25 August 2015

The BRICs hit the wall


At the beginning of the new millennium, it became fashionable to proclaim the West’s economic decline and the rise of a new global leadership. In 2001, Goldman Sachs analyst Jim O’Neill captured the trend by coining the soon-to-be-famous acronym BRIC, referring to the leading economically emerging nations—Brazil, Russia, India, and China—that would constitute that new leadership. Eventually, South Africa was added to the group, making them the BRICS, but many people still think first of the original four, and refer to them as the BRICs.

As the 2000s ended, the leaders of these emerging nations symbolized their ambition to replace Western leadership by agreeing to meet annually. The first gathering took place in Ekaterinburg, Russia, in 2009. Last year, at a meeting held in Brazil, the BRICs officially created their own international development bank, with the intention of replacing, or at least counterbalancing, the American- and dollar-dominated World Bank. At each summit, the West’s influence—especially the U.S.’s—over international institutions comes under fire.

Yet while the BRICs often seem unified against a common American adversary (India generally excepted), they have proved far less homogeneous when seeking to define their own future. China, for example, opposes Brazil’s ambition to become a permanent member of the UN Security Council and has had tense political exchanges with India. The BRICs certainly don’t share political values. Brazil and India (and South Africa, if we include it in the group) are democratic regimes, while Russia is an authoritarian state and China remains closer to totalitarian in its suppression of political and intellectual liberties. As for unified economic leadership, the Chinese push to replace the free-market “Washington consensus” with a Shanghai consensus based on state-directed capitalism hasn’t succeeded. India is moving in a more free-market-oriented direction under dynamic new prime minister Narendra Modi; China itself seems to be refocusing its economic policy toward deregulation and a convertible currency.

And to work a variant on Mark Twain, the decline of the West has been greatly exaggerated. True, Western global leadership isn’t as secure as it was 15 years ago. Thanks to rapid growth, the BRICs are now collectively producing the rough equivalent of the U.S. or European economy yearly. But on a per-person basis, these countries remain much poorer. With 40 percent of the world’s population, the BRICs’ output adds up to only 27 percent or so of global production. They may be catching up to the West, in other words, but they’re a long way from vaulting ahead of it. And for various political and economic reasons, the BRIC economies have run into stiff headwinds over the last few years, even as the United States has begun growing again.

Everyone should rejoice when poor countries become wealthier, and the last two decades have witnessed that welcome development on a remarkable scale. According to the World Bank, 1 billion people across the planet have escaped poverty since 1995, crossing the symbolic threshold of $1 a day in disposable income. This undeniable progress had nothing to do with the invention of some new economic model or shortcut on the road to prosperity. Emerging economies—the original four BRICs leading the way—started to grow rapidly only when they discarded statist models of economic organization (as in Brazil and India) or outright socialism (as in China and Russia) and embraced markets, free trade, private entrepreneurship, income inequalities, and at least a decent minimum of property-rights protection and other aspects of the rule of law. As Milton Friedman used to say, growth is spontaneous as long as governments do not forbid it.

India offers a striking example. Until the late 1980s, Indians were forbidden from creating a new business, down to the smallest artisan shop, without an administrative license from the government—the “License Raj,” as the system came to be known. Foreign investment was mostly forbidden, the borders closed to trade; India was supposed to be self-sufficient. Under such restraints, which lasted from independence in 1947 until the conservative Bharatiya Janata Party (BJP) started to free up the economy during the 1990s (a process still far from complete), India’s growth rate stagnated at around 3 percent, just above the country’s 2 percent yearly population increase, meaning a per-capita income growth of barely 1 percent. After the BJP’s reforms, the economy began expanding more rapidly, even rising to double-digit growth at times. China’s turbocharged acceleration, in many years exceeding 10 percent GDP growth, got its first spark in 1979, when Deng Xiaoping, the Communist nation’s “paramount leader,” gave land back to the farmers and proclaimed that it was all right to earn money—and that it was acceptable, too, that some people would become wealthier than others. Into the 1990s, Brazil was suffocating under regulations almost as onerous as India’s. The only way for a Brazilian lacking political connections to get ahead was to work in the informal sector, where growth is limited because of the lack of property rights and sources of credit. Brazil’s economy took off—growing more modestly than India’s and China’s but still hitting mid-single-digit annual GDP growth—only after the country opened its borders to trade and allowed informal entrepreneurs to register their businesses, encouraging investment (though here, too, the process has a long way to go). Post-Communist Russia emerged from its economic struggles of the 1990s with an energy-fueled boom that lasted until recent years.

