The Death of Money (19 page)

BELLS, BRICS, AND BEYOND

We aim at progressively developing BRICS into a full-fledged mechanism of . . . coordination
on a wide range of key issues. . . . As the global economy is being reshaped, we are
committed to exploring new models.

Declaration of the BRICS

March 2013

Citizens of the Baltic countries can be grateful that their leaders never listened
to Krugman.

Anders Åslund

September 2012

■
Supranational

The European Union, the United States, China, and Japan constitute a global Gang of
Four that comprises 65 percent of the world’s economy. The remaining 157 nations tracked
by the IMF make up the other 35 percent of global output. Among these 157 nations
is a Gang of Ten consisting of Brazil, Russia, India, Canada, Australia, Mexico, Korea,
Indonesia, Turkey, and Saudi Arabia, which each produce between 1 percent and 3 percent
of global output. Each of the smallest 147 nations produces less than 1 percent of
global output, and most produce far less. The wealth concentration
among
nations is as starkly skewed as it is
within
nations. Among the 80 percent of nations with the lowest output, any one could disappear
tomorrow and the impact on global growth would scarcely be noticed.

This is important to recall when Wall Street analysts promote theses on investing
in emerging markets, frontier markets, and more exotic
locales. The fact is there are few significant capital markets, their capacity to
absorb inflows is limited, and they have a tendency to overheat when they try to absorb
more than a modest amount of capital. Yet as China heads for a hard landing, as the
United States is stuck in low gear, as Japan endures its third decade in depression,
and as Europe muddles through a structural adjustment, it is difficult to deny the
Gang of Ten’s investment appeal, and the appeal of those not far behind, such as Poland,
Taiwan, South Africa, Colombia, and Thailand.

Consider the BRICS. For convenience, as well as for marketing purposes, analysts bundle
smaller nations into groups tagged with acronyms made of members’ names. BRICS is
the granddaddy of such groups, consisting of Brazil, Russia, India, China, and a late
entry to the club, South Africa. Each BRICS member has its own attractions and problems;
what the BRICS do not have is much in common. The Russian economy is best understood
as a natural-resource-extraction racket run by oligarchs and politicians who skim
enormous amounts off the top and reinvest just enough to keep the game going. China
has produced real growth but has also produced waste, pollution, and corruption to
the point that China has an unsustainable model hostile to any foreign investor from
whom it cannot steal technology. India has growth and great promise but has not come
close to realizing its potential because its world-class red-tape
raj
stifles innovation. Among the BRICS, Brazil and South Africa come closest to being
“real” economies in the sense that growth is sustainable, corruption is not completely
rampant, and entrepreneurship has room to breathe.

Yet there is no denying the success of the BRICS moniker.
The original term
BRIC
was created by Jim O’Neill and his colleagues at Goldman Sachs in 2001 to highlight
the group’s share of global GDP and higher growth rates compared to established large
economy groups such as the G7. But O’Neill’s analysis was not primarily economic;
it was political. Beyond the basic facts about size and growth, O’Neill called for
rethinking the G7’s international governance model to reduce Europe’s role and increase
the role of emerging economies in a new G5 + BRICs = G9 formula.

In his proposed G9, O’Neill glossed over differences in social development, including
bedrock principles such as civil rights and the rule of law,
with the comment “
The other members would need to recognise that not all member countries need to be
the ‘same.’” He recognized that the BRICs were not at all homogeneous as economic
models: “The four countries under consideration are very different economically, socially
and politically.”

How O’Neill’s original work morphed from a political manifesto to an investment theme
is best explained by Wall Street’s penchant for salespeople engaging their customers
with a good story. But it is difficult to fault O’Neill for this; he had a political
agenda, and it worked. By 2008, the G7 was practically a museum piece, and the G20,
including the BRICS and others, was the de facto board of directors of the international
monetary system. O’Neill correctly foresaw that in the post–Cold War, globalized world,
the economic had become the political. Economic output trumped civil society and other
traditional metrics of inclusion in global leadership groups. The BRICS concept was
never an investment thesis so much as a political injunction, and the world took heed.

