Just another BRIC in the wall?

The term BRIC’s represents four countries that have the potential to become the world’s next global powers: Brazil, Russia, India and China. Yet these nations are struggling to live up to their promise as they each face different problems with their economies.

Brazil is South America’s largest country and economy, as well as the 6^th largest economy in the world. The nation has huge potential, with two future international events set to be staged in the country in the next 4 years, a thriving industrial sector, low unemployment and lots of FDI still pouring into Brazil. Above all they can boast a reliable democracy and good institutions that instil the rule of law, none of the other BRIC nations can match this. Yet Brazil is still on a worrying path. In 2010 Brazil grew by 7.5% to great applause from the rest of the world, but in the following year slumped to just 2.7%, well below the rest of the BRIC nations and Brazils high expectations of themselves. This year Brazil have forecasted growth of 4.5%, but external sources are much more pessimistic predicting just 3.5% a figure that is too low for a country like Brazil that needs high growth to keep up with the social costs of modernising its economy. So what are the reasons behind this slump in growth? For that there are many answers; the euro crisis and a strong currency slowing down demand for Brazilian exports, falling commodity prices (which help fuel Brazil’s economy), a complex tax system (that takes a higher percentage than any other middle income country) and their government. The last factor is a big reason for their slowdown in growth as the government continues to badly manage the country’s economy. Brazil remains a nation full of inequality, this is a problem the government has failed to solve for years now, as spending has been focused on financing government projects and an over generous pension system rather than reallocating funds to the poorer regions of the country. The government has also failed to invest in infrastructure with the transport system truly a mess, though the impending World Cup could help push the government into action. This leads on the next point that the government desperately needs to reform the economy to keep boosting growth, yet seems unwilling to make any big changes while the going is still good. The main reform that is needed is to free up their economy, protectionism is still a key policy of the government (especially in the oil industry) and it keeps inefficient Brazilian firms in business that should have gone under years ago. The best option could be to sign a free trade agreement with the rest of South America, which could in turn help boost Brazilian exports like the eurozone did for Germany. Without these reforms Brazil could face low growth for the next few years yet, undermining their status as one of the BRIC nations.

Brazil showed the lowest growth last year out of the BRIC nations. 

Next is Russia, whose political corruption remains their biggest problem. Vladimir Putin recently swapped jobs with Dmitry Medvedev to once again become Russia’s president, allowing Medvedev to take up his old position of prime minister. This was greeted by mass protests on the streets, but to little effect as the Kremlin kept their control over Russia. The problem is Putin seems unwilling to reform the economy, while the corruption that is rife in Russia makes it an unlikely destination for businesses to conduct deals (ranking 143^rd in the world for transparency and 120^th for “ease of doing business”). Its BRIC standing creates the perception that Russia is still an emerging economy with lots of potential, but instead it has become an oil dependant nation that seems stuck in its ways. Inequality is also a big problem, where the country is split into the very rich and the very poor, with only recently a middle class looking to emerge. Still the ultra rich have too much of a say in how the country is run, with government policy dictated by how it can profit the monopolies in Russia’s markets. The city of Moscow has the largest proportion of Billionaires in the world, where conveniently power is heavily centralised, while 20% of GDP is supplied by the ultra rich in the country (again the highest percentage in the world). Putin has made some promises in changing the economy (like improving investment) but has failed to implement promised policies in the past and there are no signs that he has changed his ways. Despite this Russia still enjoyed 4.3% growth in 2011 and are projected to grow again this year by 3.6%, this will keep the market wolves at bay and as long as there aren’t any big oil crises then Russia should continue to improve. But if Russia is to really become a global power then they will need to diversify their economy away from oil and make their country more attractive to outside investment.

Russia with the second highest amount of Billionaires, beating the other BRIC members. 