Extraordinary historical circumstances aided the BRICs’ emergence, too. The fall of the Berlin Wall in 1989 proved unequivocally that the socialist economy was a dead end; it also cut off the aid that the Soviet Union provided to India and other states outside the Western camp. Borders soon opened and free trade became the global norm, spreading its wealth-creating effects. Two technological innovations proved crucial in this context. The first was the Internet, which made instantaneous communication possible, reducing transaction costs and spreading knowledge from one side of the planet to the other, before becoming a remarkable commercial platform during the late 1990s. The second innovation was containerization—a system of intermodal freight transport that enabled firms to ship basically anything anywhere, at the lowest cost ever. Rich countries subsequently began to outsource all sorts of services and production—from call centers to microchip-assembly plants—keeping at home the most creative (and profitable) activities. The BRICs, understanding the new conditions, seized the opportunity. They had strong comparative advantages in a global economy. Russia, for example, had oil and gas in abundance, the demand for which exploded as China and other growing countries consumed ever more energy. Brazil provided soybeans and chickens for the burgeoning Chinese market. And China, India, and Brazil could offer inexpensive manufacturing workforces for foreign firms to deploy (and, at times, exploit).

With the exception of Russia, which had already become more urbanized as a consequence of the Soviet emphasis on industrial production, the BRICs have also experienced the economic boost of urbanization. When a peasant from the impoverished countryside flocks to the teeming metropolis, he accesses greater capital, infrastructure, and industrial employment and thus dramatically improves his productivity. Economic historians have shown this to be true of past centuries in Europe. Brazil, China, and India have been building chaotic but more productive urban societies at an incredibly rapid rate, contributing to the percentage of the global population that now lives in cities, exceeding 50 percent for the first time, in 2010.

Yet the BRICs aren’t emerging as much of late (see graphs, above). Consider Russia, where a combination of what economists call the curse of natural resources and political corruption has darkened the post-Communist country’s future. During the 1990s and much of the new millennium, Russia was swimming in oil and gas money. Instead of being used wisely, say, to diversify the economy or build infrastructure, the wild profits, mostly confiscated by the government and its cronies—the so-called Russian oligarchs—have scorched the country’s industrial landscape and killed the nascent entrepreneurial spirit that had emerged in the immediate post-Soviet period. Beyond the oil and gas industries and mineral extraction, most industrial activities have suffered in Russia, as has much of the private sector. Eternal president Vladimir Putin was savvy enough to build a generous welfare state with some of the energy dollars, buying political support for his authoritarian rule, and as long as energy prices remained high, as they did until 2013, Russia seemed like a thriving economy, perhaps even the BRICs’ leader. But with the fracking revolution in the U.S. and other countries, energy prices have plummeted—and they’re likely to stay low. Russia consequently finds itself verging on bankruptcy, an emerging economy no more.

Brazil has followed a similar pattern, with soybeans replacing oil in the mix. Most other agricultural activities have taken a backseat in the country to soybeans, which bring the highest return on investment—as long as the Chinese keep buying them. As the Chinese economy has cooled, though, Brazilian growth is grinding to a halt. The welfare state the country had erected based on soybean superprofits is now increasingly supported by monetary inflation alone. Corruption is endemic throughout the economy. Would-be entrepreneurs often lack the resources to bribe their way to set up an approved business. Incumbent firms can therefore keep their privileges intact, protected from the process of creative destruction that would be the true engine of modernization.

China, still the highest-flying BRIC economy, is indeed exhibiting signs of real weakness. Denying legal rights to migrant workers long enabled China’s Communist Party authorities to keep wages extremely low, giving the country its Number One natural resource: a deep pool of cheap labor. As the pool has drained, however, wages have started to rise, making China less competitive compared with, say, Vietnam or Bangladesh. American firms that once outsourced production to China are increasingly looking elsewhere, even back home, where lower energy costs and advances in automation have led to a partial reindustrialization of the U.S. economy. (See “No Shore Thing,” Winter 2015.) China’s growth rate is rapidly falling, dropping well under the double-digit average of the last two decades; it is likely to be no higher than 7 percent in 2015. This decline has happened at the same time that the U.S. economy has been growing again, albeit unsteadily, which means that the gap between the larger American economy and the Chinese one is widening in America’s favor. (Contrary to some reports late last year, which used less reliable metrics, the U.S. remains far and away the world’s largest economy, with a real GDP more than double that of China.)

