Book reviews on global economy and geopolitical readings

ESADEgeo, under the supervision of Professor Javier Solana and Professor Javier Santiso.

1

Breakout Nations: In Pursuit of the Next Economic Miracle Sharma, Ruchir. (2012) W. W. Norton & Company, New York, London.

“If the local prices in an emerging market country feel expensive even for a visitor from a rich nation, that country is probably not a breakout nation”.

“The EU is also a stabilizing model and still an inspiration for some new members, particularly Poland and the Czech Republic, which are in that rare class of nations poised to break through and join the ranks of the rich elite. Not every Little EU member is a Greece.”

“The next two nations in line to join that elite group, probably within the next five years, are Muslim democracies with increasingly market-oriented economies: Indonesia and Turkey.”

Summary

What countries should we keep our eyes on in the coming years? What will the next

emerging countries be? Where will the money go? These and other questions are

answered in this book which serves as a guide to discerning which countries are most

likely to become economically buoyant nations in the decades ahead. While

newspaper headlines and government agendas are still paying attention to nations like

the China, Russia and Brazil, which investors watch unrelentingly as a source of

inexhaustible wealth, it is in fact other nations that are likely – thanks to a new

direction in their economic policies due to cultural or demographic factors – to take

over as the new players in the economic arena.

We will witness a decline in China's growth, which will remain high but somewhat

more discreet after the recent boom. The country is already taking measures such as

cutting investment in infrastructure, which had soared in recent years. Other

countries, however, will pay for their mismanagement, lack of control and poor

investment of incoming capital and enter into a period of recession – as was the case

of the Asian countries in the ‘90s. This will take them down several rungs in the ranking

of the juiciest countries for investors. On the other hand, the new players, the

countries that will experience steady growth, may well arise from among the smaller

nations that are already on the right track, such as South Korea, Poland, the Czech

Republic and especially Muslim democracies like Turkey. The next two trillion dollar

economy will spring from this group.

2

The author

Ruchir Sharma is the director of Emerging Markets and Global Macro at Morgan

Stanley, from where he directs assets of $25 billion in emerging countries. In this line

of occupation, which he has been carrying for the last two decades, Sharma spends at

least one week a month in an emerging market, analysing its situation and status. In

parallel, he has written extensively, with articles published in Newsweek, The Wall

Street Journal, Financial Times, New York Times, Foreign Affairs, and Economic Times.

Basic idea and opinion

Ruchir Sharma’s book is a highly interesting, essential guide to the current status of

emerging countries. But above all, it is a roadmap to understanding and identifying the

countries that will play in the premier league of the world economy over the coming

decade. Perfectly structured and in some of the most intelligent and readable prose

in the economic genre, the book examines two dozen countries – one by one – of all

sizes and continents and with diverse histories and cultures, to draw up a map

containing many surprises. The fact that Sharma has spent two decades traveling all

these countries, analysing not only their macroeconomic data but also their policies,

the nature of their leaders, history and customs, lends a unique vision which, beyond

the figures and statistics – which it also includes – solidly and realistically puts

forward reasons for his predictions.

To speak of emerging countries today is to speak about China which, while continuing

on the path of growth, will reduce the pace at which it progresses. According to the

author, Brazil and Russia, meanwhile, will be examples of missed opportunities due

to political and commercial mismanagement of their incoming cash flow. The 2008

economic crisis has redrawn the map of the world and while the West is still trying to

recover from the blow, other countries are prepared to seize their opportunity as new

investment hotspots. Meanwhile, countries like Turkey, Poland, the Czech Republic

and South Korea, and some of the so-called frontier markets (ranging from the African

nations with the best horizons to the Persian Gulf countries) are on the right path to

becoming the new stars.

With each location examined, the author provides a useful rule of thumb to be taken

into consideration when identifying emerging markets with particular potential. He

also reminds us that these countries should be analysed individually, not as a whole

that acts and reacts synchronously. Moreover, we should bear in mind that economic

growth is a transitory phenomenon which is far from everlasting. This past decade of

growth has been exceptional and we cannot expect the miracle to be repeated in the

next.

3

Despite being a book full of forecasts, the author aims to distance himself from

widespread long-term theories because, in the changing world in which we live, we

cannot foresee what will happen in 2050. However, we can forecast what will happen

in the next decade, which provides a clearer, more certain pattern in the global

economic cycle. At the beginning of each decade, we see a new global obsession, a

new idea that creates and reshapes the global economy and provides great profits. In

the ‘70s it was large US companies, in the ‘80s natural resources, in the ‘90s Japan and

in 2000 Silicon Valley – in 2010, the new fetish is emerging markets, led by China,

whose growth went from 4% to 12% in two decades.

