January 10, 2014

Ruchir Sharma's "Breakout Nations"

As someone who teaches regularly on global economic interconnection, trying to find meaningful, book-length treatments of contemporary markets that are written for a broad audience is important to me. Even when there is a lot to be critiqued in a work, the efforts are valuable. Among the more popular examples of such a work is Fareed Zakaria’s Post-American World, which discussed the "rise of the rest" relative to the developed economies, and even made a brief cameo as a debate point in the 2012 presidential campaign.

I am pleased to report that Ruchir Sharma’s Breakout Nations is a worthy successor to Zakaria’s snapshot of the state of the global economy. Despite some notable flaws, Sharma’s work is ambitious and informed. It has much to critique precisely because it is so ambitious. Sharma’s major conclusions are spot on, though I still have unanswered questions.

Sharma argues that the euphoria in emerging market investing, typified by the BRICS (Brazil, Russia, India, China, and South Africa), is not warranted. Not only do the BRICS economies not share common interests, but that it makes no sense to be treating emerging markets as a singular investment vehicle. He points out that much of the growth in emerging markets since 2003 has been driven by a flood of easy money from central banks, largely channeled into commodities and hot money investments around the world, as well as a now diminishing demand for commodities in China as its rate of growth slows. This will disproportionately punish commodity-driven exporters relative to peer economies, and reveal new “breakout nations” whose leaders and decisions have better positioned their economies to deal with a new reality of higher interest rates.

What investors are left with is a more confusing environment where each market, and each individual company, has to be looked at on their own, largely under the traditional rules for determining sound investment, political, and economic risk. Who has wise leadership, good institutions, and innovation? The coming winners include Turkey, Indonesia, South Korea, Poland, the Philippines, as well as the United States and Germany. Meanwhile, Brazil, Vietnam, Russia, and Hungary are among those headed for problems.

Chapters are clearly written guided tours of the main emerging markets of interest to investors. Sharma, head of Emerging Markets and Global Macro at Morgan Stanley, gathers his evidence through a combination of data analysis, as well as gut reactions, combining them into “rules of the road,” which are shared throughout the book. 

This is fun reading, but also disconcerting. There is no systematic way of knowing which rules apply under which conditions, or to what degree relative to each other. Sharma himself uses the phrase that it is “more art than science.” Nevertheless, his rules of the road reveal some intriguing indicators, such as second-city growth relative to capital cities, the potential downsides of a country’s companies’ deciding to “go global,” and methods through which a country’s billionaires make their money.

Sharma makes a point to travel to the emerging markets he is responsible for in his investment portfolio, and gathers intelligence from “locals.” It is not always clear which locals he is meeting with; and, while I don’t begrudge his protection of assets that lend to his professional advantage, there’s no way of knowing whether his conversations actually reflect broader opinions in the population.  Like Friedman’s notorious cab drivers, one wonders how often Sharma leaves the hotel at times.

For example, Egypt’s Muslim Brotherhood is seen through the prism of its rising stock market, not the popular coup which followed, and was encouraged by the same class of people who were of core importance to removing Mubarak. Brazil is held up repeatedly as a place where the population is going to punish incumbent politicians, yet the PT appears poised to win another presidential election (too soon to tell), even in the face of last summer’s massive protests. Turkish and Thai leaders are praised (particularly the former) for building bridges across societal divides and promoting economic growth. However, recent history has not been kind to these cases.

Another flaw is that there is inconsistency in how Sharma’s rules are applied across his cases, with amorphous cultural explanations sometimes given to explain his judgments. Conditional cash transfers (CCT) in Brazil and Mexico are bad investments (and not well explained to the reader), but other human capital investments are good. Brazil’s large internal market, benefitted by anti-poverty programs, is a socialist drain, but the large internal markets in Indonesia, Poland, and potentially the Philippines, help to weather macroeconomic storms. More is badly needed on CCT programs, and Sharma’s definition of socialism cries out for conceptual clarity.

One final, and glaring issue, is Sharma’s attempt to link economic recovery from the Great Depression in the United States to some sort of Hayekian policy set. Yet, the role of the massive Keynesian stimulus from World War II merits barely a mention, and not until the end of the book. It is simply skipped when comparing Eastern European austerity to the U.S. in a way that undermines the credibility of the argument. I was left wondering whether Sharma was more interested in promoting a political agenda, or if he simply doesn’t know much about American economic history during the war.

But to reiterate my earlier point, I highlight these problems only because they are so out of step with what is an intriguing and highly informative set of case studies, and main points that I find wise to consider. I would be extremely interested in a full treatment on how his predictions have played out, particularly with respect to Mexico and Turkey. In Mexico, President Enrique Peña Nieto has tackled the challenge of major sectoral reforms, while Erdogan in Turkey is struggling mightily with advancing his agenda, and whose charisma is no longer bridging necessary gaps in society. The slow rollback of easy money has begun to taper in the United States, and Abenomics is seeking to turn the corner in Japan. Sharma’s take on infrastructure investments over more poverty reduction, in light of the World Cup, will be playing out in Brazil. I’d appreciate reading Sharma’s views on all of these developments.

Ultimately, this highlights the struggle in writing about development; history and money move faster than publishing. I will be looking for, and assigning, more of Ruchir Sharma’s writing (registration or subscription required). For now, Breakout Nations is well worth the effort to read. 

*I received desk copies of the books mentioned above for classes taught, and no compensation for this review. 

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