International Research Journal of Finance and Economics ISSN 1450-2887 Issue 69 (2011) EuroJournals Publishing, Inc. 2011 http://www.eurojournals.com/finance.htm Status of the BRICs : An Analysis of Growth Factors Holly A. Bell Business Department, University of Alaska Anchorage, Mat-Su College, Palmer, Alaska E-mail: hollybell@me.com Tel: +1-907-746-9316; Fax: +1-907-745-9711 Abstract In 2001, Goldman Sachs coined the term BRICs (Wilson, Kelston, & Ahmed, 2010) to describe the four large developing countries of Brazil, Russia, India, and China that Goldman Sachs predict will overtake the G6 (US, Japan, UK, Germany, France, and Italy) in terms of GDP (in US$) by 2050 (Wilson & Purushothaman, 2003). The report established a set of four core factors that would create the conditions the BRIC countries would need for the predicted growth. This paper explores recent reports on those factors and others to compare the BRIC and G6 countries in terms of readiness for (or sustainability of) growth. An analysis of what these factors might indicate, potential difficulties with economic development in the BRIC countries, and the role of the Goldman Sachs report are also considered. Keywords: BRIC, Comparative Economics, Economic Performance, Goldman Sachs, Economic Freedom, Global Competitiveness 1. Introduction In 2001, Goldman Sachs coined the term BRICs (Wilson, Kelston, & Ahmed, 2010) to describe the four large developing countries of Brazil, Russia, India, and China that Goldman Sachs predict will overtake the G6 (US, Japan, UK, Germany, France, and Italy) in terms of GDP (in US$) by 2050 (Wilson & Purushothaman, 2003). The report established a set of four core factors that would create the conditions the BRIC countries would need for the predicted growth. The required factors include macro stability, institutions, openness, and education (Wilson & Purushothaman, 2003). The purpose of this paper is to explore how the BRIC countries are performing in the four core factors, as well as other indicators of economic growth in a global environment, compared to the G6 countries. The paper begins with a brief overview of the 2003 Goldman Sachs report outlining the growth of the BRIC economies followed by an analysis of economic freedom and global competitiveness indicators for both the BRIC and G6 countries. 2. The Goldman Sachs Report In 2003 Goldman Sachs published a report written by Wilson and Purushothaman entitled Global Economics Paper No. 99: Dreaming With BRICs: The Path to 2050. Eleven key points summarized the report. The following are among the findings, assumptions, and predictions: The combined BRIC economies could exceed that of the G6 in terms of US dollars in less than 40 years and could be half the size of the G6 by 2025.
International Research Journal of Finance and Economics - Issue 69 (2011) 20 The United States and Japan could be the only countries currently in the G6 that would continue to be among the six largest economies (in US$) by 2050. The increase in US dollar GDP from the BRIC countries would be in the form of higher real growth (two-thirds) and currency appreciation (one-third). Real exchange rates could appreciate by as much as 300% over 50 years. While GDP relative to the G6 will grow significantly, per capita income will continue to be lower than the G6 countries. However, China and Russia are expected to perform better in this area than Brazil and India. Annual increases in US dollar spending from the BRIC countries could exceed the G6 by as early as 2009. The increased growth could mean increased demand for capital as well as higher returns on investments. Due to rising incomes local spending patterns might change in the BRIC countries creating demand for different types of products. The authors of the report admit there are certain underlying assumptions necessary to produce the type of economic growth they predict. Specifically the BRICs must maintain policies and develop institutions that are supportive of growth and that Each of the BRICs faces significant challenges in keeping development on track (Summary, n.p.). 3. Analysis of Growth Factors 3.1. Economic Freedom Indicators Wilson & Purushothaman (2003) described openness, specifically to trade and foreign direct investment, as one of the conditions for growth. The Fraser Institute rates several indicators of economic freedom many of which are related to openness (Gwatney, Hall, & Lawson, 2010). Specifically the report measures the following: 1. Size of Government: Expenditures, Taxes, and Enterprises; 2. Legal Structure and Security of Property Rights; 3. Access to Sound Money; 4. Freedom to Trade Internationally; and, 5. Regulation of Credit, Labor, and Business (Gwatney, Hall, & Lawson, 2010, p. v). Table 1 of this paper indicates the ratings and rankings of the BRIC and G6 countries in the above indices. Summary scores charted over time (Figure 1) indicate that the BRIC and G6 countries are moving closer to convergence in terms of economic freedom. This fact supports the environment Wilson and Purushothaman (2003) require for economic growth within the BRIC countries and levels the playing field with the G6 allowing for direct competition. What remains to be seen is whether the BRIC countries and the G6 move toward classic convergence or some form of Ralston s (2008) crossvergence (conforming, static, or deviating). The level of crossvergence may, in the long-run, determine the rate at which the BRIC countries catch up to (conforming-crossvergence), remain behind (static-crossvergence), or surpass (deviating-crossvergence) the G6.
