Think Again

Think Again: The BRICS

Together, their GDP now nearly equals the United States. But are they really the future of the global economy?

"The BRICS Are in a Class by Themselves."

Yes and no. There is no question that the BRICS -- Brazil, Russia, India, China, and the group's newest member, South Africa -- are big. They matter. In terms of population, landmass, and economic size, their pure dimensions are impressive and clearly stand out from those of other countries. Together, they make up 40 percent of the world's population, 25 percent of the world's landmass, and about 20 percent of global GDP. They already control some 43 percent of global foreign exchange reserves, and their share keeps rising.

Jim O'Neill of Goldman Sachs put the spotlight on the rise of the original four of these big new economic powers when he gave them the name BRICs in 2001, and their collective growth began to soar. But in reality their economic success had been a long time coming. Twenty years before that, when I was at the World Bank's International Finance Corp. (IFC), we were identifying the opportunity to rebrand these countries, which, despite their enormous economic potential, were still lumped together with the world's perennial basket cases as "underdeveloped countries" stuck in the "Third World." At the time, Third World stock markets were simply off the radar screen of most international investors, even though they were starting to grow; I gave them the name "emerging markets." Local investors were already quite active in Malaysia, Thailand, South Korea, Taiwan, Mexico, and elsewhere, as homegrown companies became larger and more export-competitive while market regulation became more sophisticated. But until the IFC built its Emerging Markets Database and index in 1981, there was no way to measure stock performance for a representative group of these markets, a disabling disadvantage when stacked against other international indices, which were skewed in favor of developed countries such as Germany, Japan, and Australia. This brand-new research on markets and companies provided investors with the confidence to launch diversified emerging-market funds following the success of individual country funds in markets such as Mexico and South Korea.

The BRICs, however, took much longer to get ready for prime time. Until the beginning of the 1990s, Russia was still behind the Iron Curtain, China was recovering from the Cultural Revolution and the Tiananmen Square unrest, India remained a bureaucratic nightmare, and Brazil experienced bouts of hyperinflation combined with a decade of lost growth. These countries had largely muddled along outside the global market economy; their economic policies had often been nothing short of disastrous; and their stock markets were nonexistent, bureaucratic, or supervolatile. Each needed to experience deep, life-threatening crises that would catapult them onto a different road of development. Once they did, they tapped into their vast economic potential. Their total GDP of close to $14 trillion now nearly equals that of the United States and is even bigger on a purchasing power parity basis.

Here's the problem, however, with asking whether the BRICS "matter": Big is not the same as cohesive. The BRICS are part of the G-20, but not a true power bloc or economic unit within or outside it. None is fully accepted as "the" leader even within its own region. China's rise is resented in Japan and distrusted throughout Southeast Asia. India and China watch each other jealously. Brazil is a major supplier of commodities to China and has relied on it for its economic success, but the two powers compete for resources in Africa. Russia and China may have found common cause on Syria, but they compete elsewhere. And though intra-BRIC commerce is growing rapidly, the countries have not yet signed a single free trade agreement with each other. Then there's South Africa, which formally joined this loose political grouping in 2010. But being a member of the BRICS doesn't make it an equal: South Africa doesn't have the population, the growth, or the long-term economic potential of the other four. Indonesia, Mexico, and Turkey would have been other logical contenders -- or South Korea and Taiwan, for that matter, which have comparable GDPs but much smaller populations than the original BRICs.

The BRICS are also nowhere near economically cohesive. Russia and Brazil are way ahead in per capita income, beating China and India by a huge amount -- nearly $13,000 compared with China's $5,414 and India's $1,389, according to 2011 IMF data. And their growth trajectories have been very different. What's more, the BRICS face stiff competition from other emerging powerhouses in the developing world. While China and India seemed to have a competitive edge for a while due to their low labor costs, countries like Mexico and Thailand are now back on the competitive map. And while growth in the BRICS seems to be slowing, many African countries are receiving more foreign investment, may be more politically stable, and are at long last moving away from slow or no growth toward much more robust economies.