The optimistic take on the Chinese slowdown is that the country has caught up with more mature economies, so reduced economic growth becomes inevitable. There is some truth to that argument, but it’s important to remember that a quarter of China’s population still lives in rural destitution and that per-capita income in the country is one-third of what it is next door, in South Korea. The slowdown may actually reveal a deeper flaw in China’s development model. That model has been based in part on exporting inexpensive products to Western countries, with accompanying investment and infrastructure built primarily to serve Western consumers. The risk of excessive reliance on exports, a characteristic of all the BRICs, is that when foreign demand shrinks, the domestic market may not be large enough to absorb the supply—and that has been the case in China. After the 2008 financial meltdown, Wal-Mart consumers cut their spending sharply; Southern Chinese factories, which supplied Wal-Mart with inexpensive goods, had to close down.

The other engine of Chinese growth has been real-estate development, where speculation runs rampant. The government has prevented the typical Chinese citizen from investing his savings in reliable stocks or abroad, so the money gets invested in the construction of unused houses and office buildings instead. Some observers estimate that as much as one-third of Chinese economic growth is the result of this real-estate bubble. The bubble is set to burst, and the government knows it. Chinese banks are now offering more diverse and profitable financial investments to stop the building frenzy.

India has had slower growth than China, but its growth is probably more sustainable, since it is based, at least in part, on private entrepreneurship. (See “The Indian Century,” Spring 2015.) The country has a long way to go, though, to catch up with its Asian BRIC neighbor, where the per-capita income is twice as high. India still has twice as many farmers as China, the rural exodus starting there almost a quarter-century after China committed itself to rapid urbanization. Nor has India fully dismantled its License Raj system. As in Brazil, entrenched private and public monopolies resist the threat of competition with all their might. A thick blanket of regulations covers the labor market, cosseting unions but excluding the masses, who find jobs scarce in such a stifling and often corrupt environment. India is also a federal country, with many provinces under the control of leftist politicians hostile to economic freedom.

The emerging economies would be in a less vulnerable position if they had proved able to create appealing brands, but thus far, anyway, that hasn’t happened. Nobody in the West or Japan buys a device or product because it is made in Brazil or China or India or Russia. None of the BRICs has invented the equivalent of a Hyundai car, Samsung phone, or Sony computer that consumers want to buy for its own merits, rather than cheap cost. The absence of recognizable brands reflects a lack of investment in research, which also shows up in emerging economies’ abysmally low number of global patents registered annually (see chart, below). In 2014, American, Japanese, and European firms and universities registered three-quarters of such patents, which represent the products and services of the future, once entrepreneurs transform them into marketable units. One sometimes hears or reads that China registers more patents annually than the United States. But this is an unreliable comparison, since nearly all Chinese patents are registered in China only. They tend to be imitations, and the patents are established mostly to protect the domestic market against foreign imports.

Why are the BRICs so lacking in innovative spirit? The overreliance on natural resources doubtless has something to do with it. There is less incentive to create a brand or invent a product when selling soybeans or oil can mean gigantic profits. Innovation also requires freedom of expression, which, among the BRICs, China and Russia don’t encourage, to put it mildly. No eastern version of Silicon Valley will arise in these nations until they begin to tolerate the erratic individualism of America’s West Coast. Further, when corruption is as extensive as it is in the BRICs, entrepreneurs rightly don’t trust the legal protections granted to intellectual property; instead, they go to the U.S. or to Europe to register their patents.

The BRICs’ experience also raises questions about the connections between economic growth and democracy. Back in the early 1990s, the great political scientist Samuel Huntington tried to establish a positive link. Above a certain income, he argued, all citizens would begin to demand, and obtain, democratic rights. Huntington based his “law” on two examples: South Korea and Taiwan. True enough, when the majority of people in these two countries left poverty behind, authoritarian military rule gave way to democratic institutions. But it’s important to remember that both countries, threatened by Communist neighbors—North Korea and mainland China, respectively—had a pressing incentive to prove that democracy, free markets, and prosperity ran hand in hand. They also found themselves nudged toward democratic capitalism by a persuasive mentor: the American government.

