The book provides a nice summary of economic events of the recent past (~50 years) and builds upon the case for the coming 10 years.
The Myth of the Long Run
- All emerging markets are different – a herd approach to investing in “emerging markets” is dangerous rather each market should be analyzed individually.
- Long-term predictions are essentially random – a lot can happen in the next 20 years or so, so any predictions made about 2050 are meaningless.
- 2003-2007 was the period in which credit was flowing into emerging markets – the stock market growth of that era is more due to cheap credits rather than structural reforms in these economies.
China’s annual growth rate will probably slow down to ~6%. Its aging population is, of course, a concern. Inflation is threatening long-term growth.
The ruling party is good enough to avoid a hard landing.
Rule: political leaders (and the government’s stability) matter more than political ideologies.
The socialist schemes might take India down the path of the welfare state of Brazil in 1970. India is a high-context society (like Latin America) is misleading for most foreigners. Being more heterogeneous than (say) China or Brazil also is (culturally) more similar to the EU. The missing infrastructure is bad since it leads to supply chain problems leading to inflation which further leads to less capital for investment (in infrastructure). The demographic dividend is overrated.
Brazil is doing well because (its only export) commodities have become expensive (due to the availability of cheap credit from central banks which is fueling commodity speculation). Infrastructure has become horrible. Cities are more expensive than in the developed world. CEOs use helipads for their commute. High-interest rates (to control inflation) reduce investment in infrastructure. High commodity prices further make the currency expensive and lead to a decline in manufacturing exports (Dutch disease).
A market dominated by a nexus of oligopolists and politicians.
Heavy net emigration (2.4 Million in 2006-2012) due to bad internal security and a stagnating economy.
Rule: Rulers who have outlived their usefulness are dangerous since they are looking less to prove themselves and more to protect their position.
Another country dominated by the nexus of oligopolists and politicians.
The middle class is missing (Russia has a disproportionately larger number of billionaires than millionaires). The economy got a recent boost due to (oil) commodity prices but growth is not sustainable. The population is graying fast, infrastructure is poor, and sparse population density discourages big retail.
Rule: If a country generates a disproportionate number of billionaires then something is wrong.
The two emerging countries which have performed well in Europe are the Czech Republic and Poland – they controlled government debt and focused on the free market economy. Hungary has fared worse due to its government’s approach to interfering with the economy.
Rule: Common currency (in this case, Euro) is bad for nations with lower productivity since, at the time of economic crisis, the government usually allows its currency to fall in price and hence, keep its exports competitive (and save wages and jobs). But since Euro members cannot make the currency cheaper on their own, this leads to an internal devaluation of the currency (fall in wages) to keep exports competitive.
Since the arrival of new Prime Minister Erdoğan in 2001, Turkey saw several major economic reforms, its exports are growing and the ruling party has been able to develop a stronghold among both secular and Islamic voters. The future of Turkey looks bright.
Indonesia uses to be a commodity-exporting economy but after the bust in rubber and tin prices in 1950, it focused more on its non-commodity exports. Now only ~25% are commodity exports). The country suffers from corruption but it’s very “efficient” (once you find the right person, work will be done).
Rule: The population of the second city must be at least one-third of the first city. Otherwise, it indicates unbalanced economic growth.
The Philippines is still stuck with crony capitalism, though with new President Aquino, there is hope for change. The sudden development of the call center industry (~350, 000) is also a ray of hope.
Thailand suffers from a strong regional imbalance between urban and rural populations, its domestic market is small and hence, exports play a huge role in the economy and which caused the downturn in 2008. The future of Thailand is still doubtful.
Rule: A balanced economy should be devoid of excesses, even export excess becomes a liability (since the economy becomes vulnerable to a fall in exports).
Malaysia decided not to fix its economy after the crisis of 1998 (and rather blamed it on a Jewish conspiracy). The economy is still not in good shape and is dominated by government spending. Foreign investment is falling. The strife between bumiputras (Malays) and Chinese/Indians is growing due to affirmative action in favor of Malays leading to further tensions between the ethnicities.
Rule: When a financial crisis happens, money flows out in three phases, first ones to leave are local investors who move money through underground channels (due to rules limiting capital flow) – this shows up as “errors & omissions” in the balance of payments or over-reporting of imports /under-reporting of exports. Second is the foreign creditor, when they leave, short-term interbank loans from foreign banks slow down or reverse.
The last one to leave is foreign investors – they are easiest to spot and the media usually have an eye on them – therefore, they get the blame (as in Malaysia in 1998).
An economy that has grown at 5% annually for 50 years (the only other one being Taiwan) while keeping a check on income inequality. Samsung, Hyundai, and LG alone account for 16% of the GDP. Unlike in Taiwan, Korean companies are increasingly outward looking and have developed global brand names. Korea used the crisis of 1998 as a basis to clean up its economy, even companies like Daewoo were not saved by the government. Interestingly, most Korean companies are family-controlled.
