The question of why some states succeed and others fail is a long and timeless one. Scholars such as Jared Diamond, Ian Morris and most recently Daron Açemoglu and James A Robinson have all had a go at answering that fundamental problem.
For investors, however, the question can be spun in a slightly different way to make it a little more ‘relevant’, by asking which states will ‘break out’ in the future. As the head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management, Ruchir Sharma has one angle for measuring success: economic growth. In Breakout Nations, he assesses a range of ‘emerging markets’, weighing up their perceived strengths and weaknesses in order to form an opinion over whether they are likely to grow in the future. Those which he deems likely to make the jump into a higher-income class – usually from below the $4,000 per capita barrier – are described as ‘breakout nations’. He cautions that many countries grow, but few leap forward. Breakout Nations tries to determine those that are most likely to make that transition.
Each chapter of Mr Sharma’s book reads like a country profile from an Economist survey, weighing up the political and economic landscape of each state. He offers some interesting facts and anecdotes: about property prices in Japan, he says that at their peak in the 1980s, the country accounted for a full 40% of property value on the planet, and the land under Tokyo’s Imperial Palace alone was worth more than the whole of California!
Mr Sharma only briefly delves into why some states have got to the place that they are, however, and a history of each is limited. As an international investor – and investment advisor – he, and perhaps most of his readers, may be more directly interested in the tangible present, and the prospects for prosperity. Amid a rush to invest in emerging markets, Mr Sharma warns that they should no longer be seen as a class of countries that are necessarily going to develop, but as individual cases, some of which will make the breakthrough (and therefore make foreign investors rich), but others which will fail.
Mr Sharma’s methodology is primarily grounded in his experience. He observes the basic data of each country, but has adopted a number of “rules of the road” that inform his impression of whether an economically emerging state is likely to sustain its growth. This includes: monitoring per capita income levels, billionaire lists, politicians’ speeches, prices of black-market money changers, profit margins of monopolies, the size of second cities (to judge whether too much power is concentrated in the hands of a political elite), and the travel habits of local businessmen (including where they place their money). He argues that these measures have allowed him to gain a deeper understanding of how a country is progressing, and what problems it might encounter in the future. He finds various examples of things to worry about in standard emerging markets. For example, Brazil’s top businessmen travel around in helicopters, avoiding the roads where possible, suggesting a lack of investment in infrastructure. Russia, meanwhile, suffers from an oligarchic control of its economy, ranking third globally for the number of billionaires, but not even in the top 15 for the number of millionaires. India, similarly, suffers from a form of “crony capitalism” that impedes good governance in favour of skewed, vested interests, and therefore hinders its development. This book was written before the recent power cuts that plunged almost the whole country into darkness, but that could presumably have been used as an example of a failure to deliver public goods effectively.
For investors, as well as global businessmen and those working in international politics, the book provides valuable insights into the workings of many of the emerging economies. Mr Sharma dispels a few myths, and takes a sceptical line about many countries. He fears a case of Dutch disease in Brazil, and worries about inefficient, corrupt governance in places such as Malaysia and India. Mexico has potential to grow but suffers from having too many cartels (both legal and illegal) and the concentration of power in too few hands: he says that the ten richest families in Mexico account for more than a third of the country’s stock market value. About China, Mr Sharma is cautiously optimistic, believing its rulers to have a clear focus on growth (“at all costs”), but he expects its trajectory to slow to around 6% or 7%.
There are a few countries that Mr Sharma expects to break out. He finds Recep Tayyip Erdoğan’s government to have brought valuable stability and responsible governance to Turkey, which explains its development, although he does voice a quiet worry that the Prime Minister will try to remain in power beyond his “usefulness”, thereby damaging his legacy (as he says has happened with Vladimir Putin, who is once again Russia’s President).
Mr Sharma is most optimistic about South Korea, though, which he speaks of in extraordinarily praiseworthy terms, describing it as the “sole gold medallist” in the pack of emerging economies. Indeed, Korea’s per capita income is now above $20,000, so it is already much more advanced than some of the other countries that he assesses, but here he seems genuinely impressed by how the country achieved this. The Cambridge economist Ha-Joon Chang has written much about Korea’s unconventional but highly successful development path, and, to his credit, Mr Sharma acknowledges that the country’s growth has not come through following neo-liberal prescriptions. Indeed, he mentions that most country’s shift from manufacturing to services when they reach about $10,000 per capita, and despite having more than doubled this level over the past 15 years, Korea’s manufacturing sector is still expanding. “So perhaps it is carving out a rare exception to the normal evolutionary path”, he says. South Korea has also had the most success out of all the emerging economies in building genuinely multinational brands, such as Samsung, LG and Hyundai. In addition it is the only manufacturing exporter to have gained market share in China over the past 10 years, and its leaders and policymakers anticipate a fall of its estranged northern twin, whose population, it is hoped, will be smoothly absorbed into a unified Korean state. Mr Sharma expects such a unification to add to Korea’s development, providing the country with greater resources and a much larger workforce.