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"The Continued Rise of the BRICS Is Inevitable."

True, but their growth is slowing. Forecasts by Goldman Sachs and others project China will overtake the United States in GDP before 2030. China, meanwhile, dwarfs the other BRICS, whose combined economic size isn't expected to catch up to China during that period. The BRICS will approach the total size of the seven largest developed economies by 2030, and by the middle of this century they are projected to be nearly double the size of the G-7.

BRICS consumers are also beginning to rival their American counterparts in terms of total purchasing power. More cars, cell phones, televisions, refrigerators, and cognac are now sold in China alone than in the United States. Even with slower growth, the economic engine of the BRICS should be more important than that of the United States or the European Union for most of the 21st century.

Then again, there's no guarantee that the BRICS can maintain their torrid growth rates. Just as their expanding economies took the world by surprise over the past decade, the big shock for the next decade may be that they will grow less quickly than assumed. Japan, South Korea, and Taiwan have already shown that growth rates slow down once a basic level of industrialization has been reached. The unquenchable thirst for "goods" tends to moderate when basic infrastructure is in place and consumers want more health care, education, and free time.

To some extent, this is already occurring. Leading Chinese economists now expect China's annual growth to slow down from rates of 10 to 12 percent to 6 to 8 percent by the end of this decade. Dreams of India reaching sustainable annual growth of 8 percent or more have been lowered to 5 to 6 percent after the country hit an inflation barrier and offshore gas production disappointed. Brazil has also struggled to return to its exuberant pre-crisis growth, while Russia has been staggered by Europe's economic problems. The projections by Goldman Sachs and others always expected slower growth for the future, but some enthusiasts did not read the footnotes.

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"The Financial Crisis Was Good for the BRICS."

Not for long. The 2008 financial crisis did not emanate from emerging markets. Instead, the BRICS came to the rescue when the United States, Europe, and Japan collapsed due to their overspending, fiscal imprudence, and overreliance on just-in-time production that made them too dependent on a consumer economy that quickly blew up. After the BRICS suffered brief, V-shaped recessions of their own, as swift in their decline as they were in their recovery, the BRICS' demand helped pull the global economy out of its initial slump.

It certainly wasn't clear initially that this was how the crisis would play out. The Financial Times warned (and many investors feared) that the banking systems of emerging markets would succumb to the same massive financial problems that plagued the United States and Europe, but Asia and Latin America had learned their lessons from earlier financial crises and put their houses in order. The Chinese had ample reserves for a fiscal stimulus that was not only massive, but, unlike its U.S. counterpart, also disbursed funds quickly. The BRICS' central banks, along with those in other emerging markets, cooperated on global monetary easing. Without it (and without China's quickly disbursed stimulus at home), Western stimulus and easing would have been inadequate and ineffective. With it, demand for commodities stabilized and the world avoided a depression.

These crisis interventions came at a significant cost, however, the full price of which is not yet clear even today. The real estate bubble, which played such a big part in the United States and Southern Europe, didn't burst in the BRICS. Inflation also increased well beyond the comfort zone of central banks in China, India, and Brazil. Although all this did not provoke another crisis, it might have planted the seeds for future problems. Economic history teaches us that the next crisis usually comes from the region where the applause and self-satisfaction were loudest the previous time around. If that holds true, the next economic shock will more likely than not come from the BRICS.

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"The BRICS Are Unbeatable Competitors."

No. The BRICS benefited for several decades from cheap labor, higher productivity, massive (but far from universal) investment in infrastructure and education, and a hunger to catch up with wealthier rivals. Their transformation was remarkable: With better-off populations, domestic markets finally became economically attractive, South-South trade exploded, and leading corporations transformed themselves from second-rate producers of cheap goods into world-class manufacturers of smartphones, semiconductors, software, and planes. China's Lenovo took over IBM's PC business. Brazilian and South African beer companies became leading global brewers. Just as had been the case with the Russians after Sputnik and the Japanese in the 1980s, the BRICS became feared and formidable competitors, even if some of the fears about their rise were exaggerated.

