A successful neighbour helps but not as much as a growing population, finds Duncan Weldonby / June 16, 2016 / Leave a comment
Published in July 2016 issue of Prospect Magazine
The Rise and Fall of Nations: Ten Rules of Change in the Post-Crisis World
by Ruchir Sharma (Allen Lane, £25)
Fifteen years ago, Jim O’Neill, then at Goldman Sachs and now a Treasury Minister, coined the term “BRIC” in a paper outlining how economic power was shifting from the G7 group of advanced economies towards the rising nations of Brazil, Russia, India and China. Those four countries never had much in common but the term caught on. It even prompted those states (later joined by South Africa to make BRICS) to hold summits and to launch a multilateral bank—possibly the world’s first case of an international organisation being born from an investment bank research note. But just as with the example of Japan—which in the 1980s was praised as the economic model of the future, before it experienced a profound financial crisis and instead became a cautionary tale—the original BRIC thesis is looking rather worn. Russia and Brazil are mired in recession, China’s growth has slowed sharply and only India’s prospects still look as rosy.
Much global economic commentary consists of taking an existing (and often recent) trend and projecting it forwards. Japan grew swiftly from the 1950s to the 1980s and so it was thought that this would inevitably continue. China experienced three decades of record-breaking growth and so the same assumption was made. By contrast, countries that have recently struggled are often written off. At the turn of the millennium Germany, struggling with the fallout of reunification, was derided as the “sick man of Europe” while serious analysts wrote about the Spanish and Irish “economic miracles.”
Ruchir Sharma, the head of emerging markets at Morgan Stanley, attempts to make sense of this pattern in his compelling new book, The Rise and Fall of Nations. Sharma’s book is about spotting the turning points where failing economies start to perform and previously favoured nations take a wrong turn. Sharma distils his insights into 10 “rules” which he covers in 10 chapters, each based on an analysis of global economic data since the 1960s coupled with the insights he has gained from a 20-year career researching emerging economies. The combination of statistical analysis and anecdotes makes the book a success. The local insight adds colour, while the data reassures us that his analysis is underpinned by more than a series of conversations with taxi drivers.
While Sharma is a fund manager specialising in emerging markets, The Rise and Fall of Nations is much more than an investment primer. The issues he deals with, from growth to inequality, are of much broader interest.
Perhaps the most striking aspect of his approach is how, in one regard, it is both modest and brave. Sharma limits his rules to trying to guess the likely path of an economy over a five-year time frame. While recent works such as Thomas Piketty’s Capital in the Twenty-First Century or Robert Gordon’s The Rise and Fall of American Growth tried to predict how the world will look over the next few decades, Sharma looks no further than the early 2020s. This does not necessarily mean he will be right —but it does mean his projections are more easily testable.
Adjusting for price differentials and purchasing power, in the 1980s emerging economies accounted for around a third of global output and 43 per cent of global growth. Between 2010 and 2015, they accounted for over half of global output and contributed almost 79 per cent of global growth. In other words anyone trying to project where the global economy is headed in the next few years has to take emerging economies seriously. The United States, the eurozone or the UK are less important drivers of the global economy than in previous decades.
But there are reasons for caution. Investors in emerging markets have had a torrid time since 2011 as asset prices have fallen, commodity prices (still an important factor for many countries) have collapsed and global capital has flowed away from previously lauded economies. China’s industrialisation cycle appears to have played out: Sharma is not alone in thinking that 6 per cent annual growth over the coming decade looks unlikely for the Chinese, let alone the double digits of recent memories.
In a speech in Washington earlier this year, the International Monetary Fund’s David Lipton outlined his case for optimism on the future of the global economy and globalisation. With China’s “super-charged” growth period over, only India has the potential to play a similar role. But rather than putting all our eggs in one basket, Lipton called for a “strength in numbers approach.” He argued that if 10 to 15 smaller countries—places such as Vietnam, Bangladesh, the Philippines, Indonesia, Peru, Colombia, Ethiopia and Nigeria —were to take advantage of young populations and rising educational levels, as well as receiving international support, they could become a major component of global growth. Six per cent growth across this group—not historically implausible—would add more to global output than the eurozone returning to health. Sharma’s analysis, while not quite as optimistic, suggests that Lipton’s vision is plausible.
