Monday, 16 January 2017

“Compact with Africa”: Institutional Investors for African Infrastructure? (Episode #1)

Germany will use its presidency of the G20 group of leading industrialised and emerging economies to “encourage private investment and investment in infrastructure” in Africa, according to Finance Minister Wolfgang Schäuble. Paul Collier, who has been called upon by the German Finance Minister to produce a blueprint for a “Compact with Africa”, has specified in a recent interview with the weekly Die Zeit  that it is intended to stimulate the huge asset base of insurers and pension funds to help finance Africa´s infrastructure.

In a series of blog posts, I will discuss the issue here; so stay tuned.

G20 policy focus on fostering private sector engagement in funding sustainable infrastructure in Africa is all but new. Throughout the 2010s, G20 leaders have highlighted the importance of private long-term financing - focusing on infrastructure investment - to foster long-term growth. The rational for private investment in Africa by long-term institutional investors is high, but so are the barriers.
Aging countries will see rising capital-labor ratios and reduced the returns to capital, while the rising share of sub-Saharan Africa’s working-age population is increasing the continent’s productive potential and capital returns in Africa. This constitutes the economic case for sending long-terms savings to younger economies[1]. This economic case has been joined recently by added pension pressures due to tumbling interest rates. The global search for yield is akin to drive long-term investors to look beyond OECD bond and equity markets, into so-called alternative investments.
According to the World Bank´s Africa Infrastructure Country Diagnostic (AICD), the infrastructure need of Sub-Saharan Africa exceeds US $93 billion annually over the next 10 years[2]. To date less than half that amount is being provided (mainly from domestic and foreign official sources, with about half from China)[3], thus leaving an annual financing gap of more than US $50 billion to fill. During the first decade of the 2000s, all African regions have made progress in improving their infrastructure, but since 2010 Africa´s infrastructure deployment has become uneven and on average not progressed further, according to AICD data.
Pension funds, life insurers[4] and sovereign wealth funds are characterized by the long-term nature of their balance-sheet liabilities, which enables them to invest for the long-term in infrastructure projects with long gestation periods. Asset classes such as infrastructure, which are valued less frequently and can therefore have a lower ex-post standard deviation of returns, can be a way for funds to maintain higher return targets, while dampening portfolio volatility.
There is fairly sketchy evidence on the total asset base of institutional long-term investors. Taken together, total assets managed by pension funds, insurance companies and sovereign wealth funds (SWFs) are projected by PcW to reach $ 100 trillion by 2020, up from $ 62 trillion just eight years earlier (Table 1).

Table 1: Global Assets Managed by Long-Term Institutional Investors
Assets, $ trillion/Year
2012
2020
Pension funds
33.9
56.5
Insurance companies
24.1
35.1
Sovereign wealth funds
5.2
8.9
Total, long term institutions
62.2
100.5
Source: PwC Asset Management (2016), 2020: A Brave New World, New York

Ignoring valuation changes, the rise projected for the three groups of institutional investors translates into annual asset additions worth $4.78 trillion per year on average. To fill Africa´s annual infrastructure funding gap of $50 billion, one percent of new institutional investment by pension funds, life insurance companies and sovereign wealth funds would need to be invested in Africa´s infrastructure every year.

Despite the longstanding policy focus of G8/20 leaders, private long-term investment in Africa´s infrastructure has remained deficient. Private finance still plays a minority role in funding Africa´s infrastructure. Table 2 documents the share of private finance in funding Africa´s infrastructure; it has apparently declined between 2012 and 2015, from 23 percent in 2012 to 15.6 in 2015[5].

Table 2: Who Is Financing Africa’s Infrastructure?
External finance
2011
2012
2013
2014
2015
Private, %
7.5
23.0
19.9
18.2
15.6
Public, %
92.5
77.0
80.1
81.8
84.4
Total, $bn
31.9
37.9
44.1
28.0
47.5
Source: ICA (2016), Infrastructure Financing Trends in Africa – 2015

The questions the German G20 Presidency should therefore raise go beyond announcing another “Compact with Africa”. It should explore why the decade-long G20 push for private investment in Africa´s infrastructure failed to produce results so far. Rather, regulatory supply-side barriers and low-income Africa host barriers should be analysed to identify root causes, appropriate dialogue partners and vested interests. The next episodes will provide them: watch this space! Single mega projects such as the Ouarzazate Solar Power Station should not blind us to these urgent questions.





