BRICs A Look at Economies of Emerging Markets

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 BRICs: A Look at Economies of Emerging Markets




                              Michael Modon

                                April 26, 2008

                       Intermediate Macroeconomics




                                     Abstract

This paper examines the current economies of Brazil, Russia, India, and China.
Investment firm Goldman Sachs has determined that these four countries will become
economic superpowers by the year 2050. The paper examines the different factors of
countries and their reasoning for becoming economic powers. Upon the conclusion,
there is a comparison to the United States historic economic development.
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       In 2003, Goldman Sachs examined the global economy and observed the future

capabilities of a cluster of nations, specifically Brazil, Russia, India, and China. Coined

as the “BRIC” countries, the American investment firm has hypothesized that these four

countries will become the next economic superpowers by 2050. When reexamining their

thesis again in 2007, Goldman Sachs remains firm in declaring that Brazil, Russia, India,

and China are well on their way to becoming fully developed economic powers by, at

latest, the year 2050. Many different variables such as inflation rates, government deficit,

and technology were examined in determining these four countries’ futures. Due to the

huge influx of technology in recent years, underdeveloped countries show huge potential

in growing and expanding in world markets. The BRIC countries somewhat resemble the

United States when it experienced huge amounts of growth, allowing for its rise in

economic power.

       Goldman Sachs has developed an index in determining which countries are

considered “developing” countries. From this index, called the Growth Environment

Score (GES), the company has grouped data into five different groups: macroeconomic

stability, macroeconomic conditions, technological capabilities, human capital, and

political conditions in order to fully explain their model (O' Neill, Wilson,

Purushothaman, & Stupnytska, 2005, p. 10). Figure 1 shows how several developing

countries score on the GES. From these five base factors, the company sees potential in

Brazil, Russia, India, and China. The actual measurable data variables are inflation,

government deficit, external debt, investment rates, openness of the economy, penetration

of personal computers, phones, the Internet, education, life expectancy, political stability,
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rule of law, and corruption. While this is similar to the Cobb-Douglas production

function of Solow Growth model, which states that

                                           Y/L = (K/L) α (E) 1-α,

the Growth Environment Score has broken down the core variables into more easily

obtainable data.1

       Overall, the BRIC countries seem to have many positive factors surrounding them

since the term was coined back in 2003, and investors in the finance world are starting to

notice. In 2007, emerging stock markets in Asia returned grew 33%. An average of a

30% increase in value of currency was seen in Latin American countries (Glassman,

2008, p. 26) Figure 2 shows the performance of the financial markets of the BRIC

countries. Of the top 100 companies of “new global challengers” determined by Boston

Consulting Group, 41 are based in China, 20 in India, and 13 in Brazil. There are other

indices that look at emerging market growth besides Boston Consulting Group’s

classifications.2 American mutual fund companies have recognized this potential in

foreign countries and have created opportunities for American investors. For example,

the Fidelity Emerging Markets fund (ticker symbol FEMKX) has experienced a

prosperous run by having over twenty percent returns each year since 2003 (Glassman,

2008, p. 28). In this diversified fund of over 200 stocks, 12% belong to Brazil, 10%

belong to China, and 7% are Indian companies, mostly focusing on the energy sector. As

a whole, all four of the BRIC countries scored in the top eleven in a ranking of



   1
     The Solow Growth Model Equation is Y/L = (K/L)α (E)1-α, where Y is the Gross Domestic Product of
   a national economy, K represents the total amount of capital, E is the amount of technology, and L
   represents the amount of labor (DeLong & Olney, 2002/2006, p. 87).
   2
     The Fortune Global 500, a list of the publicly traded firms with the highest revenues, included 35
   companies from China, Brazil, and India, an increase of about 50%, or 24 companies, since 2005.
   (Glassman, 2008, p. 26)
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environmental commitments for emerging countries defined by the Organization for

Economic Cooperation and Development (OECD) (Herra, 2007). In this ranking, the

OECD ranks the countries on their “efforts to build prosperity, good government, and

security,” and looks at data regarding trade, investment, migration, environment, security,

and technology (Herra, 2007). This figure is extremely important to the larger countries

like Russia and Brazil, specifically because natural resources are available in these

regions of the world. India and China, on the other hand, beat all other countries in

population, each having over one billion citizens. This could allow for the countries to

expand their GDPs simply because their labor forces have the potential of being so large

compared to other global competitors. It is also noted that the four developing countries

are among the top seven in land, top eight in population, top ten in terms of GDP

purchasing power parity and top fourteen in nominal GDP. Population in the BRIC

countries accounts for 40% of the world (Bharadwaj, 2006, p. 52). Purchasing parity

power, according to the OECD, refers to the currency conversion rates that eliminate the

difference in price levels during conversion. Countries with high purchasing parity

power show signs of having a strong economy.

