Reaching Tomorrow's Consumers

Why the BRICs aren't where it's at anymore, if they ever were.

Hey, buddy, looking to sell some products abroad? Need to find the best new market for your pillow shams, or maybe your shampoo? A new book, The $10 Trillion Prize: Captivating the Newly Affluent in China and India, purports to have the answer. Yet the hype about China, India, and other big emerging economies glosses over the difficulties of doing business within their borders. Sure, size matters, but plenty of other factors should make companies look elsewhere, as well as make governments take a hard look at their policies.

Enormous populations make China and India obvious targets for business, but selling to their people is only half the battle. Once a multinational company has collected its revenue and paid its costs, it has to bring its profits home to shareholders. That's not always easy in developing countries, where corruption, arcane tax and legal systems, changeable customs regimes, unscrupulous self-dealing, and self-serving joint venture partners can eat away at the final take.

Just imagine you've arrived in a big emerging economy, and you're hoping to sell to tens of millions of new consumers. If you work in, say, consumer products -- toilet paper, soap, and so on -- your business might normally earn margins of 10 to 15 percent. But what if each of the problems above eats away a bit of your revenue, even just 1 or 2 percent? Pretty soon, your margins are down to zero -- and that's without considering other issues like exchange-rate fluctuations and capital controls.

All the BRIC countries -- Brazil, Russia, India, and China -- suffer from a selection of these problems, and often to a much greater degree than some of their smaller neighbors. As a result, the consumers who are truly profitable for companies might be located in places with better economic institutions and friendlier business climates, such as Malaysia, Peru, South Africa, and Turkey. These midsize countries are by no means perfect places to do business, but by several metrics they're a lot better than the BRICs.

Of course, executives of multinationals are still under tremendous pressure from analysts and investors to come up with a "China strategy" and an "India strategy." These markets' size makes them hard to ignore, and they offer the potential to realize huge economies of scale. After all, you only have to pay the setup costs of entering the market once, and then you have access to almost unlimited consumers.

But companies have to balance the apparent savings -- which may not be so large once you account for differences in regulations across 35 Indian states and territories and 32 Chinese provinces, municipalities, and autonomous regions -- with the costs of doing business in a difficult environment. For all but the biggest multinationals, serving several countries of 30, 50, or 70 million people where doing business is relatively easy might be more profitable than fighting for a share of China's market. Not every company should be in China, India, and the other BRICs, just as not every company should be in the United States, or any other country for that matter.

The flip side of this conclusion is that China and India, even as their economies cool a bit, still offer fantastic opportunities to grow. The gradual opening of their economies over the past three decades has already lifted hundreds of millions of people out of poverty. It's hard to imagine that China and India could repeat this feat, yet they just might by removing some of the obstacles outlined above. By fighting corruption, making legal systems more transparent, and instituting better protections for investors, these countries could see a second, perhaps even bigger boom.

The possibility of these reforms has long seemed remote, like the advent of democracy in China or the resolution to India's feud with Pakistan. Now, however, the economic picture has changed in a way that makes change more urgent.

The BRICs are still feeling the effects of the global downturn; the International Monetary Fund has predicted growth rates for this year that are just a shadow of what they were in 2007. Moreover, the BRICs can now begin to see the limits of their growth in the absence of reform. Wages are finally rising in China, along with the currency, making exports more expensive. Brazil is reaching peak urbanization. Russia's energy-based influence will dwindle as substitutes and other sources come online, and India has been reluctant to lay out the welcome mat for foreign companies in many industries.

Soon enough, all the BRICs will need to find new ways to attract investment, create jobs, and raise living standards. Making their consumers a more attractive proposition to foreign companies would go a long way to achieving all three by laying the groundwork for new production facilities staffed by local workers making goods and services for local households.

India, the poorest of the BRICs, has finally started down this road. In the past few months, it has made industries ranging from insurance to supermarkets more open to foreign companies. Joint ventures with local players will still be required in many cases, but greater foreign ownership will be permitted. It's not quite a multitrillion-dollar free-for-all just yet, but it's a start.

