The defining theme over the coming decades is almost certainly going to be the shifting balance of power in the global economy. This is not simply an emerging market story, as new markets have always emerged over time. It is the resurgence of sleeping giants and a historic shift in wealth from West to East that will change the economic and investment landscape forever.
The rise of emerging powers, the impact of globalisation and a historic transfer of wealth (predominantly from western developed nations to eastern developing nations) will transform the familiar economic, political and investment landscape.
For much of the 20th century, the US provided the world with economic and political leadership. After the Cold War receded and capitalism was seen to win out over communist ideologies, we entered a relatively stable world where the US was the undisputed economic and military heavyweight.
However, the growth of emerging powers – principally Brazil, Russia, India and China (known as the BRICs) – is increasingly challenging this model. In 2050, we are likely to have a very different economic “top 10”. China is almost certain to be the largest economy in the world. India will not be far behind the US, while Brazil and Russia will demote the major western European powers into the lower echelons of the top 10. (Source: Goldman Sachs BRICs Model Projections, ‘Dreaming with the BRICS’ 2003).
One of the most natural consequences of the move to a world with several dominant countries – in which US power is diminished – is that emerging markets will consider alternative models of development. Instead of emulating the western approach for political and economic progress, more countries may be attracted to China’s centrally-driven model. This may be particularly true for African nations, as China has already forged strong ties with them by investing significant sums to secure access to commodities.
Non-state entities are likely to become more influential. In fact, powerful companies with global brands may gain influence at state level. The senior managers of leading financials, commodity producers and other strategic industrials may be found treading the corridors of power almost as much as elected parliamentarians.
Political forums and trade organisations are likely to have greater power and influence in an interdependent world and will increasingly become used in negotiations between trading blocs. Traditional forums and alliances will weaken; the G8 is almost defunct, having been recently overshadowed by the G20 summit. These major power-broking events are likely to set the tone for a plethora of multi-lateral and bi-lateral negotiations between regions and individual states.
In a world with several dominant powers, there is greater potential for discord but also a greater need for co-operation and technical progress to solve widely recognised problems. Economic and population growth will put increasing pressure on geographically-constrained energy, food and water resources – raising the prospect of resource nationalism. The World Bank predicts the demand for food will rise 50% by 2030.
In particular, the need to move away from constrained energy sources, such as oil, is something that is recognised by all governments but there is no wholly satisfactory solution. In the short-to-medium term, countries that produce oil and gas could increase their economic and political power. In the longer term, they could lose out as alternative energies are found. Green and renewable energies will slowly increase their share, but further technological advances are likely to be required to fulfil the global economy’s burgeoning energy needs.
The US dollar’s position as global reserve currency has already been questioned in the fall-out from the credit crisis and the resultant surge in US government debt. Whispered calls for a new international reserve currency gained little more than newspaper inches, but how this story develops could have significant implications for financial markets.
The long-term view is compelling and it is supported by historical precedent. Power shifts are nothing new and history can tell us about the conditions that typically accompany them. Of course, it is difficult to separate military and economic power when looking at the past, as the two went more firmly hand-in-hand, but we can still make some insightful conclusions.
In the 1500s and 1600s, China and India were responsible for huge chunks of the global economy and international trade. They then entered a period of international isolation and self-sufficiency in the 1800s, which began to reverse in the two decades following the Second World War.
The resurgence is overdue. They are, after all, the two most populous nations on earth. The difference now is that their governments and entrepreneurs are firmly embracing economic and industrial progress.
The turnaround in the fortunes of many emerging economies has been dramatic. It was only 12 years ago that Russia suffered a debt default and Brazil had a major currency crisis. The current account surpluses and healthy foreign reserves the emerging markets now hold have been driven by increases in oil and commodity prices, which have generated windfall profits for the Gulf states, Russia and Brazil. Meanwhile, the competitive advantage of low-cost labour has seen Asia establish itself as the world’s manufacturing powerhouse. At the same time, consumption hungry western nations have largely provided the demand side of the equation, which has resulted in a consistent current account deficit for the G7 since 2000.
