When it comes to the growth sweepstakes, it’s like a game of snakes and ladders. It’s not easy for any country to avoid all the snakes, says Ruchir Sharma, head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management. Most recently he has authored the bestselling Breakout Nations – In Pursuit of the Next Economic Miracles.He generally spends one week a month in a developing country somewhere in the world. Based on those experiences he even refers to his book as an ‘economic travelogue’. Sharma was speaking a literary festival in Mumbai on Sunday. Here are a few excerpts from what he said.
The past has no prologue
One of the first rules of the road that I would like to set at the outset is that the past has no prologue. Because what we do is extrapolation and we take what happened in the past and draw straight lines out into the future and say this is what is going to happen in the future. That is just one of the basic rules that does not work.
If you look at it, there are very few countries in the world that can sustain economic success. Only about one third of all economies are able to grow 5% or more for on an average in any decade. Only about one third of the 180 economies in the world. Of the 180 economies in the world only about 35 are developed economies, everyone else is emerging.
What this basically means is that there are these countries which grow for a short span of time and then come back down. It is like the game of snakes and ladders. You sort of go up and get bitten by a snake and come down. Some countries find a lucky ladder and leap frog and get to the top. Very few countries are able to get to the top and very few countries are able to sustain economic success.
Given this, one of the biggest negatives against India at this point is that they have had such an extraordinary decade. And after this extraordinary decade the complacency had set in where we thought of demographics and other factors we would be able to cruise control and nothing else matters as far as growth is concerned and that really has been thrown out of the window.
The average life of a good government is seven to eight years
The other rule is that the average life of a good government is about seven eight years. Typically governments tend to do well for seven to eight years, maximum to a decade and after that the performance of the governments typically tends to decline. This is true even for Russia where the first two terms of Putin was relatively fine. In the UK Margaret Thatcher did very well for about eight nine years and was booted out after that. François Mitterrand faced something similar in France.
There are some exceptions like Lee Kuan Yew of Singapore who are outliers. Usually the average life of good government is seven to eight years and which is why we are concerned about governments that remain in power for too long and very concerned about countries which try and change the constitution to hold onto power for too long. Then there interest is only in ensuring that there power and vested interests are taken care of and they run out of fresh ideas.
So that is the thing with the current government that it has been in power for a long period of time. But typically after seven to eight years governments don’t do well. That is the life cycle. There are very few who do well for a decade or more.
Markets reform when in crisis
The other sort of rule that I have figured about markets is that they only tend to reform when they have their back to the wall. Crisis is what focuses your mind. Otherwise you have a boom, you fitter the gains away and then you sort of slide away and then try and stop it.
That is why I said that of the 180 economies in the world today only 35 are developed because very few are able to grow for a sustained period of time. So you get these sort of growth spurts because they don’t reform.
India’s case is very interesting to look at it. Every 10 years at the start of the decade India seems to consistently have a some sort of a macroeconomic crisis. This was there in the early 1970s, early 1980s, 1991, the early 2000s period when we had the tech boom bust cycle and the growth rate slipped. You can argue that this year has turned out to be similar. The good news for India is that every time we have this macroeconomic crisis or a threat or a currency weakness that is when we take to reform. In 1981 we did that under the IMF, in 1991 we did that, 2001-2002 the same thing happened and we seem to be doing that now.
Very few emerging markets have taken to reform in a proactive manner. They tend to reform with their backs to the wall and that is what China did with such an exception. China pro-actively reformed every 4 to 5 years and came up with some big bang reform. They were proactive about it and not complacent about it. You can argue that complacence is setting in now. But the last thirty years has been a stream of pro-activeness.
Premature populism is a bad sign
The other sort of rule is to look for is populism. This is one of the things which is very hard to say because it is politically incorrect, but building a welfare state pre-maturely creates the wrong incentives. Schemes like NREGA keep too many farmers at the farm. A mass form of populism which has taken place in India over the last ten years. On the other hand if you look at the successful economies like Korea, Taiwan or even China, they did very little in terms of the welfare state at this stage of their economic development. There focus was lets get grow, and make the pie big enough. And then we will share the the pie later.
Today you can argue that countries like Korea and Taiwan don’t do enough of a welfare state. The Korea story is very fascinating. It is one of the most equal societies. And it is a very well educated society and Korean women are very well educated. Yet their participation in the labour force is very low. And that is because many of them are not able to leave their children at home and go to work because they don’t have a good enough child care support system. They don’t spend enough on those kids. In Korea’s case I can argue they need more welfare and in India’s case I can argue that there is too much welfare.
Social spending as a share of GDP for Korea and India is equal even though Korea’s per capita income is more than ten times higher than India’s per capita income. So to have too much populism prematurely is a bad sign.
