a bigger world - the economist

A bigger worldA special report on globalisation

September 20th 2008

Globalisation.indd 1Globalisation.indd 1 5/9/08 16:33:075/9/08 16:33:07

The Economist September 20th 2008 A special report on globalisation 1

Globalisation is entering a new phase, with emergingmarketcompanies now competing furiously against richcountry ones.Matthew Bishop asks what that will mean for capitalism

ing cap in hand to the sovereignwealthfunds (stateowned investment funds) ofvarious Arab kingdoms and the Chinesegovernment.

One example of this seismic shift in global business is Lenovo, a Chinese computermaker. It became a global brand in 2005,when it paid around $1.75 billion for thepersonalcomputer business of one ofAmerica’s bestknown companies, IBM�including the ThinkPad laptop range beloved of many businessmen. Lenovo hadthe right to use the IBM brand for �ve years,but dropped it two years ahead of schedule, such was its con�dence in its ownbrand. It has only just squeezed into 499thplace in the Fortune 500, with worldwiderevenues of $16.8 billion last year. But �thisis just the start. We have big plans to grow,�says Yang Yuanqing, Lenovo’s chairman.

One reason why his company could afford to buy a piece of Big Blue was its leading position in a domestic market buoyedby GDP growth rates that dwarf those indeveloped countries. These are lifting theincomes of millions of people to a levelwhere they start to splash out on everything from new homes to cars to computers. �It took 25 years for the PC to get to the�rst billion consumers; the next billionshould take seven years,� says Bill Amelio,Lenovo’s chief executive.

The sheer size of the consumer marketsnow opening up in emerging economies,especially in India and China, and their

A bigger world

GLOBALISATION used to mean, by andlarge, that business expanded from

developed to emerging economies. Now it�ows in both directions, and increasinglyalso from one developing economy to another. Business these days is all about�competing with everyone from everywhere for everything�, write the authorsof �Globality�, a new book on this latestphase of globalisation by the Boston Consulting Group (BCG).

One sign of the times is the growingnumber of companies from emerging markets that appear in the Fortune 500 rankings of the world’s biggest �rms. It nowstands at 62, mostly from the socalledBRIC economies of Brazil, Russia, Indiaand China, up from 31 in 2003 (see chart 1,next page), and is set to rise rapidly. On current trends, emergingmarket companieswill account for onethird of the Fortunelist within ten years, predicts Mark Spelman, head of a global thinktank run byAccenture, a consultancy.

There has been a sharp increase in thenumber of emergingmarket companiesacquiring established richworld businesses and brands (see chart 2, next page), starkly demonstrating that �globalisation� is nolonger just another word for �Americanisation�. Within the past year, Budweiser,America’s favourite beer, has been boughtby a BelgianBrazilian conglomerate. Andseveral of America’s leading �nancial institutions avoided bankruptcy only by go

An audio interview with the author is at

www.economist.com/audiovideo

A list of sources is at

www.economist.com/specialreports

The new championsEmerging markets are producing examples ofcapitalism at its best. Page 3

Ins and outsAcronyms BRIC out all over. Page 5

The empire strikes backWhy richworld multinationals think they canstay ahead of the newcomers. Page 6

Oil, politics and corruptionBad capitalism carries its own risks. Page 9

The rise of state capitalismComing to grips with sovereignwealthfunds. Page 11

Cities in the sandA new sort of investment partnership.Page 12

Opportunity knocksAs long as the protectionists don’t spoil it.Page 13

Also in this section

AcknowledgmentsIn addition to those cited in this report, the author isparticularly grateful for the insights, many of them o� therecord, of Hal Sirkin, Nandan Nilekani, Alvaro RodriguezArragui, Bernard Charles, Joshua Ramo, Michelle Guthrie,Arjun Divecha, Len Blavatnik, Viktor Vekselberg,Malvinder Singh, Bill Ford, Michael Green, Lord JohnBrowne, John Studzinski, Bill Rhodes, Diana Farrell,Mikhail Fridman, Graham Mackey, Thor Bjorgolfsson, RamCharan, Nabil Habayeb, Diana Glassman, DavidRubenstein, Eli Jacobs, Dambisa Moyo, Alastair Newtonand Michael Patsalos Fox.

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More articles about globalisation are at

www.economist.com/globalisation

2 A special report on globalisation The Economist September 20th 2008

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rapid growth rates, will shift the balance ofbusiness activity far more than the earlierrise of less populous economies such as Japan and South Korea and their handful of�new champions� that seemed to threatenthe old order at the time.

This special report will argue that theage of �globality� is creating huge opportunities�as well as threats�for developedworld multinationals and new championsalike. The macroeconomic turbulence thatthe world is now going through after almost a decade of smooth growth willprobably not alter the picture fundamentally, but it will complicate it. Despite all thetalk of �decoupling�, emerging economieshave recently been growing more slowlybecause of their exposure to increasinglycautious American consumers.

Moreover, high oil and food prices arecreating in�ationary pressures in manyemerging countries that had enjoyed yearsof stable, low prices along with extraordinary economic growth. The sidee�ects ofrapid development, such as pollution andwater shortages, also need to be tackled.�After a long period in which globalisationhas been all about labour productivity, thebusiness challenge everywhere, and especially in emerging markets, will increasingly be to raise resource productivity�usingfuel, raw materials and water more e�ciently,� says Bob Hormats of GoldmanSachs, an investment bank.

A cheaper mousetrapAssuming that the upbeat growth forecastsfor emerging markets remain broadly ontrack and the developed economies getback on their feet, what will be the maincompetitive battlegrounds of global business? One is those new consumers, whooften demand products at far lower pricesand often in more basic forms or smallersizes than their developedcountry coun

terparts. Emergingmarket �rms with experience of serving these consumers thinkthey are better placed to devise such products than their developedworld competitors. Lenovo, for example, is going afterthe developing world’s rural markets witha cheap, customised PC that enables farmers to become networked.

Some of these innovations have globalpotential. Lenovo’s Chinese R&D labs developed a button that recovers a computersystem within 60 seconds of a crash, essential in countries with an unreliablepower supply. Known as �Express Repair�,this is now being incorporated into itscomputers everywhere.

The same logic may apply to innovations in business models that allow goodsand services to be delivered in fundamentally di�erent ways and at much lowercost. Lenovo, for example, has developed ahighly e�ective formula for selling to Chinese consumers that it has since taken toIndia and America.

Yet the rise of the new champions hasbrought a vigorous response from some ofthe old ones. IBM may have felt that it wasno longer worth its while to compete inPCs, but Lenovo is facing �erce competition from American companies such asHewlettPackard and Dell everywhere, including in China. Nor was IBM’s decisionto sell its (lowmargin) PC business due to alack of commitment to emerging markets:it now employs 73,000 people in India,against 2,000 at the start of the decade, andhopes to increase the share of its globalrevenues coming from emerging marketsfrom 18% now to 30% within �ve years.

Although multinational companies indeveloped countries must grapple withlegacy costs of various kinds��nancial(pensions, healthcare liabilities), organisa

tional (headquarters far away from newmarkets) and cultural (old ways of thinking)�they have advantages too. The greatest of these may be a deep well of managerial experience, which emergingmarket�rms often lack. Yet Lenovo has shownhow to overcome this management de�citby hiring a group of seasoned international executives, including Mr Amelio, anAmerican who cut his managerial teeth atIBM and Dell.

But Lenovo went further than hiring international managers. �We are proud ofour Chinese roots,� says Mr Yang, but �weno longer want to be positioned as a Chinese company. We want to be a truly global company.� So the �rm has no headquarters; the meetings of its seniormanagers rotate among its bases aroundthe world. Its development teams aremade up of people in several centresaround the world, often working togethervirtually. The �rm’s global marketing department is in Bangalore.

A huge e�ort has been made to integrate the di�erent cultures within the �rm.�In all situations: assume good intentions;be intentional about understanding othersand being understood; respect cultural differences,� reads one of many tip sheets issued by the �rm to promote �e�ectiveteamwork across cultures�. Mr Yang evenmoved his family to live in North Carolinato allow him to learn more about American culture and to improve his already respectable command of English, the language of global business.