Taiwan, even though, has gained stronger control of the PC market, its manufacturers are commoditized name-less entities used by HP, Dell, and other brands who play these manufacturers against each other to maintain prices.
The ANC (African National Congress) which fought against Apartheid is still enjoying dividends from the same and has no chance of getting displaced anytime soon, so the sense of complacency has overtaken it.
This is equivalent to the complacency which the Indian National Congress had in India since it takes almost a generation (~25 years) for the new generation of voters, which is not thankful to the old party, to emerge. The economy has become more welfare-oriented which is a bad sign in the long run.
Key point: If the local population is large but the companies are still going global, it might be a sign of national weakness (as in South Africa).
The Fourth World
Though most emerging markets move in sync, that does not hold for frontier markets.
Cambodian Stock Exchange has only one company listed (which also appeared after two years of its creation).
Laos has just two companies listed on the stock exchange.
Ukraine has 500 companies since it forced companies with more than 100 stockholders to list them and gave out a small free float of their stocks. This made the stock market a joke and most companies who want to go public go to either London or Warsaw.
Saudi Arabia is closed to foreign investors.
At the time of the financial crisis, emerging markets take either the Keynesian view (of protecting the market) or the Hayekian view (of letting the market crash). But frontier economies, simply close the markets, Nigeria did that in 2008. The same happened with Pakistan and Argentina in 2009 (both limited their trading). Most information about these markets is available in the form of rumors.
Sri Lanka looks promising since the LTTE issue is resolved and will hopefully get a peace dividend now. The same goes for Uganda and Mozambique.
Vietnam even though its wish to have Chinese-style economic growth has failed due to its inability to handle foreign inflows properly and take harsh steps like China to build infrastructure. An attempt to jump too fast (Intel’s plant) has been an audacious attempt. The education system is still weak and government spending is fueling inflation.
African countries suffer from poor infrastructure and are primarily commodity exporters but (at least) the emergence of democracy and the end of civil wars has given some hope. Nigeria has shown promise due to its strong leader (Jonathan) and stable government.
The Middle East suffers from subsidies (people are paid instead of being taxed). Saudi Arabian officials believe “it’s cheaper to provide subsidy than to build public transport” and the country still imports refined gasoline since it has no refineries. Qatar has the world’s highest per capita income (~100, 000 $ per annum) and still has had gas reserves for about two centuries. While nations are emphasizing oil funds and education (for the future), the citizens have become lazy due to subsidies which is evident due to the large army of ex-pat consultants who do everything for them. Investing in these markets is dangerous due to opaque books, murky rules, and too few good companies. Interestingly, none of these countries are susceptible to Dutch disease (due to a complete lack of exports in the first place).
Predictions for coming years
Commodities have lost price for ~200 years but have seen a sudden upswing in the past 10 years. The fear of Chinese manufacturing surging commodities is overhyped since overall manufacturing is shrinking. Low-interest rates provide cheap money and thus, encourage investment in items based on scarcity (gold, oil, etc.) rather than productivity and thus, is fueling commodity speculations. Food prices might increase in the short run but should go down in long run (due to population stabilization) and a lot of countries in emerging and the frontier world still have ample room to improve productivity. Further, rising prices of gold and oil fuel further investment into their mining/exploration. The eventual crash in prices of commodities is evident and is commodity.com (similar to .com of 2000). The strength of the USA lies in its strong R&D, especially in software companies. Japanese companies are more inward-looking (eg. mobile payments were started in 2004 in Japan but no Japanese company launched it globally).
The Third Coming
The phrase Emerging markets is pretty new from an investment standpoint.
Its first phase was from 1987 to 1994 followed by a dip from 1994 to 2002. The second coming was from 2003 to 2007. The third phase started in 2009 when markets are going to return smaller gains and smaller boom-bust cycles (~3 years). The breakout nations could be
- The Czech Republic and South Korea – in 20,000 to 25,000 $ income range
- Turkey – in the 10,000 to 15,000 income range
- Thailand – in the 5,000 to 10,000 income range
- China, Malaysia, Sri Lanka, and Nigeria – in the under-5000 income range
Inflation is expected to go down (in emerging markets) in the coming years. The increased integration of the global supply chain implies a strong correlation in economies and hence, more volatility. BRICS will not be able to come out as single political clout due to conflicting economic interests.
A few issues with the book:
- Factual mistake: The author says that Google purchased Orkut in 2002 which is incorrect.
- In the chapter on Sri Lanka, the author while referring to Sinhalese – Tamilian conflict (which started in 1970), mocks (economic) analysts by saying that they know how to do financial modeling but fail to understand the societal conflicts leading to war. Weirdly, the author fails to mention the same for India. Any mention of a growing threat due to China or Islamic terrorism is completely missing.
Overall, it’s a nice book.