But the story is not over. Cheap, abundant energy from shale gas is attracting new investment in the United States, giving energy-intensive industries a renewed competitive edge. Abundant shale gas could also make Russian Arctic drilling and Brazilian pre-salt production too expensive. Stagnant U.S. wages and soaring pay in China and India are eroding the BRICS' labor-cost advantage, while their seemingly bottomless labor pool has suddenly started emptying out, leaving them with shortages of trained labor.

Mechanization is also allowing the developed world to make a comeback. Increasingly affordable and sophisticated robots can now do what 10 or more human workers did until recently. They work 24 hours a day and do not ask for higher wages or better benefits. Smartphones and tablets may still be made in Asia, but the BRICS lag behind in taking advantage of the productivity gains they bring. As a result, traditional multinationals are fighting back after years of retreat, from General Motors winning the biggest market share in China to General Electric's foray into producing low-cost medical equipment to Nestlé's invention of the wildly successful Nespresso machines, turning high-end coffee from a store-bought luxury into an at-home convenience. The competitive edge may be turning back to the West much faster than we thought.

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"The BRICS Are the Best Place to Invest."

No longer true. Until 2008, the BRICS performed far better than other emerging equity markets -- or developed markets, for that matter. And by a lot: For the five years ending in 2007, investors in the four original BRICs earned an annualized 52 percent return, compared with just 16 percent in the G-7 markets. But in the past five years, through Aug. 31, that figure was -3 percent for the BRICs and -1 percent for the G-7. This was in part a correction to exaggerated expectations, which drove up valuations and currencies to unsustainable levels. It also seems, however, that the BRICS' competitive edge is now being questioned in more fundamental terms. Of course, it makes perfect sense for investors to diversify and not ignore such a huge, successful part of the global economy, but that is different from blind euphoria.

Each of the BRICS is very different, and so are the question marks that accompany their economies. For example, China's wage costs had been so much lower than Mexico's for several decades that Mexico had difficulty competing, despite its closeness to the U.S. market. But that wage gap has closed in recent years -- Chinese labor rates have grown from 33 percent of Mexico's in 1996 to 85 percent in 2010 -- and now investment is flowing back to Mexico. Even when Indian growth rates went through the roof, bureaucracy, budget deficits, and infrastructure bottlenecks remained serious impediments. Brazil successfully turned around its floundering economy in the 1980s and then benefited from three windfalls: China's thirst for commodities, energy discoveries, and a competitive edge as an agribusiness giant. Now, however, China's slowing economy and the world's shift toward ubiquitous shale gas is changing the picture. Or consider Russia, which, to its peril, has squandered its oil-and-gas weapon by pooh-poohing the potential of shale gas, opening up export opportunities for the United States in Europe.

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"The BRICS Will Surpass the West."

Not so fast. Yes, the BRICS will remain the main source of growth in tomorrow's world, as they already are today. Together they will dominate the global economy later this century the way Europe and the United States once did.

Just as the pendulum swung far toward the BRICS but then swung back hard in recent years, there are signs of new forms of BRICS competitiveness. Research and development in the BRICS is paving the way for increasingly high-value-added production. Ninety-one percent of U.S. plants are more than a decade old, versus only 43 percent of China's plants, according to a 2007 IndustryWeek survey. While 54 percent of Chinese companies cited innovation as one of their top objectives in the survey, only 27 percent of U.S. respondents did. Chinese telecom equipment-makers are giving more traditional players a run for their money, Indian-made generic drugs are making inroads, Brazilian protein producers dominate world markets, and Russian oligarchs are making smart investments abroad. The BRICS are going through a rough patch right now, yet they're poised for a roaring comeback.