       As host of the 2008 Summer Olympics, much attention has become focused on

China. The country is the most populated in the world, and is showing signs of potential

economic development. Growth in China is blistering, with GDP values increasing by

11.2% in the fourth quarter in 2007 and 11.5% in the third quarter of the year.   China’s

debt is a good proponent of huge GDP growth. The country’s public debt is only 17% of

its GDP, which is far below the average of developing countries ("Poles Apart," 2008, p.

82). China scores extremely well with the Growth Environment Score in macroeconomic
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stability, investment, openness to trade, and human capital (O' Neill, Wilson,

Purushothaman, & Stupnytska, 2005, p. 11). However, technology is currently holding

the Chinese back from rapid expansion. Computer usage is still not up to standard

compared to other emerging markets countries. With over 1.3 billion people in the

country, the capability for Chinese production to become a very powerful factor in their

economy is present. Figure 3 shows how the Chinese economy scores in each of the

thirteen sub-categories that compile the GES, along with the other three nations.

       One of the biggest concerns with the economic expansion of China is the threat of

the coupling theory. The United States economy has become soft after prosperous years

between 2004 and 2006, and many economists fear the American economy will be going

into a large recession, assuming it has not occurred already. The biggest apprehension

with the Chinese and other Asian markets is the idea that the United States markets will

bring down its Asian counterparts with it. The “decoupling” theory states that the outside

economies, particularly Asian markets, can shrug of an American recession ("An

Independent Streak," 2008, p. 72). While this idea that the Asian markets can expand

while the American ones contract seems good for foreign countries, exports and profits

will be squeezed due to the recession in the United States, thus somewhat affecting the

global economy. The good news, however, is that the Chinese are not as exposed to the

“coupling” theory because exports to the U.S. make up only 8% of the national GDP.3

Over 95% of China’s growth of 11.2% in the fourth quarter of 2007 is from domestic

demand ("The Decoupling Debate," 2008, p. 79). It has been noted that “China’s

economy would probably still expand by around 8-9% if export growth dried up. During

   3
     This number is relatively small compared to other East Asian countries. Exports account for over 20% of
   the GDP of countries like Singapore, Hong Kong and Malaysia. On the other hand, India’s exports to the
   United States only accounts for 2% of their GDP ("An Independent Streak," 2008, p. 12).
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the 2001 American recession China’s GDP growth barely slowed.” ("An Independent

Streak," 2008, p. 72) While theoretically it looks at though the Chinese economy will be

able to decouple from the United States, recent events would say otherwise. The Chinese

stock markets seem to be extremely affected by the movements in the American markets.

       The second most populated country in the world, India, is another vital piece to

the BRIC puzzle. India focuses on the services industry, with a concentration on

information technology, as well as on pharmaceutical companies (Glassman, 2008, p.

28). Since the BRIC countries were defined, India has seen a vast expansion in their

economy, growing by 9% per year since 2004 ("What's Holding India," 2008, p. 11).

India has a democratic government, and thus their rule of law, coupled with external debt

and inflation, are major drawing points for having India’s economy surge in future years

(O' Neill, Wilson, Purushothaman, & Stupnytska, 2005, p. 11). However, this was not

always the case. India suffered many years under a socialistic government, and this

burned the economy: annual GDP growth rates between 1965 and 1975 are only 2.6%,

which was close to the population growth during that time period of 2.3% ("India's

Economy: Open," 2008, p. 94). This significantly hurt the country’s standard of living,

especially because there was no room for improvement in their average household

income. Looking towards the future, India’s economy has been growing significantly,

allowing for the capability for standard of living to increase in the nation. In addition, the

low inflation is a benefit for India’s economy because it encourages investment and

growth performance.

       One of the biggest barriers that India has to face is the lack of education of its

citizens. The country’s Human Development Index (HDI), a measurable figure of a
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country’s socio-economic status looking at poverty, illiteracy, low-life expectancy, and

over-population is extremely low, earning them an HDI value of .619, ranked 128th in the

world4 (“India: Human Development”). India’s literacy rate of citizens over 15 years old

is only 61%. However, since India is considered the poorest of all the BRIC countries,

this allows for the growth potential to be the greatest as well. Another obstacle the

Indians have to overcome is the horrible gap between rich and poor. Over 75% of the

population live on USD $0.50 daily ("India's Economy: Open," 2008, p. 94). Because so

many people in the country have so little money, consumption spending and investment

are extremely minimal by a majority of Indians. India’s infrastructure is extremely

weak, and while the government is considered democratic, the size of the government is

large. Around 10 million individuals work for the state ("What's Holding India," 2008, p.

11). Having a large amount of the population work in the public sector does not help

increase output, and thus income per individual tends to diminish as well. Because the

population is growing so fast, citizen income is struggling to grow compared to other

BRIC countries.

