In his newly released book, The 10 Rules Of Successful Nations, global investor and author Ruchir Sharma reminds countries of what it takes to win, consistently. While the attributes are familiar, ranging from population to geography to currency and debt, they are cast in new light due to Sharma’s use of decadal data and sometimes unconventional measures, such as a Bad Billionaires index.
In an interview with BloombergQuint, Sharma, whose day job is Chief Global Strategist at Morgan Stanley Investment Management, shared his personal views on the global economy, India growth and asset allocation.
Here are key comments from the interview.
- There’s enough economic evidence I found to suggest that it is not that a nation becomes successful because of better education but often successful nations are able to offer their citizens better education.
- The modern menace of inflation is not consumer price inflation but asset price inflation.
- If you don’t have a big increase in population growth rates it’s virtually impossible to achieve high economic growth rates - that are defined as growth rates of more than 6% a year.
- The longer a leader stays in power, worse tends to be the stock market returns on a relative basis.
- Now for countries in India's income class...a growth rate of anything above 5% should be considered a significant achievement...
- On a larger fiscal stimulus in India - I've used this quote before from my favourite movie Top Gun - that our ego keeps writing checks that our body can't cash.
- When income inequality and wealth inequality become a big issue in a country, that is not conducive for a government then to carry out economic reforms, because you have a lot of popular anger against this sort of wealth creation in a country.
- Unicorns in India are so hugely funded by the Chinese, Japanese, of course, U.S. investors that not too much wealth creation itself is happening in India. That to me is also a bit of a worrying sign that we are in this new era of tech colonialism.
- This was for me, one of the defining features of India especially compared to other developing countries. We had some very good quality companies that we could invest in. Over the last few years, that number has shrunk considerably.
- I don't want to read too much into what the enduring impact of this pandemic can be. If anything, I think what this pandemic has done is accelerated some of the trends that were already in play before this crisis broke out.
- I think that until interest rates start rising again, which may happen if inflation comes back sooner than what people think, asset prices across the world will remain inflated or above what we used to think is fair value.
Watch the full interview here.
None of these 10 rules are new parameters or measures of success. Yet, as you were parsing the data did you come upon anything new that altered how you have looked at these parameters over a period of time?
As you say that while the headlines of these titles may suggest that this is familiar stuff, I think it's important for me to point out that what I have done here it is looked at many more factors than the 10 that you have listed to try and estimate as to what is relevant and what is not relevant. Also, even when you look at things like population or inequality, what I have tried to do is to show what the right way of looking at these metrics is. For example, on income inequality I've tried to say that, just as we look at Gini coefficients as many economists do, it doesn't work as the data is far too old. What you have to do much more is to focus on live data. So in that way, this is a very non-academic approach to an economic book that I have written based on empirical findings and also an innovative way in terms of how to be current rather than be lost in academic ivory tower. So, many surprising conclusions and data.
And also I think it's interesting as to what data I have not used or what rules did not make the 10 rules cut -- because I see myself as a practitioner and as an investor. We want to look at factors which are relevant in our time horizon which is typically three five years at best a decade. Academics on the other hand have time horizons that are so long that neither you nor I will be here to know whether we were right or wrong when using those time frames.
So one example here has to do with education- I've not put education as an explicit factor for the 10 rules that I use for successful nations. Now some people will say, how can you do that? Education at one level plays such a fundamental rule for a successful nation, and my contention is that when I looked at economic data and I tried to see the relationship with economic growth, I found no relationship between education levels and the time horizon I'm interested in, which is three to five years, in explaining which country is going to do well and not do well. In fact, education is likely a factor that plays a role maybe over 40-50 years in explaining how a nation does and even then, there's a chicken-egg factor.
So, it's that kind of elimination, parsing the data, eliminating what is good, eliminating what is not relevant for what I think is a realistic time horizon that I've used. So, with that we can argue that those are some of the surprising conclusions as to why education does not matter in explaining if a nation will be successful or not successful over a five year time horizon. Or when we look at income inequality, what's the relevant metric to use if not the Gini coefficient in explaining that. So, that for me is really essential here.
How do you view things like state power or debt differently from say 10-15 years ago - given the endless QE that we've seen, the repetitive fiscal stimulus, the new debate around MMT. Did your perception of some of these measures or attributes change?