Then there is India, a country with huge resources at their disposal (huge population, lots of natural resources) yet one that is not quite achieving their potential. The economy of India is still growing at levels that Europeans could only dream of, with the average growth level since 2000 being 7.4%, but this is mainly down to the radical economic reforms that India made in the 1990’s, which freed up its economy. Similar reforms are now needed again to keep up growth, but the current government seems reluctant to act. The problem is that India now has a worse current account deficit and worse debt level than they did back then, meaning if anything reforms are even more vital. The country needs to attract investment into its country first and foremost, with a recent controversial “retroactive tax” policy causing more harm than good with a damaging fight with Vodafone over the tax that the firm is suggested to owe the Indian government from the acquisition of Hutchinson’s Indian business in 2007. The tax bill came in total to $3.75 billion and has only deepened the worry that foreigners have in investing in the country, though Vodafone have confirmed they will continue an $18.6 billion investment into the country. The country relies on good FDI (foreign direct investment) to finances its current account deficit at around 4% of GDP (the country exports more than it imports), so good relations with investors are a must. There is also too much regulation over foreign investment and too much intervention into the countries markets by the government. The power production industry is still largely state run, while the telecoms, insurance and retail markets are made extremely hard to enter for foreign firms (through a mix of corruption and regulation). Add to this the fact that Western investors are now much more reluctant to throw money around and India is facing a big problem attracting investment, on which its economy is run on. For a country with one of the best manufacturing sectors and a big potential service market (with over a billion people in the country), attracting FDI should not be a problem, yet the government’s antics have made companies question such decisions. The expensive subsidies that India pays to help its local companies cost them around 2.4% of GDP, increasing an already high budget deficit of near 6% and high inflation at near 7% which show the country’s economy is potentially overheating, as it relies too heavily on foreign capital. That isn’t to say progress hasn’t been made, with 52 million people being lifted out of poverty in the last 5 years, but the fact that half of all Indians still have to defecate in the open shows there are still major problems with the country. For India high growth of at least 6% is necessary to support their burgeoning population (of which a third still live below the poverty line) and pay off their high debts, while only a rise in wages and a major improvement in the country’s infrastructure will allow India to finally achieve their status as a new world power.

India has the highest budget deficit and highest public debt to GDP ratio compared to the other BRIC members

China completes the list, with the world’s second largest economy and is widely predicted to overtake the USA in the near future to take the top spot. Yet China faces similar issue to India, with its economy slowing down and its people reliant on high growth. China’s predicted growth this year is 8.2%, a world high still but actually China’s weakest expansion in 13 years. Like India, China needs high growth to support its huge population and keep the economy running, with 8% probably the minimum requirement. The country experienced a fast decline in industrial production, construction and electricity output in the last year which has lead many critics to suggest the economy is overheating. But China’s economy is surprisingly unreliant on foreign capital and is actually financed heavily by the state, which has the nasty habit of creating barriers to entry for foreign firms but does help make China more resilient than India and less dependent on private confidence. This investment by the state into the country’s infrastructure and factories is what boosts growth more than its exports, as it counted for 48% of GDP last year. China also the capital to re-finance any banks that might go under (a serious problem in Europe) and is one of the few countries not facing a liquidity problem. China’s general population is also much older than India’s, meaning the high growth needed to supply such a hefty workforce may no longer be needed in the future. Out of all the BRIC countries China is undoubtedly the strongest and can already call itself a world power, but the country does face some issues in the future.  China will have to free up its economy sooner or later to foreign investment or risk inefficient national firms wasting the countries resources, while inequality between the countries inner and outer regions is high, something the government will have to try and fix in the long term. China also has competitors in its industrial sector; as once the cheapest option for foreign firms, countries like Vietnam can now boast cheaper costs, making China less attractive. This could be a factor in China’s current account surplus, once as high as 10% in 2007, dropping to 2.8% of GDP this year, though the main reason is probably the increased investment by the state as mentioned earlier. This is still a good surplus and in fact many countries felt China wasn’t spending enough anyway and was manipulating their currency to keep it low, but it could prove a problem if investment isn’t sustainable as many economists believe.  China’s big problem is that their population is still incredibly poor for such a big economy (China ranks 90^th in the world for income per person) and the investment that causes such high growth is not a long term option, meaning China will have to free up its services and financial markets if it to continue high growth and increase the income of its population to the standing that its economy now holds.

China’s current account surplus drops from 10% to 2.6% in the last 5 years.