21 International Research Journal of Finance and Economics - Issue 69 (2011) Figure 1: Area Economic Freedom Summary Ratings Over Time Data Source: The Chain-Linked Summary Index of Ratings, 1970-2008 by J. Gwartney, J. Hall, and R. Lawson, 2010, Economic Freedom of the World: 2010 Annual Report, (n.p.). 3.2. Global Competitiveness The World Economic Forum (2010) produces an annual report on global competitiveness. The report begins by dividing countries into five stages of development based on GDP per capita (in US$) based on the criteria in Table 2. Table 2: Development Stage Income Thresholds Stage of Development GDP per capita (in US$) Stage 1: Factor driven <2,000 Transition from stage 1 to stage 2 2,000-3,000 Stage 2: Efficiency driven 3,000-9,000 Transition from stage 2 to stage 3 9,000-17,000 Stage 3: Innovation driven >17,000 Data Source: Income Thresholds for Establishing Stages of Development by World Economic Forum, 2010, The Global Competitiveness Report 2010-2011, p. 10. Table 1: Area Economic Freedom Ratings (Ranks), 2008 1 2 4 5 A 5 B 5 C 3 5 Size of Legal System & Freedom to Trade Credit Market Labor Market Business Sound Money Regulation Government Property Rights Internationally Regulation Regulation Regulation Rating(Rank) Rating(Rank) Rating(Rank) Rating(Rank) Rating(Rank) Rating(Rank) Rating(Rank) Rating(Rank) BRICs Brazil 6.39 (71) 5.25 (84) 7.87 (77) 6.39 (96) 5.01 (135) 7.07 (123) 3.91 (130) 4.04 (134) China 4.51 (131) 6.38 (46) 9.38 (27) 7.38 (37) 5.62 (125) 7.18 (120) 4.82 (118) 4.86 (121) India 6.84 (51) 5.93 (63) 6.69 (108) 6.79 (72) 6.31 (101) 6.89 (124) 7.29 (42) 4.75 (123) Russia 7.27 (37) 5.73 (68) 8.43 (61) 5.77 (114) 5.91 (117) 7.50 (113) 6.07 (80) 4.14 (133) G6 France 5.43 (110) 7.31 (24) 9.54 (7) 7.30 (43) 7.01 (62) 9.22 (44) 5.62 (90) 6.19 (53) Germany 5.64 (103) 8.17 (14) 9.51(13) 7.70 (18) 6.25 (105) 8.22 (83) 3.94 (129) 6.61 (29) Italy 5.71 (100) 5.67 (71) 9.48 (16) 7.11 (57) 6.54 (88) 7.91 (98) 6.30 (70) 5.40 (95) Japan 6.18 (84) 7.49 (22) 9.77 (1) 6.10 (105) 7.73 (26) 8.91 (62) 8.19 (16) 6.10 (57) UK 6.02 (91) 8.11 (15) 9.41 (24) 7.63 (22) 7.89 (17) 8.96 (58) 7.98 (18) 6.71 (27) US 7.13 (43) 7.50 (21) 9.69 (2) 7.57 (26) 7.89 (16) 7.74 (103) 9.20 (4) 6.73 (26) Data Source: Economic Freedom Dataset by J. Gwartney, J. Hall, and R. Lawson, 2010, Economic Freedom of the World: 2010 Annual Report.