I think that some metrics have changed. For example, take the chapter on inflation. What I've argued there in that chapter, is that historically everyone's looked at inflation in a very classic way which is focused on consumer price inflation- the everyday kind of prices that we look at -- foods, vegetables and other items we buy.
Whereas what I show in the book is that the modern menace of inflation is not consumer price inflation but asset price inflation, which is that a lot of this easy money is not necessarily leading to higher inflation, the way we think about it with the prices of goods and commodities going up, but more in terms of asset prices going up.
In the U.S., it's stock prices and bond prices. Across the world, we've seen home prices being inflated by easy money.
So, one data that I cite in the book is that the size of the financial economy which consists of stocks and bonds and other financial assets today is four times larger than the size of the underlying real economy. In the 1980s, that number was even, the size of the financial economy was as big as the size of the actual underlying global economy.
So, now in terms of what leads to problems for countries, what can lead to financial instability in this post-QE era, and potential MMT era, I think it's very important to look at asset price inflation as well, because when asset prices fall, the blowback for the real economy can be huge.
In many ways now the tail wags the dog.
It's no longer the fact that asset prices merely reflect what's happening in the underlying economy but what's happening in the financial economy has a blowback impact on the real economy just because the financial economy now is so much larger than the underlying economy. So I think it's those kinds of tweaks or changes in the concepts that I've had to incorporate as the world has evolved.
The Population Headwind
I want to discuss Population, the first rule in your book. You write that
- Global working age population growth is down from 1.9% to 1.2%.
- Countries with an over 2% growth in working age population are down from 17 to 2 and soon just one.
- That the success of the United States owes more to babies and immigrants than to big ideas coming out of Silicon Valley.
Your broad message in that chapter is that global growth for the next 5 to 10 years is going to come down considerably because of the population dynamic.
Yes. So, just look at the basics of economic growth in terms of what creates economic growth. There are two factors. One is the increase in the labour force which is the number of people showing up at work and two is how productive these people are. That's just a basic economic identity in terms of what determines economic growth. What I argue here is that both these factors contributed to an incredible global economic growth spell we had in the post-World War II era.
The global economy grew at an average pace of nearly 4% a year between 1950 and 2008. In the history of economic development going back hundreds of years if not centuries, we had never seen such a period where economic growth averaged nearly 4% a year for the global economy.
Why did that happen?
A big reason why that happened is because we had a huge demographic surge in the world following the end of the Second World War, the baby boom generation as it was called in the United States. Even in countries like India and China, in the 60s and 70s and 80s, you will recall we had such a huge increase in population growth rates -- driven both by high birth rates and falling mortality rates as medical facilities got much better and we saw significant strides in medical treatments.
So what I show now in this latest era is the fact that population growth rate around the world is slowing down very significantly over the last 15 years or so and that if population growth slows down very significantly, a major driver of economic growth goes into a very different mode here.
So, as you cited, the world's working population was growing at a pace of nearly 2% so much of post-World War II history, now that the rate is down to nearly 1%.
So the definition of what we call economic success has to naturally change, including in India.
In India's case, the working age population growth rate now has slowed down to less than 2%. This number in the 1960s and 70s was way higher -- when the average family in India was producing five or six kids. Now that number is down to basically two kids. So, I think this is a very significant change that has taken place in the world's working age population.
How do we reset our expectation of economic growth country-wise?
What I show in that chapter is that demographics is necessary but also not a sufficient condition for economic growth. If you have good demographics, you can end up getting very high economic growth but only one in four countries historically has been able to convert the demographic advantage into high economic growth and most of those countries were in East Asia. So I think this is the key point. Demographics or population growth is a necessary but not a sufficient condition for economic growth.
If you don’t have a big increase in population growth rates it’s virtually impossible to achieve high economic growth rates that are defined as growth rates of more than 6% a year.
So, now, what's the flip side of that?
The flip side of that really is that everywhere around the world if the population is not growing as quickly, you can't aspire for those growth rates anymore, including in India’s case. Our working age population growth rate is now slipping below 2% a year. Virtually, no country in the world has been able to grow at a very rapid pace with that sort of a population growth rate -- which is a working age population growing at less than 2% a year.
So in India's case also we need to think about what is the definition of economic success. And, another related factor that I point out here is the fact that the female participation in the labour force is very low just now in India. So, it is even more important in India to take measures such as increasing the female participation in the labour force to try and boost our economic growth rate.
Did Modi Miss The Growth Sweet Spot?