Sharma’s proposed “rules” range from economics to politics: from how to distinguish a country with “good billionaires” (generally the self-made and entrepreneurial sort) who suggest a dynamic economy to one with “bad billionaires” (a sign of corruption) to how the price of food can be an advanced warning for the under- or over-evaluation of your currency. Some of his rules are givens that policy makers cannot change. He notes, for example, the importance of geography—countries near other fast-growing countries are likely to perform better. It is no surprise to Sharma that the so-called Asian Tiger economies of Singapore, South Korea, Taiwan and Hong Kong industrialised at the same time. Other rules are driven by domestic policy makers. Like many observers of the developing world, Sharma places a great deal of importance on the role of popular, reforming leaders such as Brazil’s Lula da Silva, who was president from 2003 to 2011.
Perhaps Sharma’s most important rule (certainly one that seems to overshadow the others) is an obvious insight often overlooked by macroeconomists: demographics and people matter.
Paul Krugman wrote once that “productivity isn’t everything but in the long run it’s almost everything.” He was right that it is rising productivity—the ability to get extra economic output from each hour worked—that causes GDP per head and living standards to rise. But just as the amount of output produced per hour matters for the national economy so too does the total amount of hours worked. Unless the length of the working week is going to start heading north fast, this means that slower growth in the size of the workforce will slow down economies.
“Optimism and pessimism about a country’s growth tend to be overdone, often amplified by the international media”
Sharma does not disagree with Krugman on the crucial role of productivity and he is concerned by the fact that productivity growth has slowed sharply in recent years. But while productivity growth is notoriously difficult to predict, population changes are much easier to forecast. For the purpose of his rules therefore, he sticks to the knowable.
He argues convincingly that much of the slowdown of advanced economies after the financial crisis has been driven by slowing working-age population growth. Indeed, even before the crisis America’s economic out-performance of Europe always looked less impressive on a per capita basis than the headlines would suggest. Over the last three decades, the US population has grown twice as quickly as France’s or the UK’s. But now the world is undergoing a demographic shift—the result of rising longevity increasing the number of retired people and falls in the fertility rate, meaning that fewer young people are about to enter the labour force.
Going through decades of data, Sharma find that countries that manage to grow at 6 per cent a year for a decade tend to have fast-growing working age populations. In cases where population growth is weak, growth tends to disappoint.
While the demographic change in the advanced economies is well known, the challenge for emerging economies is almost as large. The working age population of China fell in 2015 for the first time in half a century. Over the coming five years the working age populations of Russia, Poland and Thailand look set to contract. The growth of workers is forecast to fall below 1.5 per cent annually in Brazil, Indonesia, India and Mexico. As Sharma argues, as recently as the 1980s, 17 of the 20 largest emerging economies experienced working age population growth above 2 per cent annually. By contrast, in the coming decade only two of the largest emerging economies will match this feat.
The countries with a demographic bounty—2 per cent or more annual growth in the labour force—are places such as Bangladesh, Nigeria and the Philippines. Of course demographics are not destiny. Changing the retirement age, migration, decreasing unemployment or encouraging more economically inactive people (especially women) into the workforce can change the picture considerably.
Bad policy can even turn a demographic dividend into a problem. The Arab world experienced rapid population growth between 1985 and 2005—well above the world average—but rather than faster economic growth, it was translated into high youth unemployment, which became one of the catalysts for the Arab Spring. For Sharma, population growth can be an important component of economic growth but it is not the whole story. Still, it is a useful building block for economic analysis and one that for many countries is about to turn from a useful tailwind to a difficult headwind.
Sharma’s message is that the immediate future does not necessarily resemble the recent past. Optimism and pessimism about a country’s growth tend to come in cycles and be overdone in each case, often amplified by the international media. The world economy is going through a transition—headline growth has slowed, international trade is weaker and economic power is shifting. Sharma’s book provides a good guide for working out what will come next.