The Rise and Fall of Nations: Ten Rules of Change in the Post-Crisis World

by Ruchir Sharma

Markets can punish these attempts to manage currency values in many ways. The most important is that if a country has borrowed heavily in dollars or euros or some other foreign currency, then devaluing its own currency by, say, 30 percent is going to raise its payments on those foreign loans by an equal margin. One of the more persistent questions about the global economy in 2015 was why so many emerging countries, including Brazil, Russia, and Turkey, had gained so little from the recent decline in the value of their currencies. The answer was that they had not fallen far enough to feel unequivocally cheap.

Devaluations can do other unintended damage as well. In a country that lacks strong manufacturing industries, the cheaper currency can do little to promote exports, earn foreign currency, and help balance the current account deficit. This is the classic vulnerability of commodity-exporting countries, though recent research shows that, compared to ten or twenty years ago, it is getting more difficult even for manufacturing powers to capitalize on a cheap currency. The reason is the recent global integration of supply chains, which means that many manufacturers buy a significant share of their parts and raw materials from abroad. As a result, exports now contain a larger share of imports, and if manufacturing powers try to gain an export advantage by devaluing their currency, they end up raising the price they have to pay for these imports.

China had little foreign debt, it did not rely too heavily on imported goods, and most important, it had a strong manufacturing sector, which grew even faster after Beijing devalued the renminbi.

Of course, a free fall in a currency is not a good sign, particularly if the country has substantial foreign debt and does not have a manufacturing base for exports that can benefit from a cheap exchange rate.

One strong thread in their research linked the major credit crises going back to the Great Depression of the 1930s and in some cases even to the “tulip mania” that tripped up Holland in the 1600s. The precursor of all these crises—and thus the most powerful indicator of a coming crisis—was that domestic private credit had been growing faster than the economy for a significant length of time. This is a very important clue.

In a detailed 2014 study of financial crises going back to 1870, the economist Alan Taylor and his colleagues concluded: “The idea that financial crises typically have their roots in fiscal [government borrowing] problems is not supported by history.” The origin of the trouble is normally found in the private sector, though countries that enter the crisis with heavy government debt will suffer from a longer and deeper recession, simply because the government will find it hard to borrow to finance bailouts or stimulus spending.

New players that came to be known as the “shadow banks” started to appear, many selling credit products promising to deliver yields that were too high to be true. The big state banks responded to the competition by offering “wealth management products” that bundled their loans together with the higher-returning debts of the shadow banks.

There are four basic signs of a stock market bubble: prices rising at a pace that can’t be justified by the underlying rate of economic growth; high levels of borrowing for stock purchases; overtrading by retail investors; and exorbitant valuations.

There was the obvious moral hazard of a market in which most lenders assumed the government would bail them out if their loans failed, the obvious potential for conflicts of interest and crony lending when the state owns the biggest banks and also their biggest customers, and the familiar spectacle of new lending enterprises popping up faster than the hand of the state could whack them down.

A worse scenario for China is also possible, however. It is the path of 1990s Japan, which tried to avoid pain at any cost after rising debts led to the collapse of its property and stock market bubbles. Rather than take steps to slow lending growth, or to force banks to recognize and clean up bad loans, Japan bailed out troubled borrowers and covered bad loans with new loans. This daisy chain of bailouts was supported by the keiretsu, large conglomerates like Mitsubishi and Mitsui that were built around one bank, whose officials often felt personally obligated to keep their various subsidiaries alive.

By the late 1990s, a survey of all publicly traded firms in Japan’s construction, manufacturing, real estate, wholesale, and retail industries found that 30 percent qualified as “zombie companies,” meaning that they were being kept alive by subsidized loans. This life-support system for failing companies blocked financing for new ones, undercutting Japan’s productivity.

In fact, the more slowly debt has been growing as a share of GDP over a five-year period, the more likely it is that the economy will witness an increase in growth, boosted by healthy credit, in the ensuing years.

Indonesia resolved bad loans and recapitalized banks with unusual aggression and speed. Given the disrepute into which banks had fallen, it was politically less difficult to inflict pain on them. The government took control of some $32 billion in bad loans, which would eventually be sold for pennies on the dollar, and injected new capital—typically, simple government bonds—into the banks that were in the best shape. Many of the rest were forced either to merge or to close, and within two years the number of banks in Indonesia had fallen from 240 to 164. Four of the worst state banks were folded into one of the stronger ones, Bank Mandiri. Nine of the failed private banks were folded into a transformed Bank Danamon, whose original owner was one of Suharto’s closest associates, but who ended up fleeing the country with the authorities close on his heels.

The basic rule: the global media’s love is a bad sign for any economy, and its indifference is a good one.

By the time a story reaches the cover of Time or Newsweek, it’s dead.

One of my objections to all the hype for the BRICs during the last decade was that this “one acronym fits all” approach to understanding the world made no distinction between manufacturing economies that grow by making things, such as China, and commodity economies that grow by pumping stuff out of the ground.

Crop yields are about half as high in China, Brazil, and the former Soviet countries as in the United States, so output could rise radically if these countries copied foreign methods. Nearly 30 percent of all food and 50 percent of all fruits and vegetables are lost in transit in the emerging world, so better roads in Brazil and Russia could greatly boost the amount of food that reaches the marketplace.

On average, authoritarian governments are no more or less likely than democracies to produce long runs of strong growth, but they produce much less steady growth and tend to experience volatile swings from very strong to very weak growth.

The Philippines is very unusual in the emerging world for the light touch of the state, which offers no subsidies for electricity or gas and has no ownership stake in major banks or in any of the companies on the Manila stock market.

In the postwar period, major economies with a shrinking working-age population have posted an average growth rate of just 1.5 percent, and have never sustained a growth rate of 6 percent or better. It seems unlikely China can buck its bad demographics either.

Today every one-percentage-point slowdown in China’s economy reduces global GDP growth by nearly half a percentage point, with emerging markets bearing the brunt.

For the practical purpose of tracking the rise and fall of nations, the time frame needs to be short enough to be plausible, but also long enough to be useful for planning and policy purposes.