In short, Lenovo is well on its way to becoming a role model for a successful multinational company in the age of globality: a

2Lean and hungry

Source: Dealogic

Top five emerging-market M&As

Deal valueYear Target Buyer $bn

2006 Inco Companhia Vale do 18.7 Canada Rio Doce, Brazil

2006 Rinker Group Cemex SA de CV 16.7 Australia Mexico

2008 Rio Tinto (12%) Alcoa; Aluminum 14.3 Britain Corp of China US; China

2006 Corus Group Tata Group 13.0 Britain India

2007 GE Plastics Saudi Basic Industries 11.6 US Corp, Saudi Arabia

3The new giants

Source: Fortune

Ten biggest Fortune Global 500 emerging-marketcompanies, 2008

Global 500 RevenueCompany Country rank $bn

Sinopec China 16 159.3

State Grid China 24 132.9

China National China 25 129.8Petroleum

Pemex Mexico 42 104.0

Gazprom Russia 47 98.6

Petrobras Brazil 63 87.7

Lukoil Russia 90 67.2

Petronas Malaysia 95 66.2

Indian Oil India 116 57.4

Industrial & China 133 51.5Commercial Bank of China

1Sixty-two, and counting

Source: Fortune

Emerging-market companies in the Fortune

Global 500

0

10

20

30

40

50

60

70

2000 01 02 03 04 05 06 07

Non-BRICBRIC


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good reason to be optimistic about the future of capitalism, even capitalism with aChinese face. Perhaps Lenovo and othernew champions will become the �rst of anew breed of truly global companies, rooted in neither rich nor developed countriesbut aiding wealth creation by making themost of opportunities the world over.

Good and bad capitalismBut is such optimism justi�ed? Indeed,would Lenovo even have been allowed tobuy IBM’s PC business today? Congressnearly blocked the deal at the time becauseit feared that valuable intellectual propertymight fall into the hands of the Chinesegovernment. Since then, Chinabashinghas increased, there has been some Arabbashing too, deals have been blocked andthe rhetoric in Washington, DC, has become ever more protectionist.

One fear is that American jobs will disappear overseas. This is despite plenty ofacademic evidence that open economiesgenerally do better than closed ones, thatin America in particular many more andgenerally better jobs have been created inrecent years than have been destroyed,and that the number of jobs lost to outsourcing is tiny compared with thosewiped out by technological innovation.Mr Yang explains that �people thought wewould manufacture all our products inChina, but in fact we have opened newplants in Greensboro and also Poland, aswe need to be close to our customers.�

Lately a new fear has been adding to

the protectionist sentiment, turning evensome usually enthusiastic global capitalists into protectionists. Could the rise ofthe new champions re�ect the advance ofbad forms of capitalism at the expense ofgood forms?

In their 2007 book, �Good Capitalism,Bad Capitalism and the Economics of Prosperity and Growth�, William Baumol,Robert Litan and Carl Schramm identifyfour main models of capitalism around theworld: entrepreneurial, big�rm, oligarchic(dominated by a small group of individuals) and stateled. Most economies are amixture of at least two of these. The besteconomies, say the authors, blend big�rmand entrepreneurial capitalism. The worstcombination may be of oligarchic andstateled capitalism, both of which areprevalent in many emerging markets.

The worriers point out that, throughcorporate acquisitions and the investments of sovereignwealth funds, the roleof the state (often an undemocratic one) inthe global economy is rapidly expanding.Given the lamentable history of state intervention in business, they say, this does notbode well.

Such fears are not easily dismissed, ifonly because what is happening is so newthat there is not much evidence either way.Sovereignwealth funds insist that they areinterested only in getting a good return ontheir money and will not meddle in politics. Perhaps they will turn out to besources of good corporate governance andpatient capital, in admirable contrast to the

growing number of shorttermist institutional investors in developed countries.But perhaps they will not.

Again, Lenovo o�ers an encouragingexample. Even though its largest shareholder is in e�ect the government of China, its acquisition of IBM’s PC businessdoes not seem to have had any troublingconsequences. But maybe the Chinesegovernment was restrained by its coinvestors, two of America’s leading privateequity �rms. Besides, the new champions maybe typi�ed not by Lenovo but by, say, Gazprom, through which the Russian state canmake mischief abroad. As Mr Yang pointsout, of the 29 Chinese �rms in the Fortune500, Lenovo is the �only one that is trulymarketdriven�. Most of the rest enjoy monopoly power or operate in the naturalresources industries, where there is far morescope for politics and corruption than inconsumer electronics.

At the very least, the growing role ofstates that often lack democratic credentials creates a sense that the competitionfrom emergingeconomy champions andinvestors is unfair, and that richcountry�rms may lose out to less wellrun competitors which enjoy subsidised capital, helpfrom political cronies or privileged accessto resource supplies.

So there is a real risk that bad capitalismwill spread in the coming decades. Yet atthe same time this latest, multidirectionalphase of globalisation o�ers enormouspotential for business to raise living standards around the world. 7

SAFARICOM may not be a householdname in the rest of the world, but in Ken

ya it is famous. On June 9th the country’smost popular mobilephone company,with 10.5m customers, listed its shares onthe Nairobi stock exchange, raising over$800m in the biggest initial public o�eringyet in subSaharan Africa. The o�ering wasnearly �ve times oversubscribed, and Safaricom’s share price quickly rose by 60%.

Even subSaharan Africa is feeling itsway towards the emergingmarkets bandwagon. In January Goldman Sachs published its �rst bullish report on the continent, �Africa Rising�, noting at the timethat subSaharan stockmarkets in 15 coun

tries (excluding mighty South Africa) listedaround 500 companies with a market capitalisation of nearly $100 billion.

Seven years after Goldman Sachs invented the BRICs acronym, the performance of the emerging stockmarkets isrunning well ahead of the bank’s high expectations. Even after recent falls, at thestart of this month Brazilian shares wereup by 345% since November 2001, India’sby 390%, Russia’s by 639% and China’s, depending on whether you go by the mainland or the Hong Kong exchange, by 26% or500% (see chart 4, next page). In 2001Goldman Sachs had predicted that by the endof the decade the BRIC economies would

account for 10% of global GDP at purchasingpower parity (PPP); by 2007 their sharewas already 14%. The investment banknow expects China’s GDP to surpassAmerica’s before 2030.

Most economists believe that this upward trend will not be seriously broken bythe current economic slowdown. Nor is itrestricted to the BRICs. In 2005, for the �rsttime since the dawning of the industrialage, emerging economies accounted formore than half of global GDP at PPP.

Yet the emerging markets are not merely generating economic growth. They arealso producing companies that are worthinvesting in, and that are even starting to

The new champions

Emerging markets are producing examples of capitalism at its best

A special report on globalisation The Economist September 20th 2008

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take on and beat the best of the developedworld’s multinationals. As well as Lenovo,the new champions listed by Antoine vanAgtmael in his book �The Emerging Markets Century� include Haier, a Chinesewhitegoods �rm; Cemex, a Mexican cement company; Embraer, a Brazilian aircraftmaker; Infosys, an Indian softwaregiant; and Ranbaxy, an Indian drug company. The list of emerging �rms in �Globality� that are said to be �changing the gamein every industry� also includes �rms suchas Goodbaby, which has an 80% share ofthe market for baby buggies in China and a28% share in America, and the Tata Group,an Indian conglomerate that spans carsand steel, software and tea.

Lately, Tata, which has operations in 85countries, has been making a series ofhighpro�le acquisitions that are fundamentally transforming a company set upin 1868. In 2000 it bought LondonbasedTetley, an iconic tea company. In 2007, aftera �erce bidding war with CSN, a Braziliansteel �rm, it paid $12 billion for Corus, aEuropean steel company. In March thisyear it paid Ford $2.3 billion for two legendary car businesses, Jaguar and Land Rover.

Tata could a�ord to pay high prices forits acquisitions, re�ecting the growing �nancial strength of some of the new champions. In part, they are bene�ting fromhaving large, pro�table shares of fastgrowing domestic markets. The rapid development of domestic �nancial marketsin many emerging economies�not juststock exchanges, but also markets for corporate debt�has also made it far easier toget the capital needed to expand abroad.

Equally, richcountry capital marketsnowadays are open to and actively recruiting emergingmarket companies. The NewYork Stock Exchange is even seeking to listits shares on the Shanghai stock exchange.And the world’s leading consultants, law

�rms and investment banks are courtingemergingmarket companies at which, notso long ago, they would have turned uptheir noses. McKinsey, a consultancy, hasadvised Lenovo on how to unite its Chinese and American cultures. GoldmanSachs has appointed Lakshmi Mittal, an Indian steel magnate, to its board.