[1] See the collected essays in Helmut Reisen (2000), Pensions, Savings and Capital Flows: From Ageing to Emerging Markets, Edward Elgar Publishing Ltd in association with the OECD, Cheltenham (UK).
[2] Vivien  Foster and Cecilia Briceno-Garmendia (Eds.) 2009, Africa’s Infrastructure: A Time for Transformation, World Bank, Washington DC: 2009.
[3] IMF (2014), Regional Economic Outlook: Sub-Saharan Africa, Washington, DC: October, chapter 3.
[4] Not all insurers have long-term liabilities. Casualty insurers, for example, have short-term liabilities. In Europe, however, life insurance companies hold 80 percent of the assets held by insurers.
[5] For data, see ICA (2016), Infrastructure Developments in Africa 2015, The Infrastructure Consortium for Africa Secretariat c/o African Development Bank: Abidjan. 

Wednesday, 16 November 2016

Dealing with China´s Acquisitions: Reciprocity or Unilateralism?

In an earlier blog post on how to deal with China´s acquisitions of German firms, I had opted for a case-by-case and sector-by-sector approach, rather than arguing indiscriminately that any acquisition attempt originating from China is a devious attempt to steal the crown jewels. Here I will specify conditions under which welfare considerations may call for reciprocity rather than unilateralism, despite the heavy potential cost of retaliation.

Meanwhile, the protectionist backlash against Chinese deals has hardened in Germany.  Berlin is now pushing for the EU to adopt rules to limit Chinese takeovers of European companies in areas such as defence, saying it wants to limit deals driven by China’s industrial policy. Sigmar Gabriel, Germany´s economic minister and Vice-Chancellor, did not even shy away from retroactively withdrawing its approval for a Chinese acquisition of Aixtron, a chipmaker. So much for Rules versus Discretion.

Lobbyists call for a tit-for-tat approach, or reciprocal liberalisation, in dealing with China. The seminal contribution to the tit-for-tat strategy as advocated by Gabriel and lobbyists has been developed by game theorist Axelrod (1984)[i], at a time when Japan´s investment in the US and Europe provoked a similar protectionist backlash as China´s acquisitions do now. Germany´s quid pro quo is likely to invite retaliation. Such retaliation is more likely in knowledge-intensive high-tech industries. Just as manufacturing is often regarded as providing broader political and economic benefits in developing countries, the location of high tech industries within own borders is a matter of ´strategic´ importance in advanced countries. Protectionism is easy in high-tech, R&D intensive industries because most governments want these industries because of an implicit belief of them being of ´strategic´ importance. Resistance to protectionist demands is therefore less likely.

Government opposition toward a certain transaction can be systematically predicted on the basis of national security sensitivity, economic distress, and reciprocity factors[ii]. Don´t forget that China created a “National Security Review” (NSR) process that mirrors the American system (CFIUS). Politicians are more likely to express opposition to “state-owned” enterprises attempting to acquire American companies. State ownership of the foreign firm—epically ownership by the Chinese government—is likely to increase fears that acquisition will create risks to both national security. When competition among rival suppliers is high and switching costs are low, however, there is no genuine national security rationale for blocking a proposed acquisition no matter how crucial the goods and services the target company provides[iii].

Table 1: China´s FDI flows and FDI Restrictiveness

2005
2010
2015
Inward FDI, $billion
104.1
243.7
249.9
Outward FDI, $billion
13.7
58.0
187.8
FDI Restrictions (0 to 1)
0.56
0.42
0.38

Lobbyists point to China´s restrictions on foreign investors, despite the fact that China has been liberalising its FDI regime continuously over the last decade. Western calls for reciprocity, while always present, seem to have intensified recently despite China´s progress as documented by the OECD (Table 1). This index of FDI restrictions, running from 0 (very open) to 1 (closed), indicates a composite of equity restrictions; screening and approval requirements; restrictions on foreign key personnel; and operational restrictions such as on land acquisition and capital repatriation. Despite all the noise from Western industry lobbies and politicians, China has steadily liberalised its capital account, from an index score of 0.56 in 2005 to 0.38 in 2015.  (As an aside, US President-elect Donald Trump calls China a ´currency manipulator´…)[iv].