In 2003, all countries considered emerging (those with per capita incomes under

$25,000) doubled their GDP growth and, in addition, the total European and US inflow

into their stock markets increased by 92% between 2000 and 2005. Certain countries

managed to invest this flow wisely in education, transport and communications while

others did not. But the most important factor driving this boom has been overlooked:

an enormous global flow of easy money that laid the foundations for the great

recession of 2008. Since then, the West has been experiencing a new reality, but so

too have emerging countries, which have seen a drop in their exports to the part of the

world that has been damaged most by the crisis.

The basic law of economics that states that the richer a country becomes, the more

difficult it is to increase its national wealth at a rapid pace, is beginning to show, and

China will be one of the biggest victims. When a country reaches a per capita income

of $4,000, its growth goes from 9% or 10% to 5% or 6%. These rates, for China, will

imply some degree of recession. And while some adapt to these new times, others will

emerge as the new stars. A basic rule for identifying these types of countries will

always apply however: economic regimes, the factors that drive growth in a country at

a particular time, are constantly changing. Different rules apply in different countries

depending on changing circumstances. The countries that were emerging in 2011 are

now too large to be treated as one and can only be understood individually.

China

After more than a decade of double-digit growth, the situation is set to change.

Chinese leaders are already rethinking their strategy. The country’s huge investment in

infrastructure, education, etc., has amounted to unsustainable spending and other

factors, such as the slowdown of migration to cities and wages increases are changing

China’s future. In addition, it is becoming clear that the much-discussed figure of the

repressed Chinese consumer is a myth and that the country is now at the head of

those nations consuming luxury goods. The slowdown of China's growth to 6% will

mean a slight recession but not a cataclysm for the global economy: the country will

remain the biggest contributor to global growth.

4

India

India, meanwhile, risks falling victim to its own optimism, namely the widespread

assumption that it will follow China’s course and become the fastest growing economy

in the coming years. It now embraces the once-dreaded issue of overpopulation,

which, in the country’s eyes, has worked so well in China. This overconfidence is very

dangerous. Culturally and politically India looks less like controlled China and more

like chaotic, confusing Brazil. Both Brazil and India are societies geared towards family

and community, with a tendency towards the group, and which are more susceptible

to corruption. Indeed, corruption has become a serious problem. To avert a crisis,

India will have to create a society governed by rules, not by personal connections that

place potential assets in the wrong hands. Crony capitalism is a cancer that

undermines competitiveness and reduces economic growth. India has more

advantages than any other major economy, but politicians cannot take for granted the

success that the country’s demography could offer. Rather, they should tackle the real

challenges such as crony capitalism or increasing social benefits.

Brazil

What has happened in Brazil is that the flow of foreign exchange into the country has

made its currency one of the most expensive in the world. Here the author mentions

one of the rules to be kept in mind: If local prices in a developing country are

expensive even for a visitor from a rich country, that country will probably not top the

list of successful economies. Despite its role as a major exporter, Brazil is still one of

the most protectionist economies in the world, with hostile trade barriers that scare

away foreign investors. It must carry out the much-needed reforms; otherwise it will

see its growth decline.

Mexico

In the case of Mexico, oligarchs control virtually every industry. This culture is creating

a perpetual form of inequality that also leads to violence. Another rule comes into

play here: strong companies and a strong stock market do not instantly make for a

strong economy, and as such, these concepts should not be confused. If

competitiveness increases and large companies are weakened, then prices will fall,

productivity will increase and the country will grow.

Russia

In Russia, the author detects the excesses and ostentation of the country’s millionaires

as a sign of economic weakness. While some flaunt their wealth, the country suffers,

amongst others, from lacking transport connections caused by poor government

investment. Russia is an oil state that has lost its way. The combination of slow

5

growth after the 2008 coup and high prices suggest that the growth rate is

plummeting. The country’s lack of investment means that its workers are becoming

less productive and leaders, namely Putin, have adopted an authoritarian attitude

through their control over industry. Here, Sharma warns that alarm bells should start

to sound when rulers outlive their usefulness. Russia does not have a single

noteworthy multinational company and the iron-fisted surveillance of the Kremlin

leaves little room for manoeuvre, which has left the country absolutely dependent on

its largest source of income, natural energy resources. Of all the emerging countries,

Russia has taken the longest to recover from the 2008 recession. Russia needs a new

economy that is not based on oil and a new non-Tsarist mind-set that does not

project that level of popularity to leaders such as Putin.