Tata rejects suggestions that it overpaidfor its acquisitions�a charge that has beenlevelled at several of the new champions.It insists it is paying prices justi�ed by itslongterm investment horizon and its philosophy of deep decentralisation thatgives plenty of freedom to the management teams it acquires (and typicallyleaves in place). The acquisition of Jaguarand Land Rover is a case in point. Shortterm market pressure may have forcedFord to sell two �rms that it had done goodwork restructuring, says Alan Rosling,Tata’s (British) chief strategist: �Tata willreap the bene�t of all Ford’s hard work.�

Another reason to be optimistic aboutTata’s growing global reach is its Indian origin, which makes it more sensitive to cultural di�erences than many of its peers indeveloped countries, claims Mr Rosling.And in its strategy, the �rm has benchmarked itself against some of the world’sbest companies. It has borrowed ideasfrom �rms such as Warren Bu�ett’s Berkshire Hathaway, Mitsubishi, a Japaneseconglomerate, and GE, says Mr Rosling.

The new champions are becoming increasingly innovative, both in their busi

ness models and in their products. For instance, Tata Consulting Services, alongwith Indian counterparts such as Infosysand Wipro, has built up a large organisation for outsourcing business processes,serving companies around the world. Initially this was a fairly lowtech operation,thriving largely on India’s low labourcosts. Increasingly, however, it has movedinto highervalue businesses, as have its Indian peers.

Frugal engineeringNot so long ago, the most exciting thingabout emerging markets was their cheaplabour. Local �rms supplied �rst manufactured goods and then services to developed markets and multinationals. That remains an attraction, but a declining one aswages in emerging markets and transportcosts go up. No one expects Walmart, theworld’s largest retailer, to rethink its famously e�cient supply chain, which bringsbillions of dollarsworth of Chinese goodsto the developed world. But these daysmultinational �rms are looking for theskills that workers from emerging marketscan bring to a job as much as for lower labour costs.

Increasingly, though, the most excitingthing about emerging countries is the rapidgrowth in the number of consumers intheir own markets, and in the number ofentrepreneurs to serve them. Already,wealthy consumers in these countrieshave proved a godsend to the world’s lead

4Hares and tortoises

Source: Thomson Datastream*Chinese shares

listed in Hong Kong

Share prices, November 1st 2001=100

2001 03 04 05 06 07 080100200

400

600

800

1,000

1,200

Brazil

Russia

India

China ‘A’ shares

Hong Kong*

4


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IS IT time to retire the phrase �emergingmarkets�? Many of the people inter

viewed for this special report think so.Surely South Korea, with sophisticatedcompanies such as Samsung, has fullyemerged by now. And China already hasthe world’s fourthlargest economy.

The term �emerging markets� datesback to 1981, recalls the man who inventedit, Antoine van Agtmael. He was trying tostart a �ThirdWorld Equity Fund� to invest in developingcountry shares, but hise�orts to attract money were being constantly rebu�ed. �Racking my brain, atlast I came up with a term that soundedmore positive and invigorating: emergingmarkets. ‘Third world’ suggested stagnation; ‘emerging markets’ suggested progress, uplift and dynamism.�

Later in the 1980s the fastgrowingeconomies of SouthEast Asia acquiredthe tag �Asian Tigers��until they ceasedto roar during the �nancial crisis of199798. In 2001 Jim O’Neill, chief economist of Goldman Sachs, came up with theacronym �BRICs� for the next four coun

tries it expected to enter the economic bigleague: Brazil, Russia, India and China. Hesays that the BRICs, Korea and Mexico�should not be really thought of as‘emerging markets’ in the classical sense,as many still do. We regard these countries as a critical part of the modern globalised economy.�

In its search for de�nitive rigour, theFTSE group has come up with three categories for what used to be known as thirdworld economies: advanced emerging,secondary emerging and frontier markets(which have a stockmarket but perhapsnot much else).

�Emerging markets are places wherepolitics matter at least as much as economics to market outcomes,� says IanBremmer of Eurasia Group, a politicalrisk consultancy. That de�nition surely includes Russia. One Russian billionaire,after lambasting the �emerging� label asinsulting, suggests using �highgrowtheconomy� instead. Sounds good�butwhat if a recession comes along? Thatmight call for a new tag: �submerging�.

Acronyms BRIC out all over

Ins and outsing brands of luxury goods. But the emerging markets’ new middle class may alsohave helped many new champions along.

Goldman Sachs calculates that the global middle class�which it de�nes as people with annual incomes ranging from$6,000 to $30,000�is growing by 70m ayear and rising. By 2030, the bank predicts,another 2 billion people may have joinedthis group. At incomes of $6,000 the consumption of energy starts to rise, and at$8,0009,000 purchases of highervalueconsumer durables take o�, so the growthin demand for these things already underway in emerging countries should continue for many years.

One of the �rst management gurus tonote the rise of the emergingmarket consumer was C.K. Prahalad in his book, �TheFortune at the Bottom of the Pyramid�. Heargued that to serve these new consumers�both in the new middle classes and atthe bottom of the income pyramid�companies will need new business modelsand products that are pro�table at muchlower prices than in rich countries.

Companies from emerging marketsmay be more adept than their richcountryrivals at making do with the bare minimum of resources��frugal engineering�,as Carlos Ghosn, the boss of RenaultNissan, calls it. And it may be much easier for acompany starting from scratch than for anestablished �rm with a �legacy mindsetand legacy costs�, says Mr Prahalad. Therapid spread of mobile telephony amongpoorer consumers in the emerging marketsis one notable example. AirTel, the Indianmarket leader, charges what may be thelowest prices in the world�around twocents a minute for nationwide calls�yet ishugely pro�table, thanks to an innovativebusiness model in which many of its operations are outsourced to big multinationals such as Ericsson and IBM.

Safaricom joins a group of emergingmarket mobilephone companies with acombined market capitalisation which MrPrahalad estimates at $500 billion. �Poorpeople, once mobilised and provided withvalue, can create tremendous wealth forbusiness,� he says. He sees similar potential in a number of other industries, ranging from agribusiness to health care andwater to �nance.

What it takes to succeedMr Prahalad says he can now answer �yes�to �ve questions he posed seven years agowhen he launched his pyramid idea. Isthere a real market? Is it scalable? Is therepro�t? Is there innovation? Is there a global

opportunity? Soon, he reckons, �rms inemerging markets will develop productsthat �straddle the pyramid��developingbasic highquality products, but di�erentiating between customers at di�erent income levels by adding various �bells andwhistles for the rich�. For instance, a mobile phone may include a torchlight forpoorer customers and a fancy camera forthe bettero�.

Tata, too, is at the forefront of this frugalengineering trend. In January it unveiledits longawaited Nano, a new �people’scar� that will be sold for just $2,500. Thiswas �not just the result of using cheap Indian engineers�, says Mr Rosling. Nor is itabout accepting lower standards on safetyor environmental emissions. The company used stateoftheart virtual designtechnology and global teams to drive genuine innovation. Mr Tata saw the Nano asa safer alternative for Indian families currently travelling by motorcycle, but consumers in developed countries are alreadytalking of it as a possible second car for usein towns because, being small, it is easy to

park. Still, the Nano will probably sell bestin other emerging markets.

Already, new champions such as AirTeland Desarrolladora Homex, a Mexicanbuilder of lowcost housing, are planningto take their innovative business modelsand pricing to other emerging markets, betting that they will transfer more easily between developing economies than fromdeveloping to developed ones. Homexhopes to serve communities �in highlypopulated and underserved areas wherewe believe our replicable business modelwill be most e�ective,� says its chief executive, Gerardo de Nicolas.

The company is investing a total of $4min a joint venture called Homex India andhas struck an alliance with the EgyptianSawiris business dynasty to build 50,000new homes in Cairo. Mr de Nicolas is oneof a growing number of talented entrepreneurs making waves in countries that hitherto have not seen much entrepreneurship�a very di�erent breed from theresource billionaires, the other face of today’s emergingmarkets business. A new


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book by Tarun Khanna, �Billions of Entrepreneurs: How China and India are Reshaping Their Futures and Yours�, may beoverstating the numbers, but the basic ideais right.

For example, in Nigeria, an economynow showing more hopeful signs than forseveral decades, oil and mining is a bigdeal, but so are consumeroriented businesses such as media. Brazil has a largenumber of entrepreneurial startups withglobal ambitions in the cleanenergy sector, for example. Fadi Ghandour, a Jordanian who has built Aramex into the �FedExof the MiddleEast�, sees entrepreneurshipstarting to take hold throughout that regionas younger people realise that tradingideas may o�er a better route to riches thanland or oil.

Admittedly, venture capital is laggingbehind other sorts of �nance in establishing a presence in emerging markets. Yet almost everywhere in the developing worldthe outlook for entrepreneurs is far betterthan it was even �ve years ago.