          The other two counterparts to China and India are Brazil and Russia. Both are

considered to be in the shadows of the Chinese and Indian economies, but are still

projected to become economic superpowers. Unlike China and India, the population is

not as big of a factor, but instead natural resources in Brazil and Russia are extremely

important. Brazil has had a democratic government since the 1980s and considered to be

politically stable. Another huge benefit to Brazil is the amount of technology, where the

number of computers, phones, and an individual’s capability of accessing the Internet are

all above average for developing countries (O' Neill, Wilson, Purushothaman, &
   4
       In comparison, the HDI value of the United States is .951, ranking them 12 th out of 177 countries.
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Stupnytska, 2005, p. 10). The country has just become a net creditor, and their national

stock market, Bovespa, has been evaluated deemed the single most progressive index in

the MSCI by Citigroup. The Brazilian index is up 5% since October 2007.5 Brazil’s

location and climate provides for rich soil along the Amazon River, and with technology

and capital, can easily increase the amount of natural resources used to create products

for the country. Neither Brazil nor Russia truly relies on the United States as a

contributor to the growth of their economy. Only 3% of Brazil’s GDP is exports to the

U.S., and they only account for 1% of the Russian economy ("The Decoupling Debate,"

2008, p. 79). This is a good indicator that both of these foreign markets should not be

dramatically affected with the economic recession the U.S. is experiencing today.

       In transition of a new president, Russia has become a very interesting country that

has much potential in becoming an economic power. The country has experienced

annual growth of real income consistently in double digits ("Briefing Russia's Economy,"

2008, p. 27). Russia scores well for the GES with political stability, technology, and

openness of trading. (O' Neill, Wilson, Purushothaman, & Stupnytska, 2005, p. 10-11)

Internally, the country is supporting construction, where the industry is growing by nearly

20% annually ("Briefing Russia's Economy," 2008, p. 28). The development of

infrastructure is extremely important in Russia because of the size and geography of the

country, and transportation costs are extremely high due to the fact that there is so much

undeveloped land east of Moscow. Also, Russia is focusing on the importance of capital

in their economy. Capital investment increased by 21% last year in Russia. The last

important piece of evidence to look at regarding Russia is the amount of foreign direct


   5
    During the same period, the Chinese stock markets have decreased on average by 20% ("Food, Fuel,
   and Froth," 2008, p. 80).
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investment in the country. Last year alone, the amount of foreign direct investment

doubled to $27.8 billion ("Briefing Russia's Economy," 2008, p. 29). However, this

value is only 2.2% of the country’s GDP, which is an extremely low value.

       Natural resources contribute to Russia’s potential simply due to the immense size

of the nation. The country has used oil as the main drive to keep their economy afloat.

However, with the extreme volatility of the price of oil today, there is some risk

associated with having so much invested in the commodity. According to the Institute of

Economic Analysis, 31.6% of Russia’s GDP is contributed to oil and gas ("Briefing

Russia's Economy," 2008, p. 27). With the price of oil increasing enormously over the

past few months, attention has been drawn Russia’s economy because it is so affected by

the price of fuel. Because the Russian economy is not very diversified, the country’s

growth could be severely affected. If the price of oil were to fall dramatically, it could be

detrimental to the Russian economy. Another restriction Russia has developing is the

amount of corruption in the country. Law enforcement is constantly bribed by private

firms to bend the rules.

       The BRIC countries are somewhat mirroring the rapid growth of the United States

economy during the Industrial Revolution. During this time period, America was gaining

inventions of machinery like the steam engine, cotton gin, and wheat shearer. While the

U.S. was entirely an agrarian nation, these inventions, which can be referred to as capital,

helped increase production in the United States. Income per person rose, and it helped

propel the U.S. to grow, both physically and economically. The BRIC countries also

started to resemble the “dot com” bubble in the late 1990s in America. The economy

expanded immensely, as seen in the domestic stock markets, as technology increased.
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This increase in technology leads to an increase in efficiency and theoretically should

increase individual income as well as growth in the country. Yet, unlike any of the BRIC

countries, the United States has always had political stability and a capitalistic economy

to promote innovation and competition throughout periods of economic expansion.

When these emerging market countries develop over the next few decades, it will be

interesting to see if their political structure changes, prospers, or suffers.

        The four leaders in the emerging markets group – Brazil, Russia, India, and China

– all have somewhat similar situations. All four countries have many positive factors that

contribute to their overall potential. However, all four also have a few limitations that

could bottleneck their economy and not allow for growth as predicted. Given the

appropriate figures, Goldman Sachs believed the BRICs countries to be economic

superpowers by 2050. The four nations seem to be off to a good beginning, having all

posted favorable returns to foreign investors. Hopefully, with the effects of increasing

technology promoting globalization, the growth seen in Brazil, Russia, India, and China

jumpstarts many other poor economies toward growth and prosperity.
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                               Appendix

   Figure 1                                                      Figure 2




                                Figure 3




Note: All graphs in appendix are from Goldman Sachs Global Economics Paper 134
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