But though the era of American or Western domination may be over, BRICS domination is still some time off. What is already a fact is that the clear delineation between developed and "backward" countries is a thing of the past. Western multinational companies are seeking to expand in the BRICS as growth in their home markets has dried up. Chinese and Indian corporations are building their brands in other emerging markets and the West. More than ever, developed countries' economic fates are tied to those of emerging markets.

Intellectual property remains a strong suit of advanced economies. The United States, Japan, and Germany -- just three advanced economies -- accounted for 58 percent of patent filings in 2011, according to the World Intellectual Property Organization. But even here the BRICS are catching up: China's applications soared 33 percent in 2011, Russia's filings were up 21 percent, Brazil's 17 percent, and India's 11 percent. Compare that with 8 percent growth for the United States and 6 percent for Germany. Chinese telecommunications equipment giant ZTE Corp. dislodged Japan's Panasonic from the global top spot with 2,826 patent applications. China's Huawei Technologies was in third place, while a previous American leader, Qualcomm, dropped from third to sixth place in 2011. Why does it matter? Because patents are a key indicator of future economic strength.

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"Politics Could Be the BRICS' Undoing."

True, and you disregard them at your peril. The spread of democracy and free markets in much of Asia, Latin America, and Eastern Europe is impressive, but some BRICS have been laggards rather than leaders in this area. Legitimacy in these countries often depends on meeting sky-high expectations for economic success, while political checks and balances remain in their infancy. So forget about all those paeans to "authoritarian capitalism" you read in the op-ed pages. Just because Beijing has a fancy new airport and President Vladimir Putin can bulldoze entire neighborhoods at will doesn't mean China's and Russia's politics give them an edge. Even in democratic India, politics are often overwhelmed by corruption, and politically open Brazil struggles with crippling crime stats and political scandals.

The BRICS may seem stable now, but nobody knows what the future holds. Admiration for oligarchs easily turns into envy and anger. Ubiquitous mobile-phone cameras and instant Internet distribution constrain the use of public force. Under the surface and among the younger generation, pride in economic achievements and a sense of material well-being are now coupled with demands for better health care and national recognition. Increasingly, more is not the answer -- citizens of the BRICS want better. Local elites must act adroitly to keep this new mood from developing into a combustible mix. The current generation of leaders in China has not forgotten the lessons of the Cultural Revolution -- but the next generations may.

Some tailwinds that have benefited the BRICS these past decades may yet turn into headwinds. For instance, these countries have benefited from relatively low budget allocations to military spending -- a fruit of Pax Americana. That could change if conflict broke out on the Indian subcontinent or Iran acquired nuclear weapons. And serious political unrest could easily derail the rise of the BRICS: The Bo Xilai case in China, the upheavals following the Arab Spring, and the power blackout in India were recent red flags that showed the dramatic impact of sudden events.

Still, the BRICS are not going anywhere. Sure, they may face tough adjustments getting used to less lofty growth expectations while satisfying more demanding populations. But one way or another it's safe to say: These big emerging economies will put their stamp on the 21st century.

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Democracy Lab

Think Again: Burma’s Economy

Burma is open for business, and foreign investors are champing at the bit. Time for a reality check.

"Burma is the next Asian Tiger."

Don't bet on it. The economies of the Asian Tigers don't look anything like Burma's, which is driven by primary industries such as natural gas, agriculture, timber, jade, and minerals. Together these industries made up over 80 percent of exports last year. They also dominate foreign investment: oil, gas and mining alone comprised almost 90 percent of FDI over the last half decade. Burma's rapprochement with the West has brought even more interest in these sectors. The new government signed deals for 10 oil and gas blocks earlier this year and is offering 23 more. They're also awarding mining concessions and land for plantations. While there's also some interest in telecoms and banking, it's the extractive industries that are Burma's main draw for potential investors.

The Asian Tigers, by contrast, were mostly resource-poor and relied on export-oriented manufacturing to develop. Their foreign direct investment (FDI) was mostly in manufacturing, not resources. They also developed in a much different international environment, one with far fewer competitive exporting countries. They sold their wares mostly to the high-consuming countries of the West, the same countries that are now grappling with the lingering effects of the global financial crisis.

