how to spot the turning points in the data on money flows.

 

Follow the Local Money

Even though global capital flows dried up after the crisis of 2008, many politicians are still quick to blame any local financial crisis on the flight of “evil” foreigners. My finding is the opposite: in ten out of the twelve major emerging-market currency crises over the past two decades, local investors headed for the exits well before foreigners. Locals are the first to know when a nation is in crisis or recovery, and they can choose many backdoor channels to dump the local currency—the Turks tend to convert bank accounts from lira to dollars, Indians often sell rupees for gold. Lately, locals have shipped money by the billions out of many emerging nations, particularly Russia and China.

 

What Doesn’t Matter

Countless forces can shape a nation’s fortunes, and one basic aim of this book is to narrow them down to the ten that matter most. Though many Indian experts argue that focusing on economic growth can undermine development in education and health, countries with the best growth records tend to have the highest “human development” scores. I largely ignore education, one of the most popular targets for reform, because investing in schools pays off too slowly to signal turns in an economy. I also avoid popular rankings like the World Economic Forum’s Competitiveness Report and World Bank surveys on the “ease of doing business,” because they rely heavily on slow moving factors (such as education) or are subject to marketing manipulation. Though foreign businesses now avoid Putin’s Russia, it has risen fast on the World Bank survey, after the Kremlin hired consultants to help improve its scores. I try to focus on the data that is most timely, and reliable.