The Unelected Super Mario

In November 2011, Mario Monti was invited by the Italian President to form a government after the resignation of Silvio Berlusconi; he swiftly set up a new cabinet, appointed himself the finance minister and refused any salary. Mario Monti is an incredibly intelligent individual and has performed wonders in such dire times for Italy, especially after the farce of Berlusconi’s time in power. Silvio Berlusconi was known for his scandalous private life and questionable business decisions, while his cabinet held a former calendar girl, a minister linked with the mafia and only one female with heavy responsibilities. Mario Monti was a professor of economics, a European commissioner for 10 years and before his announcement as Prime Minister he was chosen as a Senator for Life (of which there are only seven in Italy). His cabinet also holds much more respected officials including: the chairman of NATO’s military committee, the boss of Italy’s biggest retail bank, six other professors and three women in high up positions namely the Interior Minister, Justice Minister and the head of employment and welfare.

The contrasting Time covers of both Italian Prime ministers.

Mr Monti needed a high class cabinet however to face Italy’s over whelming problems, namely that it is Europe’s biggest debtor, with Italy the only country along with Greece to have a debt to GDP ratio over 100%. Many in Europe fear that a Greek default could topple Europe, but it remains a small country, the real worry is Italy. If Italy were to crash it would all but end the euro, the current EU set up does not have the funds to bail it out and Italy’s combination of size and debt would be too much to handle for a fractured Europe. There are signs that Italy will have to be careful not to fall into this trap, with bond yields (borrowing costs) high in January at around the levels that saw countries like Portugal and Ireland needing a bailout (at 7%) and currently are at 6% and rising again. Yet Italy is actually running a very good budget, with the biggest primary budget surplus in Europe (budget excluding the interest payments on old debt), a low budget deficit when compared to European neighbours (targeting 2.7% this year) and a budget plan that hopes to wipe out the deficit by next year. It is rather growth that is Italy’s weakness, they are forecast to shrink this year by around 1% and have hardly grown in the last 10 years. This is mainly down to poor competitiveness by the county in comparison to countries like Germany as they have allowed wages to race upwards making Italy unpopular for industries.

The rise of Italian debt over the last few decades. 

In such a short space of time, Mario Monti is attempting to make more changes to the Italian system than Berlusconi made during his whole time in power. He has managed to push heavy reforms through parliament while keeping acceptable approval rates with the public, who have realised that changes must occur for Italy to survive. One big step he is taking is to make Italy more competitive within its economy, this is important as monopolies have existed in markets such as the gas industry for far too long. He hopes to complement this with extensive labour reforms that could change the level of difficulty for firms to sack their employees. This sounds wrong to begin with in such harsh times, but it could actually motivate employers to hire more Italians as they would have increased flexibility in staff turnover. There are also other unforeseen problems with the current labour rules; as it restricts young workers from entering the job market with the older generation so enshrined in their jobs, and encourages firms to offer short term contacts which offer less stability to employees and less tax for the government. This first point is backed by current unemployment statistics; Italy’s total unemployment stands at just under 10% (not great but better than most others in Europe) but the country fairs less favourably with Youth unemployment (under 25 years old) where 30% of young Italians are unemployed (only Spain, Portugal, Slovakia and Greece have higher percentages). Mr Monti is also applying strict austerity on his country to try and tackle the huge debt that is weighing them down. This means making unpopular cuts in public spending to try and decrease the budget deficit while also trying to balance it out with growth policies to stop Italy from sliding into a severe recession. This has only been accepted by the Italians as they have seen what could happen if they leave their debt unattended, with Greece not too dissimilar to Italy in some statistics. Mario Monti has also made important reforms to the pension schemes in the country and has campaigned fiercely against tax evasion (rife in Italy).

While Italy’s total unemployment is relatively low, their youth unemployment is disturbingly high. 