Looking at the BRICs, no Huntingtonian law reveals itself. In Russia, privatization and trade liberalization took place after the dissolution of the Soviet Union and under Boris Yeltsin, the most democratic president Russia has ever elected. But the shift to a market society was so disruptive and impoverishing to many, in the short term, that the Russian people began to long for a more orderly—and far less democratic—regime, which would be led by Putin from 2000 on. Putin has been luckier than Yeltsin: his presidency coincided, until recently, with a major rise in energy prices, which brought Russians higher wages and, via the redistributive state, those plusher welfare benefits. Nowadays, most Russians identify authoritarian rule with economic prosperity and democracy with confusion and economic misery. Russia’s democracy advocates, like China’s, are disproportionately intellectuals and students, unfairly accused of being stooges of the West, from which they receive little support. As Russia enters a new era with lower energy prices, less redistribution, and even more despotism, how will people react? Futurology offers only uncertainties.

By contrast, India, democratic since its 1947 independence, ran a protectionist and state-controlled economy for decades afterward. Indians never indicted democracy, however, for slowing development; they saw the rule of law (however imperfect), free elections, the right to dissent, and other democratic rights as values in themselves that need to be protected, with or without economic progress. India moved away from the statist economic model only in the early 1990s, when Russia began to demand actual currency (i.e., dollars) for the oil it delivered, instead of the barter arrangements that the Soviet Union had maintained. The Indian government, encouraged by its then–finance minister, Manmohan Singh, understood that India had to boost its export economy to meet this demand and that such a goal could be achieved only if private entrepreneurs could prosper.

Authoritarian China has grown twice as rapidly as democratic India, in part because of the choice for trade and entrepreneurship made by the Communist Party more than three decades ago. (The Anglo-Bengali economist Amartya Sen has argued that development shouldn’t be measured solely by material growth; noneconomic values should gauge progress as well. Sen plausibly concludes that India may be wealthier than it looks, and China less so.) That the Communist Party’s leaders became China’s first capitalists, enriching themselves through entrepreneurship or graft, probably helps explain the party’s surprising enthusiasm for freeing the economy. The continuing hazy confusion between public officials and semiprivate businessmen, though, makes China a singular experiment in state capitalism, not a replicable model. No real trend toward democratization has swept China, despite the emergence of a middle class that now encompasses a third of the population. Indeed, rather than embracing democracy, many in the Chinese middle class fear that they would lose their party-based economic privileges if the poor ever won greater political power. How long this fraught situation can last is uncertain. Some believe that the Communist Party can keep control only as long as the economy keeps thriving. But the party’s legitimacy is based not just on its economic success but also on its capacity to maintain peace in a vast and diversified nation that remembers its past civil wars and hopes never to repeat them.

Brazil is another singular case. Democracy has favored and then hindered the country’s economic growth. During the 1980s, hyperinflation was the scourge of Brazil, ripping apart the social fabric and annihilating investments. By 1994, Brazilians finally had had enough, and they elected sociologist Henrique Cardoso, who imposed a strict monetary policy: the government stopped printing money, prices stabilized, investment returned, and a new era of growth opened, albeit disproportionately based on soybeans. In this instance, democracy worked on behalf of sound money and economic growth. The socialist president who succeeded Cardoso, former union leader Luiz “Lula” da Silva, adopted the same sensible—and winning—policy. Then Dilma Rousseff, from Lula’s party, was elected, but she has pursued aggressive economic-redistribution schemes, leading to a return of inflation and declining investment.

Huntington’s law was reductive. The BRICs’ history underscores that economic progress is only one dimension of any society; it interacts with history, culture, and other noneconomic factors to make any broad generalizations about democracy and growth—or about inevitable paths to development—suspect.

But then, the appeal of the BRICs concept for many observers was that it heralded the decline of Western civilization. In fact, the West retains its historical advantage of combining democracy with economic freedom, and despite its economic ups and downs in recent years, it still is growing faster than the rest of the world, measured by income per capita. The per-capita income index is far more relevant to our personal lives than national production figures, which largely reflect population size. The West continues to be the cradle of innovation, an advantage rooted in the vitality of its intellectual debates and academic bodies. The emerging economies owe their success mostly to adapting Western economic institutions; only those nations that refuse or are unable to embrace these institutions stay mired in utter destitution.

Every free society should learn from its mistakes (Friedrich Hayek used to say that we don’t learn from others’ errors, but our own). Free-market development is a process of trial and error, fundamentally different from socialism’s fatal conceit that a perfect social system can be built from scratch. The BRICs, and comparable emerging economies, have taken long strides toward better lives for their people, but their progress has slowed—and, in some cases, been reversed—in recent years. If they learn from their errors, though, their development will be rekindled.

Guy Sorman, a City Journal contributing editor and French public intellectual, is the author of many books, including Economics Does Not Lie.