The second rule I wanted to discuss is leadership, as one potentially differentiating factor given this kind of growth headwind in terms of population. In the Politics chapter you've defined what you think are some of the critical success factors. You've said that democracies have delivered sustained growth and that there is often second term fatigue.
But there's very little mention of either India or Prime Minister Modi in that chapter and broadly speaking in the book. How do you view the leadership of the current government in India?
See what I've done in the book is keep out current affairs so as to focus on all the historical evidence that I've gathered over the years to identify what are the 10 most important rules that define successful nations. Now each nation such as India, if they would like, could use these 10 rules to figure out how are they faring on these various 10 rules and what can be done to improve their scores on these 10 rules if they would like.
So on leadership what's my take away in the politics chapter.
The real big takeaway in the chapter is this - that the history of various leaders across developing countries suggests that the maximum bang for the buck you get is when you elect a new leader because typically a new leader enacts economic reforms in the first couple of years and after that you have diminishing returns to power.
So that is my main point here which is the fact that on average, typically when a new leader comes to power and the country has its back to the wall, that's the sweet spot for getting economic reforms.
My broad point even as far as India is concerned is that most emerging markets follow this circle of life. They only carry out economic reforms when they have their backs to the wall. That sows the seeds for some sort of a boom to take place and that boom in turn then sets the stage for a decline later on to take place because complacency is what rules.
There is plenty of mention of India in the book but as far as politics is concerned, the takeaway should be that -
- the longer a leader stays in power, typically, the more the diminishing returns to power because the political capital erodes.
- the second fact that I put in the book very clearly is that economic reforms tend to be carried out when you have your back to the wall.
There's also one other interesting related point, and this debate goes on forever, that do authoritarian governments or democratic governments produce high economic growth? Which is better for the economy?
What I show is that it’s not whether the regime is democratic or authoritarian. In fact the outcomes in both regimes for economic growth are virtually equal. It is the fact that when you have a democratic government, you tend to get not very big extremes in economic growth and when you have authoritarian governments you get very big extremes in economic growth.
Why does that happen, because when you have an authoritarian government, they can carry out economic reforms but there's no one to offer a check or balance if something goes wrong and they carry out the wrong kind of reforms or they go the wrong way. In a democratic setup you have much more and much greater checks and balances.
So, it's these kinds of takeaways that I have that you can apply to a country like India but the broad takeaway of the politics chapter is that the best time for a nation is when a new leader comes to power and is committed to carry out economic reforms because the country has its back to the wall. That is the sweet spot for a successful nation.
So did we make the most of the sweet spot that Mr. Modi's ascension to power offered in 2016, 2017 and 2018 or have we missed that bus?
No. I think that when he came to power I was at least optimistic from an economic perspective - no matter what may be my personal feelings. That, with a new leader, and he spoke so much about development and he invoked the mantra of minimum government and maximum governance, I was hoping for a much more of a free market type agenda and instead we got a lot more of incrementalism.
We really have not ever had a period of true free market reform by any conviction. In the early 1990s, when we had our back to the wall that's when we carried out some pretty significant reforms and joined the global economy with some force but really, we have never ever reformed with conviction.
Reform in India has always happened at best by stealth because I think there is very little fundamental belief in free markets, and socialism and statism is a much greater belief amongst our political class.
I think that Prime Minister Modi too, has followed that path broadly.
Yes, there have been some incremental reforms but the kind of economic freedom that I was expecting did not materialise and that I think is the most underestimated aspect of what makes China and other East Asian economies so successful. That they may have had very authoritarian governments but they carried out a lot of free market reforms and did not spend much on social welfare in the first few years if not decades of their economic development.
That's not a path that India seems poised to follow under any leader, including Prime Minister Modi.
Do you think we might be at a pivot point now given some of the legislative changes when it comes to the farm sector or labour laws. Do the changes seem deep enough for you to be labelled as reform?
No. I think that this is still incremental stuff. Yeah I do feel that because this lockdown, which was so draconian in nature and it led to such severe economic consequences, that some reforms are being carried out as a consequence of that.
But is this really big bang earth shattering stuff? I don't think so and I think that with these farm bills we have seen that it also depends how you carry it out and how much are you able to take the Opposition with you. I don't think that that's really happening.
So, yeah, I think it's a positive sign that we are getting some reforms and that is at least back on the agenda, but this is not a 1991-type moment where you're getting any big scale reforms or you're going to go back to privatisation. I don't see that.
