In the late 1800s, the
story of a startling magic trick emerged from India and spread. In its
fullblown version, the story describes a street performer who begins to
play his flute over a coiled rope, which climbs dancing like a cobra to a
great height. The boy assistant scrambles to the top of the rope and
disappears. The magician calls for the boy, grows impatient, grabs a
large knife and scrambles up the rope, vanishing too. Then limbs, a
torso, and a head fall out of the sky. The magician reappears,
reassembles and covers the body parts, and from under a bloody sheet the
boy reappears , grinning. It would be one hundred years before "the
great Indian rope trick" was fully exposed as a hoax: a composite pasted
together in the imagination of Western visitors from the full menu of
tricks performed by Indian street magicians. Magic societies offered
rewards, but no one ever performed "the world's greatest illusion."
In recent years visitors have been returning from India in a similar
state of awe, overwhelmingly impressed by the nation that perhaps has
been most deeply transformed by the emerging-market levitation act of
the last decade. But India now risks falling for its own hype, based
largely on the assumption that it is repeating a trick pioneered by
China - a seemingly endless stretch of 8 to 9 percent growth - and is
therefore destined to be the fastest-growing economy over the next
decade. At least until the last months of 2011, when growth forecasts
dipped below 7 percent and rattled investor confidence, the Indian elite
seemed more focused on how to spend the boom's windfall than on working
to make sure the rapid growth actually happens.
The best
example of this rosy thinking was the way the ongoing baby boom in India
has been transformed from a "population time bomb" into a "demographic
dividend" . Until the 1990s the Indian government was still working hard
to rally the nation against the dangers of overpopulation, but that
fear has melted away, based on the argument that a baby-boom generation
of newworkers helped fuel China's rise and will do the same for India.
India's confidence ignores the postwar experience of many countries in Africa and the Middle East, where a flood of young people into the labor market produced unemployment , unrest, and more mouths to feed. I put the probability of India's continuing its journey
as a breakout nation this decade at closer to 50 percent, owing to a
whole series of risks that are underappreciated, including bloated
government, crony capitalism, falling turnover among the rich and
powerful, and a disturbing tendency of farmers to stay on the farm.
The next decade is full of bright spots, but you can't find them by
looking back at the nations that got the most hype in the last decade,
and hope they will hit new highs going forward. The stars of this decade
will be the breakout nations,
by which I mean the nations that can sustain rapid growth, beating or
at least matching high expectations and the average growth rates of
their income class; for the richer emerging markets with average incomes
of $20,000 to $25,000 (like the Czech Republic or South Korea) breaking
out will mean 3 to 4 percent growth in GDP, while for China, in the
class of $5,000 and less, anything less than 6 to 7 percent will feel
like a recession. Similarly, it makes no sense to think of India ($1,500
per capita income, with a high-growth population) in the same way as
Russia ($13,000, with a shrinking population ). The richer the country
the tougher the growth challenge.
The growth game is above all
about expectations. People are always asking me, "So what if India slows
from 9 percent to 6 to 7 percent - that is still three times faster
than growth in the West, right?" Well, for India that slip would
initially feel like a recession, because it is one of the poorer nations
in the low-income group - the economies
with per capita income under $5,000 - and every Indian has come to
enjoy the levitating sensation of rising fast from a low base. Last
year, New Delhi built its budget based on the revenue it could expect at
9 percent growth, and the prices in the Mumbai stock market were based
on what Indian companies would be worth down the road if the economy
continued to grow at a pace of at least 8 percent. In 2011, therefore, a
growth rate of 7 percent was enough to trigger a bear market in Indian
stocks.
India's 'Silent Cal'
Signs of an unraveling have begun to emerge under the administration of Prime Minister Manmohan Singh,
but not really because of it. When Singh was tapped to become prime
minister in 2004, many hoped that he could continue to push reform, but
in reality he became more of a figurehead, presiding over an economic
boom unleashed by global rather than local forces, particularly the tide
of easy money that was flooding out of the United States, stirring an
unprecedented boom across all emerging markets.
Singh could not
force reform on a political class and culture that had grown deeply
complacent, and he now reminds me of U.S. President Calvin Coolidge,
the nondescript leader who was in office during the boom of the 1920s
but did not use his power to correct fault lines that would bring down
the U.S. economy in the 1930s. A man of few words, Coolidge earned the
moniker "Silent Cal," and Singh too is known for keeping his mouth
shut..
Brazil, Not China
China is
not the only possible model for India. Culturally and politically India
has far more in common with the confusion of modern Brazil than with the
command-and-control environment that defines China.
Both India and Brazil are "highcontext" societies, a term popularized by the anthropologist Edward Hall
to describe cultures in which people are noisy, quick to make promises
that cannot always be relied on, and a bit casual about meeting
deadlines. These societies tend to be built on close ties built over
long periods of time, creating an environment in which a lot goes
unsaid-or is said very briefly-because much is implicitly understood
from context. The spoken word is often flowery and vague; apologies are
long and formal. Such societies believe deeply in tradition, history,
and favoring the in-group , whether it is one's family or business
circle, and thus they are vulnerable to corruption.
"Low
context," in contrast, describes societies like the United States and
Germany in which people are individual oriented, care about privacy, and
are more likely to stick to timelines and their word. People tend to be
on the move, to have many brief relationships, and thus rely on simple, open communications and codified rules to guide behavior.