Mr Monti has finally given Italy credibility in Europe again as well (sorely missed under Berlusconi) with his sensible policies and likeable nature. He seems to get on with most other political leaders and has recently been offering advice on how to solve the Euro’s problems, notably backing the idea of “Eurobonds”. This is refreshing to see as it challenges the status quo that Germany is the only nation allowed to organise the policies of the euro. It is an idea that seems to be catching on as the recently elected French President Francois Hollande has also challenged the authority of Angela Merkel in deciding the EU’s future. He is also keen to get Britain back involved in the EU after David Cameron refused to sign the Fiscal Compact which seemed to set them apart from its fellow EU members.  He now needs help from his neighbours, to help Italy face its problems. He has called on Germany to push through reforms on their service industry to help boost European demand and he has called on the EU to help lower the interest rates Italy have to pay on their debt as a reward for the punishing reforms currently being pushed through by his government.

Mario Monti hopes to enjoy a good relationship with David Cameron, to try and get Britain back involved in Europe. 

There have been problems for the Italian Prime Minister however, as disagreements over his reforms, political squabbles and the impact of a weak eurozone have damaged his recovery of the Italian economy. His labour reforms have been fiercely criticised by the Trade Unions of Italy, as they argue it will just the give the big employers more power to sack Italians. Mario Monti should have reason to fear as the past two individuals who attempted labour reforms were both assassinated for their efforts. His reforms now seem to have been watered down to appease the trade unions, but there are worries they will become useless and that more weakening of Monti’s resolution to change Italy’s labour market could occur. Originally in the reforms companies would be able to fire employees for economic reasons, Mr Monti has had to back down slightly by allowing courts to reverse these situations, though he hopes to speed up the whole process. The point of the reforms are to free up the labour market and give more freedom both to employers and employees, if this watered down reform doesn’t have the same effect, then Italy would have wasted a great opportunity. Another worry with his labour reforms are that they are long term in nature, so many Italians might not have the patience to keep supporting such changes while future governments could be inclined to scrap the ideas altogether if public cries become loud enough. Public turmoil over politics is also damaging the Mario Monti’s government, as local elections showed a decline in turnout and a rise in protest parties like 5-star movement, a party headed by a comedian who rejects the current Italian set up. This doesn’t bode well for Mr Monti as faith in the government wears thin, while his backing has also taken a hit after a controversial tax on property was released by the government (disliked in a country with 70% homeownership). Then there is the ever raging Euro Crisis, as problems in Greece and Spain reverberate around Europe and cause panic in the markets, effecting Italy’s economy. If the EU was in fine order, then Italy would currently be doing a lot better, with increased demand for its exports and more money available for external investment in Italy, instead the opposite is happening as Italy’s exports are struggling and FDI in Italy is almost nonexistent. This leaves Mario Monti facing an uphill struggle to lead Italy into a recovery, with outside and inside forces both working against him.

Beppe Grillo’s 5-star movement party gained seats in the recent local elections, showing Italian distrust of the current political set up. 

The real question is what will happen when Mario Monti has to step down next Easter; the Italian political scene is a disaster with no parties able to boast a clear backing from the public. Many want him to continue as despite the harsh austerity measures he has implemented, he still has the majority of the public’s backing and no-one else can boast that right now. But Mario Monti has always stated he will not continue after next year, plus it would mean him heading a political party, which would negate the neutrality he brings to the current parliament. If he were to be kept in power in any other way it would be democratically questionable as he would remain unelected by the Italian people, a quality that too closely resembles that of a dictatorship. Yet Mr Monti has arguably been Italy’s best leader in years, and has gone about the task of fixing Italy’s problems with integrity and commitment.

Next year will probably bring back the shady Italian politics of old with underhand deals, bribes and deceit. We should value the steady and articulate leadership of Italy while we still can, it’s just a shame that it has come about from an unelected professor being handed the job.

Why does the Spanish Stock Exchange Shrink? By Adrian Espallargas

Spain entered in recession last month for the second time in three years. This country has been economically struggling since the 2008 financial crisis. The harsh austerity policies passed by the conservative government have not tackled the two main economy troubles of the country: The high unemployment rate and the very damaged financial sector. Therefore analysts are not very optimistic about the future of the Spain´s economy. In fact, the IMF expects the Spanish economy to shrink by 1.7% during this year.

Consequently, the Madrid Stock Exchange has continuously fallen since July 2011. Have a look at this graph.

However, some European countries economies have grown in the last two years or have recovered somehow after the 2008 financial crisis. For example Germany.

