Executive summary
In this article Professor Tyrone Carlin examines:
- the new juggernaut of Brazil, Russia, India and China (BRICs) and their growing impact on international financial markets
- how the growth of BRICs offers investment opportunities in physical, financial, social and human infrastructure for Australian organisations, and
- future population growth patterns in the 21st century through statistics to illustrate why the BRICs are impossible to ignore.
The building BRICs of the new global economy
Introduction
A new financial year has just begun and given the dramatic events which continue to unfold in global financial markets, observers of economic affairs could be forgiven for feeling distinctly uncomfortable. After a false spring late in March and April, chill winds once again buffet credit markets, where liquidity constraints continue to represent a material day-to-day challenge and widened credit spreads show no signs of abatement.
Almost without exception, equity markets around the globe have suffered savage falls and in many jurisdictions real estate prices are under severe pressure. Commodity prices remain strong, ostensibly to the benefit of producer nations such as Australia, but even this represents something of a double-edged sword given its profound implications for inflationary pressures here and abroad.
In an era of US$140 per barrel oil, this possibility is brought into stark relief in light of International Energy Agency modelling suggesting that each $10 per barrel increase in average oil import prices could subtract 0.4 percentage points from growth and add 0.5 percentage points to inflation in OECD economies.
Thus, the gravity of the present situation should not be underestimated. Indeed, in its most recent annual report, the Bank for International Settlements describes the turmoil presently enveloping financial markets as without precedent in the post-war period and suggests that the global economy may be at a tipping point.
Nonetheless, the consensus view remains that though global growth will slow during 2008 (to around 3.7 per cent), a synchronised downturn will likely be avoided. While not the sweetest message investors could hope to hear, neither does this seem to be the bitterest of pills to swallow. Irrespective, great care must be taken in interpreting present consensus growth forecasts.
One hint of the dangers presently inherent in undertaking this task lies in the unusual degree of dispersion between the growth forecasts being promulgated by a range of national central financial agencies and bodies such as the IMF, or indeed the substantially differing monetary policy stances currently operative in key economies.
Clearly, the gravity of the current situation and the probability that the stresses acting on the global financial system are unlikely to dissipate in the near term must be acknowledged and factored into the decision frames adopted by businesses and investors. Equally, it is arguable that the forces buffeting financial markets with their flow-on effects to the real economy are best viewed in the context of the fundamental transformation of the global economic fabric now occurring as a consequence of the rise of key emerging market economies.
As the United States economy dips towards recessionary territory and signs of economic weakness become apparent in the United Kingdom, parts of the Euro zone and in Japan, there has been much discussion of the ‘de-coupling’ phenomenon. Put simply, the focus of this discussion lies on taking a view as to whether economies such as those of China can continue to grow essentially unabated as the United States and other substantial economies slow.
Suffice to say, this has been a divisive issue, some commentators are adamant in the view that a slowdown in China and other engine rooms of growth cannot be avoided as the United States slows, while proponents of decoupling theory propound the opposite view. In this article, no attempt is made to resolve the decoupling debate.
Instead, the focus lies on assisting readers to develop an understanding of tectonic forces at work which are likely to exert enormous influence over the shape of the global economic system over the coming decades, irrespective of whether emerging economies decouple from slowing advanced economies in the short to medium term.
Growth isn’t what it used to be
In 1995, the United States economy alone generated 16 per cent of total global real GDP growth with an equal proportion generated by the Euro area. A combination of nine other advanced economies—including Japan, Canada and Australia represented a further 11 per cent of 1995’s total global real GDP growth. Meanwhile a group of around 20 key emerging economies drove a little over half of global real GDP growth.
Those same emerging economies contributed around 50 per cent of real global consumption growth and about the same proportion of real investment growth in 1995. By 2007, the picture had altered dramatically. The emerging economies represented two thirds of real global GDP growth, almost 70 per cent of global real consumption growth and 85 per cent of global real investment growth.
Meanwhile the United States contribution to global real GDP growth shrank to around 10 per cent and to around 15 per cent of real global consumption growth. In the same year, real investment growth in the United States was negative, meaning that the United States economy actually subtracted from global investment.
While some of this result may be attributed to the relative weakness of the United States economy by 2007, the better view is that the pattern revealed in these numbers is persistent rather than a transient blip. The drivers of the change evident in the high-level aggregates discussed above are grounded fundamentally in demographic and resource endowment phenomena.
As such, developing a clearer picture of the financial future demands attention to the role which will be played by emerging economies. Of these, four stand out and are worthy of particular note. These include Brazil, Russia, India and China—the so called BRIC economies. While most in the business world have heard of the BRIC juggernaut, many find it difficult to articulate why these economies stand out individually and as a group, and how they are likely to exert influence over the global economic system. The next section of this article turns to a consideration of these questions.
Why bother about BRICs?
Sometimes superlatives are used in circumstances where they are unwarranted. It is difficult to do this in relation to the BRICs. The key statistics are simply staggering. The four nations which comprise the BRIC grouping cover an expanse of approximately 38.5 million square kilometres of land, an area into which Australia could fit five times over.