The billionaire’s index
One of the popular parts of the book that resonated with many people was the billionaire’s index. Forbes publishes a billionaire’s list in March. It sort pours over across the world to see who are the good billionaires, who are the bad billionaires and stuff like that. I think the key dimension will be to look at the billionaire’s index which is that you need to figure out that in case of how many of these billionaires the wealth has been created because they are genuinely productive billionaires. They are creating wealth in sectors such as technology, pharmaceuticals, manufacturing etc. When you have wealth created in those sectors you are respected but when you have wealth created in so called sectors where the benefit has happened because you had a good government connection, that is just not good. In India’s case we saw many such billionaires rise over the past decade which is what made me somewhat concerned. It is a bad sign for democracy as well .
Other thing to see in the billionaire’s index is that you need churn, you need new people to come up the list. You don’t need holders of the past always there. The third thing is that you need the concentration of the billionaires as a share of the economy to not be that high. That leads to resentment. Having said that India respects its billionaires a lot.
The James Bond moment
When I go and meet billionaires in countries such as Mexico, Brazil, or even Russia, in all those countries you have all these billionaires with a whole bunch of armed bodyguards. There are scared to go out on the streets on their own because they fear that they are going to be attacked. In places like Brazil, you will find a sale of luxury cars is quite low for a country of that size, because people are scared to display that kind of wealth. And if there are luxury cars they are all bullet proofed because they are scared about what is going to happen.
On the other hand Brazil tops the list of maximum number of helicopters sold. The only time I feel like James Bond is when I go to Sao Paulo in Brazil. In Sao Paulo the traffic is really bad but the permission to fly helicopters is quite easy to get unlike what happens in Mumbai.
My sort of James Bond moment is after you finish your meeting they will take you to the roof of the building where there is a helipad waiting for you, you run to the helipad, you take the helicopter and go to the next destination. And you see the aerial view of Sao Paulo and there is a whole bunch of helipads up there on top.
That is a sign. It is a sign of poor infrastructure and you are using these helicopters to short circuit roads and to sort of not care about what is happening on the street and take a helicopter across it. And then you got gated community where they you behind these fortresses. And I think that is just a bad sign. Brazil is the most extreme and my James Bond moment will remain and therefore I relish my trips to Brazil.
The Four Seasons Index
What I do not relish going to Brazil let me tell you are the costs. And this is one my other rules in terms of the cost with the Four Seasons index. I am fortunate that I get to stay in the Four Seasons hotel in all these countries. And I think its good benchmark to look at a country to figure out whether its cheap or expensive?
In Brazil when I go I find the rates are exorbitantly expensive. To get a top hotel on a trip to Rio de Janeiro you pay $800-1000 a night. And that is really exorbitant. You go to East Asia, places like Jakarta and Bangkok, you pay about $200-300 a night, and that is pretty competitive. In places like Brazil and Russia you pay $800-1000 a night. And the currency seems very expensive. My colleagues went to Brazil last year and one of them bought a a t-shirt. The t-shirt cost more than $100 and it did not last even a single wash. So terrible quality and you are like paying a huge price for that.
Hence, Brazil has been one of the big laggards because of expensive currency. This year the Brazil’s growth rate will be only 1%. When you have expensive currency it is bad news. India on the other hand one of the positive would be currently is that the currency is extremely competitive at this point of time.
But isn’t a weak rupee a sign of weakness?
People are concerned that this is a sign of real weakness in India and whether India is about to face a balance of payment crisis? Is money going to leave the country in a huge way because is the currency is quite weak?
One of the rules of the road I watch out for is that one of the first people who take money out of the country when they think that the country is going to face a crisis are the locals. And this is counter-intuitive because most people like to believe that its the foreigners who flee when they sight trouble.
So I am always watching what are the locals doing? Are they taking money out of the country? Or are they bringing money in? This happened in India in 1991. Similarly in East Asia in the late 1990s.
The good thing for India on a balance of payment front is that we don’t have too much outflow on that front. We don’t have mysterious outflows which show up on the RBI balance sheet. You know that is going on when the hawala rates are way way more expensive than what your official rates are. You don’t see such signs in India. So it seems that the currency weakness is happening in an orderly manner. The currency is adjusting for the overvaluation because of our inflation.
The businesses are complaining about investing in India. They are saying that listen we are better off investing abroad rather than India because the cost of India doing business has become very high. So they are even going to places like Indonesia etc. So I asked one businessman in India, that isn’t Indonesia also very corrupt? So why are you investing in Indonesia? His answer was very interesting. But Indonesia is something what you call efficient corruption compared to India which is like in Indonesia if you pay money to somebody the work is done.
And I have got first hand evidence of efficient corruption. I went to Indonesia and I was struck in Jakarta in a traffic jam. The person who was taking me around Jakarta called a number up and without me knowing police escorts arrive. What you do there you pay a $100-200, and call up a number, police escorts arrive, who clear the traffic for you and take you to the airport. That is efficient corruption for you as far as that country is concerned.