The recent rise of the emerging marketshas owed much to the combination of abenign global economy and relatively sen

sible policymaking at home. Neither ofthese can be taken for granted in the yearsahead because at least three of the forcesbehind the recent economic boom no longer apply: strong American consumer demand, cheap money and cheap oil. Indeed, the latest trends in the worldeconomy are highlighting signi�cant differences (eg, in reserves of natural resources) between emerging economiesthat tend to be grouped together as if theywere essentially homogenous.

School of hard knocksIn turn, this is putting the competence ofeconomic policymakers in emerging markets to the test, with potentially big implications for the new champions. In commodityrich Brazil, for example, the boomin naturalresource prices and the centralbank’s determination to be tough on in�ation has made the real one of the world’sstrongest currencies. This has hurt Brazilian exporters such as the widely acclaimednew champion, Embraer, whose regionaljets have proved an unexpected hit withairlines the world over. The reliance of India and China on imported oil, which their

governments have long been subsidisingfor domestic consumers, may have nastylongterm consequences.

Yet the familiar emergingmarket mixof volatility and bad economic policiesmay have been the making of the most talented bosses of emergingmarket �rms(admittedly not a large group), forcingthem to concentrate on cutting costs, raising productivity and ensuring a strongcash�ow. �Some managers from emergingmarkets have had to develop certain abilities that are proving very valuable whenthey go to a �rstworld economy, whereproductivity is crucial,� says Antonio Bonchristiano of GP Investments, a big Brazilian privateequity �rm. �Look at LakshmiMittal, who has done brilliantly in one ofthe world’s most basic industries.�

Another example is Carlos Brito, theBrazilian chief executive of InBev, a beergiant, which in July spent $52 billion onbuying America’s AnheuserBusch to become the world’s largest brewer. Like MrMittal, Mr Brito has a reputation as an effective costcutter. That said, few old multinational champions are likely to admit defeat as easily as AnheuserBusch. 7

�YOU get very di�erent thinking if yousit in Shanghai or São Paulo or Dubai

than if you sit in New York,� says MichaelCannonBrookes, just o� the plane fromBangalore to Shanghai. �When you wantto create a climate and culture of hypergrowth, you really need to live and breatheemerging markets.� Mr CannonBrookes isthe head of strategy in IBM’s newly created�growth markets� organisation, whichbrings together all of Big Blue’s operationsoutside North America and western Europe. �This is the �rst line business in 97years of our history to be run outside theUS,� he says excitedly, noting that �LatinAmerica now reports to Shanghai.�

IBM’s thinking about emerging markets, and indeed about what it means to bea truly global company, has changed radically in the past few years. In 2006 Sam Palmisano, the company’s chief executive,gave a speech at INSEAD, a business schoolin France, describing his vision for the�globally integrated enterprise�. The modern multinational company, he said, had

passed through three phases. First camethe 19thcentury �international model�,with �rms based in their home countryand selling goods through overseas saleso�ces. This was followed by the classicmultinational �rm in which the parentcompany created smaller versions of itselfin countries around the world. IBM

worked liked that when he joined it in 1973. The IBM he is now building aims to re

place that model with a single integratedglobal entity in which the �rm will movepeople and jobs anywhere in the world,�based on the right cost, the right skills andthe right business environment. And it integrates those operations horizontally andglobally.� This way, �work �ows to theplaces where it will be done best.� Theforces behind this had become irresistible,said Mr Palmisano.

This ambitious strategy was a responseto �erce competition from the emergingmarkets. In the end, selling the personalcomputer business to Lenovo was relatively painless: the business had become com

moditised. But the assault on its servicesbusiness led by a trio of Indian outsourcing upstarts, Tata Consulting Services, Infosys and Wipro, threatened to do seriousdamage to what Mr Palmisano expected tobe one of his main sources of growth.

So in 2004 IBM bought Daksh, an Indian �rm that was a smaller version of thebig three, and has built it into a large business able to compete on cost and qualitywith its Indian rivals. Indeed, IBM believesthat all in all it now has a signi�cant edgeover its Indian competitors.

Being willing to match India’s lowcostmodel was essential, but Mr CannonBrookes insists that IBM’s enthusiasm foremerging markets is no longer mainlyabout cheap labour. Je� Joerres, the chiefexecutive of Manpower, an employmentservices �rm, also thinks the opportunitiesfor savings are dwindling. �When you seeChinese companies moving in a big wayinto Vietnam, you think there is not muchlabour arbitrage left.�

Perhaps a bigger attraction now, accord

The empire strikes back

Why richworld multinationals think they can stay ahead of the newcomers


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ing to IBM, are the highly skilled people itcan �nd in emerging markets. �Ten years,even �ve years ago, we saw emerging markets as pools of lowpriced, lowvalue labour. Now we see them as highskills,highvalue,� says Mr CannonBrookes. Asfor every big multinational, winning the�war for talent� is one of the most pressingissues, especially as hot labour markets inemerging markets are causing extremelyhigh turnover rates. In Bangalore, for example, even the biggest �rms may lose 25%of their sta� each year. IBM reckons that itsglobal reach gives it an edge in recruitmentand retention over local rivals.

IBM also says it can manage the risk ofintellectualproperty theft�a perennialworry for multinationals in emerging markets, especially China�well enough tohave cuttingedge research labs in Indiaand China. And it is starting to �localise� itssenior management, including moving itschief procurement o�cer and the head ofits emergingmarkets business to China.But as yet it has no plan to move its headquarters from Armonk, New York, whereas Halliburton, an energyservices �rm,shifted its headquarters to Dubai last year.One notable success has been the company’s partnership with AirTel in the Indian mobilephone market, which it has already extended to other Indian phonecompanies and is likely to take to othercountries. In this partnership IBM manages much of AirTel’s backo�ce operations and shares the �nancial risk with thephone company. �We grow as they grow,�says Mr CannonBrookes, noting that IBM

is now the largest service provider to localcustomers in India.

Risksharing has worked well for othermultinationals too. Vodafone, for example, is a big shareholder in Safaricom. InJune Daiichi Sankyo, a Japanese pharmaceutical giant, bought a 51% stake in India’sRanbaxy Laboratories. Such deals increasingly involve strategic partnerships ratherthan the joint ventures of old. Daiichihopes the deal will add value to its research and development expertise andprovide access to Japan’s fastgrowingmarket to Ranbaxy, which in turn bringslowcost manufacturing and an understanding of the generics market.

In many emerging markets the most attractive potential customer is the government, thanks to an infrastructure boomthat promises to span everything from mobile telephone networks to roads, airportsand ports, energy and water supply. IBM isnot alone in pitching directly to governments for this business, relying on its es

tablished brand and on the growing pressure on emergingcountry governments�even those that are not strictlydemocratic�to deliver highquality, valueformoney infrastructure. Instead of tryingto sell speci�c products, they say, these�rms aim to help governments draw upplans for improving their country�planswhich invariably require substantialspending with the company concerned.Both Cisco and GE have recently started establishing longterm problemsolving relationships with governments in which the�rms help to design an infrastructure programme as well as build some or all of it.

Buy my strategyThree years ago Cisco combined all itsemergingmarkets activities into a singleunit. Since then the share of its revenuescoming from emerging markets has risenfrom 8% to 15%, accounting for 30% of its total revenue growth. �We identify the country’s most important industries and go tothem with a blueprint for a strategy to improve them using our technology to beatglobal benchmarks; this is about revolutionary not incremental change,� says PaulMountford, head of Cisco’s emergingmarkets business.

In 2006 GE�which since launching itsEcomagination strategy in 2003 has bet bigon a boom in green technologies�signed a�memorandum of understanding� withChina’s National Development and Reform Commission to work jointly to safeguard the country’s environment. It alsowants to forge relations with local government in 200 secondtier Chinese cities,each of which will soon have a populationof at least 1m and will need everythingfrom a power supply to an airport.

More recently, top GE executives havegot together with Vietnam’s governmentto discuss the huge problems facing thecountry in water, oil, energy, aviation, rail

and �nance�all areas in which GE has products to sell. At one meeting GE’s presidentfound himself in the same room with nofewer than three Vietnamese leaders whohad taken part in a leadership programmeat GE’s famous training facility in Crotonville, New York, recalls John Rice, the company’s head of technology and infrastructure. This programme of inviting groups of3040 senior government and businessleaders from a particular emerging country to Crotonville for a week was launchedmore than a decade ago, starting with agroup from China. �We transfer a lot oflearnings between us, and we end upfriends for life,� says Mr Rice.

