Now the BRICs Party Is Over, They Must Wind Down the State's Role

by Anders Aslund, Peterson Institute for International Economics

Op-ed in the Financial Times
August 22, 2013
Financial Times

After a decade of infatuation, investors have suddenly turned their backs on emerging markets. In the
BRIC countriesBrazil, Russia, India, and Chinagrowth rates have quickly fallen and current account
balances have deteriorated. The surprise is not that the romance is over but that it could have lasted for
so long.
From 2000 to 2008 the world went through one of the greatest commodity and credit booms of all times.
Genesis warns that after seven years of plenty, "seven years of famine will come...and the famine will
ravage the land." Perhaps the combined commodity and credit cycle, from which the BRIC countries have
benefited more than their due, is divinely appointed.
The boom was prolonged for half a decade by quantitative easing in mature economies, flooding them
with cheap financing. During their years of plenty, the BRICs did not have to make hard choices. Today,
their entrenched elites seem neither inclined to nor able to do so. Their lives have been too good.
Now the booms are over. Brazil and Russia have been hit by the leveling out of commodity prices, which
are expected to decline for several years. Those two countries may also be caught in the "middle-income"
trap. Recent research has also found that countries tend to experience a sharp growth slowdown when
GDP per capita reaches about $15,000.
While the BRICs have accumulated large foreign reserves, they did not take advantage of the good years
to improve the underlying state of their economies. China's banks are overleveraged and India suffers
from most economic ailments. Its inflation is too high; its budget deficit, public debt, and current account
deficit are too large. Governance is mediocre at best, reflecting substantial corruption and poor business
environments.
The World Bank compiles its ease of doing business index for 185 countries. The BRICs do even worse
by this measure, with China ranking 91, Russia 112, Brazil 130, and India 132. Russia has set the longterm goal of rising 100 steps but so far has done little to accomplish it. China, meanwhile, is lobbying the
World Bank to abolish this index.
One can see the hubris of the boom in the construction of white elephants; Olympic Games tell it all. In
2008 Beijing beat all prior games with an expenditure of $40 billion. Russia is expending $51 billion on the
2014 Sochi Winter Olympics compared with $6 billion spent on Vancouver's in 2010. Brazil's recent
protests were, in part, about the cost of the 2014 football World Cup and 2016 Olympics.
When it comes to vital infrastructure investment, however, Brazil, India, and Russia invest too little,
leading to multiple bottlenecks. Russia has not expanded its paved road network since 1994. Only in

2018 is a highway finally expected to connect Moscow to St. Petersburgand only then because it will be
Russia's turn hosting the World Cup.
Worse, the current BRIC thinking goes in the wrong direction. All have large state sectors and are
relatively protectionist. Because of their recent economic successes and the western financial crisis, their
policymakers increasingly see state capitalism as the solution, and private enterprise and free markets as
problems. Especially in Russia and Brazil, influential circles call for a greater role of the state, although
the corrupt state is their key problem.
Last month Igor Rudensky, the United Russia parliamentarian who chairs the State Duma's committee on
economic policy, even stated: "The leading role and the commanding heights in the economy should
belong to state corporations.... We have to preserve all the positive from [the Soviet] historical
experience." Back to the future!
Even if the BRIC political leaders were to face up to reality, their giant state corporations rule the roost.
They hold an iron grip over energy, transport, and banking. But the BRICs do not rule the world. Because
of them the West has played down the World Trade Organization, instead seeking regional trade
agreements among like-minded countries such as the Transatlantic Trade and Investment Partnership
between the United States and Europe and the Trans-Pacific Partnership with most states but China
around the Pacific Rim.
The BRICs party is over. Their ability to get going again rests on their ability to carry through reforms in
grim times for which they lacked the courage in a boom.

2014 Peter G. Peterson Institute for International Economics. 1750 Massachusetts Avenue, NW.
Washington, DC 20036. Tel: 202-328-9000 Fax: 202-659-3225 / 202-328-5432
Site development and hosting by Digital Division

Are Emerging Economies Entering a Lost Decade?

by Anders Aslund, Peterson Institute for International Economics
Op-ed in Bloomberg
September 10, 2013
Bloomberg

Morgan Stanley has named Brazil, India, Indonesia, Turkey, and South Africa the "fragile five." They share
some common characteristics: All took in excessive short-term international financial inflows, which
enticed them into accepting excessive current-account deficits for too long. High economic growth has
made their governments complacent, even as rising exchange rates undermined their competitiveness.
Now their growth rates and exchange rates are falling.