The most popular soap opera in Brazil in recent times has been A
Passage to India, a Brazilian-Indian love story filmed in the Indian
cities of Agra and Jodhpur in which Brazilian actors play the Indian
roles and pass easily for North Indians. To Indians who have seen it,
the show is a dead ringer, in terms of look and mood, for the style of the Indian producer Ekta Kapoor, who has turned out some of the most popular serial dramas in Indian TV history.
In politics there is also a distinct Indo-Brazilian connection: a
desire for state protection from life's risks - social welfare for the
nation as one big in-group-to a degree rarely found in other highcontext
societies. The political elites of India and Brazil are fond of
welfare-state liberalism, and both populations demand high levels of
income support even though the economies do not yet generate the revenue
to support a welfare state. Per capita income is about $12,000 in
Brazil and $1,500 in India.
It was easy for India to increase
spending in the midst of a global boom, but the spending has continued
to rise in the post-crisis period. If this continues, India may meet the
same fate as Brazil in the late 1970s, when excessive government
spending set off hyperinflation and crowded out private investment,
ending the country's economic boom.
Crony Capitalism
Crony capitalism is a cancer
that undermines competition and slows economic growth. That is why the
United States moved to take down the robber barons by passing anti-trust
laws in the 1920s. Ever since, the American economy has seen constant
change in its ranks of the rich and powerful, including both people and
companies. On average , the Dow index of the top-thirty U.S. industrial
companies replaces half its members every fifteen years. India's market
used to generate heavy turnover too, but in late 2011, twenty-seven - 90
percent - of the top-thirty companies tracked by the benchmark Sensex
index were holdovers from 2006. Back in 2006 the comparable figure was
just 68 percent. Further, the top-ten stocks on the Sensex now account
for twothirds of the total value, while the top ten on the Dow account
for just half the total value, showing a higher concentration of
corporate wealth in India.
Like most emerging nations India
celebrates when its companies "go global," but this is not necessarily a
good sign. To hit its 8 to 9 percent growth target India needs its
businesses to reinvest at home, but they are looking abroad. Investment
by Indian businesses has declined from 17 percent of GDP in 2008 to 13
percent now. Overseas operations of all Indian companies now account for
more than 10 percent of overall corporate profitability, compared with
just 2 percent five years ago. Given the boom in the Indian middle
class, Indian companies should see huge opportunity at home: they are
leaving because of the growing resentment against the domestic operating
environment.
In the global media India is closely associated
with its dynamic technology entrepreneurs, who often grace the covers of
international magazines. But this misses the retreat inward, the
high-context side of India. Lately the enterprising moguls are getting
replaced on the billionaire list by a new group: provincial tycoons who
have built fortunes based on sweetheart deals with state governments to
corner the market in location-based industries like mining and real
estate. India has always been top-heavy with billionaires, which is
partly a function of the way ingroups work to horde the economic pie for
themselves.
Political Chameleon
India's boom has also sparked a rise in inequality, which to some extent
is natural in the early stages of economic development; however,
inequality can stall growth if it goes unchecked. Over the last decade,
consumption levels have grown dramatically for all Indians, but 6
percentage points faster per year for the richest 10 percent than for
the poorest 10 percent. Political leaders have been working to contain
social tensions, mainly by increasing government handouts rather than by
widening business and job opportunities. The Gandhi family has
continued to show its trademark sensitivity to the poor, but in ways
that may backfire against economic growth by running up deficits.
This habit - deficit spending in good times as well as bad - was a major contributor to the current debt problems in the United States and Western Europe,
and India can ill afford it. What's more, welfare schemes such as the
rural employment guarantees create a perverse incentive for villagers to
stay on the farm. China was able to convert its growing labor force
into an economic miracle by encouraging a rapid mass migration of inland
farmers to the more productive coastal cities. Over the past decade the
share of the Chinese population living in urban areas rose from 35 to
46 percent. During the same period India's urban population grew much
more slowly-from 26 percent to 30 percent of the whole.
Why it is 50-50
No other large economy has so many stars aligned in its favor, from its
demographic profile to its entrepreneurial energy and, perhaps most
important, an annual per capita income that is only onefourth of China's
. But Indian policy makers cannot assume that demographics will triumph
and that problems such as rising crony capitalism and increased welfare
spending are just sideshows instead of major challenges . These are
exactly the factors that have prematurely choked growth in other
emerging markets.
The wild card for India is its freewheeling
democracy, an environment in which the zeitgeist can change very
quickly. It was only in the last decade that India came to see itself as
the next China, and came to see its growing population as a competitive
advantage rather than as a threat. The recent case of national
overconfidence could give way just as fast to a healthy sense of
urgency, with new state-level leaders who see the complex picture of
India for what it is.
The great Indian rope trick may be
impossible, in its mythical form, but Indian leaders don't need to come
up with something that dazzling. An economy with low per capita income
is relatively easy to levitate. And lesser versions of the rope trick -
with no one disappearing into the sky and no falling body parts - are
still impressive enough to keep audiences riveted to the show.
Excerpts
from Ruchir Sharma's new book, Breakout Nations: In Pursuit of the Next
Economic Miracles, published by Allen Lane/Penguin. The author is head
of Emerging Markets and Global Macro at Morgan Stanley Investment Management