Today’s leading multinationals �are nolonger the slowmoving creatures theyused to be. They are not going to be beatenup like the big American companies wereby the Japanese,� says Tom Hout, a formerconsultant at BCG who now teaches atHong Kong Business School. With PankajGhemawat, who last year published awellreceived book, �Rede�ning GlobalStrategy�, Mr Hout has analysed theemerging market in which multinationalshave competed longest against local champions: China. Whether the establishedmultinationals or their local rivals are winning �depends on the segment you’relooking at�, says Mr Hout. Established Japanese and Western multinationals dominate in the hightech sectors of the economy; the Chinese are strong at the low end.The main battleground is in the middle.This is quite di�erent from the conventional wisdom, which is that establishedmultinationals are getting pushed out bylocal companies, he concludes.

A 2007 study by Accenture of China’stop 200 publicly traded companies foundthat the best businesses in China are notyet on a par with the world’s foremostones. Although their revenue growth increased on the back of China’s continued


2 economic growth, their ability to createvalue was still only half that of their globalpeers. �It remains to be seen whether China’s best players have built the management practices and supporting businessoperating models that will allow them togenerate pro�table growth in more maturemarkets over the long term,� the studywent on to say.

Their legacy thinking and cost structures notwithstanding, some establishedmultinationals are increasingly trying totake on the frugal engineers of the emerging markets headtohead, says Mr Ghemawat. �Smarter multinationals have all given up on the idea that they can simplydeliver the same old products in the developing world,� he explains. �If they just focus on pricing high in mostly urban areas,they will miss out on the mass consumermarkets that are emerging. And they haveto be able to compete as coste�ectively asthe local �rms, which can mean fundamentally reengineering their productsand business model.�

A recent report by BCG, �The Next Billion Consumers�, highlighted many innovative business models and products offered by multinationals such as Nokia�still the biggest mobilephone producer inChina, despite frequent predictions that itwill fall behind a local rival�and Procter &Gamble, as well as similar e�orts byemergingmarket �rms.

In search of excellent managersThe decisive factor may turn out to bemanagement. Although some emergingmarket �rms are very well managed, byand large established multinationals stillseem to have the edge. Mr Hout reckonsthat the expatriate managers now deployed by multinationals in emerging markets are generally of a much higher qualitythan the �young bucks or retirementposting types� they used to send. �They are aggressive, smart, at the heart of their careers.And they tend to be married to moreworldly women than management wivesused to be.�

That said, the multinationals’ management advantage is based more on trainingand experience of running a large businessthan on exposure to other countries. Indeed, leading multinationals are reducingtheir use of expats, and those they do sendare often expected to train a local manageras their successor. There is still a strikinglack of executives from emerging marketsat the top of developedcountry multinationals. Even at GE, which is wholeheartedly committed to emerging markets,

around 180 of the top 200 managers arestill Americans. �The single biggest challenge facing Western multinationals is thelack of emergingmarket experience intheir senior ranks,� says Mr Ghemawat.

Such companies’ boardrooms are evenless globalised. According to Clarke Murphy of Russell Reynolds, a recruitment�rm, American multinationals now have a�ferocious interest in attracting nonAmericans to the board�, but as yet even Europeans are a rarity, let alone directors fromemerging markets. The share of nonAmericans on the boards of Americanmultinationals is less than 5%.

The main problem �is attendance, especially if there is a crisis and the board needsto meet a lot at short notice�. Once again,Goldman Sachs seems to have found aclever compromise by appointingLakshmi Mittal to its board. The Indiansteel tycoon is based in London and oftenvisits New York, where the investmentbank has its headquarters.

Some European �rms are doing slightlybetter than their American counterparts atinternationalising their boards. Nokia recently appointed Lalita Gupte, an Indianbanker who had just retired from ICICI

bank, one of the world’s most innovativepractitioners of bottomofthepyramid �nance. And leading British companieshave lots of foreigners in their executivesuites and boardrooms.

Moreover, multinationals have greattrouble retaining the managers they dohave in emerging markets, says Mr Hout.�Welltrained, good, honest people arescarce in emerging markets. Multinationals are better at training these people thanemergingmarket companies, which preferto poach them once they are trained.�

The founders of emergingmarket �rmsare often impressive, but such �rms typically lack the depth of management talentof old multinationals, says Mr Hout. Thebest students he has taught on MBA

courses in Hong Kong and Shanghai havetypically worked for developedcountrymultinationals.

Part of the problem in China is that running a big company�even a giant such asChina Telecom, with its 220m customers�still has a lower status than a political jobsuch as governor of a province. And Chinese managers, being used to protectedmarkets, often lack the skill to operate inmore sophisticated markets overseas.

Anil Gupta, coauthor with HaiyanWang of a forthcoming book, �Getting China and India Right�, says that recognitionof their lack of management capability

may have been one reason why no Chinese steel �rms joined their Indian andBrazilian peers in the bidding war for Corus, and why no Chinese carmakers entered the battle to buy Jaguar and LandRover. �If one could create a Jack Welch index of leadership and assess companieson such a measure, the top 50 companiesfrom India would come out way ahead ofthe top 50 companies from China,� saysMr Gupta, a professor of strategy at theUniversity of Maryland.

Certainly some Indian �rms are extremely well run. The senior ranks of Tata,for example, are full of professional managers. On the other hand, many Indian�rms are in family ownership, and �it canbe hard to �nd room for professional managers when you have several sons demanding jobs of similar high status,� saysMr Ghemawat.

Perhaps the bestknown example ofthe problems of family ownership is thefeud between the Ambani brothers, whoafter their father’s death divided the family’s huge conglomerate, Reliance, between them. The dispute still simmers on.In July a bid by Reliance Communications,run by Anil Ambani, to buy a South African mobilephone company was thwartedby Mukesh Ambani, the boss of RelianceIndustries. No wonder that the brothers,who live in the same opulent apartmentbuilding, have separate lifts to avoidchance meetings. 7


1

TO MOST Western businessmen, thissummer’s hounding of Robert Dudley

was clearly the work of the Kremlin. Nevermind that the four billionaires whosecourt actions drove the British chief executive of BPTNK out of Russia presented it asan ordinary business dispute over theterms of the oil joint venture, rejecting theidea that their origins in the Soviet Unionmade them Kremlin stooges. (One of themtold a group of journalists in New York recently: �If you believe that the Kremlinlikes me, you are very wrong. First, I amJewish. Second, I am rich. Third, I am independent.�) To the outside world, this wasyet another reminder of the huge politicalrisk involved in doing business in Russia.

Political risk is arguably more pervasiveand fundamental to who makes or losesmoney than at any time since the secondworld war. And not just in Russia. Indeed,although political risk is most prevalent inemerging markets, it is not con�ned tothem, as Dubai Ports World discovered in2006 when it tried to buy some Americanports from their British owner, P&O, onlyto be delayed in Congress. A year earlierthe Chinese National O�shore Oil Company (CNOOC) had tried and failed to buyUnocal, an American oil company.

In 2006, when Lakshmi Mittal bid forArcelor, a European steel �rm, he met �erceand seemingly racist opposition from thegovernments of France, Luxembourg andSpain, which preferred to see their champion merge with a Russian rival rather thanwith �a company of Indians�, as Arcelor’schairman put it. The deal went ahead onlywhen India’s government threatened atrade war.

�Developedcountry governments do

unexpected things that are every bit astroublesome as emergingmarket governments. If you are an oil or gas company today, do you worry more about emergingmarkets or a windfallpro�t tax in the US?�says GE’s John Rice. Look, too, at the recentheavyhanded interventions in the �nancial system by the American government.Yet most business leaders around theworld reckon that political risk is a fargreater problem in emerging markets. Askthe boss of Carrefour, a French retailer,whose shops in China saw violent proteststhis year after proTibet campaigners disrupted the progress of the Olympic torchthrough Paris.

Western oil and mining companies,having started to improve their behaviourin Africa under pressure from NGOs, nowface competition from Chinese, Indian andRussian rivals that seem willing to cutdeals with even the most unsavoury African politicians. And how do Western �rmscompete in countries where bribes areseen as an ordinary cost of doing business?

Then there are the more humdrum uncertainties about emergingmarket governments’ attitude to the rule of law. Will theftof intellectual property be punished? Willlax regulatory enforcement allow yourcompany’s supply chain to be contaminated? (For example, Whole Foods Market discovered in July 2008 that Chinese powdered ginger it had been selling as organiccontained a banned pesticide.) Might thegovernment issue a decree that alters thefundamentals of your business, withoutconsultation or recourse, as often happensin China? Will it decide suddenly to breakup local monopolies, or alternatively encourage their formation?