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Daniel Altman

Mr. 3.75 Percent

Paul Ryan wants to cut federal discretionary spending to the level of Equatorial Guinea. Yes, that's as crazy as it sounds.

In my last column, I wrote of the need for us to take a longer time horizon in our planning at home, at work, and in government. One political leader who likes to plan for the really long term is Paul Ryan, the Republican nominee for U.S. vice president. By 2050, Ryan's budget plan would reduce federal spending outside health-care programs and Social Security to 3.75 percent of GDP, down from 12.5 percent last year, according to the nonpartisan Congressional Budget Office. So, what would it mean to chop away two-thirds of the federal government?

According to the World Bank, government spending minus health care was already lower in the United States than in all of the European Union, Japan, China, and India in 2009, the latest year with comprehensive figures. At just 3.75 percent of GDP, the United States would be one of the world's lowest spenders. The only countries that spent less in 2009 were Equatorial Guinea, the Democratic Republic of the Congo (DRC), and the Central African Republic.

The first of these three is a small West African country where per capita income is as high as in much of Europe, but life expectancy is just 51 years; a tiny elite monopolizes revenue from oil exports while the majority stays mired in poverty. The other two countries are in the top 10 of Foreign Policy's Failed States Index, meaning that their governments barely function and provide almost no services to their people.

Even the meager spending of these governments is greatly subsidized by foreign aid, to the tune of 13 percent of spending in the Central African Republic and 29 percent in the DRC as of 2011. Their people also depend heavily on private charity. Many basic services are provided by nonprofit organizations such as Oxfam and Mercy Corps, and security has been provided by the United Nations in the wake of regional conflicts.

Of course, the United States isn't going to turn into a war-torn sub-Saharan republic overnight because of budget cuts. But Ryan and his cohorts do want to replicate some aspects of life in Africa's poorest countries. They prefer to replace public services paid for by taxes with programs run by charities; because the decision to fund the latter rests with the individual, no state power tells you how much of your income to surrender. They also want many of the services now paid for by the federal government to come under local control, as they are by default in failed states. Yet we saw in the past few years what happens when an economic downturn hits the states: massive budget cuts, blanket layoffs of public employees, and services slashed at the moment they're needed most.

The problem with this approach is that an economically efficient outcome is very unlikely. In principle, a government's spending has three motivations: 1) it can provide something more efficiently than the private sector, 2) it can ensure quality in a way that the private sector can't, or 3) the private sector alone doesn't have an incentive to provide enough of the item in question. These days, the first motivation is rarely relevant, except in small countries where some industries may offer the most benefit to society as publicly run monopolies. But the second often is, as in the case of airport security. And the third covers a huge variety of "public goods" such as infrastructure, scientific research, and vaccinations, all of which have benefits for society beyond the benefits that an individual purchaser would receive.

If we rely on charity to fund all these items, we may simply end up with too little of them. Imagine, for example, a United States with a stripped-down Justice Department, a bare-bones military, and only tiny agencies to deal with issues like highway safety, air traffic control, food safety, and the disposal of nuclear waste. All these would rely on individuals' goodwill to continue providing services that protect the entire population.

Charity would also have to fund long-term investments like the National Science Foundation and the National Institutes of Health. These organizations dispense just under $38 billion a year in grants for research in the physical, chemical, biological, and social sciences, or about $121 per American. Many projects they fund are too fundamental to have immediate applications for business. Yet these same projects lay the groundwork for waves of innovation in the future. They are not crowding out research in the private sector, either; rather, they are complementary, as additional publicly funded research leads to more research in the private sector as well. Left to their own devices, would Americans support a science charity to the same degree?

In fact, every American would have a strong incentive to contribute nothing and free-ride on the contributions of others. After all, they would still receive the same benefits from things like national defense and technological innovation. Government solves the free-rider problem by coordinating all of us to pay for public services collectively. Without government fulfilling this role, public services may simply disappear.

To rely on charity would diminish the potential of the United States to grow, and it would create new risks that could push the country back through economic time. That the United States has done so well despite much lower spending than many other wealthy countries is a testament to the strength of its private sector and the ingenuity of its people. But there is a limit to how much you can cut.

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