Terra Firma

There are plenty of deceptively simplistic words and phrases in the lexicon of international politics. The term “leftist”, applied to both Venezuela’s President Hugo Chávez and Brazil’s President Luis Inácio Lula da Silva, obscures vitally important differences in the two men’s political philosophies and governing styles. What does the word “conservative” mean when applied to various senior figures in the Iranian government? Or the US government?

The term “emerging market” is another such deceptively simple term of art. I define an emerging-market state as one in which political threats to state stability matter at least as much as economic fundamentals for the performance of its economy. But the phrase “emerging market” as it is commonly used conceals crucial differences in how the governments of these states govern – and what these differences mean for the development of their economies.

Take the four most talked-about of the emerging-market countries. Since a team of Goldman Sachs economists popularised the term “BRICs” (Brazil, Russia, India and China) in October 2003, these countries have assumed ever-greater importance in the international investment community’s collective imagination. The Goldman Sachs analysts argued that, with sound political leadership and a bit of luck, these four economies could collectively outpace the original G6 industrialised nations in dollar terms by 2040 – a profound shift in the world’s economic balance of power.

Yet the political factors that drive economic policymaking in these countries differ in crucial ways. There are good reasons to invest in each of them. But for long-term growth potential with limited downside political risk over the next ten years, India’s investment climate holds important advantages over China’s, while Russia has many of the investment-unfriendly attributes of a classic petro-state. From a political risk perspective – and leaving aside differences of scale in the four economies – Brazil’s upside potential and limited downside make it the best long-term bet of the four.

Brazil – Determinants of economic growth will have less to do with politics

First, Brazil may already have “emerged”, because its problems are now the sort that challenge relatively mature free-market democracies. When Lula became Brazil’s first “leftist” president in 40 years in 2002, many feared he would renege on campaign promises to pursue disciplined economic policy at the first sign that profligate social spending would boost his popularity. Some worried he might follow the lead of Venezuela’s Chávez and throw Brazil’s economic liberalisation into reverse. None of that has happened. Lula is known as a “leftist” mainly because he made his reputation as a tough-minded labour negotiator. But Lula is a pragmatist and deal-maker, not a Chavez-style ideologue.

As a direct result, Brazil has come a long way over the last half decade. It has paid its debt on schedule, the economy has generated more than 4.5 million new jobs, and annual trade surpluses now top $40 billion. The lowest inflation rates in decades and an expansion of consumer credit have bolstered the purchasing power of millions. Many among the rural poor receive small, but badly needed, monthly payments from the state in exchange for keeping their children in school and ensuring they are properly vaccinated. The variables that now determine how quickly Brazil’s economy will grow have more to do with reform projects, inflation, regulatory debates and fiscal policy than with risks of political instability or debt default.

Of the four BRIC countries, Brazil has by far the lowest average growth rate, and a tax burden of nearly 40% of GDP. Fiscal and pension reforms will progress only by fits and starts. But the transformation of Brazil’s political left, a domestic consensus in favor of disciplined, market-friendly macroeconomic policy, and stable democratic governance have created a solid foundation for long-term growth.

India – Looming skilled labour shortage may slow India’s emergence

India’s relative political transparency and progress on economic liberalisation have attracted plenty of investors looking to hedge bets on China’s longer-term political stability. The country continues to slowly shed the statist economic model that generated the infamous “Hindu rate of growth” before ambitious liberalisation began in 1991 under former Finance Minister (now Prime Minister) Manmohan Singh. The country’s increasingly pragmatic relations with China, the United States and, most importantly, Pakistan suggest that its political stability is an increasingly strong bet. As in Brazil, India’s growth prospects now depend more on economic fundamentals than on political management of threats to state stability.

But political challenges remain, including some directly related to India’s ability to grow its appeal as an information-technology investment hub. These challenges reveal the risks associated with the country’s decentralised democratic politics. Unless India’s central government can persuade local leaders and their diverse constituencies to collaborate on an ambitious nationwide education reform programme, India will soon face shortages of the workers this fast-growing sector will need. The country’s IT and engineering schools remain world-class, but its primary schools and universities cannot keep pace with growing demand for high-skilled labour. Only 25% of India’s university graduates are now qualified for work in the service sectors that are fuelling India’s economic expansion.