International Research Journal of Finance and Economics - Issue 69 (2011) 22 All of the G6 countries are in Stage 3 of development while Brazil, China, and Russia fall into Stage 2 with India lagging behind in Stage 1. This is consistent with Wilson and Purushothaman s (2003) prediction that per capita income of the BRIC countries will continue to lag behind the G6 even as their economies grow. In addition to openness discussed in the previous section, Wilson and Purushothaman (2003) describe macro stability, institutions, and education as being important factors in creating the conditions for growth in the BRIC countries. The Global Competitiveness Report 2010-2011 (World Economic Forum, 2010) measures these and other pillars of global competitiveness. The data is divided into three sub-indexes and twelve pillars as follows: 1.Basic requirements; a. Institutions; b. Infrastructure; c. Macroeconomic environment; d. Health and primary education; 2.Efficiency Enhancers; a. Higher education and training; b. Goods market efficiency; c. Labor market efficiency; d. Financial market development; e. Technological readiness; f. Market size; 3.Innovation and sophistication factors; a. Business sophistication; b. Innovation (pp. 4-9). Basic requirements are considered key for Stage 1 (factor-driven) economies; Efficiency enhancers are key for Stage 2 (efficiency-driven) economies; and, Innovation and sophistication factors are important for Stage 3 (innovation-driven) economies. While no year over year information was available, graphing the sub-indexes for the BRICs and G6 countries at the time of the report results in the following (Figure 2, below): Figure 2: Global Competitiveness Sub-Indexes by Country Data Source: Table 5: The Global Competitiveness Index 2010-2011 by The World Economic Forum, The Global Competitiveness Report 2010-2011, pp. 15-16.
23 International Research Journal of Finance and Economics - Issue 69 (2011) Further statistical analysis reveals numerically what the patterns of the chart demonstrate. The least variability within the ten countries (BRIC and G6) is found in efficiency enhancers (SD= 0.47; CV=9.7%). This is not surprising, as the Stage 3 G6 countries have passed through this phase of development and 3 of the 4 BRIC countries are currently within this stage. The largest gap appears in innovation and sophistication factors (SD=0.81; CV=17.5%) with the G6 countries outpacing the BRIC countries. The Stage 1 basic requirements fell in the middle (SD=0.58; CV=11.4%) with China significantly outpacing the other BRIC countries. The World Economic Forum (2010) also describes the most problematic factors for doing business in each of the BRIC countries. Table 3 represents the top five in each country. Table 3: Problematic Factors For Doing Business In BRIC Countries Brazil China India Russia Tax regulations Access to Financing Inadequate supply of Corruption infrastructure Tax rates Policy instability Corruption Access to financing Inadequate supply of Corruption Inefficient government Tax regulations infrastructure bureaucracy Restrictive labor regulations Inefficient government Restrictive labor regulations Crime and theft bureaucracy Inefficient government bureaucracy Inflation Access to financing Inflation Data Source: Key Indicators by The World Economic Forum, The Global Competitiveness Report 2010-2011, pp. 106-287. 4. Discussion and Conclusions Wilson & Purushothaman (2003) in a report for Goldman Sachs indicated that Brazil, Russia, India, and China were poised for GDP growth (in US$) at a rate that would cause them, as a whole, to surpass the G6. However, in order to accomplish this task certain core factors macroeconomic stability, institutional capacity, openness and education would need to be in place as conditions for growth. This paper explored recent reports on those factors and others to compare the BRIC and G6 countries in terms of readiness for (or sustainability of) growth. Indicators of economic freedom from Gwatney, Hall, & Lawson (2010) demonstrate the BRIC and G6 countries are moving toward a form of crossvergence. The form of crossvergence (conforming, static, or deviating) will be dependent on economic freedom policies implemented by both the G6 and BRIC countries in the near future. This is a powerful indicator of increased competitiveness between the BRIC and G6 countries. However, the report includes data from 2008, so the full impact of the global recession may not be indicated in the numbers. One risk is for countries to become less open and more protectionist during difficult economic times. Global competitiveness indicators from the World Economic Forum (2010) show the variability in ratings of efficiency enhancers to be relatively low (SD=0.47; CV=9.7%) between the total BRIC and G6 countries. The greatest variability (SD=0.81; CV=17.5%) was in innovation and sophistication factors, with the G6 countries scoring higher as a group than the BRIC countries. While the data is an interesting snapshot of a moment in time, additional analysis across time is necessary to determine if these indicators are converging or diverging. However, the high variability in some categories does indicate the BRIC and G6 countries do not have the same level of global competitiveness. China is a possible exception as it is outperforming the rest of the BRIC countries in all three categories. The BRIC countries continue to lag behind the G6 countries in terms of per capita income even as their economic freedom and global competitiveness structures begin to look more like the G6. This is consistent with Wilson & Purushothaman s (2003) prediction that even as GDP growth improves in the BRIC countries they will continue to lag behind the G6. Rates of population growth will have a significant impact on per capita GDP with Russia potentially outpacing the other BRIC countries
