In business-book publishing today, authors are expected to present their readers with easily digestible tips, preferably delivered in boldface type. In a nod to this irritating trend, Ruchir Sharma, author of "Breakout Nations," periodically offers his readers some "rules of the road" for assessing emerging economies. The road map imagery is obvious, but in this case Sharma has written what he calls an "economic travelogue." It's as handy an emerging-markets travel guide as one can hope to find.
A managing director at Morgan Stanley who heads the investment bank's emerging-markets equities coverage, Sharma deftly takes readers on a quick tour of many of the world's evolving economies while managing to avoid most of the usual, clichéd landmarks. In the process, Sharma upends a lot of conventional wisdom that needs upending. He dampens unbridled enthusiasm on the future of the biggest emerging markets -- Brazil, Russia, India and China -- and many others as well. To those that say there's an inexorable rise of all emerging economies, as if this movement were somehow preordained, Sharma practically yells, "Not so fast!"
His alternative path is welcome. Too often, we get caught up in romantic visions of what we want countries and their economies to look like, rather than their messy realities. What's worse, we base future prospects on former performance and assume progress will be a straight line upward. "It's not a game of extrapolation," Sharma says in an interview. "The biggest mistake we all make is [to believe] that the past is the prologue."
Sharma's main thesis is that we were seduced by a period of extraordinary and almost universal economic growth. In much of the past decade, just about every emerging economy out there expanded, as if the world's developing nations were being pumped full of Miracle-Gro cheap money. Those days, he proclaims, are over.
If Sharma can be faulted, it's for indulging in some wishful thinking of his own when it comes to predicting which countries will break out from the pack next. In doing so, he sometimes sidesteps those maddening elements of nationhood that can easily trump economic well-being.
For example, he gives both the Philippines and Sri Lanka a nod. But these two strife-torn nations have consistently broken hearts and failed expectations for decades. Can they change? Anything is possible, though both remain mired in enormous social, cultural, religious and class divisions, all of which stunt economic growth.
On the other hand, Sharma bypasses some real pockets of economic progress, primarily in Latin America. While he is rightly critical of Brazil and Mexico, he ignores Colombia's and Peru's remarkable turnarounds.
There are other limitations. Sharma picks both countries and equities for a living. So it's natural that he thinks of investment in terms of stock markets. Direct investing often can be a very different story. Witness his nomination for a "gold medal" emerging economy: South Korea. No one can argue with its success. Yet that country remains a tough draw for investors wanting to buy whole companies, not just shares in them.
Sharma is a boyish-looking 38-year-old who started with Morgan Stanley in his native India 16 years back and moved to New York with the bank in 2003. He recently sat down in his midtown office with The Deal magazine's Matt Miller to elaborate on the theories that underscore "Breakout Nations." Here are excerpts of that conversation.
The Deal magazine: You are highly critical of the economic trajectories of Brazil, Russia, India and China. Is BRIC a misguided notion, or has it simply outlived its shorthand usefulness?
Ruchir Sharma: In the boom years of 2003 to 2007, every emerging market did well. By the end of the decade, you could package any group of countries together and it would seem like a great concept. The fanciest acronym I heard was called Civets, after the cat: Colombia, Indonesia, Vietnam, Egypt [Turkey and South Africa], countries that have nothing to do with each other. They just sound exotic.
It was not just a BRIC phenomenon, but BRIC got maximum currency because it captured the four largest emerging markets. The history of economic development is that some countries fail, some countries succeed, but failure is more the rule than success. Snakes and ladders, as I put it.
Talk about your narrative of China's economic future.
It's not a critical narrative, as I see it. It's a maturing phase. [Look at] the biggest economic success stories of the past century, the so-called East Asian economic miracles of Japan, Korea, Taiwan, when they reached what is China's stage of development today, that is per capita income of $6,000, plus an urbanization rate of just about 50%. These are all very important signposts. They suggest that China's economy is about to slow down, that the hypergrowth is over. When you become middle-aged, you can't sprint any more.
Even in America, this notion that developed after the financial crisis that the Chinese economy, because it's a command and control economy, is able to achieve what it wants to -- it doesn't happen all the time like that. In China today, no one expects any sort of a downturn. Everyone thinks there is no business cycle in China. That perception has to change. They're moving to be a more normal, maturing economy. As they grow more mature, the problems become more complex.
You make the point in the book that there's a mistaken notion that China can turn around and become a consumption-driven economy.
