Practice matters more than theory in investing, and The Rise and Fall of Nations by Ruchir Sharma was one of the best summaries of emerging markets I’ve come across. There are not many books I feel compelled to summarize, but this is one of them.
Adapt and use to your own ends.
People Matter: population matters, but sheer size isn’t that important.
Heuristic: is the working age population growing at 2%? Good heuristic that relates to future growth. In general is the economy and society opening up opportunities for the elderly, women, foreigners to contribute?
Circle of Life: a single regime in power too long will go stale.
Heuristic: where is the economy/society in the cycle of crisis -> revolt -> reform -> complacency? Societies that are positioned to allow a turnover of power during the revolt phase are better positioned for future growth.
- Contrary to consensus, autocratic governments are NOT correlated with sustainable economic growth. Those in favor will cite South Korea, Taiwan, China – BUT, look at Venezuela, Iran, Syria, Iraq.
- Autocracies are prone to long slumps and flip-flops of fortune. Since 1950, of 36 countries that showed 9 years of 7%+ growth followed by 9 years of -% growth, 27 were autocracies.
- Countries such as Iran, Ethiopia, Iran, Jordan, Syria, Cambodia, Nigeria, all showed 15+ years of 7% growth in the post WWII period. But, these booms were wiped out by long slumps.
Good/Bad Billionaires: billionaire lists are good indicators of the structure and incentives in the economy.
Heuristic: how much of the economy do billionaires control? Is there churn/change in the billionaire lists? Are the lists for any particular country dominated by rent-controlled (i.e. prone to corruption) industries?
- Inequality is a fact of capitalism, this in and of itself is not the issue. Inequality is also present in all stages of development: poor, middle income, rich countries. Also, redistributive policies also enhance corruption.
- Compare India’s top 10 tycoons controlling 12% of GDP in 2010 <=> in China, the same figure is 1%. Russia, 16%. Red zone above 15%.
- Bad billionaires = “sour cream that rise to top of corrupt societies”
- Observations on how inequality kills growth: a) rich have marginal propensity to consume b) inequality calls for bad policies @ exact wrong time – taxes, transfers c) rich more likely to indulge in financial speculation d) strong link to corruption – i.e. purchase of political power.
Perils of the State: how much is the state meddling in the economy?
Heuristic: what is the direction of the change of state control? Change in level of government spending as % of GDP. Is the spending going to productive ends? Do private companies have room to grow? Any misuse of companies and banks for political ends?
- US, Austria, Australia – state spends 35-40% of GDP. Brazil – 40%, Russia – 50%.
- BUT: perils of a small state as well in the form of uncontrollable civil wars, black economy, tax dodgers. Mexico – 14% of GDP, Pakistan has 180 million people but 1 million file taxes.
- Indonesia: president can be impeached if the deficit is > 4% of GDP.
- Many draw the wrong lesson from China. Only started to become an economic superpower after the state began to meddle less. GDP of SOE’s fell from 70% to 30%.
- Although: in 1990s in China, didn’t have cash to burn, so couldn’t borrow way to growth. In 2008, the reverse was true. As a result, in 2007 where it took $1 of spending to generate $1 of GDP in China, now $4/$1.
Location: is the economy making the most of, or is it poised to make the most of its location?
Heuristic: what % is trade of GDP? Total trade volume < 50% of GDP is ‘closed’ economy. How large is the second largest city compared to the largest? In midsize nations, the ratio should be 1/3. Is the economy next to big markets or shipping lanes?
- Brazil: trade is 20% of GDP. Being open to trade means economies are more competitive. In 1880s, Sweden was poorer than the Congo. Dubai – open house in a closed neighborhood, biggest Iranian expat community after the US.
- Bangkok 10 million, Chiang Mai 1 million. Paris/Lyon ratio is 7/1. Whereas, Mexico has produced 10 cities of more than 1 million in population since 1985, India has only grown 2 cities of less than 250k –> 1 million+. This is important, as it shows whether the economy is distributing growth evenly.
- Notes that the headquarters of service industries from finance to insurance, to law, are congregating in a network of 50 global service cities.
Factories first: is investment increasing or decreasing?