Unfortunately for Burma, countries that have relied on primary product exports tend to grow more slowly than countries like the Asian tigers due to unequal investment in other parts of the economy, a concept known as Dutch Disease. Burma already suffers from this illness, and it will continue to hamper the country's development in the years ahead. The export of natural resources helped drive up the value of the country's currency, the kyat, from over 1400 to the U.S. dollar in 2007 to less than 700 in 2011 - a major obstacle for any reform effort. The continued overvaluation of the kyat -- along with high transaction costs, poor infrastructure, and a competitive international environment -- will all make it difficult for Burma to develop the manufacturing sector it needs to emulate the Tigers.

"Burma needs foreign investment and it needs it now."

It's complicated. The foreign investment that Burma will receive most of is the kind it needs the least: resource investment. This type of investment tends to create little direct employment. Its major benefit is the income it generates for the government. But the government of Burma, like so many others, isn't good at turning resource revenues into productive investments.

Despite this, the prevailing attitude in the capital seems to be that "foreign investment equals development." That's just not true. Different types of foreign investment have drastically different effects on the economy. Investment that transfers technology and brings know-how can be beneficial, but resource investment can be dangerous because it creates revenue by selling non-renewable assets. Why sell these assets so quickly if the government does not yet have the capacity to invest all the proceeds in productive ways? Burma's recent steps toward acceptance of the Extractive Industries Transparency Initiative (EITI), which would help fight corruption by providing for open public accounting of resource revenues, could help but transparency and sovereign wealth funds are no substitute for a balanced economy. Burma would actually be better off without a massive rush of primary sector investment.

"Burma's problem is that it lacks capital."

Yes, but... the fundamental problem isn't a lack of capital, but an economy that is inefficient at putting it to productive uses. The massive boom in property prices in Yangon and Mandalay over the past few years shows that Burma's elites have significant financial resources. An acre of land in either downtown easily goes for over $1 million, even higher than in Bangkok. While other factors have contributed to the rise, one of the major culprits is the lack of alternative investments. Banks aren't trusted and moving money overseas is difficult. So people store their wealth in fixed assets like property, gold, and gems.

At the same time, there is a dire lack of credit in the countryside. Those who don't have collateral must rely on informal loans with interest of 10 percent per month. The state agricultural bank lends farmers barely a third of what they need to cultivate their land. Private banks are prohibited from lending to farmers at all -- one of many needless restrictions inherited from socialist days past. The result is a system in which capital can't get to the rural sector, and more money will not fix this core problem.

"Sanctions were the cause of Burma's economic problems."

Not if you look closely. Sanctions did affect Burma's economy, but they were not the biggest problem faced by the private sector. Talk to businesspeople in Yangon and Mandalay and they'll tell you that the biggest challenges they've dealt with over the years were electricity supply, political instability, and corruption, all factors well within the government's control. Sanctions were the next biggest obstacle because of the additional costs imposed by the U.S. financial services ban and the loss of the large American export market. Many other factors, including poor infrastructure, arbitrary decision-making, and the lack of an impartial judiciary also made business in Burma costly. For most companies, sanctions were a modest part of the challenges of doing business.

Sanctions were originally conceived as a response to human rights problems in Burma, but now they've outlived their usefulness. The biggest and best-connected companies, which sanctions are supposed to target, have the financial resources and international connections to circumvent them. Those without these resources -- the small and medium enterprises (SMEs) that are so vital for Burma's development -- bear the brunt of sanctions. Sanctions weren't the major cause of Burma's economic problems, but keeping them will not help address human rights concerns and will hinder reforms and development.

"Old ways of doing business are quickly changing."

