December 5, 2013
Jim O’Neill, ex-chairman of Goldman Sachs Asset Management, coined the term BRIC in a 2001 paper titled “Building Better Global Economic BRICs.” The original paper is still available on Goldman Sachs’ website. O’Neill’s main conclusion in the paper was that Brazil, Russia, India and China would see their share of the global economy grow significantly over the following decade. A conclusion that even he admits was not exceptionally profound at the time.
In his 2011 book The Growth Map: Economic Opportunity in the BRICs and Beyond, he expands upon the insights he’s developed since publishing that original paper. It’s interesting to note that the BRIC theme, which is over a decade old, has come under much criticism lately. Morgan Stanley one of Goldman’s main competitors has even gone so far as to label the currencies of Brazil, Indonesia, India, South Africa and Indonesia as the “fragile five”. Each of the “fragile five” is facing high inflation, weakening growth and large current account deficits. Naturally, investors are now wondering whether the BRIC story is finally over. Before I provide my take on that question, I think it’s interesting to highlight a bit of history and just how far the BRIC economies have come. In the book, O’Neill states:
All four of the BRIC countries have exceeded the expectations I had of them back in 2001. Looking back, those earliest predictions, shocking to some at the time, now seem rather conservative. The aggregate GDP of the BRIC countries has close to quadrupled since 2001, from around $3 trillion to between $11 trillion and $12 trillion. The world economy has doubled in size since 2001, and a third of that growth has come from the BRICs. Their combined GDP increase was more than twice that of the United States and it was equivalent to the creation of another new Japan plus one Germany, or five United Kingdoms, in the space of a single decade.
I highlight O’Neill’s original growth forecast because it’s rare to have an investment thesis play out accurately over the span of a decade. Chapter two of the book provides an overview of his forecasting methodology and his personal macroeconomic framework. This chapter alone makes reading the book worthwhile. I believe he was correct because he based his long-term growth forecast on demographics and productivity trends.
I always find it interesting when I see two different authors come to the same conclusions but from two very different perspectives. In his book Probable Outcomes, Ed Easterling states the following:
There are several ways to assess GDP and break it into component parts. One is to view the economy based upon its essential elements: labor and productivity. Since an economy represents the conversion of labor to value, the quantity of labor is a major driver of economic output and growth…Beyond population, the other element of economic growth is productivity. This is the ability to produce more goods with a given quantity of labor.
If you’re interested, you can read my full review of Probable Outcomes here. Both Easterling and O’Neill are able to make accurate macroeconomic forecasts because they break down economic growth into its core constituent parts, population growth or in other words labor growth and productivity. The key takeaway from both books is that demographic trends are very stable over time. Countries with young and growing populations will grow faster than economies that are aging.
The second factor in determining growth is productivity. The higher the investment in education, training and infrastructure the faster GDP growth will be. Although these concepts appear too simple to be of any value, the accuracy of O”Neill’s original forecast supports my belief that adding complexity to economic models doesn’t improve accuracy. You could even say there is an inverse relationship in economic forecasting between complexity and accuracy.
One of the main themes of the book is that the BRIC countries have already emerged and to lump them together with other emerging countries is a disservice to investors. O’Neill has created the new term “growth markets” to refer to the BRIC economies. The other interesting thing about O’Neill’s original forecast was that it was too conservative. His original estimate was that the combined share of global nominal GDP in US dollar terms for the BRICs would increase from 8% in 2000 to 14.2% in 2011. You can see in the table below, created using IMF data, that the actual combined share of global GDP for the BRIC countries hit 19.3% in 2011.
What’s surprising to me is that India’s share of global GDP has marginally risen from 1.5% in 2000 to 2.5% in 2012. In comparison, China’s share of global GDP has risen to 11.5% in 2012 from 3.7% in 2000. It’s clear that the past decade has been about the rise of China as a major world economy. O’Neill clearly lays out in the book that growth rate differentials are going to occur as each BRIC economy has its own set of economic and policy issues.
Ultimately, one of the major themes of the book is that the emerging markets are going to grow faster than their developed peers for decades due to lower capital stocks on a per capita basis. Essentially, individual countries in the emerging markets are starting with smaller capital bases. Thus, increased investment will result in faster growth relative to developed markets as workers in emerging markets catch up in terms of productivity with their developed market peers. Investing in emerging markets is simply a convergence trade.
I think the book as a whole can best be summed up by a comment O’Neill makes in his concluding remarks.
Many of us in business and finance have grown up thinking that the U.S. consumer drives the world. By 2020, this notion will be a mere historical observation. The next decade will power BRIC economies to be bigger than the United States, power the eight Growth Market nations to be nearly as big as the G7 and determine most Western multinational’s global success or failure.
The Growth Map: Economic Opportunity in the BRICs and Beyond is really O’Neill’s argument on why the emerging markets have already emerged. There is no doubt in my mind that the 20th century was the American century. Given the current crisis in emerging markets it may seem early to call the 21st century the BRIC century, but it’s clear that Jim O’Neill is making that bet. I would recommend all investors to read this book, particularly American investors who currently don’t see the need to invest outside their domestic market. Following the stunning performance of the S&P 500, a lot of pundits are calling the emerging market story over. However, as O’Neill so clearly highlights in the book the “growth market” story is not going to play out in just 2013 it will play out over the next few decades and possibly beyond.