Local officials, who control education policy within their districts, have resisted the central government’s early efforts at reform. In the near term, faculty shortages and poor infrastructure can be improved at the margins. But the country’s factionalised politics continues to limit state and local co-operation on these problems. This looming shortage of skilled labour threatens the speed of this emerging market’s emergence.

China – Globalisation poses growing challenges

China must manage a much broader range of domestic and international challenges than those facing Brazil or India. The country’s growing demand for secure and reliable long-term supplies of the oil, natural gas and other commodities needed to fuel its economic growth exposes China to the tangle of international politics as never before. The Communist Party leadership has relatively little experience managing political risk in the Middle East, Africa and Latin America, as well as protectionist threats from Europe and the United States.

But the country’s greatest challenge is in managing the growing risks generated at home by the unprecedented speed with which ideas, information, people, money, goods and services now cross international borders. Globalisation bolsters long-term stability in Brazil and India by making their opening economies and societies more dynamic.This is true to some extent in China as well. But globalisation has also brought China severe environmental damage, widening gaps between rich and poor, large-scale social dislocations as millions migrate from the countryside to cities, and the social unrest that bubbles up when an authoritarian government provides its citizens with so few opportunities to vent their anger over all these changes.

In addition, China’s long-term growth prospects may fall victim to the success of its one-child policy. According to analysis from Deutsche Bank, the percentage of working-age Chinese in the population (those aged 15 to 64) will peak around 2010 at 72.2%. Over the next 40 years, that number will fall to just 60.7%, according to UN forecasts. The picture may be darker than these numbers suggest. Many Chinese leave the workforce well before the age of 64; the current retirement age is 50 for most women and 60 for most men.

The country’s pension system is not prepared for this problem. The International Monetary Fund has projected that the transition from the current pension system to a more sustainable one could cost China $100 billion, not including local government obligations – though it is clearly difficult to forecast what it will cost China to care for the estimated 265 million people who will be 65 or older by 2020.

The collective risk generated by all these challenges may eventually persuade more foreign investors, already wary of China’s opaque, authoritarian political system, to further diversify their portfolios in favour of investment in other emerging markets.

Russia – Economic stability depends on global energy markets

Russia’s growth is based on (and limited by) very different factors than exist in Brazil, India or China. The country’s growing middle class offers excellent opportunities for investors in the retail, banking, high-tech, telecoms, pharmaceuticals, automotive assembly and food production sectors of the economy – though corruption clouds the picture in all these areas. But in sectors the state has formally designated as “strategic”, the Kremlin has proven interested mainly in leveraging Russia’s enormous resource wealth to consolidate control of domestic politics and to restore Moscow’s international clout, particularly within former Soviet territory. This strategy threatens Russia’s emergence in several ways.

First, the key assumption underlying the Goldman Sachs’ projection was that the BRICs would hit their growth targets only if political leaders committed themselves to “maintain policies and develop institutions that are supportive of growth.” But Russia’s recent growth is based mainly on the revenue windfall generated by high oil prices, leaving economic stability at the mercy of cyclical global energy markets. Brazil, India and China have neither Russia’s natural resources nor the temptations they offer to resist foreign investment.

Second, Russia’s small- and medium-sized businesses account for only 13% of Russia’s GDP. While energy exports account for one-fifth of the country’s growth, the sector has produced only about 1% of Russia’s jobs. This lack of diversification limits the country’s capacity for technical innovation on which longer-term growth will depend. In reality, Russia should be considered in an entirely different category than Brazil, India, China and other so-called emerging markets.

Crucial differences in the political factors that will drive economic change

The analysts at Goldman Sachs were wise enough to hedge their bets on all four countries, but long-term economic projections that hold political variables constant are likely to be revised many times before they reach maturity. Had we turned to economists in 1977 to offer 30-year growth projections on Brazil, India, China and the Soviet Union, we would not have been well-served by their forecasts. In other words, the impact of politics on markets ensures that not all emerging markets are created equal. This catch-all phrase will remain in wide circulation. It should not obscure the quite different political circumstances that will drive economic change in each of them.


Ian Bremmer, President, Eurasia Group

Ian Bremmer is president of Eurasia Group, the world’s largest political risk consultancy. He is also a columnist for Slate, a contributing editor at The National Interest, and a political commentator on CNN, Fox News and CNBC.