Are the BRICS in the midst of a midlife crisis? Based on recent data, this would appear to be the case. China grew at a rate of over ten percent for 30 years, but its growth rate has now slowed to around 7%, and it may fall further if the reforms to rebalance growth from credit-fuelled fixed investment to consumption are delayed at the risk of a hard landing.
India, meanwhile, grew rapidly earlier this decade (9%+, in 2010-2011) but its growth rate slumped to 5% in 2013 and may only modestly pick up this year. The other BRICS are even worse: in 2013 growth was 2.5% in Brazil, 1.3% in Russia and 1.9% in South Africa. This year things will not be much better, and I forecast mediocre growth of 1.8% in Brazil, 1.7% in Russia and 2.6% in South Africa.
Three of the five (Brazil, India and South Africa) are now part of what investors consider the Fragile Five emerging market economies (the other two being Turkey and Indonesia). These fragile emerging markets share weaknesses, such as large current account deficits, large fiscal deficits, falling growth, rising inflation and political and policy uncertainty, and they all face parliamentary or presidential elections this year. Last year their financial markets headed south (with weaker currency, weaker bond markets and weaker equity markets) and this year could also be a challenging one.
What ails the BRICS (and a few other emerging market economies)?
First of all, while most of them implemented first-generation reforms, they failed to implement second-generation structural reforms that are more micro-based and boost productivity growth. As a result, their potential growth rate has fallen.
Second, not only did they fail to implement market-oriented reforms, most of them moved toward a growth regime based on state capitalism: an excessive role for the public sector and state-owned enterprises in the economy, an excessive role for state-owned banks in the allocation of savings to investment and credit creation, trade protectionism, resource nationalism, and so on.
State capitalism may have worked at earlier stages of development and during the global financial crisis, which had prompted a fall in private spending, but it is now distorting economic activity and leading to a fall in potential growth, as investment becomes less efficient. All of the BRICS have experienced a stagnation of the business environment, with few reforms after 2006. With the easy sources of growth gone and the external environment less supportive, issues such as the rule of law and operating rigidities become a more significant speed bump.
Third, the commodity super-cycle is probably over – for a variety of reasons – and this hurts the BRICS that are commodity exporters: Russia, Brazil and South Africa. Given the slowdown of China, after years of high prices, commodity prices may fall further, hurting the growth of the commodity-oriented BRICS.
Innovation is harder to achieve than the mobilization of resources and the copying or reverse engineering of existing technologies. Thus, many BRICS may be close to the point where the easy sources of growth are gone, while the sources of fast growth that propel an economy to high-income status are harder to achieve
Fourth, in the boom years for the BRICS and for emerging markets, macro policies became too loose, leading to overheating: excessive credit growth in part driven by excessive capital inflows; growing currency appreciation, which led to a loss of competitiveness and in some cases external deficit; and looser monetary and fiscal policy, given cheap external financing. The deterioration of macro policies was serious in Brazil, India and South Africa but even in China credit-fuelled investment has led to a surge in public debt that will burden the official and shadow banking system.
Fifth, in some BRICS – specifically China and Russia – there is no demographic dividend, as the population is aging for a number of reasons: the one-child policy in China and more fundamental low fertility rates and high mortality rates in Russia. Lower population growth is associated with lower potential growth.
Sixth, many BRICS may end up in the middle-income trap, failing to progress to a higher per capita income. Solid institutions, good governance and appropriate macro policies, and the mobilization of savings, capital and labor inputs can lift an economy from a low per capita income to middle-income status (as many emerging markets and most of the BRICS have done in the last two decades), but transitioning into a developed market is much more difficult. Indeed, World Bank studies suggest that only a small number of emerging market economies have escaped the middle-income trap, and as more emerging markets navigate from low to middle income, avoiding the trap becomes harder.
Making the transition means moving from resource mobilization (of labor and capital) to sustained increases in total-factor productivity growth, and requires innovation, investment in new technologies and the digital economy, an opening up of the economy, and the fostering of private-sector development. Innovation is harder to achieve than the mobilization of resources and the copying or reverse engineering of existing technologies. Thus, many BRICS may be close to the point where the easy sources of growth are gone, while the sources of fast growth that propel an economy to high-income status are harder to achieve.
Of course, in spite of their recent economic difficulties, one should not be too pessimistic about the future of the BRICS. There are many reasons to be optimistic about their prospects for growth.
First, they are all large economies with large populations and markets, and three out of five still benefit from a demographic dividend. Second, in spite of the delays in the last decade, most may eventually shed a model of state capitalism and implement structural reforms that increase potential growth. Third, the macro weaknesses that some of them faced are solvable; none of them face the past risks of severe currency, sovereign or external debt crises. Fourth, some secular forces are still in their favor, such as urbanization, industrialization, the catch-up from low per capita income, the rise of stable middle classes and the development of a consumer-oriented society and economy.
However, future success will depend on fixing macro-imbalances, implementing appropriate structural reforms, strengthening weak political and other institutions, shedding state capitalism, and further opening up their economies to global trade and investment. If such policies are put in place, the risk of hitting a thick brick wall of low growth will be avoided, and the future of the BRICS could be bright again.
Nouriel Roubini is Chairman of Roubini Global Economics, Professor of Economics and International Business at the Leonard N. Stern School of Business, New York University. He participated in the World Economic Forum’s Annual Meeting 2014.