It is Germany, not China, which has been identified among those countries where a pronounced worsening of commercial policy has been observed in the recent couple of years in the 20th Global Trade Alert Report (Evenett and Fritz, 2016[v]). A ranking of G20 members according to the total number of protectionist measures implemented since the first G20 Leaders’ Summit in November 2008 shows Germany at rank 6 out of 20. By contrast, Argentina and China are the only G20 members where no pronounced pick up is found in 2015 and 2016. For Australia, France, Germany, Italy, Saudi Arabia, the UK, and the USA, the 20th GTA Report finds “legitimate concerns about the protectionist dynamics building up in these G20 members”. Since November 2008, by number of times harmed by protectionist measures imposed by Germany which are currently in force, China has been hit by more than 60 measures. It is thus the world´s most harmed country by German protectionist measures[vi].

Since Adam Smith published his “Wealth of Nations” in 1776, the prevalent view among trade theorists has been in favour of unilateralism in commercial policy instead of some form of reciprocity. In its 2016 Report, the German Council of Economic Advisers also supported that Germany´s capital account stays unilaterally open, even in face of China´s FDI restrictions. The Council refers to “Free Trade for One” theorem, a term introduced by Jagdish Bhagwati (1989)[vii].
However, it can be shown in a simple trade model (Klodt, 2008)[viii] that general unilateralism can harm the host country when all three specific qualifications hold: The Chinese acquisition
i)  embodies a transfer of technology,
ii) deteriorates Germany´s terms of trade, and
iii) Germany has been a net exporter of the output produced by the acquired firm.

The economy produces two outputs, High Tech, T, and Rest, R. Its efficient frontier –its production capacity - is represented by the red transformation curve - with relative prices between T and R given by PW. Absent international trade, a would also denote the consumption of the economy. But international trade allows the economy to consume any combination of T and R along the line PW, which also denotes the country´s budget constraint. The gains from international trade result from the difference between the national production and consumption possibilities.

Diagram 1: Welfare Impact of Foreign Acquisitions


As long as foreign acquisitions do not impact PW, the country will be better off by not interfering in foreign acquisitions, analog to the “free trade for one” theorem. This presumption will hold for passive investors but not for the current wave of Chinese investments. If Chinese FDI in Aixtron, Kuka and others entails a transfer of T technology to China, the global supply of T goods will rise. The relative price of T/R will drop, the price line will turn from PW to PW´. As it can be safely assumed that the country is a net exporter, its initial position has been at to the right of a. Its welfare sinks as a result of the technology transfer as it can´t reach any longer.

The three qualifications elaborated in Diagram 1 should specifically be identified by the host government before it imposes restrictions on foreign acquisitions. These qualifications should help avoid discrimination, hence arbitrary intervention by governments, unstable conditions in world markets and commercial friction among nations. Bilateral determination of China´s fairness can be expected to lean towards being self-serving. What is tit and what is tat becomes problematic and contentious. The tit-for-tat strategy advocated by many is likely to be captured by those who seek protection. With globalization in retreat, there is a premium on unilateral liberalism in commercial policy.