The excess foreign reserves held by emerging markets have been invested in US financial assets such as Treasury Bonds and have led to the establishment of sovereign wealth funds that have been active in the equity investment and corporate finance arena. After a flurry of activity at the start of the credit crisis, they have been a little quieter recently, but are sure to play a significant role in the future.
History demonstrates that economic and geopolitical power has tended to rest with the largest creditor nations. In broad-brush terms, Spain dominated the 1500s thanks to South American gold, Holland gained influence in the 1600s on the back of emergent capitalism and seafaring trade, and France held sway in the 1700s. Great Britain powered its way to economic hegemony in the 1800s on a combination of industrialisation and imperialism, before the US took over in the 1900s. Asia, as a region, and China, in particular, should be the next names on the list.
As recently as the 1980s, the US was the world’s largest creditor nation. Since then a burgeoning trade deficit has been funded by foreign investment in the US. Figures from the US Treasury Department show that China currently holds around $740 billion in US debt.
China recently overtook Germany as the world’s largest exporter. This reflects the huge industrial progress China has made, but it also disguises the unbalanced nature of China’s externally-facing economy.
Although China is the king of exports, it has weaker consumption than its western peers. Consumer spending is growing strongly (and western firms are scrambling to get access to the Chinese consumer), but this is happening from a low base. The transition is complicated by China’s preference for saving. As the chart below shows, the consumption share of GDP has been falling steadily in developing Asia as exports have risen.
One western concept that China has rapidly embraced is inequality of income. Despite pockets of excessive spending among the very rich, however, China has become less of a consumer economy in the past decade. The high savings rate in the household sectors of China, India and developing Asia generally can be partly explained by the lack of a social safety net. If governments begin to tackle this issue, Asian domestic consumption looks likely to be a dominant growth driver over the next few decades.
An interesting aspect of the power shift is that loose affiliations, such as the BRICs, have bonded and found common ground in their pursuit of national power and economic progress. All the BRICs have large populations, underdeveloped economies and governments that are willing, to varying degrees, to embrace global markets.
However, they are very different countries. China is now an acquisitive, high-investment economy with a powerful competitive position in low-cost manufacturing. India’s economy is more closed and insular. Its jewels are a globally competitive software industry and a large outsourcing sector. The Brazilian economy is dominated by agro-exporters, while Russia is overwhelmingly biased to oil and gas. Given that the growth of the BRICs has been built on differences, we should not assume they will behave as a group going forward. In future, they may find they have as much to quarrel about as to celebrate.
A decade of rapid growth in itself is not enough for the BRICs to completely wrestle the baton of global economic leadership from the US and Western Europe. There are short-term worries that China, especially, is in a bubble. Many investors question its ability to create self-sustaining growth without significantly increasing domestic consumption. The Chinese government introduced a $585 billion stimulus package in November 2008 and loosened bank credit. All the economic figures subsequently suggested that it worked like a dream. However, much of the funds were channelled to strategic export industries and public works, which has raised the risk of overcapacity in these areas.
Nevertheless, the long-term story is compelling, as the BRICs and other emerging markets are expected to deliver growth that simply overshadows mature, credit-crunched western economies. We believe it is possible to be very positive about the medium-to-long-term outlook.
If we are right, investors should make sure they have exposure to the beneficiaries of this historic shift in power. This will involve more than just having the foresight to identify the right countries. It will be essential to have the capability to undertake fundamental research that can identify the companies with the ability to succeed in what is certain to be a more competitive world.
The value of an investment can go down as well as up so you may get back less than you invested. Overseas investments are subject to currency fluctuations and emerging markets may be more volatile than established markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. This information does not constitute investment advice and should not be used as the basis of any investment decision, nor should it be treated as a recommendation for any investment.