The second city rule
One of the other rules that I looked for is the second city rule. If you look at all the successful economies across the world that whenever there is a growth spurt you get the rise of second cities in that country.
As far as India is concerned we don’t have one prominent city and everything else below that. We have four to five mega cities. And here is the difference with China. You look at India’s mega cities with populations of 10 million, 16% of India’s population lives in these mega cities. And that is why these mega cities are bleeding because that is way too high a number. You take the case of China 5% of the population lives in the mega cities of China .
The question is why? Because there has been a huge rise in the second -tier cities in China. If you look at the last fifteen year or so more than 20 second tier cities have come up in China. And second tier I define as cities which had a population of a less than 100,000 but now have a population of a more than a million. In India’s case only six such cities have come up over the last forty to fifty years. And that is the real difference and so there is big pressure on the big cities in India.
A 5% growth rate is a big disappointment
So is India going to be a breakout nation or not? And here is what I find quite fascinating as far as India is concerned. When the book came out this year, the general response was that by giving India a 50% chance of becoming a breakout nation, you are being too pessimistic.
And how I define breakout nations? I define breakout nations as those countries which are going to do better than other countries in the same per capita income class and countries which will grow faster than expectations.
So those are two my major major definitions of breakout nations. And why those two? Because if people tell me that if India grows at 5% what is the big deal because that is still faster than the US or many of the European countries. And my response to it is that is the wrong way of looking at it because if India grows at 5% per year, India’s per capita income is really low and it is far too low to satisfy India’s potential and for India to get people out of poverty.
And which is why India’s case of a 5% growth rate is a big disappointment and specially when you take into account that at the beginning of the year there was an expectation that we will do 9% this year.
A bit conflicted on India
On most countries in the book I was quite categorical. Like I was quite negative on Brazil as you have guessed by now. Even on Russia. I had a fixed view on China. On India I was a bit conflicted. I came out with the book and the most common response here was that are you being a bit pessimistic by giving it a 50% chance. Fine. Six months later by August, the response of most people was that you are being too optimistic on India by giving it a 50% chance of being a breakout nation. So that is how dramatically sentiment has swung on India this year. We went from euphoria on a straight line extrapolation. And how great we are. And how are going to concur the world.
And then there was complete disappointment by August. Last couple of months sentiment has shifted back again. The needle has shifted again. The good news is that expectations are much lower now for India to be a breakout nation.
Indian democracy versus authoritarian China
Gone is the story that how we are going to be the next China out there. One thing I find do disturbing is that a lot of people respond to this by saying you know the reason India cannot be the next China is because we are democracy. And that is the price we pay for being a democracy. China is a authoritarian state. It can implement reforms the way it wants. It can displace people and acquire land. It can set projects up.
India is a democracy therefore we have to pay a price by accepting a lower growth rate. And this argument irritates me. If you look at the high growth instances of the last thirty years, a high growth instance is a situation when a country is able to grow at 5% per year or more in any particular decade. And there are hardly 120 such cases over the last 30 years. How many of them were democracies and how many of them were authoritarian? Its a 50: 50.
For every successful China following an authoritarian regime, there are failures like Vietnam, which was built as the next China, and which has turned out to be a real disappointment, following the authoritarian system. A whole bunch of countries in Africa including the dictatorship of Zimbabwe have failed.
So what matters is the quality of economic leadership and not whether you are democratic or authoritarian. A lot of democracies have done well over the last twenty thirty years. Democracy lets remember is a relatively new concept in much of the emerging world and that is something that we should celebrate.
India is 28 countries with almost distinct identities
There are some state leaders in India who are able to do quite well because they are focussed much more on economic growth. And that to me is a real positive about India as to how India is emerging as a land of 28 independent states, almost 28 countries with distinct identities. We have many good state leaders and the relationship between economic growth and getting re-elected is increasing.
If you manage to grow above the national average and at a past faster than the preceding five years the chances that you as a state leader will get re-elected are extremely high. I think that’s the big message. So therefore you get states like Gujarat where you keep getting victories and then you get a state like West Bengal where you finally get defeated after a very poor performance. This is being backed by data over the last five years.
The picture for India for me is still one that is mixed. But it is improving and improving principally because our expectations have been balanced compared to where we were at the start of this decade. Gone is the era of straight line extrapolations. India still has a reasonable shot at being a breakout nation. But if we got to do it we got to do it state by state. This really is a land of 28 countries like no other emerging market I know. For example China is a very homogeneous society where as India is a lot more heterogeneous. And this bottom up model of economic growth state by state gives up the best hope.
The article originally appeared on www.firstpost.com on December 11, 2012.
Vivek Kaul is a writer. He can be reached at [email protected]