  





[i] Robert M. Axelrod (1984), The Evolution of Cooperation, New York: Harper Collins: Basic Books. 
[ii] D. Tingley, C. Xu, A. Chilton, and H. Milner (2015), “The Political Economy of Inward FDI: Opposition to Chinese Mergers and Acquisitions”, The Chinese Journal of International Politics, (Spring 2015) 8 (1): 27-57.
[iii] Theodore Moran (2009), “When does a foreign acquisition pose a national security threat, and when not?”, Voxeu.org, 11 September.
[v] Simon Evenett and Johannes Fritz (2016), FDI Recovers? The 20th Global Trade Alert Report, London: CEPR Press.
[vi] Gabriel´s retroactive withdrawal of an acquisition approval is compatible with another observation of the GTA Report: Economic Policy Uncertainty Indices, which are available on a monthly basis through to July 2016 for 12 G20 members, indicate that Germany has witnessed in the recent period 2015-16 the highest level of policy uncertainty.
[vii] Jagdish Bhagwati (1989), “Is Free Trade Passé After All?”, Weltwirtschaftliches Archiv, Bd. 125, H. 1 (1989), pp. 17-44.
[viii] Klodt, Henning (2008): Müssen wir uns vor Staatsfonds schützen?, Wirtschaftsdienst, ISSN 0043-6275, Vol. 88, Iss. 3, pp. 175-180, http://dx.doi.org/10.1007/s10273-008-0772-z

Monday, 24 October 2016

Brexit, a Development Opportunity

Pre Brexit, the UK economy and polity had features that could be found at the end of various boom episodes in emerging countries. The boom distortion centered around London´s City and some satellite services, with highly paid jobs in the financial sector and attracting some smart cosmopolitan crowd (and much low skilled labour). An overvalued exchange rate had burdened manufactures profits and wages, the periphery and people with only basic skills. According to Ashoka Mody, "the pound had been driven up to nose-bleed levels from 2011 to 2015 by global property speculators and the banking elites acting in destructive synergy, causing serious damage to Britain’s manufacturing base and long-term competitiveness". Britain was suffering a variant of the ‘Dutch Disease’, although in this case the problem was over-reliance on finance rather than commodities. (The Telegraph, 10/10/2016)

In James Meade´s country, there was neither external nor internal balance. The current account of the balance of payments stood at 7% of GDP. Productivity growth was absent since long and below the level obtained by European peers. The public sector had been reduced to the bones in various areas, so there was little room to compensate the poor for unfavorable market outcomes. Meanwhile, super rich foreigners could launder money by investing in London´s real estate that saw ever rising  prices to the detriment of young families. The role of the City as the unrivalled financial centre of Europe made it a magnet for speculative property flows from Russia, China, the Mid-East. Regional imbalances between the prosperous South and the rest of the UK deepened. Compared to other developed countries the UK has a very unequal distribution of income. Out of the 30 OECD countries, the UK is the sixth most unequal, and within this data set it is the third most unequal in Europe, according to the UK Equality Trust.

 Nonetheless, the outcome of the referendum - a small but significant majority voted for leaving the EU - surprised most observers who had lost touch with the UK outside London. The EU had been badmouthed since long in the UK, notably by the evil Murdoch press. It provided to insular minds a welcome scapegoat for all the ills that had plagued the UK since long.

To a development economist, the macroeconomic policy needs for Britain seemed fairly obvious. It was not about leaving the EU, especially as the UK did not suffer from the Euro straightjacket. What was needed, however, was a rebalancing toward more regional and personal equity, the creation of pro-poor growth and jobs, implying the need to tame the City plus its satellites. A more competitive exchange rate, infant industry support and a public sector - reborn and rebalanced - were essential to any strategy to bring the UK back on a sustainable development path. Well, today the British pound stands 20% lower as measured by the BIS real effective exchange rate index. Amd parts of the financial industry threatens to move elsewhere...

Paint it black: Most of the selfreferential observers who did not see Brexit coming now deny that anything good can come out of the ´pounded British pound´. They were and are uniform in their warning that Brexit would cause a sharp recession. That recession has still to materialize (as has Brexit). In my mind, they make two loose statements:

Elasticity Pessimism. Many people seem to believe that real exchange rates don’t matter for adjustment — that is, that external and internal devaluation (downward adjustment of nontradables and wages relative to trading partners) don’t help alleviate imbalances as trade and resource flows fail to respond. The Center for European Reform, a privately sponsored think tank that gets more media attention than the quality of its opinion-heavy output might suggest, is just one example. Elasticity pessimism that was popular post WW II but has been largely refuted by considerable evidence of emerging countries that succeeded to crowd in foreign demand by sustained real exchange rate devaluation. To be sure, a short term flash crash will not provide the  incentives and signals that a sustained real devaluation will confer.

