Modon 1 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. Modon 2 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, Modon 3 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) Modon 4 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 Modon 5 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). Modon 6 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 Modon 7 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. Modon 8 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). Modon 9 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. Modon 10 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. Modon 11 Appendix Figure 1 Figure 2 Figure 3 Note: All graphs in appendix are from Goldman Sachs Global Economics Paper 134 Modon 12 References Bharadwaj, P. N. (2006, December). BRICs countries - A competitive analysis. Journal of Global Competitiveness, 14(2), 52-54. Briefing Russia’s Economy: Smoke and mirrors. (2008, March 1). The Economist, 386(8569), 27-29. The decoupling debate. (2008, March 8). The Economist, 386(8570), 79-81. DeLong, J. B., & Olney, M. L. (2006). Macroeconomics (2nd ed.). New York: McGraw- Hill. (Original work published 2002) Food, fuel, and froth. (2008, March 8). The Economist, 386(8570), 80. Glassman, J. K. (2008, March). Exotic blue chips. Kiplinger’s Personal Finance, 26-28. Harr, T. (2006, June). BRIC - the major issues. Powerpoint presented at Danske Bank. Herra, A. (2007, October 22). “BRIC” countries top many industrialized nations in environmental. In Worldwatch Institute. Retrieved March 8, 2008, from http://www.worldwatch.org/node/5410 An independent streak. (2008, January 26). The Economist, 386(8564), 72. India: Human development index. (n.d.). Human Development Report. Retrieved March 12, 2008, from United National Development Programme Web site: http://hdrstats.undp.org/countries/country_fact_sheets/cty_fs_IND.html India’s Economy: Open wide. (2008, March 8). The Economist, 386(8570), 94. O’ Neill, J., Wilson, D., Purushothaman, R., & Stupnytska, A. (2005, December). How solid are the BRICs? (Global Economic Paper No. 134). New York: Goldman Sachs. Poles apart. (2008, February 16). The Economist, 386(8567), 82. Modon 13 Purchasing power parities. (n.d.). Organization for economic co-operation and development. Retrieved March 11, 2008, from OECD Web site: http://www.oecd.org/department/0,3355,en_2649_34357_1_1_1_1_1,00.html A stimulating notion. (2008, February 16). The Economist, 386(8567), 81-83. What’s holding India back? (2008, March 8). The Economist, 386(8570), 11.
Pages to are hidden for
"BRICs A Look at Economies of Emerging Markets"Please download to view full document