The catalyst, though not the actual cause, of the current market developments was the prospect of a rise
in US interest rates that began to take shape with Federal Reserve Chairman Ben S. Bernanke's May 22
talk about "tapering" quantitative easing. Since then, the US 10-year Treasury yield has surged by more
than 100 basis points and continues to rise, even though the Fed hasn't begun to reduce the pace of its
securities purchases.
Bond yields of vulnerable emerging economies have risen faster. Investors had always known that the
zero US interest rates would eventually normalize. Given that the Fed inflation target is 2 percent, and a
real 10-year bond yield of 3 percent used to be the average, it is reasonable to expect the bond yield to
rise to about 5 percent.
Emerging economies are in trouble because the credit and commodity booms that brought high rates of
economic growth are unsustainable. Many have received large volumes of fluid international capital. If
their exchange rates fall rapidly, large volumes of money will float out and inflation may surge. If they
defend their exchange rates with reserves, those will shrink fast. In either case, emerging economies may
have to cope with the sudden end of international financing.
Global Investment
The global investment ratio is bound to decline significantly as real interest rates rise. In recent years,
China has accounted for a large share of global investment, and in 2009, fiscal stimulus pushed its
investment ratio to an extreme level of 48 percent of GDP, from an already high rate of 35 percent in
2000. That isn't sustainable. The Chinese investment ratio is bound to fall by at least one-tenth of GDP,
which would reduce the global investment ratio, too.
Similar trends were visible at the beginning of Latin America's lost decade, in the early 1980s. As then,
the world is now approaching a downward turn of two long cycles, the 15- to 20-year long financial cycle
and the even longer commodity cycle. Emerging markets benefited from both the credit and commodity
cycles that have now peaked and begun a long-term decline of a decade or so.
The macroeconomic situation of today's emerging economies is far better than it was in some of the Latin
American countries in the 1980s. Argentina, Brazil and Peru had large budget deficits and pegged
exchange rates, leading to hyperinflation and default. Today, major emerging economies have low
inflation, limited budget deficits, mostly floating exchange rates and large international reserves. It's worth
recalling that the same was said about the United States and Europe before the recent recession.
Demand for commodities is bound to decline with less investment. In recent years, China has accounted
for about 40 percent of global consumption of major commodities. The long commodity cycle peaked in
1980, and it reached a new peak in 2008. After the oil shock of the 1970s, oil prices were very high from
1973 until 1980. But from 1981 until 1986, they fell steadily as energy consumption declined.
We are in a similar situation today. Global commodity prices rose sharply from 2003 until 2008, and they
maintained a high level until 2012 because of the very loose global monetary policy, which encouraged
both investment and speculative positions in commodities.
Energy Savings
After such a long period of high energy prices, greater energy savings are likely. Technological revolutions
such as shale gas, tight oil, deep-sea drilling and liquefied natural gas production have generated a far
greater supply effect than in the 1980s. This year, prices of almost all commodities have declined, and are
likely to continue to fall for at least half a decade.

In the early 1980s, the world experienced similar critical trends: rising global interest rates (both nominal
and real), declining investment ratios, and lower commodity prices. Poorly managed emerging economies
were battered then, and they are likely to be affected again.
Emerging economies with large current-account deficits, foreign indebtedness, budget deficits, and public
debts would be the first to suffer. The turmoil could then spread to large commodity exporters, such as
Russia, Brazil, and South Africa. China, by contrast, would benefit from lower commodity prices, but it
appears overleveraged, with a huge bank credit that amounts to twice GDP.
Global trends don't change very often, but when they do change, they do so sharply. From 2000 to 2012,
emerging economies grew 5.9 percent a year on average; US growth was 1.8 percent. This led many
people to declare the victory of the emerging economies over the West. But the high levels of emergingmarket growth were artificial, caused by the global credit boom (the Greenspan put) and then huge credit
transfers from the West.
The pre-boom period, 19802000, may be more representative of a normal period. Then, the emerging
economies grew an average of 3.7 percent a year, significantly faster than the United States, at 3.2
percent a year. That meant increasing economic divergence, because the United States increased its
advantage given the far lower staring level of the emerging economies.
Financial Turbulence
As a consequence of these global developments, in the early 1980s, the United States experienced large
currency inflows that drove up the trade-weighted US dollar exchange rate by 40 percent from 1980 to
1985, and lifted stock and bond prices. This is likely to happen again. Global economic growth will
probably moderate with deleveraging and financial turbulence in the emerging economies, while the
United States will proceed with a normal growth rate of 2.5 percent to 3.5 percent a year.
In Europe, the long recession has brought fiscal consolidation and substantial structural changes, such as
labor market reforms. The continent is now returning to growth, which is likely to be accelerated by those
tough reforms. For a decade or so, the West could take the global economic lead once again as it did in
the 1980s.
Many emerging economies that ignored necessary structural reforms during the boom could experience
low growth for a prolonged period. They have allowed state and crony capitalism to thrive, locking
themselves into a middle-income trap. Those that carried out sound reformsCentral and Eastern
Europe, Chile, Mexico, Colombia, and South Koreaare likely to do well.
Eventually, after making enough mistakes, the struggling emerging economies will be forced to undertake
the necessary reforms. In Latin America of the 1980s, this involved democratization, liberalization,
macroeconomic stabilization, and privatization, which took at least a decade. The next round of reform will
be hard, too, but change is the only way forward.

2014 Peter G. Peterson Institute for International Economics. 1750 Massachusetts Avenue, NW.
Washington, DC 20036. Tel: 202-328-9000 Fax: 202-659-3225 / 202-328-5432
Site development and hosting by Digital Division