International Research Journal of Finance and Economics - Issue 69 (2011) 24 (Wilson & Purushothaman, 2003) due to rapidly declining birth rates. According to the World Bank (2010) Russia s birth rate was -0.1% in 2009 with China at 0.5%, Brazil at 0.9%, and India at 1.3%. While China, India, and Brazil all continue to have positive birth rates, the rates of birth among all the BRIC countries are declining. Due to obstacles in data collection in several of the BRIC countries, the accuracy of birth rates remains questionable. Significant problems remain when it comes to doing business in the BRIC countries according to the World Economic Forum (2010). Three of the four BRIC countries report inefficient government bureaucracy, access to financing, and corruption as major impediments to growth. Two of the four report tax regulations, inadequate supply of infrastructure, restrictive labor regulations, and inflation as obstacles. The impact of inflation remains to be seen across the BRIC countries as gains from growth that occurs too rapidly could be diminished by inflation and the resulting declining currency values. While the BRIC countries appear to be poised for growth, a final question remains regarding the motivation for the 2003 Goldman Sachs report. The report by Wilson & Purushothaman (2003) for Goldman Sachs is peppered with subtle sales pitches for Goldman Sachs securities related to the BRIC countries. Some examples from the report include: Higher growth may lead to higher returns and increased demand for capital. The weight of the BRICs in investment portfolios could rise sharply. Capital flows might move further in their favour, prompting major currency realignments (Summary). As today s advanced economies become a shrinking part of the world economy, the accompanying shifts in spending could provide significant opportunities for global companies. Being invested in and involved in the right markets particularly the right emerging markets may become an increasingly important strategic choice (Summary). Over 80% of the value generated by the world s major equity markets will come from earnings delivered more than 10 years away. Developing strategies to position for growth may take several years and require significant forward planning (p. 4). We will be using the tools developed here to look in detail at different kinds of scenarios and to flesh out the links between our growth projections and investment opportunities (p. 14). While the BRIC countries were indicating growth prior to the Goldman Sachs report, the primary motivation for the report appears to be to sell securities in these emerging markets. We can not rule out the possibility that by promoting the BRICs and discussing at length the factors that must be in place for the level of economic growth required to meet the projections of the report, that Goldman Sachs may have been attempting to influence those markets to produce the desired growth rates. It is interesting to look at the time series graph of economic freedom (Figure 1) and note that Goldman Sachs coined the term BRIC in 2001 and followed up with their extensive report in 2003 while crossvergence began to happen around the same time periods. It is worth considering whether BRIC performance influenced the Goldman Sachs report, or if the Goldman Sachs report has influenced performance, at least in the short-run, of the BRIC countries. In a follow-up report in May, 2010, Goldman Sachs warns: In the past decade, BRIC equity markets outperformed significantly because the strong growth of these economies surprised many and the BRICs themselves came into focus.now that the BRICs story is better known, expectations are higher and the valuation gap is much smaller, the same degree of outperformance seems much less likely, even if the BRICs deliver solid returns (Wilson, Kelston, & Ahmed, 2010, p.1). As Goldman Sachs begins to downplay the potential for significant returns on investment going forward in the BRIC countries, will it cause their economic growth to slow at the same time? This author looks forward to further research in 2020.
25 International Research Journal of Finance and Economics - Issue 69 (2011) References [1] Gwartney, J., Hall, J., & Lawson, R. (2010). 2010 economic freedom dataset. In Economic freedom of the world: 2010 annual report. Fraser Institute. Retrieved from http://www.freetheworld.com/release.html> [2] Ralston, D.A. (2008). The crossvergence perspective: reflections and projections. Journal of International Business Studies, 39, 27-40. [3] Wilson, D., Kelston, A.L., & Ahmed, S. (2010). Is this the BRICs decade? BRICs Monthly 10(3). New York: Goldman Sachs. [4] Wilson, D. & Purushothaman, R. (2003). Global economics paper no. 99: Dreaming with BRICs: The path to 2050. Retrieved from http://www2.goldmansachs.com/ideas/brics/bricsdream.html [5] World Bank. (2010). World Development Indicators. Retrieved from http://data.worldbank.org/data-catalog/world-development-indicators?cid=gpd_wdi [6] World Economic Forum. (2010). The global competitiveness report 2010-2011. Geneva, Switzerland: SRO-Kundig. Retrieved from http://www.weforum.org/reports