Heuristic: is investment + or -? When rising, probability of accelerated growth is higher. Sweet spot = 25%/GDP during the course of the boom. 25-35% puts the economy in a strong position to grow. <20%, weak. Beyond 35%, could be a binge/excessive.
- Investment is the most important driver of growth and business cycles.
- “Manufacturing” escalator has been proven; i.e. manufacturing and factories as a ticket out of poverty. No other business has the ability to play such a booster role – job creation, export earnings, national development, etc. “Service” escalator has been touted, but not proven: problem is that in many EM, service jobs are mom + pop stores, barbers, taxi drivers, etc., so not a route to mass employment nor export earnings.
- Hard to know whether investment is going up or down. Look at: a) scale of public investment plans b) is state luring private companies to invest.
Prices: “most long booms have been accompanied by low inflation”
Heuristic: is inflation low or high.
- High inflation is always a bad sign. Young economies are vulnerable to demand-driven inflation if supply networks are underinvested.
- Rulers often toppled when food prices are high. Examples from history are rife; i.e. revolutions of 1848, 1946-83 in Latin America, coups.
- Examples often given of China, Taiwan, Singapore, South Korea – however, they rarely saw inflation > the EM average.
- When inflation is high, it also tends to be volatile, leading to uncertainty and stalled investment/decision-making.
- Deflation: long bouts are rare, but 1 year periods are not.
- 1990s were a paradigm shift in Central Bank decision-making: explicit targeting of inflation. Now, globalization has stabilized inflation, but destabilized asset prices.
- Fed leads a global culture of central banks who see their job as stabilizing prices, but for consumer goods only.
Cheap is good: follow money flows
Heuristic: what do cross-border flows look like? If current account (broader measure of remittances, foreign aid, overseas borrowing) deficit has been rising for 4 years, and hits a peak of 5% of GDP, a good chance that it will reverse as confidence in the country is lost. Are locals moving their money in or out of the economy?
- A currency collapse is often the starting point for stabilization, to growth again.
- Many countries make fallacious assumption that currency strength = bright economic future.
- Devaluing your way to prosperity does not work as this invites the same from other economies. Also, a) makes foreign debts more expensive b) will kill an economy with a small manufacturing base c) imports more expensive. Some may cite the case of China, but also consider Brazil, Turkey, Nigeria, Argentina, Greece. The strategy should be to make price-insensitive goods of high quality i.e. Switzerland.
- Locals, not foreigners, are the first to indicate a currency crisis. Better information, more sensitive to informal signs.
Kiss of debt
Heuristic: is debt growth growing faster or slower than economic growth? Look over a period of 5 years. High chance for slowdown if consistently higher credit/GDP ratio.
- Thailand in 1990s – economy growing at 10%, debt at 25%.
- Since 1960, the 30 most severe cases of 5 year credit growth all resulted in some form of slowdown.
- The world now is more deeply burdened by debt than it was at the outset of 2008 crisis. $21t increase in China since 2007 – out of total $57t for the world.
- This is the case despite the presence of savings or currency reserves. Taiwan in 1995 saw a banking crisis despite having fx reserves that were 45% of GDP. In Japan and Malaysia in 1970s/1990s respectively, savings were 40% of GDP.
Hype watch: what are the talking heads saying
Heuristic: be cautious of hype – and conversely search for the economies that are not being watched.
- Cover curse. If TIME magazine downbeat about an economy, then fortunes reversed 55% of the time within a few years. Conversely if it was upbeat, then reversed 66% of the time.
- 1970s – Venezuela’s income level was close to that of the US and was called a “rising capitalist democracy”.
- 1950s-1960s – In Asia, Philippines and Burma were rich in metals and resources and were hyped. Everyone had a dim view of China, Taiwan, India, South Korea.
- Commodity economies tend to fall right when prices fall.
- What this shows is that emerging markets tend to be highly cyclical – have boom periods of 5-10 years followed by busts.
Unfortunately I returned the book before I wrote down his picks. However, those I do remember are: Philippines, Indonesia, India, Pakistan, Bangladesh, Czech Republic, Romania, Poland.