The BRICs boast a combined population of 2.85 billion, around 43 per cent of the present global total. They are believed to have a combined labour force of around 1.5 billion. By way of contrast, Australia’s labour force was recently estimated at 11 million people—so the combined BRIC labour pool is about 140 times as large as Australia’s labour pool.
While grappling with the sheer size of the BRIC block population is an important component of the development of an understanding of the significance of these countries to the globe’s economic future, coming to grips with the less well understood matter of population age profile is even more vital.
In essence, the median population age across the BRIC grouping as a whole currently stands at approximately 29.5 years. For example, compare this to median age of the United States—37, Australia—38, the United Kingdom—40, Germany—43.5 and Japan—44. This has profound implications. A careful look at some data will reveal why.
Consider China and India. Both have similar total populations, the former with approximately 1.3 billion people, the latter with some 1.2 billion. Yet on present estimates China has a labour force of approximately 805 million (62 per cent of total population) as against India’s estimated present labour force of 520 million (43 per cent of total population). How can this apparently wide discrepancy be explained?
The answer lies in the age structure of the respective populations. China’s population, with a median age of 33, is measurably older than India’s, at 25. Around one fifth of China’s present population is aged 14 or less, while in India, almost a third of the total population falls into that category. This means that at present there are in excess of 150 million more people in India than in China who are yet to enter the labour force, even though India’s total population is lower than China’s. Over the next two decades, this will have interesting consequences for the potential comparative growth levels in India and China.
When comparing the BRIC grouping to existing advanced economies, two key facts are worth noting. The first key fact is that without exception the working age population of the BRIC economies as a proportion of total population is higher than in established advanced economies. By way of example, while in established advanced economies the working age population as a proportion of total population presently stands at around 60 per cent, the equivalent proportion in China is closer to 68 per cent.
In other words, if China’s demographic profile was the same as an average established advanced economy, its potential labour force would be smaller by some 108 million people. It takes little imagination to understand the consequences of this in terms of consumption demand, investment needs, productive capacity, wealth generation and general economic vigour.
The second key fact is that though the working population to total population ratio of the BRIC grouping will decline over time, the point in time when this key ratio begins declining is later in the BRIC nations than in established advanced economies. This means that over the next four to five decades, the working age population to total population share in BRIC economies will always be higher than in the established advanced economies. As an example, it is projected that by 2050, around 60 per cent of India’s population will be of working age, while in the established advanced economies this figure will lie around the 50 per cent mark.
So, population size and profile will represent a considerable source of impetus for both absolute and relative economic development in the BRIC economies over coming decades. But the BRIC story is more than just a question of population numbers and age profiles. It is also a story about where and how vast numbers of people will live their lives and about the location of the resources they will demand as they do so.
Not just a people story
On present estimates, some 74 per cent of the Russian population and 85 per cent of the Brazilian population are urban dwellers. This is not so in the case of India and China. Urban dwellers represent 30 per cent and 43 per cent respectively of the total population. However, this is changing rapidly. It has been estimated that in both China and India, approximately 20 million new people are being added to urban populations each year.
Place this in context by imagining twice the population of Australia moving into previously non-existing cities every year. Imagine further that this were to occur year after year for the foreseeable future. This requires some imagination indeed—as do the end results—including the likelihood that by 2025, China (as an example) will have 220 cities with populations of more than 1 million and at least 24 cities with populations in excess of 5 million.
The scale and pace of investment necessary to underpin such expansion is truly epic in its proportions. To understand the magnitude of the challenges associated with this fundamental force is to understand why in 2007 alone, China installed new electricity generating capacity equivalent to twice Australia’s total installed generating capacity. It explains why in that country alone, more than 20,000 kilometres of new rail lines are presently under construction, why 85,000 kilometres of new motorways are planned for rollout over the next five years and why 48 new airports each capable of handling in excess of 25 million annual passenger movements are being built.
Nor is this simply a China story. While China leads the BRIC economies in relation to investment as a share of GDP (at around 40 per cent), India’s investment ratio is not far behind at 35 per cent of GDP. Russia is next at 25 per cent and Brazil at around 20 per cent. Each of these countries is making substantial investment in the growth of their infrastructure and productive capacity. Further, particularly in China and India where substantial population substitution from rural to urban dwelling settings is occurring, there is a strong likelihood of material increases in total factor productivity.
One side of the BRIC coin is the creation over the next decade or so of in excess of 200 million new urban dwellers, whose productivity, income, dietary requirements, consumption patterns and wealth-generating potential will be substantially greater than the rural dwelling populations they will in effect replace. Of necessity, this means rapidly growing demand for energy on the one hand and raw materials (including agricultural commodities) on the other.
This is the other, perhaps less well understood side of the BRIC coin. Consider the often overlooked fact that on a day-to-day basis, Russia is the world’s second largest producer of crude oil, supplying approximately 10 million barrels of oil per day (around 12 per cent of total global demand). Consider the same country’s known reserves of 60 billion barrels and in addition the vast potential of the relatively unexplored eastern Siberian region.