Devaluation makes Britain poorer. It is often argued that a cheaper pound makes Britain poorer. The Economist, not seldom on the wrong site of history (remember Africa - A Failed Continent?), titled recently: "Brexit is making Britons poorer, and meaner". But international trade theory has learnt us that a devaluation only makes a country poorer if it leads to a deterioration of its terms of trade. According to Fritz Machlup´s definite Kyklos (1956) study, … there is a "strong presumption that devaluation of overvalued currency lead to better resource allocation". This mirrors the UK case so that an improvement of UK´s terms of trade should not be excluded. But even if the terms of trade worsen as a result of devaluation, it does not follow that income is hit. Machlup: "The contention that a deterioration of the net terms of trade will normally cause a reduction of the real national income and a worsening of the balance of trade by equal amounts must surely be rejected."

In many poor countries, resource dependence generated slower growth, reduced economic diversity, and produced economic instability, inequality, conflict, rent-seeking and corruption. The Finance Curse produces similarly effects, often for similar reasons. Beyond a point, a growing financial sector can do more harm than good. The Tax Justice Network had, before Brexit, released a very readable pamphlet, entitled "The Finance Curse: Britain and the World Economy". Its conclusions might silence the black painters of the outcome of Brexit, a more competitive pound and a reduced finance sector:

" The financial services sector should be downsized. Macroeconomic policy should be conducted in the interests of a broader set of objectives and constituency. In turn, industrial policy should explicitly target diversification and the spatial diffusion of economic activity. Downsized finance itself will provide the basis for such a transformation with, for instance, finance losing its virtual monopoly on UK talent."

Paint it rose. The pound´s fall and the withdrawal of banks from the City could well be a blessing in disguise. Maybe, just maybe, Britain is at the first stage of a sustainable development upswing.

Saturday, 24 September 2016

Trump Bleeds Mexican Peso: a ´Peso Problem´ or Prediction?

According to Deutsche Bank, the Mexican Peso (MXN) is now the world´s cheapest currency on three fundamental valuation metrics: MXN purchasing power beats others; effective exchange rates are at historical lows; and the fundamental equilibrium exchange (external and internal balance) has dropped into the sink. [i] The question is: does the cheap Mexican Peso reflect a “peso problem” or a rising probability of a Trump presidency?
The term “peso problem” is often attributed to Milton Friedman in comments he made about the Mexican peso market of the early 1970s when the interest rate on Mexican bank deposits exceeded the interest rate on comparable U.S. bank deposits, despite a hard peg of the peso to the US dollar since 1954. Peso problems can arise when the possibility that some infrequent or unprecedented event may occur affects asset prices. The event must be difficult, perhaps even impossible, to accurately predict.

The event now is a Trump presidency that hopefully will never materialise. The markets have tended to assume that Hillary Clinton would win the election but the polls have narrowed and some have Donald Trump ahead. No doubt, a Trump victory would be a disaster for emerging market assets. Countries that run a heavy bilateral trade surplus with the United States would suffer from isolationist and protectionist U.S. policies. Countries that rely on financial markets to fund their current account deficits would suffer from a rise in US interest rates as a result of loose fiscal/tight money policy mix under a Trump presidency. Société Générale has found that Treasury bond yields tend to rise when Mr Trump gains in the polls while emerging market currencies (and the Mexican peso in particular) tend to fall. Citicorp economists recommended this summer to short the MXN as a “Trump trade”.[ii]



A Trump victory would be negative for the entire emerging market asset class – with perhaps the notable exception of the Russian market as Western sanctions would likely be withdrawn. So far, however, MXN has priced in substantial Trump risk premia.  MXN has underperformed emerging market currencies (EM FX) since May (use of MXN as a hedge for EM risk), but this underperformance has accelerated recently. According to Deutsche Bank, MXN has decoupled from external factors such as the oil price or the S&P500, being increasingly driven by Trump risk premia.

