Ruchir Sharma is the author of Breakout Nations: In Pursuit of the Next Economic Miracles (which was excerpted by Wonkblog here), as well as head of emerging markets and global macro at Morgan Stanley Investment Management. He spends much of his time studying emerging economies, and he's not particularly surprised by the outbreak of protests in middle-income countries. We spoke by phone Tuesday morning, and a lightly edited transcript of our conversation follows.
Ezra Klein: So as I understand it, your view is that people shouldn't be surprised to see protests in Brazil and riots in Turkey. It's the long period of economic growth and political calm that preceded them that you consider surprising, or at least unusual. Is that right?
Ruchir Sharma: Absolutely. The last decade gave us this misleading impression because growth was booming in every single emerging market and that was keeping everything calm. It gave the impression that this was a new era for the emerging world.
But a lot of that growth was driven by low interest rates and the commodities boom. The long-term growth rate of emerging markets is about 4 to 5 percent annually, but from 2003 to 2008 it was over 7 percent. At the same time, inflation, which used to be a big problem, collapsed. But now all that's reversing. In Brazil, for instance, growth is down and inflation is creeping back up. And that's how you get a situation where a rise in bus prices can be the final straw that gets people into the streets.
EK: Much of the argument, however, has been that these countries got much better at building political institutions and managing economies over this period. The idea behind a higher permanent rate of growth is that they made structural improvements, not just cyclical ones, to the way they're governed. Do you think that's all illusory?
RS: I think that it’s true that some of these changes have been made, and for the better. But it’s very difficult to talk about all these countries as a homogenous entity. They're 80 percent of the world’s population and 40 percent of the global economy. Some of these countries will make mistakes and falter. In the last decade, money was so easily available, the cost of credit was so low, and there was a lot of catch-up growth from the crises many of these countries had in the '90s. But now that’s ending.
What’s happening now is things are changing. People are becoming more aware of the fact that these emerging economies have their own issues. Some of the political changes they made were really good, but some of them were made to look better by the easy money and the commodities boom.
EK: This would seem to suggest a vicious cycle: As people become more aware of the political and economic issues in these economies, capital will flow out of them, further worsening the economies, further exacerbating the issues.
RS: That’s exactly what happened last decade. Success begets success. More money flowed in; the cost of capital went down; the lower cost of capital led to faster growth and faster credit growth. Brazil had the biggest credit boom in its history between 2003 and 2008. Now the opposite can happen. Capital flows out; cost of credit goes up; that hurts growth. It can be a self-reinforcing cycle that moves for awhile.
EK: How much is what we're seeing in emerging economies a hangover from the financial crisis? There were a lot of plaudits for how well these countries did even as the United States and Europe and Japan suffered. Are their current problems related to that period?
RS: That’s part of the reason. They used up their bullets in the immediate aftermath of the crisis. But they’re out of bullets now. I was in China two weeks ago, and there the clear concern is they’ve spent so much in terms of GDP growth and now they're finding it harder to keep that going. At this point they’re having to spend $5 of debt to create $1 of GDP growth. So some of this is a slow-motion unwind of the financial crisis.
EK: Do you think the protests and instability we're seeing in these countries are actually a threat to the regimes or more of a normal venting process?
RS: The good thing in these countries, I think, is they do have a properly functioning democratic system. This is more about venting and the normal political process. I don’t foresee in Brazil and Turkey any major destabilization. They have the institutions in place to deal with this in a peaceful manner.
But it tells you that all these countries we celebrated for doing so well have their own faultlines. And that’s the biggest mistake we made: We looked at their successes and forgot their domestic issues. In Turkey's case, for instance, the real problem there is Erdogan has been in office for a very long period of time. A rule of thumb we use is when a leader is in power for more than a decade it becomes counterproductive for the country. A decade ago, Erdogan was much more conciliatory, much more interested in economics and much less interested in social issues. So part of the issue for Turkey is he’s been in office for much too long. In Brazil, it’s a democratic venting about the fact that after all the growth they still don’t get much in public services despite having the highest taxes in the world.
EK: They do get very large transfer programs, right?
RS: But that’s what the middle class is complaining about. They’re okay with the transfers. But they don’t get much for it, and they pay the taxes. Look at things like infrastructure. Infrastructure as a share of GDP in Brazil is two percent. That’s about the lowest I know for any emerging market. The average is five percent, and China is 10 percent. Investment spending in Brazil is low, too.
EK: Do you foresee this cycle looking like the '90s, when a lot of these countries had real crises, or just a moderation of growth?
RS: I think the emerging markets are in better shape compared to the 1990s. They’re more institutionally sound; inflation and debt are much lower. But they’re going back to a normal cycle. Of the 180-odd economies tracked by the IMF only 35 are developed. The rest are emerging. And many of these economies have been emerging forever. So we’re going to see divergence: Some countries will do well and some won’t do well. But now you need to pick your spots. Economic success is not self-sustaining -- you get complacent and then crises build up. Very few countries are able to circumvent that.
EK: So, which spots do you pick as the ones that will do well going forward?
RS: The ones that will do really well out there are places with a new political leadership that is engaged in real reforms. Places like Mexico and the Philippines and even possibly Thailand. Nigeria is doing okay, too, as they have a relatively better leader than they’ve had for the last 25 years. The key I find for emerging markets is when you have a new political leader who comes into power after a crisis, that’s typically the best time.
EK: And which places do you think will struggle more?
RS: All these commodity-exporting countries. So Brazil and Russia and South Africa -- my forecast for these three economies in that even though their per capita is a fraction of the U.S., they’re unlikely to grow faster than the U.S. in the next few years.
EK: A lot of this sounds, in a grim way, good for the United States. If the emerging economies are seen as riskier and Europe is still in trouble and Japan remains in terrible shape, we're one of very few places you can confidently put your money.
RS: I think that’s right. And that's the big change. A lot of people have focused on the Federal Reserve changing its policy in the last month, but they haven’t gotten into the underlying reasons for it. The U.S. economy is proving more resilient than we thought. The U.S. share in the global economy had been declining in the last decade. Last year it stabilized at about 23 percent.
Every major trend of the last decade is being turned on its head. I think the BRICs mania of the last decade will go down similarly to the mania for Japan and technology before it.