India: Regressing To Mean Growth?
You make the point in the preface and later on as well - that most countries eventually ‘regress to mean growth’. We've already spoken of the population headwind for countries like India. Do you think that eventually over the next five years we are going to revert to mean growth? And that our mean growth is maybe 5%-6%, nothing more than that?
If you look at the current context, what I say very clearly is this - that we are still suffering from a massive anchoring bias. What do I mean by anchoring bias? It is that because the Indian economy grew in the 1990s and particularly in the 2000s at a very rapid pace, we keep thinking that is the right benchmark in terms of what our potential growth rate is.
I show both in the book and also my subsequent research work that there is virtually no economy in the world today that is growing at a pace of let's say more than 7%. A growth rate that we thought was virtually our birth right a few years ago. And last year, even before this pandemic hit, there were hardly any economies in the world that were registering a growth rate of more than 7%. Now, in the 2000s - let's take the year at the peak of the boom in 2007, there were nearly 40 economies in the world that were registering a growth rate of more than 7% a year. There were plenty more that were growing at a rate of more than 5%.
We are in an era where because of some of the forces that you discussed-- including declining population growth rates and also declining productivity because of misallocation of capital given asset price inflation, rising income inequality, rising debt levels and also factors such as de-globalisation --- the trend growth rate for the global economy is a lot lower than it used to be, possibly around 2.5% compared to the 4% that we grew every year between 1950 and 2008 at least on average. So that's a huge step down for the global economy.
Now for countries in India’s income class, which is a per capita income of less than $5,000, I think that a growth rate of anything above 5% should be considered a significant achievement because of these dynamics from de-population to de-globalisation.
So I think that the right benchmark for India's growth rate going forward is possibly 5%.
And, if India can grow at a rate of more than 5%, I would consider that to be a significant achievement.
Whereas a few years ago if we were having this interview, I would say at least 7% should have been India's benchmark for economic success. But in today's global economic environment, a growth rate of even 5% for India's per capita income of just under $3,000 would be a significant achievement.
Now sure if we carry out huge reforms which unleash productivity like China did in the 80s and 90s, we may be able to grow at well above 5%. I just don't see the signs for that.
For the last two three years at least there have been only two pillars of growth. Private consumption and government spending. Now we are down to only one - government spending. This was pre-pandemic; the pandemic narrows that situation a lot further.
Yet when asked in previous interviews whether you think this is the right time for the government to spend more than it already has, a bulk of which has been more monetary policy support than fiscal, you've said that's not a good idea at all.
In effect, if the government doesn't step up spending at this point in time, that's yet another headwind that could impact trend growth over the next three to five years.
I think that this is where I've been so disappointed by the economic discourse in India because it's clear that our egos are way bigger than what the reality is.
I've used this quote before from my favourite movie Top Gun - that our ego keeps writing checks that our body can't cash.
All the economic experts in India want a massive stimulus. They want a stimulus and they keep referring to the U.S. and the U.K. or even to Germany. The fact of the matter is that those countries are in a very different spot because they have their own reserve currency or they have a currency that people still have faith in. The fact is that we went into this crisis with very high public debt levels at least for a developing country. So we just don't have the capacity to enact a massive stimulus. I think that is something which should have even been thought of as we were enacting the most stringent lockdown in the world -- that how are we going to pay for this?
Once that was done, there was no choice but to carry out whatever little stimulus we could because anything more than that would have led to a major erosion in confidence in the Indian currency and also potentially lead to much higher inflation.
This is another unique aspect of India, that our inflation rates are much more sticky than what we see in the developed world- the classic inflation of consumer price inflation. The developed world is not seeing any inflation and so therefore they're going on with these monetary experiments. But India's inflation rate has been much more sticky compared to those countries.
Other developing countries such as Turkey that have tried to carry out a very unorthodox approach have gotten in trouble. Turkey, last week, raised interest rates by a couple of hundred basis points because they had to restore some faith back in their currency. So that's, I think, a very important point. That we are just not living within our means or seeing what the ground reality is and we keep thinking that we can print our way out of trouble not realizing what the consequences could be.
So, I have a quarrel with the fact that whether we should have imposed such a stringent lockdown-- given our economic situation, given what a lockdown may or may not have achieved for a developing country and even the population density and the living conditions. But after that was done, that we could enact a western style stimulus was totally unrealistic and irresponsible as far as that advice goes. I think that it was either driven by a huge degree of self-importance or just political scoring points against the government.