Scary prospects if the MXN is a reliable predictor of the outcome of U.S. elections to be held in November! By contrast, the MXN risk premia would unwind with a Trump election loss, implying scope for substantial MXN appreciation. Consequently, there is significant room for MXN appreciation (round 20%) if Trump loses the election. So if you like neither candidate – like so many – you can still sweeten the outcome with your personal MXN bet.







[i] Gautam Kalani and Guiherme Marone, “MXN´s Trump Card”, Deutsche Bank Research, 19th September 2016.
[ii] Dimitra DeFotis, „4 Trump Trades For Emerging Market Uncertainty”, Barron´s, 2nd August 2016.

Thursday, 1 September 2016

Reflections on the G20 Hangzhou Summit

Yawn, we are approaching another G 20 summit. Yawn because these summits have a history of proclaiming self-evident truths that subsequently aren´t implemented. Their promises are as quickly forgotten as their stiff photo snapshots with 30 or so ´world leaders´.  The 2016 G20 Hangzhou summit, planned to be held on 4–5 September 2016, will be the eleventh G20 meeting. China’s slogan for this summit is “Towards an innovative, invigorated, interconnected, and inclusive world economy.” Who could object?
What are the macroeconomic stakes?  First, to stimulate growth, fiscal expansion in G20 surplus countries is urgently required. Second, G20 structural policy should focus on rolling back the protectionist measures taken since 2008 in the G20. Third, monetary policy is largely exhausted. At the  G 20 Brisbane summit held in 2014, G20 leaders set the goal of lifting GDP by at least 2 percent by 2018. Yet, despite unprecedented monetary stimulus much of the G20, GDP growth  projected for 2016 remains well below target growth in the Euro area (1.6%) and in Japan (0.3%), according to the IMF (WEO Update, July 2016). Don´t blame the host, China: In 2015, China contributed roughly 30 percent to global economic growth-even with its growth slowing to 6.9%, the increment of GDP that it added to the world was around $760 billion.
The policy package required for achieving the Brisbane goal – monetary, fiscal, structural – seems to have relied excessively on the central banks to do a growth job for which they aren´t assigned.

·         Monetary policy: The collateral damage of monetary easing has been the danger of competitive devaluations, notably of the Japanese Yen.  G20 policymakers have repeatedly pledged to refrain from competitive devaluations and not to target exchange rates for competitive purposes.  China hopes to constrain Japan on FX intervention and to limit further downside for the EUR and GBP (CICC, Daily Briefing, 24 August 2016) with the help of the Hangzhou summit. According to Deutsche Bank´s August 2016 FX valuation snapshot, the Chinese Yuan ranks with the Swiss Franc as the most overvalued currency on all metrics used (DB effective rates; FEER; PPP). From China´s perspective then, there is little room for monetary easing elsewhere but in Beijing. It would be disingenuous to ask Beijing for more appreciation, also from a global growth perspective.
·          
Graph: The Yuan - the most expensive G20 currency

Source: Deutsche Bank Research, FX Valuation Snapshot, 31. August 2016

·         Fiscal policy: In contrast to monetary policy, there is ample room in G20 surplus countries for fiscal expansion. G20 surplus countries beggar their neighbors by crowding in foreign demand via their savings-investment surplus. Within the G20, China, Japan, South Korea, Russia, and the Eurozone ran a balance of payments surplus last year of over $1 trillion, on average 4 percent of their GDP. In the case of Germany, the surplus is currently over 8 per cent.  The G20 needs to blame Drs. Schäuble and Merkel directly and forcefully to drop their pathological fixation on the “black zero”, the balanced fiscal budget with no red ink. Raising public spending and lowering income taxes in the G20 surplus countries are the most direct way to stimulate world demand and growth in times of zero interest rates.

·       Structural policy: Priority action for the G20 should be a standstill and rollback of trade protectionism. While global trade stagnates, FDI into G20 nations has yet to break out of a narrow range witnessed since 2009. According to the latest report by www.globaltradealert.org – a pre-G20 summit briefing on investment and protectionism - the sustained violation of the G20’s pledge on protectionism has resulted in nearly 4,000 trade barriers and distortionary incentives. Seven G20 members have implemented more protectionist measures this year compared to their crisis-era annual average: Australia, the US, UK, Saudi Arabia, Italy, France and Germany. The five BRICS countries, by contrast show a better trade policy performance, but only in comparison.


