Sunday, June 30, 2013

[Book Review] Breakout Nations: In Search of the Next Economic Miracles

Breakout Nation offers a picture of state of economy in different countries across the globe. The book is authored by Ruchir Sharma. It highlights the author’s search to identify which is the next big nation that offers good investment opportunities for the investors.

The book covers most growing economies across Asia (China, India, Indonesia, South Korea, Taiwan, Philippines, and Thailand) Latin America (Brazil, Mexico) Eastern Europe (Turkey, Czech Republic, Poland, Russia and Hungary) and Middle East countries like South Africa. Countries like Nigeria, Sri Lanka and Vietnam are considered fourth world countries – which would take longer than emerging market countries to be next breakout Nation. Further the nations considered above are classified based on their per capita income.

The author’s major focus in identifying the Breakout Nation is on the economic condition of a particular country and the factors driving economic growth. To support this, the author evaluates each country on following parameters:
  • The GDP growth of the country and its average per capita income
  • To identify the distribution of wealth within the country: The number of billionaire and millionaire in the economy, proportion of wealth in hands of billionaire and millionaire compared to overall wealth of nation. As higher number of billionaires in the country creates off balance in the economy, which could lead to stagnation. To sustain long term economic growth, it is imperative that the number of billionaire and their wealth must be in proportion to size of nation’s economy.    
  • Foreign Policy: Whether the country has friendly foreign policy to attract foreign capital inflow
  • Proportion of GDP spent on consumption and investment: If high proportion of GDP is consumed by its citizen then there is little amount left of investment in infrastructure, which would most likely hamper long term growth.
  • Total debt as percentage of GDP: High proportion of debt to GDP may increase the probability of default in repayment of debt.
  • Trend of youth and productive population: If the country has high proportion of young, educated and skilled population then the growth prospects brighten for that country. However, high proportion of aging population requires the government to spend heavily on pension and medical welfare, which dims the growth prospects.
  • Stock Exchange: The stock exchanges indicates financial sector of the country. The movement and volatility of the stock traded, number of global companies listed and proportion of stock owned by foreigner are some of the factors considered by author.
  • Dependence on export and foreign investment: If the country is heavily dependent on exports and financial assistance from outsiders for its growth, then there is likelihood that change in consumption pattern in foreign country would hit country’s growth rate.
  • Size of domestic market: If the country has large domestic market then it can protect itself during economic crises, when the exports are hard hit. 
  • High capacity utilization rate: If the country has high capacity utilization rate, which indicates the frequency with which the economy is employing its total labor and equipment, then investment in infrastructure must be increased to sustain growth.
  • Basic infrastructure and spending at home: If the basic infrastructure is well developed, upgraded to the needs of citizen and maintained, then it would low the cost of doing business in that country. Lack of basic infrastructure may encourage home companies to invest in foreign land; thereby the local investment would dry up leading to unemployment and excess of product demand over its supply, which gives way for inflation.
  • Political capability of the country to support growth: Whether the country has strong national leader to implement policy and support economic growth.
  • Tax burden: Tax on citizen is revenue to the government. So, government’s reliance on taxes to meet is expenditure plays a vital role in nation’s growth. If the high personal and corporate taxes are imposed, then business have less money to invest in research, technology and training, which would not increase productivity of the industry and the industry may remain inefficient.
  • Currency value: Whether the currency of the country command premium or discount compare to currency of other emerging markets.  If the value of the currency is high, then its exports would not be favored by other countries. Also, it would raise the cost of living in its home country, thereby affect tourism 
The economic scenario of each country is compared to “Rule of the Road” (as quoted by the author) - the dated rules (that is, the performance of other economies in similar situation) and whether they are relevant in today’s scenario. 

The book is divided into 14 chapters. Below is the summary of economy scenario of some of the countries. The individual chapters have more details about the economy’s growth.

China

  • The current economy size of China is $6 trillion a year. However, there are visible signs of slowdown in economy. China has cuts its growth forecast to around 6-7% over next two-three years, compare to double digit growth last decade.
  • High proportion of population falls in same income class (around $5,000 annual per capita income). It has few millionaire and billionaire and none of them have wealth of more than $10 billion.
  • The country is facing the disappearing the advantage of cheap labor, on account of
    • Strengthening of Yuan
    •  High Inflation
    • Wage increases faster than employees productivity
    • Ageing of population
  • Wages for unskilled labor is growing at faster pace than for skilled labor, thereby
    • Increases the bargaining power of laborer
    • Increase in instances of strike and walkouts by laborer
  •  The current position of China is similar to that of Japan in 1970s, Taiwan in 1980s and Korea in early 1990s.
  • Investment share of 50% to GDP enabled China to achieve high growth last decade, and it continues to grow at faster pace in comparison to consumption share. However, the basic infrastructure (roads, telecommunication) is reaching its maximum capacity.
  • The domestic consumption as share of GDP is falling, in spite of the fact that Chinese consumption is growing.  Further, there is a ban on advertisement of luxury goods to restrain consumption among youth and encourage savings.
  • Liberal credit terms and increase in availability of houses, increased the real estate prices in major cities which was addressed through ‘Social housing’ plan.
  • Although the official government debt is low, it experience high debt of combined government companies and household.  Also there is a presence of shadow banking sector
  • Chinese stock market does not facilitate investment by foreigners. Shanghai stock exchange list mostly state owned enterprises.
  • High possibility to be Breakout Nation 