So, I was not in favour at all of anything more in terms of stimulus. I think that would have done even more damage to India's finances and eventually India's economic credibility.
We were already underperforming in terms of growth prior to the pandemic. If government spending doesn't step up, on grounds that you've just discussed, then our underperformance in the subsequent years is going to be considerable. What is the way out?
So government spending could not be the answer to economic success. In fact in the book going back to The 10 Rules Of Successful Nations, I point out in the State chapter, that if you see what the East Asian economies did in their high growth phase or let's say when they were at a similar stage of development as India; they did not use the government so much to spend but to help the private sector spend much more and to create the right investment environment for the private sector to drive economic growth.
So, China's economic model - if you look over time China's government’s share in the economy, during the boom years kept on declining. So, this notion that the government can drive economic growth and economic success is just not right.
The government's there to provide stimulus when you have a recession, the government's there to take care of the basic needs of people but it cannot be the driver of economic growth. That's a policy that India tried to follow in the 1970s for example or even in the 1980s and ended up in trouble at the end of it. So, I don't see this as a logic in terms of the fact that the government needs to be driving economic growth here. The government in fact, if anything, should get out of the way of business and being more facilitating have a better business environment than what's been happening over the last few years.
I don't disagree with you but that's the medium longer term view. In the shorter term, two to three years, you're resigned to the fact that India is going to be a severe underperformer.
Many other developing countries are facing similar constraints as us -- if you look at Brazil, Indonesia, all these countries are facing similar constraints. That, they cannot keep spending their way out of trouble. So I would not say that India is in a unique position that way because see other developing countries.
We tend to focus a lot more on what the other developed countries are doing and this is a point I make repeatedly in my book -- that we need to get our reference points correct. That, if you look at what other emerging markets are doing and the constraints they face, that is not too dissimilar in terms of what we face.
What we have to do at this stage is to figure out a way where private investment picks up again after having been in slumber for such a long period of time, and what are the right conditions we can create for that to happen.
The reason for the underperformance that you referred to, even before this pandemic hit, didn't have to do with government spending in India. It had to do with the fact of how the private sector had been undermined by steps such as demonetisation and by the way the GST was implemented.
I think that those steps which undermine confidence, and this general environment of fear that was created for businesses where every other business is seen as a crook and you don't know who's going to come after you which authorities are going to put you behind bars. I think it's those kinds of conditions that created a much poorer domestic growth in India than what we would have liked before the pandemic hit.
So, if we really want to get India back to some sort of a reasonable growth path, that's what we need to attack and that's what we need to fix, rather than think that just more government spending is going to get ourselves out of trouble. Because that's what got us into trouble in the first place. So, what got us into trouble is how private investment had been undermined.
India’s Bad Billionaires
You speak of inequality in the book and in that you've got an interesting metric called Bad Billionaires. India ranks amongst the top five countries in terms of the ratio of bad billionaire wealth to total billionaire wealth.
Is this crony capitalism or just simply representative of the fact that so many firms in India are family-owned?
If you look at India's bad billionaire wealth as a share of total billionaires, that number has come down over the last decade. It was at its absolute height at the peak of the commodity boom a decade ago.
But I think it's important for me to explain what exactly I am trying to do with this concept here for a minute. What I say in the book, and this is where I say that the whole idea of the book is to look at things in a very contemporary way and away from an academic approach, is to say that when we have enough evidence to show that income inequality and wealth inequality becomes a big issue in a country, that is not conducive for a government then to carry out economic reforms, because you have a lot of popular anger against this sort of wealth creation in a country.
So how do you measure that? How would you be ahead of the curve in measuring that in which country could popular anger be building because you have too much wealth creation going on, due to crony capitalism? In this way I've created this index of good and bad billionaires where I say that the good billionaires are those which are largely creating their wealth on their own, through innovation in sectors such as manufacturing or technology where it's really about what the firm or the business is doing. And, the bad billionaires typically come in industries that require a lot of government help or gaming regulations - the so called rent seeking industries as economists put it. Now, not every billionaire in those industries, such as commodities and real estate that are broadly defined as bad, is a bad billionaire, and not every good billionaire in technology and manufacturing is a purist.
If you get the message - what I'm trying to create is this index on a live basis to look at where is too much wealth creation happening and is it good or bad for the economy in a way that is it going to lead to more popular anger or greater appreciation for the wealth being createrms