Add to this the fact that Russia holds the world’s largest natural gas reserves, the latest estimate of which stand at some 1,680 trillion cubic feet, a figure twice as large as the next largest holder of gas reserves, Iran. During 2007, Russia produced some 23.1 trillion cubic feet, of which 85 per cent was exported, much of it to Western Europe.
Even then the story is not complete, since to the oil & gas reserves, it is necessary to add Russia’s coal reserves, which at 173 billion tonnes are the second largest globally, after the United States.
In contemplating these facts, consider also Russia’s highly strategic location. The large and energy-hungry markets of Europe and China lie at its borders, both either connected or in the process of being connected directly to Russia’s vast resources via pipeline. Japan, almost wholly reliant on imports to satisfy its need for oil & gas-based energy, lies a short voyage from far eastern ports such as Vladivostok.
Shift continents to Brazil and an equally incredible set of statistics emerges. If Russia has the capacity to represent a 21st-century energy superpower, then Brazil must surely have the potential to realise the same prominence in agricultural commodities and other raw materials. With a burgeoning middle class now numbering some 20 million households (up from 14 million at the turn of the century), Brazil is making its presence felt in key materials and agricultural product markets.
Already the world’s top exporter of beef, coffee, orange juice, poultry, soya beans and sugar, it is also a giant in the global iron ore trade and holds the status as the world’s largest exporter of ethanol. What is more, unlike the agricultural sectors of key producer nations such as Australia, where climate effects appear to be materially constraining productive capacity, or temperate-zone countries where most available arable land is already under cultivation, Brazil has substantial room to grow.
Not only does Brazil boast 20 per cent of the world’s available freshwater supplies, but perhaps more importantly has more arable land available for expanded production than anywhere else on the globe. Add to this the advantage conferred by the combination of warm climate and adequate moisture and the potential is enormous. Just as Saudi Arabia is often considered the key swing producer in oil markets, so too may Brazil achieve that status in agricultural and bulk commodity markets.
Conclusion
Projecting forward to 2025, there is every likelihood that the four BRIC economies will represent 30 per cent of the global economy. By that time, the middle classes of these four nations will measure in excess of 1.5 billion people, with high earners in the BRIC economies likely outnumbering the combined total projected populations of the United Kingdom, France and Italy combined.
While per capita incomes in these economies will remain lower than in the present advanced economy club, it will be simply impossible to ignore the aggregate impact of this group of nations on the global financial and economic stage.
There are obvious geopolitical consequences which flow from these trends, but Australia is well placed to deal effectively with these. Equally, the medium- to long-run outlook in key commodities markets must be viewed as sound, irrespective of short-term volatility.
The true nature of the opportunities afforded by the rise of the BRICs however lies far beyond enhanced commodity price and volume combinations. The growth of these economies will require massive investment in physical, financial, social and human infrastructure over coming decades—and many Australian organisations will be well placed to play a substantial role in this process.
A poignant question to ask is whether anyone seriously believes that China and India, to single out the two BRIC nations closest to our own doorstep will be able to increase their educational infrastructure, particularly at the tertiary level, to satisfy in their own right the massive explosion in demand attendant to the growth in these nations’ urban populations coupled with their aspiration to climb the value added chain?
Expand such a question to industries as diverse as business services, construction, design and engineering, healthcare, financial services, tourism and hospitality, to name a few. This type of thinking suggests that far from obsessing about the latest decline in new housing commencements (which will of necessity bounce back in due course) or the latest month’s revelations about declining consumer confidence, businesses have far more profound matters about which to be concerned.
If the growth scenario discussed in this article bears any resemblance to the reality which emerges, then supply side constraints will represent a continuing source of anxiety. This is particularly in the context of large capital projects, the assumption that the requisite plant, components or indeed staff will be on hand as needed will often prove to be a very poor one.
Given the contrast between linear demand acceleration and lumpy supply response, concentrated episodes of cost pressure can be expected to represent a more normal feature of the business landscape. Further, this country’s relative scarcity of what I believe will be the 21st century’s most important ‘tradeable commodity’—people— represents a source of acute challenge, particularly in the services professions.
Yet on balance, there is reason for considerable optimism, something not to be overlooked in investment and planning deliberations which will take place over the coming quarters. Without a clear strategic thought frame it will be all too easy to place excessive weight on the significance of the stream of bad news which will almost certainly continue to emerge from key parts of the world’s financial system over that timeframe.
Professor Tyrone M Carlin
Sydney, July 2008.
Biography
Tyrone M Carlin is Professor of Financial Reporting & Regulation within the Faculty of Economics at the University of Sydney. Prior to his appointment at the University of Sydney, Professor Carlin held positions at Macquarie University and the University of New South Wales. He has published more than 100 scholarly articles in his fields of expertise and acts as a consultant to a substantial number of leading organisations.