But why does the German economy increase while the Spanish hits the bottom? Let’s have a look at the companies that make up the DAX 30 and the IBEX 35 indexes in Frankfurt and Madrid Stock Exchanges respectively.

   

This is Germany

Among the 30 most important companies in Germany there are:

• 10 Chemical, Technological, Medical or Pharmaceutical firms.
• 4 Automotive Companies.
• 2 Banks.
• 2 Insurance Companies.
• 2 Personal and Home Care manufactures.
• 1 Steel Company.
• 1 Cement Producer.

This is Spain

Among the 35 major Spanish companies there are:

• 7 Banks.
• 6 Construction and infrastructure corporations.
• 2 Steel companies.
• 1 Pharmaceutical.
• 1 petrochemical.
• 1 Solar Power company.
• 1 Wind Power company.

Germany has a large number of firms that manufacture diverse products. Automotive, Chemical, Technological, Medical, and Pharmaceutical industries are big job creators. Those businesses need from very low-skilled level workers to very-highly educated employees. In other words, from assemblers and transporters to scientist. Besides, the large scientific community in Germany assures the country  has very innovative top level firms.

The two main activities by the 35 major companies in Spain are banking services and construction. Precisely, the two industries most affected by the 2008 economic bubble.

Construction suddenly stopped after the bubble. This industry propelled Spain’s economic growth in the 2000s making around 10% of the GDP and employing 9% of the labor force in 2009. Construction is also a huge job creator that pushes other industries such as steel manufacturers. But Spain has over built infrastructures, buildings, and houses. In fact, Spain built more houses than Germany, Italy, and France together during the bubble. There is nothing else to be constructed. Therefore, one of the largest industries has halted its economic activity triggering massive layoffs. Now, unemployment is at pre-housing bubble levels (1994-1996). The jobless rate had decreased but once the bubble exploded, we see that Spaniards are at the same situation as when it started.

Found at http://globaleconomydoesmatter.blogspot.co.uk/2010_07_01_archive.html

On the other hand, Spain has a crippled financial sector. Banks have accumulated numerous toxic assets from unpaid mortgages. Instead of depreciating the value of those properties to the current market prices, Spanish banks keep reporting in their balance sheets that the value of those assets is the price paid before the economic crisis in order to avoid reporting loses. But those prices are not fixed to the current. Consequently, nobody will invest in real estate keeping those toxic assets in stock having banks full of properties but short of liquidity.

Therefore, banks are not lending money. Despite the fact that the Spanish government bailed-out many of the cajas (savings banks), banks have used that money to pay the debts they had with other institutions instead of injecting money into the economy. Thus, there is no credit for individuals or companies. There is no fuel to start the engine.

Therefore, having the two main industries severely damaged has left the economy stagnant. Unlike Germany, there are no other industries that can carry the economy into a better scenario. The main problem of Spain is Spain itself. Until this country invests in different industries, unemployment will be an endemic disease in this nation.

This was written by the talented Adrian Espallargas, who has a great blog http://www.storyofacrisis.com/ and can be found on twitter @storyofacrisis

An economic explanation of Bayern’s failure | Economics Intelligence

An economic explanation of Bayern’s failure | Economics Intelligence.

An economic argument for why Bayern Munich lost in the final. By the same writer as below 🙂

The Economics of Success – Why Bayern Munich will beat Chelsea | Economics Intelligence

The Economics of Success – Why Bayern Munich will beat Chelsea | Economics Intelligence.

Interesting idea behind the winner of the Champions league tonight.

The Euro’s trapdoor: Elections

Europe is once again in disarray this year as Spain announce they will miss their budget targets, the effects of the ECB’s one trillion euro injection ware off and a year of elections see the public strike back at current governments. This last point is arguably the most important as elections around Europe have changed the balance of the EU and caused panic in the markets.