India

  • India have an advantage in form of
    • broad command over English which makes it easy for them to approach outside world
    • High proportion of youth in demographic provides India a competitive age over other emerging economics (average Indians age would be 29 years  by 2020)
    • Has an entrepreneurial zeal and access to global economy which would not lead to high unemployment once the youth reaches workforce age. 
  • Per capital income is less than $5,000. However, India has total of 55 billionaires whose combined net worth is $246.5 billion, which accounts to 17.2% of the GDP. This indicates concentration of wealth in hands of few.
  • Currently India is facing issues to maintain its GDP growth of around 5%.
  • Currently the government is incurring high expenditure on food subsidy and to provide employment guarantee, which is likely to pave way for hyperinflation. Further, the deficit spending to provide basic necessities to poor may give rise to debt problem.
  • Indian businessman prefers to setup companies aboard and thereby the investment within the country is falling, which is an adverse factor for GDP growth.  Almost 50% of the earning of top 50 companies in India is depended on exports and international acquisitions
  • There is a presence of crony capitalism undermines competition and slows down economic growth
  • The commodity boom benefitted states with high proportion of natural reserves and high agriculture produce. This increased the per capita income and thereby, the demand for aspirational and luxury goods.
  • Presence of wide diversity so the concept ‘one size fits all’ does not work in India. So marketing a product in India requires much detailed research and conscious efforts by brand manager
  • Moderate possibility to be breakout Nation

Brazil

  • World’s leading exporter of raw material – sugar, orange juice, coffee, poultry, beef.
  • The strong demand for export drives up the currency value making its export expensive for outsiders. It faces high Interest rate.
  • The country spends too little on basic infrastructure (roads, airports, factories, supply chain) and citizen welfare (low investment in creating school or generating skilled labor workforce), which has increased inefficiencies and thereby overall transportation cost.  
  • Although, it has per capital income of $12,000. The high capacity utilization rate of 84%, makes labor expensive.
  • In past, the economy experienced devaluating currency and hyperinflation started in 1980s, reached its peak in 1994.
  • It is one of the most closed economies among emerging markets, with total import and export accounts for only 15% of GDP. 
  • The government has huge reliance on tax income, with tax burden of 38% of GDP, which is highest among emerging market countries.
  • The education level is very low with average schooling age of around 7 years. This makes it difficult for the country to obtain skilled labor.
  • Current focus: manage and stabilize exchange rate, interest rate and flow of foreign money in and out of the country
  • Low possibility to be a Breakout Nation

Russia

  • It has an average per capital income of around $13,000 and expenditure on consumption is one of the highest. Further, the sale of auto and luxury car is increasing at around 20%, leading to worst traffic jam in and around capital city. It has high proportion of income inequality, as it is a house for over 100 billionaire individual in Moscow but does not have many millionaires.
  • In Russia, there is excessive government control over strategic sectors like oil and gas. As the economy is protected by state, the proportion of small and medium size companies is very low  compare to other emerging market.
  • The basic infrastructure is poor with frequent power outrage, lack of connectivity between top three cities, aged railways fleet and poor road transport.
  • The Country experience slow growth rate but faces high inflation, which translates into growth rate that is sharply falling.
  • Moscow stock exchange does not have any global manufacturing firm listed. 
  • It has increasing proportion of aging population and reduction in working age population. Further, the immigration into the country is also low. In addition, the overall population size is small and dispersed which gives rise to logistical challenges in transportation of items of basic necessities. 
  • Banking system is poor and mortgage market is almost non-existent. Russians avoid depositing money in banks, thereby makes it difficult for Russian bank to lend out efficiently. Heavy investments like buying house are also transacted in cash. 
  • Reliance on foreign borrowing is high, thereby experienced severe adverse effect during 2008 economic crises. 
  • The high level of presence of crony capitalism with the country has given rise to Special job category to deal with bribe-seeking public officials within all corporate. 
  • Skolkovo, a city 500 miles west from Moscow has an incubator for startup technological companies. 
  • To be a breakout Nation, Russia need to find an alternative source of earning and reduce its reliance on commodity export.

South Korea

  • The country have experience growth rate of more than 5% for over five decade.
  • It has per capital income of more than $20,000, and it is able to maintain income equality. South Korean consumption expenditure has fallen and as they are now regarded to be suffering from ‘boomophobia’.
  • Korean Stock exchange is open to foreign investor, who owns more than one-third of Korean stocks.
  • The economy is heavy dependent on manufacturing sector, which is expanding steadily. However, it has not been able to develop service sector. The universe of manufacturing industry ranges from cars to aerospace, robotics to biotech and rechargeable batteries to material science.
  • Further, the companies invest heavily in R&D and much effort is made to reduce income inequality. Exports has grown steadily over past decade and now account for almost 53% share in GDP.
  • Samsung, Hyundai and LG are the top three Korean companies that have global presence today. Further, other Korean companies produce wide range of products, have higher pricing power and strong profits compare to its global peers.
  • Korean prefers to invest in home country rather than investing in foreign countries. This personal drive of Korean has boosted manufacturing sector within the country.
  • Apart from manufacturing Korean have brought innovation in story script, films and music.
  • The Korean stock are normally traded at discount to its value as most of its business are family owned, which is seen as more interested in generating market share rather than profits. To overcome, this situation, many reforms with respect to financial reporting and frequency of reporting are introduced within the country. 
  • Further, the banking sector is under-developed; as a result large companies are dependent on external funds.  
  • High possibility to be Breakout Nation.

Overall the author suggests that Czech Republic, South Korea, Turkey, Poland, Thailand, China and Philippines have capability to be next set of Breakout Nations.