On top of all this, there is the traditionalgame of guessing whether governmentswill abandon sound �scal and monetarypolicy at the �rst sign of economic turbulence�ie, any day now. The leading multinationals insist that emerging markets arenow so important to their longtermgrowth prospects that they have to be inthem regardless of shortterm macroeconomic policy risks. Gone for ever, they insist, is the shortsighted old habit of rushinginto emerging markets as they get hot, andout again at the �rst whi� of trouble.

East, west, which is best?There is not much consensus among leading businesspeople about the politicalrisks of di�erent emerging economies,though they agree that there are huge differences, even within the BRICs. However,Brazil (by far the richest of the four by income per person) is widely seen as remaining on the up, with the next president expected to continue with or improve on thecountry’s current macroeconomic policies, and all the bene�ts of lively privateand public equity markets, wellrun bigcompanies (Vale, Petrobras, Embraer andso on) and an increasingly innovative andentrepreneurial economy.

Some of the biggest disagreements areover Russia. �It’s very risky, but it is alsovery pro�table, especially if the Kremlinlikes you,� says another of the billionaireinvestors in BPTNK. �They like the Germans, are afraid of the Chinese, don’t likethe Americans and British, don’t mind theFrench.� Foreigners should probably avoidindustries that the Kremlin deems strategic, but which are they? Oil and mining,certainly, though that is also where the big

Oil, politics and corruption

Bad capitalism carries its own risks


2 gest opportunities lie. Technology, commercial aviation, telecoms, chemicals andagriculture are all �grey areas�, says IanBremmer of Eurasia Group.

What about property? Hank Greenberg, the former boss of AIG, is investing incommercial property in Russia because, hesays, it is �not a strategic industry� for thegovernment. But Gary Garrabrant, chiefexecutive of Equity International, who hasbeen investing in emerging markets sincethe mid1990s with Sam Zell, a propertybillionaire, is avoiding Russia �because wecan’t get our arms around the risk�. Nor ishe particularly impressed with India,where there is a �culture of institutionalised corruption around obtaining land andpermits for development�. As for China,�there is a huge opportunity in urbanisation, but stay diverse, below the government’s radar. Don’t be a target.�

The growing importance of emergingmarkets has provided plenty of work foradvisers on political risk from CambridgeEnergy Research Associates to Oxford Analytica. �The extractive industries, �rmslike Shell, got the message about politicalrisk 30 years ago, but most of the Fortune100 weren’t thinking this way until recently,� says Mr Bremmer. �Corporates in thetech area are among the worst, perhaps because their management is su�used withengineers. �

Is the political context for business inthe emerging markets likely to improve?Tom Hout is encouraged by the experienceof Cummins Engine in China. The American maker of diesel engines has done verywell in the highperformance segment ofthe market, but has missed out on dieselvehicles lower down the scale that fail tocomply with local rules on emissions.Now, in the more sophisticated cities, �ahigherquality civil servant has startedprosecuting trucks billowing smoke,� sothese trucks are being replaced with betterones, using engines made by Cumminsand other �rms from developed countries.

In a similar vein, as Chinese �rms getbetter at developing intellectual property,they are starting to seek protection for it incourt. This has meant that IP rights are being taken more seriously, which shouldbene�t foreign �rms too.

NGOs are beginning to spring upthroughout the emerging markets, demanding higher ethical standards of business and political leaders. In Africa, for instance, much of the initial pressure forbetter governance and less corruptioncame from developedcountry NGOs. Butnow some African NGOs too are starting to

challenge bad capitalism. One example isChinaAfrica Bridge, an NGO based in Beijing, founded by Hafsat Abiola, daughter ofa former Nigerian president, to improvethe e�ect of Chinese business on Africa, especially in resource industries. �For Africa,China’s involvement will create winnersand losers, but currently it will too often beAfrican individuals who win, not communities and countries,� she says. In particular, there have been many reports of unethical dealings between Chinese resource�rms and leaders and o�cials of some African countries, including Sudan.

Ms Abiola’s goal is to encourage Chinato do as it would be done by in Africa.When companies such as Microsoft arrived in China, the government requiredthem to invest in a lot of infrastructure andR&D to foster the country’s own development, she says, �but as China comes to Africa, it is not being required to transferknowledge or skills or promote local jobs.�Though China is certainly building a lot ofinfrastructure�presumably to help it procure all the natural resources its �rms aregobbling up�it often brings in its own people to do the work.

As developedcountry multinationalsenter emerging economies, it is crucialthey do not lower their standards on corruption, says Ben Heineman, a former GE

general counsel who recently published abook, �High Performance with High Integrity�. �Are these multinationals going to begood corporate citizens, to increase thecredibility of globalisation?� he asks. Besides anything else, he argues, behavingconsistently ethically is in their selfinterest. Successful global companies need uniform global cultures, in which everyoneadheres robustly to the same rules, even inplaces where the local companies do not.If people in one part of the company start

adopting a lower ethical standard, it canhave a corrosive e�ect on the entire corporate culture.

This may be why the global expansionof emergingmarket champions is a goodthing. As they increasingly operate in developed countries, where corruption ismuch less acceptable, they will have toabide by their host countries’ standards.That will create pressure within these�rms to raise their standards back home.

Doing well by doing goodIn the early 1990s, when GE decided toadopt uniformly high ethical standardsthroughout the �rm, �we accepted it was acost, but that the bene�ts outweighed it.Siemens reaped the whirlwind on that,�says Mr Heineman. (In 2007, Peter Solmssen, one of his protégés, moved to GE’sGerman rival as general counsel to sort outa huge bribery scandal that had broughtdown Siemens’s chief executive.) GE embarked on this course after the Americangovernment started to enforce its ForeignCorrupt Practices act more vigorously, andother American �rms asked it to lobbyagainst the law. Instead, �we said, level up,not down,� says Mr Heineman. At timeswhen corruption was especially rife, GE

pulled back in Nigeria and Russia, henotes. The company also provided someearly funding to Transparency International, an anticorruption NGO.

GE’s Mr Rice reckons that the �rm’shard line on corruption is actually helpingit win business in many developing countries. This may be because ethical standards are rising�or, at a minimum, fear ofpublic reaction to low ethical standards isrising�in at least some emerging markets.Country leaders feel under growing pressure to deliver better infrastructure and tobe seen to be doing the best they can, saysMr Rice. Increasingly, �they understandthat corruption is a barrier to improvingthe standard of living of the poorest people, and they want to do business moreand more with an ethical �rm.�

But there are plenty of governmentsthat are not striving for good capitalism.Oilrich Russia, for example, feels it can useGazprom, its giant energy company, as aninstrument for its geopolitical strategies,by threatening to turn o� supplies toneighbouring countries that depend onthem. And as emergingcountry governments accumulate huge foreign reservesand start to invest them abroad throughsovereignwealth funds, developed countries fear that capitalism will become increasingly politicised everywhere. 7

5Safe as BRICs

Source: Eurasia Group*Higher numbers indicate greater ability to absorb political shocks

Political-risk index*

58

60

62

64

66

68

70

2004 05 06 07 08

Brazil

China

India

Russia


1

�GOING overseas: a wrong investment decision,� thundered Wu Zhi

feng on his blog, �The Invisible Wings�. Hewas furious about the performance of the$3 billion investment by China InvestmentCorporation, a sovereignwealth fund established by the Chinese government, inshares of Blackstone, an American privateequity �rm. Blackstone’s shares haveplunged since its �otation in June 2007, reducing the value of CIC’s stake by $500m.

The Chinese government’s policy of�going out��investing abroad through itscompanies and new sovereignwealthfunds instead of at home where it wasneeded�was about showing o� to theworld, wrote Mr Wu: �Chinese companiesstarted acquiring businesses here andthere in the world so that many countrieswould shout that ‘the dragon is coming’.�

If some sovereignwealth funds are unpopular at home, they are viewed witheven more hostility in the rich world,where CIC and others have been splashingtheir cash lately. Such funds have providedseveral top Wall Street �rms (as well assome of their European rivals) with largeinjections of cash in the past year�including Citigroup, which received $7.5 billionfrom the Abu Dhabi Investment Authority(ADIA). That probably saved a few of themfrom bankruptcy or a Bear Stearnsstyleforced sale, but it was controversial.

It is not just banks that have caught thesovereignwealth funds’ eye. In July theAbu Dhabi Investment Company bought a90% share in New York’s iconic ChryslerBuilding. Soon after that, Mubadala, another Abu Dhabi fund, announced that itintended to become one of GE’s ten biggestshareholders (see box, next page).

Public criticism of sovereignwealthfunds has subsided a little as the crisis inthe developed world’s �nancial marketshas made people grateful for any moneythey can get. Yet in private there are plentyof worries about the growing size andpower of sovereignwealth funds.