Graph: Ranking G20 Member Protectionism

Source: FDI Recovers? The 20th GTA Report, CEPR Press 2016.


Name and shame specific G20 countries (as outlined here) that are first and foremost responsible for global lackluster growth: this is the noble task that G20 leaders, especially US President Obama, will face this weekend. On Tuesday, 6th September, the world will hold G20 leaders accountable.

Friday, 5 August 2016

"Democracy" and "Corruption" in the BRICS




This essay will present some recent numbers on the status of democracy and on corruption for a selected group of countries, covering the BRICS and other emerging markets of systemic importance. The analysis is descriptive, comparing 2015 with 2005 data on country rankings provided by the Bertelsmann Foundation, the Economist Intelligence Unit and Transparency International. It also explores the interaction of (subjective or impressionistic) measures of democracy and perceived corruption by looking at rank correlation coefficients.
Shifting Wealth (defined here[i]) has been in decline. Income per head convergence, social inclusion and the accumulation of foreign assets have slowed down or even reversed in the BRICS and other emerging countries. Nobel laureate Michael Spence has recently attributed the BRICS slowdown to external factors[ii]:
“Developing countries are facing major obstacles – many of which they have little to no control over – to achieving sustained high growth. Beyond the headwinds generated by slow advanced-economy growth and abnormal post-crisis monetary and financial conditions, there are the disruptive impacts of digital technology, which are set to erode developing economies’ comparative advantage in labor-intensive manufacturing activities.”
Other observers have stressed governance issues. Corruptions scandals involving the political leaders in Brazil, Malaysia and South Africa; the strengthening of authoritarian rule in China, Russia and Turkey; and the lack of social inclusion fanning internal conflict top the list of concerns. The Guardian[iii] has recently concluded:
To take their rightful place in the 21st century, the Brics countries must create more open, accountable, and trustworthy systems of governance. This is a challenge of leadership, not profit and loss.“
Both democracy and corruption can matter for sustaining growth and development, although the relationship is much more complicated than many governance zealots would have us believe.
Barro (1996)[iv] has analysed growth and democracy (subjective measures of freedom) for a panel of about 100 countries from 1960 to 1990. His findings suggest a nonlinear relationship in which more democracy enhances growth at low levels of political freedom but depresses growth when a moderate level of freedom has already been attained. He also finds that improvements in the standard of living—measured by GDP, health status, and education—substantially raise the probability that political freedoms will grow.
The Transformation Index of Bertelsmann Foundation (BTI) includes ´democracy status´. This political component tries to quantify an unweighted composite of measures for stateness; political participation; rule of law; democratic institutions; political and social integration. Table 1 reports for the five BRICS (in bold) and seven relevant emerging countries how country rankings have developed in the past decade, from 2005 to 2015.

Table 1: BTI Status Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
+
20
19
China
+
85
84
India
-
24
28
Indonesia
+
52
39
Mexico
-
27
41
Morocco
-
79
94
Nigeria
-
66
85
Russia
-
46
81
Saudi Arabia
-
93
100
South Africa
-
16
26
Singapore
-
22
25
Turkey
0
34
33

For the majority of countries, Barro´s earlier finding that economic progress furthers democracy (´freedom´) is not confirmed. Western press sentiment that the BRICS have failed to become democratic during their Golden Age seems to be confirmed. Country rankings (for a sample of 130 countries) deteriorated (and in most cases the index scores) in eight of the twelve countries selected here. But not always where some would expect it. Sure, Russia scores the worst decline but it is fairly closely followed by OECD members or darlings Mexico and Morocco. Among the BRICS, only China and India kept their ranks, albeit at grossly different levels. The only major emerging country to rise markedly in the BTI rankings over the period is Indonesia.