While Breakout Nations is useful for someone generally interested in global affairs, what is paradoxically the most interesting aspect of the book is what it reveals about the thinking in the financial world, where Mr Sharma works. The one-dimensional thinking about economic growth may be fruitful for investors, but the way he occasionally dismisses social costs makes for some uncomfortable reading. The ‘welfare state’ is frequently used in a pejorative manner, and thinking about worker rights and costs are framed almost entirely in terms of ‘competitiveness’. The focus is always on growth, efficiency and profit margins.
Moreover, in times of distress, Mr Sharma reveals a preference for Friedrich Hayek’s economic prescriptions over those of John Maynard Keynes, supporting the idea that in the face of a downturn, government should stay away and “let market forces liquidate the deadbeats and deadwood in the economy.” Mr Sharma says somewhat bizarrely that this is what the US did at first in 1929, resulting in an economy of almost double the size by 1950 – as though President Franklin D Roosevelt’s New Deal policies or World War II were just bit-part players in this economic story that don’t even deserve a mention. He may be right to say that ‘Hayekian recoveries’, that sideline government intervention, shake economies out of complacency – as he says happened to many countries after the Asian crisis – but he is very far from presenting convincing evidence that it is an optimal solution. Indeed, many economists, such as Paul Krugman or Joseph Stiglitz, argue forcefully that it is not.
Mr Sharma also presents a curious rule about political economy: “the chance that any particular system – democratic, authoritarian, or any other – will have a positive impact on a country’s breakout potential is about 50/50.” It is true that some authoritarian systems have produced rapid growth (such as China or Singapore), and that believing in a necessary link between democracy and economic growth is foolish, but his analysis is far too simplistic, ignoring a swathe of research in development economics. He complacently writes that although “the 50/50 rule tells us that there is no clear connection between democratic elections and growth, elections were probably necessary in Africa to break a seemingly endless cycle of corruption and coups.”
Firstly, it doesn’t necessarily follow that elections would end that cycle – and it would seem rather naïve to believe that they do. But secondly, In Wars, Guns and Votes, the Oxford development economist, Paul Collier, shows that democracy decreases the likelihood of political violence after a country has reached $2,700 per capita – but below that level, authoritarian systems are ‘safer’. While this statistic does not specifically refer to economic growth, political stability is one variable Mr Sharma considers regularly, and a more sophisticated idea of the effects of democracy and authoritarianism on a country’s governance would certainly improve his analysis.
Beyond these substantive weaknesses in Mr Sharma’s analysis, the book is generally admirable, but for a few surprisingly sloppy errors and comments. The “massive earthquake that hit Japan in April 2011” actually occurred in March of that year. Umaru Yar’Adua, the former President of Nigeria, did not die “suddenly” in 2009, but in 2010, having received treatment in Saudi Arabia for his illness in 2009, making his death anything but sudden. Furthermore, Mr Sharma is sometimes prone to making sweeping statements that warrant much further examination. He asserts that: “It is one thing for a nation like France, a birthplace of the liberal republic, to ban headscarves in a society with no Islamic roots. It is quite another for a Muslim nation [Turkey] to do so.” Discussion of this apparently obvious difference ends there, without any thought of what it means for a ‘liberal republic’ to be banning things with scant justification, or any mention of the large French Muslim population.
From the perspective of an investor, businessman, diplomat or policymaker, this book has much to offer, at least where current affairs is concerned. Mr Sharma clearly knows a lot about his subject, including the countries he assesses, and it will be interesting to see if his predictions of which countries succeed will come true. Breakout Nations certainly has its flaws, though, and Mr Sharma’s various sweeping comments and occasional factual errors might lead a harsher critic to describe him as careless. For an investor who wishes to give himself and his clients a competitive edge, he would do well to scrutinise some of these aspects further. It may even be more profitable.