In an article in the Financial Times lastyear, Larry Summers, a former Americantreasury secretary, wrote that a �signalevent of the past quartercentury has beenthe sharp decline in the extent of directstate ownership of business as the private

sector has taken ownership of what wereonce governmentowned companies. Yetgovernments are now accumulating various kinds of stakes in what were oncepurely private companies through theircrossborder investment activities.� MrSummers called for a new policy: �Governments are very di�erent from othereconomic actors. Their investmentsshould be governed by rules designedwith that reality very clearly in mind.�

The problem, if problem it be, may bejust beginning. According to the US Treasury, sovereignwealth funds are �alreadylarge enough to be systemically signi�cant�. But the McKinsey Global Institute ina recent report forecast a dramatic increasein the assets of sovereignwealth fundsover the next few years. It predicts thatAsia’s sovereign assets, which at the end of2007 stood at $4.6 trillion, will rise to atleast $7.7 trillion by 2013 on conservativegrowth assumptions, and to as much as$12.2 trillion if economic growth continuesat the fast pace of the past seven years.

As for the sovereignwealth funds ofoilrich states such as Russia, the UnitedArab Emirates and Saudi Arabia, much depends on what happens to the price of oil.McKinsey looked at the impact of several

possible average oil prices over the next�ve years, all below what the stu� hasbeen selling for in recent months. Even at$50 a barrel (remember?), the assets ofthese sovereign investors will rise to $8.9trillion by 2013, from $4.6 trillion at the endof 2007 (see chart 7, next page).

For good or illWhat are they going to do with the money?Will these funds become instruments of a�new mercantilism�, with the controllinggovernment attempting �to ensure thatcompanylevel behaviour results in countrylevel maximisation of economic, social and political bene�ts�, as Ronald Gilson and Curtis Milhaupt suggest in a recentarticle in the Stanford Law Review? Willthey be opportunistic, as Larry Summersfears? Will they be politically aggressive, asRussia has already shown itself with Gazprom (not, strictly speaking, a sovereignwealth fund but certainly a wellendowedcorporate arm of the state)?

Or are the funds simply investors, looking for nothing more sinister than a decentreturn on their money? Earlier this year,Yousef al Otaiba, Abu Dhabi’s director ofinternational a�airs, in an open letter toAmerica’s treasury secretary, said that �it isimportant to be absolutely clear that theAbu Dhabi government has never and willnever use its investment organisations orindividual investments as a foreignpolicytool.� And as Messrs Gilson and Milhauptnote brie�y in their article, despite fearsthat sovereign funds will use their investments to secure technology, gain access tonatural resources or improve the competitive position of their domestic companies,�no one can point to a reported incidenceof such behaviour.�

In fact, there is no such thing as an average sovereignwealth fund. Some are new,like China’s; others have been around fordecades, such as the Kuwait InvestmentAuthority (KIA), set up in 1953. They varygreatly in size: the biggest is ADIA, whichwith assets of $625 billion is almost doublethe size of the nextbiggest, Norway’s.Some, like the KIA, are essentially passiveportfolio investors. Others are more active,resembling privateequity �rms (Dubai International Capital) or even industrial

The rise of state capitalism

Coming to grips with sovereignwealth funds


2

1

THE deal between GE and Mubadalaconcluded in July provides a useful

test case of whether the rise of sovereignwealth funds can be good for capitalism.Currently, both the company and the investor are claiming they have gained.

There is no doubting the ambition ofthe Gulf states as they set about buildingbrandnew cities in the desert. Dubai hasalready become a cross between Las Vegas and prestrife Beirut, with its luxuryhotels, international �nancial centre, leisure and shopping facilities and manmade islands. But Abu Dhabi, its richerneighbourcumrival, has ambitiousplans of its own, bringing in the sort ofhigh culture Dubai lacks (including outlets of the Louvre and Guggenheim) andeven looking beyond the oil age by committing $22 billion to building a futuristiccarbonfree city called Masdar.

Masdar is one of the key ingredients ofthe deal, in which Mubadala agreed to become one of the �rm’s top ten shareholders. GE will invest heavily in Masdarto make it a showcase for its Ecomagination cleanenergy programme. The �rmand the sovereignwealth fund will alsoput $4 billion each into a joint venture toprovide commercial �nance in the region.Ultimately, the two are expected to invest

a total of $40 billion in the partnership.GE’s strategy is to establish bases in cit

ies throughout the Gulf, investing inthings that are useful both to the city andto the region. It also has close relationswith Saudi Arabia, which it has made intoits regional infrastructureservices hub.Saudi Arabia is building six new �economic cities�, in the hope of providingjobs that it desperately needs. It is tryingto tempt energyintensive international�rms to move there with the promise ofcheap fuel�which may not be such aboon for the environment.

The Mubadala deal represents the latest stage of a relationship that has continued to deepen since the fund’s managersvisited Crotonville in 2005 for a week’sleadership training. GE says it is betting ona new generation of leaders in AbuDhabi�and indeed across the MiddleEast�who are committed to building amore sustainable economic foundationthat will survive the depletion of their oiland gas reserves. Mubadala, which alsohas a 7.5% stake in Carlyle, a big Americanprivateequity �rm, says that as a longterm investor it is keen to take big positions in such worldclass companies. Thatmust make Je�rey Immelt, GE’s embattled boss, feel more secure in his job.

A new sort of investment partnership

Cities in the sand

holding companies (Singapore’s Temasek).Most of them are increasingly shifting theirfocus to equityinvesting. Many of themalso invest in hedge funds and privateequity �rms.

There are big di�erences, too, in theirwillingness to use professional managersand in their competence as investors. Onereason why CIC bought its stake in Blackstone, and Mubadala its stake in Carlyle,may have been to tap the investment expertise of those �rms. Another way of raising the quality of inhouse sta� is to appoint nationals who have gained quali�cations abroad.

Singapore’s Temasek is much admiredby other sovereignwealth funds for its investment nous and its e�ective corporategovernance, and is thought to be seen as arole model by the Chinese. The deepest reserves of talent are at ADIA, says a veteranpartner at a big American privateequity�rm who has worked with many of thesovereignwealth funds. However, someof its top managers have been taken by anew body, the Abu Dhabi InvestmentCouncil, set up a couple of years ago.

At the other extreme is the Qatar Investment Authority, which the privateequityveteran says is �always teaming up withthe wrong people and operating a highlyidiosyncratic management style�. TheQIA’s illfated attempt to buy Sainsbury’s,a British supermarket chain, may alonehave lost the fund over $2 billion, he calculates.

Russia and China may be exceptions, inthat both their governments have beenwilling to use the companies they own topursue political goals and might well try todo the same with their sovereignwealthfunds. If that starts to happen, they mayneed to be governed by di�erent rules

from those applying to funds that try toconcentrate mainly on getting good investment returns.

Many sovereignwealth funds havebeen upset by the criticism they have received over their recent Wall Street investments. America’s treasury secretary, HankPaulson, is understood to have spent a lotof time reassuring them, especially aboutthe reaction to their investments in WallStreet, after Merrill Lynch, Morgan Stanleyand others persuaded the funds to shorethem up. �They have lost money and thenbeen subjected to complaints in Congressabout the lack of transparency on their balance sheet or their agenda,� says the privateequity veteran.

To try to reduce the criticism, the IMF

has been working on guidelines for sovereignwealth fund transparency, due to beagreed on at its autumn meetings in Wash

ington, DC. As things stand, transparencyranges from next to none to a lot. Again,some sovereign funds protest that they arebeing subjected to far tougher disclosurerules than many big domestic investors indeveloped countries. It will be no surpriseif the IMF proposals are given a lukewarmreception and then largely ignored.

�There is a huge amount of hypocrisyabout sovereignwealth funds in theWest,� says Richard Cookson, a globalstrategist at HSBC who keeps an eye onsovereignwealth funds. �When did thedeveloped world ever not use its economicand political clout to buy assets on thecheap?� In the Asian crisis of the 1990s,American banks bought into several troubled Asian banks. When local politicianscomplained, America accused these countries of protectionism, says Mr Cookson.The real reason the developed world is

6See how they grow

Sources: McKinsey; Global Insight; BP;Institute of International Finance

Petrodollar foreign assets, $trnAssuming oil price of:

F O R E C A S T

2007 08 09 10 11 12 130

2

4

6

8

10

12

$30 per barrel

$50 per barrel

$70 per barrel

$100 per barrel


2

1

now so upset, he suspects, is that the sovereignwealth funds symbolise so clearly theshift in the balance of economic power tothe emerging markets.

