POINT OF INFLECTION
Ruchir Sharma’s The Rise and Fall of Nations challenges some of the conventional suppositions of standard economic growth models
On December 11, 1971 Simon Kuznets in his Nobel Prize acceptance lecture defined the conditions and consequences of modern economic growth. His pioneering research, which covered growth, income and demographic data over two centuries, demonstrated how, between 1750 and 1950, aided by advances in technology and labour productivity, growth in per capita income far outstripped population growth.
Kuznets’s Nobel lecture detailed six broad characteristics for growth, which later became the guiding benchmarks for the next generation of growth economists.
High growth economies, Kuznets argued, had the following distinctiveness: GDP, per capita and population growth rates were greater in large multiples over the previous period; labour productivity always recorded a sharp jump during the high growth period; the economy moved from an agrarian structure to a manufacturing and, later, to a more sophisticated services sector; urbanisation and secularisation was a given by-product; the modern growth economies brought the world closer through trade and technology; but the spread of modern economic growth remained limited because the benefits hardly percolated to the vast majority of the world population.
In many ways, Ruchir Sharma’s The Rise and Fall of Nations: Ten Rules of Change in the Post-Crisis World challenges some of these conventional suppositions. Significantly, Sharma, the highly acclaimed Head of Emerging Markets and Chief Global Strategist at Morgan Stanley Investment Management, makes a powerful argument in favour of nudging the discussion “away from the indeterminate future to a more practical time horizon of five to ten years and to the job of spotting the next booms, busts, and protests.”
“Predictions for the next twenty to one hundred years cannot possibly be fulfilled when new economic competitors can arise within five years, as China did in the early 1980s, as eastern Europe did in the 1990s, and as much of Africa did in the 2000s.”
Sharma, whose first book “Breakout Nations: In Pursuit of the Next Economic Miracles (2012)” was an international bestseller, pertinently illustrates in his second book the unmistakable signs that show that the world is at a point of inflection. After galloping at more than 10% for years, the Chinese economy is showing signs of slowing down.
On numerous occasions, this newspaper has held that the problems of “over-capacity” and “over-leveraging” can have toxic consequences as both feed into each other. Over the last two decades, China has excelled in the art, and the science, of turning out high quality goods from its mega industrial zones at costs that are a fraction of what the rest of the world could produce.
Low wage rates aided by armies of young men entering the work force every year and collapsing technology acquisition costs propelled it into becoming the world’s most preferred shopping destination. Factories continued to add new capacity lines to fulfil voluminous export orders. Large capacities also helped companies reap economies of scale enabling them to keep the price low for long periods.
The continuous capacity addition pushed the overall level of investment in China to 46% of GDP, sharply higher than emerging market peers. For instance, investment level in India is currently about 30% of GDP.
China’s banking system funded this massive investment activity. Banks did not hesitate to offer loans buoyed by the assumption that factories will continue to remain flooded with orders from across the world and, therefore, their cash books will remain healthy enough to repay loans. The problem was, nobody was quite sure when to put a stop to creating more capacity in anticipation of an impending slowdown. Many companies raised funds from China’s costlier “shadow banking” sector in a mistaken zeal. So when the twin problems “over-capacity” and “over-leveraging” struck, companies found themselves under-prepared to deal with the cycle of bust.
China’s current state clearly reinforces Sharma’s fear about economists’ and researchers’ tendency towards “confirmation bias”, which is the propensity to collect only the data that confirms one’s existing beliefs.
His 10 rules is a blend of poring through hard data on parameters such as credit, inflation and fund flows along with the so-called softer gauges such as changes in policy and political conditions.
It isn’t easy to anticipate boom and bust cycles, and the past is not always a good proxy for what to expect in the short to medium-term. Recent history is replete with examples showing that “straight-line forecasting” and sweeping single-factor theories can turn out to be a risky proposition, in many ways a counter-view to the widely-held Kuznetsian theory largely based on past empirical evidence.
Sharma challenges the other conservative hypothesis that population growth is not a necessary condition for economic boom.
But the most important point Sharma worries about is rising inequality, partly aided by continued dominance of “rentseeking” activity and crony capitalism.
There is no gainsaying the fact that in countries such as India there exists a class of wealthy businessmen who are believed to have benefitted from their proximity to people in power. There is an argument one can’t ignore that this class of people gets to influence regulations in an economy that still hangs significantly by the apron strings of the government. Incidents of a few years ago show how, while India needed to grow rapidly to address poverty and inequality, the rise of crony capitalism and the subsequent attempt to restrain it had, instead, impeded growth.
A country’s billionaires list, if applied sweepingly, can distort conclusions affecting policy metrics. For instance, on the face of it, a rise in the number of billionaires should mean more people are getting richer reducing poverty. However, that may not be the case. In 2015, according to Forbes, the 100 richest in India had a combined net worth of $345 billion or ₹23 lakh crore, representing 18% of India’s GDP.
The clause ceteris paribus, Latin for other things remaining constant, plays a critical role in textbook economic theory. Sharma critically looks at some of these, challenging the very justifiability of assuming certain events as given in a world that is constantly changing.
The 10 rules in “The Rise and Fall of Nations” serve as an admirable check list for those who may be wondering why the current evidence is contrary to the conclusions laid out in many standard economic growth models.