Unfortunately, no. While Burma's political structure has changed, the politics of the economy remains much the same. The International Crisis Group (ICG) argued in a July report that "the system of monopolies and access to licenses, permits and contracts is being dismantled," but the evidence suggests more nuanced changes. Though ministries are professionalizing and opening to outsiders, navigating bureaucracy and accessing decision makers still depends intensely on personal connections. For example, foreigners investing in mining must now partner with one of 38 companies on a government approved list. The same applies for oil and gas, though the list is reportedly around 60. While some listed companies have expertise, others are simply beneficiaries of a needless intrusion into the decisions of private companies. Getting on those lists, and doing successful business in general, is still very much about who you know.

Recently privatized state-owned enterprises are mostly falling into the hands of the urban elite in Yangon, Mandalay, and Naypyidaw, people who have the connections and capital. Since the country lacks a strong taxation regime, Burma's people won't even enjoy much additional tax revenue from the newly privatized companies. Contrary to the stated goal of promoting the country's development, many of the reforms are in fact enabling the "oligarch-ization" of Burma. The old ways of doing business will influence Burma's economic trajectory for decades, much as they have elsewhere in Asia.

"Dramatic reforms are happening, and more are inevitable."

Not as much as you might think.Naypyidaw has taken some important steps to liberalize the economy, such as exchange rate reforms and loosening import regulations. But on the whole, it's the political reforms that have been more dramatic. New legislation on the economy has left much to be desired.

The battle over the economy is not between "hardliners" and "reformers." Very few people in Burma, even those that benefited from the previous system, look back on the past with nostalgia. Instead, the conflict is over the shape of the new economic order. On one side are businesses that would benefit from opening up to international markets, and consumers who have long been limited to overpriced and substandard goods. On the other are those who built their businesses under the previous economic order, and who could lose them if the country opens up too much or too quickly. The battle isn't over whether to reform but how to do it and who will benefit.

The debate over a new foreign investment law, which was passed earlier this month by parliament but appears unlikely to be approved by President Thein Sein, shows the contending forces at work. As part of the government's bid to attract foreign investment quickly and in large amounts, preliminary drafts of the law contained numerous concessions. As debate progressed, local businesses pushed back. They demanded numerous restrictions, including a $5 million minimum for investors, restrictions on "low technology industries," and a limit of 49 percent ownership for many foreign partners in joint ventures. The final version of the law represented a hard-fought compromise that met with little approval from foreign investors.

Missing from the agenda are some of the most urgently needed economic reforms, especially in agriculture, where 70 percent of Burma's people work. Two of the most prominent agricultural reforms, both relating to land, have been widely criticized for facilitating corporate land grabs and creating politicized land management committees. This legislation has done to little help Burma's average farmers.

"Reforms will help reduce poverty and bring broad-based economic development."

Wrong. That the current economic reform program will bring broad-based development is the greatest myth of them all. The reforms to date are a mixed bag, with positive ones such as currency liberalization mixed with poorly designed moves like the new land laws. Reforms of limited benefit for broad-based development, such as the new laws on foreign direct investment or Special Economic Zones (SEZ), are crowding out debate on more important issues.

Burma's leaders have yet to adequately address the most pressing concern for the countryside, which is that most farmers, in this overwhelmingly rural country, can't make money farming. The cost of inputs has risen with inflation while prices have dropped due to an appreciating exchange rate. The result is widespread indebtedness. The public goods needed to improve productivity and farm gate prices, such as good roads, ports, irrigation, and communication, are lacking. Instead of fixing the core problems, the government is allowing elites to set the agenda. Contract farming is on the rise, which allows companies with privileged access to lend credit and inputs to farmers, who have no recourse to any alternatives. The fact that some agricultural businesses reap big profits while farmer's lose money vividly illustrates the distortions that affect Burma's economy.

Fixing the problems of the rural economy requires a long-term strategy to increase worker productivity, build a viable manufacturing sector, and direct resource revenues into productive investments (especially infrastructure). This should not entail offering foreign investors myriad tax breaks, which will only starve the government of revenue. Broad-based development will come only by understanding and addressing the problems that affect Burma's masses. There's still a very long way to go.

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