Yet when emerging countries set upsovereignwealth funds, with separate governance and a clear investment mandate,it is often a sign of them �recognising thatthey got it wrong in the past, asking how toimprove, and concluding that an endowment/portfolio approach is the best way,�says Chuck Bralver of the Centre forEmerging Market Economies at Tufts University. �Leaving the Russians aside, theyare mostly being highly professional.�Even the Chinese sovereignwealth fundsare expected to hire hundreds of professional investment managers, mainly fromdeveloped countries.

Known unknownsWhat is certain is that as sovereignwealthfunds grow, which they are bound to do, anincreasing number of the world’s companies will end up at least partly in state ownership. And there is a possibility that thesovereignwealth funds’ good behaviouris a Trojanhorse strategy which in timewill give way to mercantilist interference.

In practice, sovereignwealth funds sofar have given little cause for alarm. Theirbiggest downside may be that they lack thecapacity to �nd a sensible home for all themoney that is likely to be �ooding in overthe coming decades, and that much valuable capital will be squandered on illadvised projects.

�I’m struck by how responsibly Chinaand countries in the Middle East are behaving,� says Laura Tyson, who used tochair Bill Clinton’s Council of EconomicAdvisers and now teaches about emergingmarkets at Berkeley. The Gulf states are try

ing to use their wealth to generate �higherliving standards over the next 100 years,not squandering it on the high life like theydid in the 1970s�. Despite much talk abouttheir desire to switch to the euro or evenmake it the next reserve currency, �they arenot dumping the dollar, they are continuing to make longterm investments,� shepoints out. Indeed, bailing out the developed world’s banking system seems heroically generous of them.

All of which, says Ms Tyson, �underscores the extent to which emerging markets now recognise that their wellbeing

depends on the stability of the international system.� Forms of state ownership willbecome more common, she concedes,�but so what? The simple dichotomy between private and stateowned does nottell us very much at this point.�

To be on the safe side, Messrs Gilsonand Milhaupt propose that shares inAmerican �rms that are bought by sovereignwealth funds should have their voting rights suspended until they are soldagain. This would beef up existing arrangements that protect American �rmsfrom foreign ownership where nationalsecurity is seen to be threatened. Withoutthe voting rights, the sovereign investorscould not interfere in the activities of the�rms they buy, but if the suspension isonly temporary, the funds would not suffer any �nancial penalties.

This looks like an elegant solution, but itis not clear if it could be enforced. Moreover, it would make sense only if therereally is reason to worry about the intentions of sovereign investors. If their intentions are good, the proposal would robcapitalists of their ability to play a valuecreating role in the governance of the �rmsthey invest in.

�We need to reconsider what is the bestway to organise largescale entities playingin global markets,� observes Ms Tyson.After all, in recent years it has become clearthat freemarket public ownership of companies can give rise to con�icts of interestand principalagent problems, which ledto the rise of private equity as a partial solution. Perhaps wellmotivated, wellrunsovereignwealth funds with longterm investment horizons could help create amore e�ective system of corporate ownership than today’s often shorttermist investors. Let’s hope so. 7

7The new moneybags

Source: McKinsey *March 2007 to June 2008

Sovereign-wealth fund investments inWestern financial institutions, $bn*

0 2 4 6 8 10

Citigroup

UBS

Merrill Lynch

Barclays

Morgan Stanley

Blackstone

Standard Chartered

London SE/Nasdaq

Apollo

Carlyle

Och-Ziff Capital

OMX AB

Asian sovereigninvestors

Petrodollarinvestors

nil

nil

nil

nil

nil

nil

nil

nil

nil

�WE CAN only be de�ned as global,�says Lakshmi Mittal. �We are not

Indian, or French, or from Luxembourg.Among the top 30 managers of ArcelorMittal there are nine di�erent nationalities.� The Indianborn steel tycoon is convinced that he is building a truly globalcompany, transforming an industry thatwas manifestly failing to deliver while itwas organised along nationalist lines. Not

so long ago every country felt it had tohave its own steel giant, even if it was governmentowned and losing a fortune.

Steel was also the �rst Western industryto go into decline, he points out�and by extension, though he does not say it, the �rstto be revived by a company started in a developing country by a businessman froman emerging market (albeit one who haslong been based in London). He wants his

�customers to be able to buy our productanywhere in the world at the same quality�. He wants to recruit the best talent inthe world, and has established Arcelor Mittal University in a grand old building inLuxembourg to help him do that.

He is measuring the �rm against theworld’s most admired companies�GE onhuman resources, leadership and purchasing, Royal Dutch Shell on IT. He sounds like

Opportunity knocks

As long as the protectionists don’t spoil it


2

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a mistyeyed internationalist when he describes the �seamless discussion the management team has on any subject�youwould not think there are di�erent nationalities in the room.� In sum, �I want tocreate a truly great global company.�

Can he do it? Some leaders in the lessemerged countries where his �rm operatesmay see how well he has done with therubbish they thought they had sold himand demand their pound of �esh. Perhapsthe policy of vertical integration which isprompting Arcelor Mittal to buy minesand energy producers at today’s highprices will prove to be misplaced. But a bigger threat is what the world’s governmentsmay do next.

Think abundanceIn particular, how will these governmentschoose to mix the various models of capitalism described by Messrs Baumol, Litanand Schramm in �Good Capitalism, BadCapitalism�? Ominously, the governmentsof some of the bigger emerging economies�notably Russia and China�seembent on a mixture of stateled and maybeoligarchic capitalism, rather than the potent blend of big�rm and entrepreneurialcapitalism that has served America, Britainand other rich countries so well.

Should the rich world worry about it?There is no evidence so far that sovereignwealth funds are trying to wield inappropriate in�uence in the companies they invest in. One day they might, but until thenthey probably deserve the bene�t of thedoubt. The most plausible scenario is thatthe growth of sovereignwealth funds,along with other possibly mercantilist forays by emergingcountry governments,will simply waste a lot of capital. Howeverunfortunate, that would be largely a matter for them. Besides, some governments,even undemocratic ones, seem to understand that it is in their interests to move inthe direction of wealthmaximising goodcapitalism rather than squander theircountry’s wealth, since it is their citizenswho will ultimately pick up the bill.

It is reasonable to worry about the activities of, say, Chinese resource �rms insome African countries, which are thoughtto have shored up some of the continent’sworst leaders�though it is hard to see howthis can be changed other than by reforming the governance of these African countries themselves. Likewise, policies inemerging countries that allow corruption,cronyism and local monopolies or treatforeign multinationals unfairly are certainly undesirable. But in neither case is protec

tionism the answer.The rise of protectionist sentiment in

developed countries is a serious cause forconcern. As Messrs Baumol, Litan andSchramm observe, capitalism is a dynamicforce and can change over time�includingfrom good forms to bad. Just becauseAmerica, in particular, has long been aforce for good capitalism does not meanthat it will continue that way.

Arguments for protectionism are basedon fears that are wholly at odds with theevidence. The experience of recent yearsdoes not support the idea that millions ofjobs will be outsourced to cheap foreign locations. Nor, as socalled technonationalists claim, is it likely that innovation willshift from America and the rest of the developed world simply because Microsoftand IBM have set up R&D centres in Indiaand China, as they and the new champions start to make better use of all the cleverengineers produced by those countries’education systems. As Amar Bhidé of Columbia Business School argues in his new

book, �The Venturesome Economy�, it is inthe application of innovations to meet theneeds of consumers that most economicvalue is created, so what matters is not somuch where the innovation happens butwhere the �venturesome consumers� areto be found. America’s consumers showno signs of becoming less venturesome,and its government remains committed tothe idea that the customer is king.

Except, that is, when it comes to protectionism, which will hurt American consumers as well as slow the rise of theemerging markets and hence the escape ofmillions of their citizens from poverty. Farbetter to engage the emerging markets inthe global economy and help them understand why it is to everyone’s bene�t to promote the good models of capitalism, notthe bad.

Mr Mittal, for one, remains optimistic.�There is currently an anxiety in the developed economies that is the opposite of theenthusiasm in the emerging markets�butin ten years a lot of the anxiety will goaway and we will see a lot closer partnership and collaboration,� he says. �I don’tthink we can really block globalisation.�

The �nal word should go to an American, albeit one who works for a Chinese�rm. Lenovo’s Mr Amelio sees strong parallels between the challenge raised by thenew age of globality and the cultural challenges his own �rm initially faced, especially its American workers’ suspicions oftheir new Chinese colleagues. The root ofthe problem is a �scarcity mentality inwhich people see things as a zerosumgame�, he says. �Instead, we need an abundance mentality that believes everyonecan become better o�.� 7

a bigger world - the economist

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