First up is France, who recently elected Francois Hollande as their new president. He is expected to cause a shake up within the EU as he calls for growth over austerity, rebels against Germany’s hold over Europe and expects to tax the French people more rather than cut spending (going against the current trend). Mr Hollande was also clearly not the candidate the rest of Europe favoured as Angela Merkel publicly backed Nicolas Sarkozy in the election and both David Cameron and Mario Monti refused to make time to meet him when he was a candidate, showing a general worry around Europe that Hollande could push the EU off course. But then his ideas aren’t that radical; he is arguing for a Growth Compact alongside the Fiscal Compact that will probably include policies already in place, he talks of austerity going too far but still agrees with reducing France’s budget deficit to 3% of GDP and while many are making a fuss over the French-German alliance breaking up, Francois Hollande’s contrasts with Angela Merkel might keep the EU more in check than the similar minded Sarkozy did. Even so, the elections show that it is clear France have chosen to change the direction that their country is heading in; from a globalised leader of the euro to a country that is looking at creating more trade barriers and reducing the power of the EU.

Hollande will have to learn to like austerity if he is to cut the French budget deficit.

Next up is Greece, where no party could gain enough votes to create a government, leaving many worried about the future of the country. The two biggest parties: the New Democracy party (Conservative) and Pasok party (Socialist) both experienced shocking results as their share of the vote fell from around 80% to lower than 30%. The Greek people instead voted for a range of anti-austerity parties, leaving no chance for a government to be elected as parties with contrasting policies refused to join in any coalition. The only hope is that a second round of elections will see the vote concentrated more on one or two parties as another scattered approach will cause many problems. But more important than the results of the next election is the message behind it, that the Greek people are heavily against the current bail-out scheme being forced onto their country. The problem is that there is no conceivable way around it, the EU will loath to re-negotiate the bail-out measures once again after writing off half of Greece’s debt at the start of the year. A real possibility now is that Greece will leave the euro, a frightening thought as the rest of the EU is still not ready for such an event despite it being the topic of discussion for over two years now.  This election has thrown a spanner in the works of Greece’s debt reduction plan and if radical parties can get into power in the next election, then Greece could refuse to pay back its debts, a move that could have far reaching effects around the Globe.

Greek election results.

The French and Greek elections have been the biggest elections in Europe so far, but both Britain and Italy have experienced damaging results in local elections. In Britain, the Conservatives lost 404 seats and the Liberal Democrats lost 330 seats, allowing Labour to gain 823 seats in total. This was a crushing result for the Coalition government and showed the public disapproval in the government’s performance, in fact if this was a parliamentary election then Labour would have won a majority government comfortably. In Italy, voters showed their disapproval by either voting for protest parties or by not voting at all (with the turnout at just 67%, compared with the French elections which had an impressive 80% turnout). One of Italy’s biggest losers was Berlusconi’s People of Freedom party, going from 37.6% to just 11.6% of the vote, as disapproval with the former prime minister has fallen onto his party. The problem with Italy is that while Mario Monti has done a respectable job at reforming the country, he is only a short term occupant, appointed as a technocrat leader by the coalition government to help sort out the nation’s economy. When he leaves next spring, Italy will face a hard job replacing someone who has united the different factions of the government superbly as a neutral.

This is not to mention the recent breakup of the Dutch government over budget cuts, with elections to be held soon to create a new coalition. While Angela Merkel’s party lost a local election in a key German state to their socialist rivals. Overall, this year follows a trend of countries chucking out their governments since the financial/euro crisis started. The UK voted in the Conservatives/Liberal Democrats in 2010 and chucked out Labour, while last year Italy voted out Berlusconi and Spain voted in Mariano Rajoy. The austerity measures currently being employed in Europe have left the public angry at the job cuts and new taxes that are popping up, but any possible new governments won’t have much choice to deviate from this plan. Any that does will be punished by the markets and perhaps shunned by the rest of Europe.

Austerity is a tough pill to swallow, but voting out the current governments will only lead to the same result at the end of the day.

The Substitution • Going down, going down

The Substitution • Going down, going down.

A new article up on The Substitution about the finances of the relegation candidates. Just click on the link to have a read if you are interested.

Are Brazil Ready for a World Cup

Are Brazil Ready for a World Cup.

An article I have written on whether Brazil will be ready in two years time for a World Cup.

Daily chart: Mayday | The Economist

Daily chart: Mayday | The Economist.

 

Good chart showing comparison in Europe and USA before and after the financial crisis