Look at the math. You'll see that consumption as a share of the economy is 35 to 40%, so you assume that consumption rates are very low. But the point is that in China, export rates are much, much higher. That's what is creating this imbalance. Consumption is at 8%, but exports and investment have been growing at double-digit rates, so consumption as a share of GDP is falling, even though consumption rates have been quite high. Consumption never increases with any country at a double-digit pace. It just doesn't happen. I think that in China, the way we'll see a rebalancing is that consumption will remain at 8%, which is a pretty high pace, but exports and investment will go sub-8%.
You appear torn about India. At one point in the book you give India a 50-50 chance of being a breakout nation, so you couldn't be more divided.
In India, they got very overconfident that, no matter what, whether there are reforms or not, they were going to be the fastest-growing economy of this decade. [There was an attitude of] "where else would the money go? It has to come here." That complacency and overconfidence is coming back to bite them now. India's per capita income is so low, $1,500, that they can make many mistakes and still be able to grow. The problem is that they keep making the mistakes.
You conclude that we must disregard the notion of blocks of economies and focus on individual ones. Does that mean emerging economies won't be the force of the future that people have projected?
Not all of them will be. There are 183 countries in the world today; 35 are developed. Everyone else is emerging. Many of these countries have been emerging for decades. The Brazils, Mexicos of the world have always been seen as being on the cusp of making it to developed-country status, and then they fall back. To treat emerging markets as a block is just wrong. They're all over the map.
Have investors been seduced by the very term, emerging markets?
I think they misunderstood what happened in the last decade. I find that the perception in America is amazing. A decade ago, [Americans] would say, "Why should we bother about emerging markets? They're so small. Who cares? We are the world." Today, the mood is the opposite. There is this paranoia that we're about to be run over. There will be emerging markets that will be stars. There are some that will be flops.
In the beginning of the book, you describe a young, wealthy Indian who declares foreign investment in his country as a given, almost like a birthright. Is that assumption -- that capital is inexorably bound for emerging markets -- fundamentally wrong?
It's not nuanced enough. A lot of the growth in emerging markets of the last decade happened because the banks and institutions in the West were taking risk all over the place. It wasn't just the housing market; they were willing to put money anywhere to work. That attitude has gone to being much more risk-averse. There's been a dramatic slowdown on capital into most emerging markets
over the past 12 to 18 months. [Capital] is not destined to go anywhere. It can remain here.
You suggest that countries that rely on commodities-based economies are almost bound to fritter wealth away. You point to Brazil and Russia. Are there any counterexamples of economies that have constructively built on commodities?
There are some success stories. Australia is an example. Chile is an example inside emerging markets. In general the rule is, if you look at the big economic success stories over the last 40 to 50 years, you are better off being a commodity importer because it puts more pressure on you to go after technological innovation and to focus on that, rather than living on cheap wealth. The odds are greater that if you don't have commodities, you'll be better off than if you have commodities.
You have a fascinating list of your candidates for breakout status: South Korea, Turkey, Nigeria, Poland. All of those have in one way or another overcome huge political, social and economic adversities. Is that a necessary element in what it takes to succeed?
What it takes is quality of leadership. If you look at the high-growth examples of the last 30 years, you'll find that the political regime did not matter. Whether it was authoritarian or democratic, it was 50-50. These countries have been lucky to have the leadership at the top which have helped them drive this process. It's all about change at the margins; it's not about dramatic stuff.
The definition of breakout nation is very modest. It's not a grand theory about which will be the next developed countries. My breakout nations are not countries that are going to become superstars. My definition is, over the next three, five, possibly 10 years, which countries will beat expectations compared to where the consensus is, and grow faster than other countries in that league.
You contrast economic development and social welfare. Do you believe one is at odds with the other?
A welfare state system naturally evolves as a country gets richer. In Brazil's case, and this is true with India, they started the welfare state far too early. That is what creates the problem. In Brazil's case, per capita income is $12,000. Typically, at that level, government spending as a percentage of GDP should be about 25%. In Brazil's case it is 40%. As you get richer, the welfare state increases. If you institute it prematurely, then you're headed for trouble. Then you're choking growth off.
So what should the role of government be in terms of the way it spends its money? Infrastructure?
Exactly. I call Brazil the anti-China. China spends 10% of its GDP on infrastructure. Brazil spends 2%. The emerging market average is 5%. If you have to spend it, you're better off on something like infrastructure, which allows the pie to get bigger before you think about how to distribute it. n