Eastern Europe

Here, the author emphasises the position of Poland and the Czech Republic, which are

stronger than Russia because of the European Union model. Although the current

situation of countries like Greece, Spain or Portugal poses questions as to its success,

the EU is still a growth engine for those new members who take its rules seriously.

According to the author, these two countries are certainly future emerging nations.

Another of the guidelines to detect such nations is an inspection of the precise

moment when political and economic reforms are carried out. Countries tend to

implement reforms when things go wrong; however, when countries go against this

current, as in these two cases, there is room for optimism. These two countries have

benefitted from the advantages of the EU but have not yet become involved in the

swampy terrain of the euro despite the renewed insistence of Germany that they

should adopt the currency.

Turkey

Recep Tayyip Erdogan is turning Turkey into a powerful Muslim country by virtue of its

brand of religious freedom that is stimulating the economy through its traditional

channels – which include the Middle East, Africa and Asia, but Europe no longer.

Currently, Turkey is carrying out an ambitious investment programme in

infrastructure and the power of the country’s leader is balanced thanks to a well-

established democracy that keeps corruption at bay. Today Turkey no longer sees

entry to the EU as a priority, denied on numerous occasions by countries such as

Germany. It has become another rising economic star, an example of development for

countries like Egypt.

Asia

With countries such as Indonesia, Sharma uses another rule of thumb: checking the

size of the second largest city in the country. In a large country, the second city usually

6

has a population equivalent to one third of the country's largest city. This figure

reflects regional balance in the country’s economy. Indonesia fulfils this rule of thumb,

and has also created a new business culture in the country’s provinces. Thailand, for

example, does not obey this rule, but the author suggests it could be among the

emerging nations if it achieves political stability; something that it has not enjoyed in

decades. It does, however, apply in the case of the Philippines, another possible

candidate, and especially in the case of South Korea. The country’s multinational

companies, sector leaders, and openness make it the one to watch in order to measure

the pulse of the global economy. It ties for gold with Taiwan in this race, as the only

two nations in economic history to achieve five consecutive decades of growth above

5%. Moreover, South Korea is projected to grow even faster than expected.

The Fourth World

The author considers as fourth-world nations or frontier markets all those countries

whose economic rise neither responds to typical patterns nor is affected by

globalisation. These are countries that are open to foreign investment but which do

not follow the rules of the market, rendering them volatile and unpredictable. They

include lower middle-income countries such as Ghana, Vietnam, Sri Lanka and the

strongest African nations, along with the world's richest nation, Qatar. In this sense,

the most isolated area in terms of global market standards is the Middle East: the key

economies in this market are oil-rich Gulf countries. They have broken dozens of basic

economic development rules and provide unequivocal proof not all emerging countries

can be treated alike. ‘One-size-fits-all’ approaches cannot be applied in assessing these

economies: each emerging nation, especially in the fourth world, is unique.

The trends of the new global balance

We currently live in the illusion of raw materials, which have replaced technology as

trading stars and now constitute 30% of the global market. At least in the tech boom,

the new millionaires were talented people, whose activities contributed to

development through new technologies that would be beneficial for everyone. The

new wave, however, lies completely aside from human progress. Moreover, the

increase in oil, cotton and wheat prices caused by these operations – and the

speculation involved – endangers the overall growth of the economy. Meanwhile, new

paradigms are invented to justify high prices. Furthermore, this situation is based on

the dangerous assumption that demand from emerging countries will rebound in

another fresh wave; but that wave has already passed us by. We may, therefore, be

about to witness yet another bubble about to bust.

However, what has already arrived is the Third Coming: a new era defined by

moderate growth, the return to the classic cycle of boom followed by decline and the

end of group behaviour. Emerging markets will also be more cautious. Therefore, the

7

definition of the emerging markets of the next decade will depend on the range of

wealth we are examining. In the $20,000 to $25,000 income range, the countries most

likely to surpass 3% growth are the Czech Republic and South Korea. In the $10,000 to

$15,000 group, Turkey or Poland will be the ones exceeding 4% or 5%.

The rise of the next decade’s emerging powers will restructure the global balance of

power: the West will regain confidence while the Brazilian and Russian stars begin to

fade. New players may emerge from the darkness, but at the top, where 15 economies

are worth over one trillion dollars a year, two states are next on the list: two Muslim

democracies with market-oriented economies, Turkey and Indonesia. And, despite

the rules and expectations, many other nations still have a good chance of becoming

the new stars on the European scene if they manage to change course and improve on

some of their weaknesses.