Table 2: EIU Democracy Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
-
42
51
China
+
138
136
India
-
35
37
Indonesia
+
65
49
Mexico
-
53
66
Morocco
+
115
107
Nigeria
+
124
108
Russia
-
102
132
Saudi Arabia
0
160
160
South Africa
-
29
35
Singapore
+
84
74
Turkey
-
88
97

Table 2 presents the Economist Intelligence Unit (EIU) Democracy Index ratings, again for the thwelve selected countries and the ranks in 2005 versus 2015 for 167 countries. The EIU Democracy Index is based on five categories: electoral process and pluralism; civil liberties; the functioning of government; political participation; and political culture. Based on their scores on a range of indicators within these categories, each country is then itself categorised as one of four types of regime: “full democracies” (20 countries only); “flawed democracies”; “hybrid regimes”; and “authoritarian regimes”. (Note that France is now considered a ´flawed democracy´ by the Economist…).
Among the BRICS, the EIU finds only Russia (??) to have slightly move up in the democracy rankings, from extremely low levels. The score in the other four BRICS deteriorated, as it did in OECD members Mexico (confirming the BTI) and Turkey. (What has the OECD Governance directorate been doing in all those years?). Strong improvements are found over the past decade in Indonesia (BTI agrees), Nigeria, and – WTF! – Saudi Arabia.
Sustained growth can also be endangered by a rise in corruption. Mauro[v] has found some subjective indices of corruption to lower investment, thereby lowering economic growth. According to the media, corruption scandals involving the presidents of Brazil, Russia and South Africa as well as anti-corruption drives in China suggest this is indeed a problem in most BRICS. Transparency International produces a Perceived Corruption Index, again a subjective index (Table 3).

Table 3: TI Perceived Corruption Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
-
70
76
China
-
70
83
India
-
70
76
Indonesia
+
130
88
Mexico
-
70
95
Morocco
-
79
88
Nigeria
+
142
136
Russia
+
121
119
Saudi Arabia
+
70
52
South Africa
-
51
61
Singapore
-
5
8
Turkey
-
60
66

Popular and press sentiment about corruption seem confirmed by the TI index. All BRICS recorded deteriorating country rankings in a sample of 167 countries, except Russia (sic!). OECD members Mexico and Turkey dropped sharply in the corruption rankings, as did Morocco. Strong improvements, by contrasts, were noted in Indonesia and Saudi Arabia.

Table 4: Rank Correlation BTI, TI, & EIU 2015
- Spearman´s Rho (p-value in brackets)-
Year
BTI 2015
TI 2015
BTI 2015
/
/
TI 2015
0.43 (0.165)
/
EIU 2015
0.76* (0.004)
0.18 (0.58)
*denotes significant by normal standards.

Rank correlation measures (Spearman´s ρ) do not indicate a significant relationship between the two democracy measures (BTI, EIU) and the TI corruption rankings. The relationship between democracy and corruption is complicated, as suggested by a vivid debate in India, for example. The only significant relation noted in Table 4 is among the two subjective democracy measures provided by Bertelsmann and The Economist.

Some tentative conclusions: The BRICS have mostly receded in international country rankings on subjective measures of both democracy and corruption. But this finding would not necessarily imply that this undermines long-term growth. The link between more ´democracy´ (as Bertelsmann and The Economist understand it) and more economic prosperity seems weaker than often thought, both over time and across countries. After all, Singapore´s authoritarian capitalism and China´s market socialism have gone a long way along rising wealth. The relationship between corruption and democracy seems weak as well. Or should we say: it´s complicated Maybe the, say, Brazilian corruption scandals will reinforce its independent judiciary and hence democracy in the end.




[i] ShiftingWealth Blogspot, “Defing Shifting Wealth”, 4 April 2011.
[ii] Michael Spence, Growth in a Time of Disruption”, Project Syndicate 27th July 2016.
[iii] The Guardian, “Has the BRICS bubble burst?“, 27 March 2016.
[iv] Robert J. Barro, „Democracy and Growth“,Journal of Economic Growth, March 1996, Vol 1, Issue 1, pp 1-27.
[v] Paolo Mauro, „Corruption and Growth“,The Quarterly Journal of Economics, Vol. 110, No. 3 (Aug., 1995), pp. 681-712.