The BRICS success bred a host of acronymic imitators. Among the recent entrants in
this naming derby are the BELLs, consisting of Bulgaria, Estonia, Latvia, and Lithuania;
and the GIIPS of the EU periphery, consisting of Greece, Ireland, Italy, Portugal,
and Spain. As a group, the GIIPS are best understood as a Eurozone subset that share
the euro and are undergoing arduous internal economic adjustments. Within the GIIPS,
one should distinguish between Spain and Italy on the one hand, which are true economic
giants making up almost 5 percent of the global economy, and Portugal, Ireland, and
Greece on the other, whose combined output is less than 1 percent of global total.
On the whole, the BELLs and GIIPS have more economic factors in common than do the
BRICS, and their proponents have explicit economic themes in mind versus the overtly
political perspectives of O’Neill and Goldman Sachs.

■
BELLs

The BELLs are small, almost inconsequential, as their economies add up to just 0.2
percent of global GDP combined. But their geopolitical
significance is enormous, since they form the EU’s eastern frontier and are the frontline
states buffering Europe and the traditional eastern powers, Russia and Turkey. Unlike
the BRICS, the BELLs do have much in common. In addition to being EU members, they
had all fixed the value of their local currencies to the euro. Pegging to the euro
has led the BELLs into the same internal adjustment and devaluation as the Eurozone
periphery, since they cannot use currency devaluation as a quick fix for dealing with
economic adjustment issues.

Economists lament that they cannot conduct scientific experiments on national economies
because many variables cannot be controlled and processes cannot be replicated. But
certain cases have enough controlled variables to produce telling results when divergent
polices are pursued under similar conditions. Two such quasi-experiments involving
the BELLs have played out recently. The first contrasts the BELLs and the GIIPS; the
second contrasts each BELLs member to the others.

Experiments are typically conducted by controlling certain variables among all participants
and measuring differences in the factors that are not controlled. The first control
variable in this real-world experiment is that neither the BELLs nor the GIIPS devalued
their currencies. The BELLs have maintained a local currency peg to the euro and have
not devalued. Indeed, Estonia actually joined the euro on January 1, 2011, at the
height of anti-euro hysteria, and Latvia joined on January 1, 2014.

The second control variable is the depth of the economic collapse in both the BELLs
and the GIIPS beginning in 2008 and continuing into 2009. Each BELL suffered approximately
a 20 percent decline in output in those two years, and unemployment reached 20 percent.
The decline in output in the GIIPS in the same period was only slightly less. The
third control variable is that both the BELLs and the GIIPS suffered an evaporation
of direct foreign investment and lost access to capital markets, a shortfall that
had to be made up with various forms of official assistance. In short, the BELLs and
the GIIPS both experienced collapsing output, rising unemployment, and a sudden stop
in foreign investment in 2008 and 2009. At the same time, the governments never seriously
considered devaluation, despite wails from the pundits.

From these comparable initial conditions, divergent policies were pursued. The GIIPS
initially continued so-called economic stimulus and
made only slight cuts in public spending. Greece actually increased the number of
government employees between 2010 and 2011. The principal way of addressing fiscal
issues in the GIIPS was through tax increases. The internal adjustment process of
lowering unit labor costs began in the GIIPS only in 2010, and serious fiscal and
labor market reform was begun in 2013; much work remains.

In contrast, the BELLs took immediate, drastic measures to put their fiscal houses
in order, and strong growth resumed as early as 2010 and is now the highest in the
EU. The turnaround was dramatic. Latvia’s economy contracted 24 percent in 2008–9,
but then grew over 10 percent in 2011–12. Estonia contracted 20 percent in 2008–9
but grew at a robust 7.9 percent rate in 2011. Lithuania’s economy did not suffer
as much as the other BELLs in the crisis and actually grew 2.8 percent in 2008. Lithuania’s
growth did decline in 2009, but it bounced back quickly and rose 5.9 percent in 2011.
This pattern of collapse followed by robust growth in the Baltic BELLs is the classic
V pattern that is much discussed but seldom seen in recent years because governments
such as the United States use money printing to truncate the V, leaving protracted,
anemic growth in its wake.

How does one account for this sharp turnaround in the Baltic states’ growth compared
to the EU periphery? Anders Åslund, a scholar at the Peterson Institute for International
Economics in Washington, D.C., and an expert on the eastern European and Russian economies,
has written extensively on this topic.
He attributes economic success in the Baltics and failure in southern Europe from
2009 to 2012 to specific factors. When confronted with severe economic contraction,
he suggests, an affected nation must embrace the crisis and turn it to political advantage.
Political leaders who explain clearly the economic choices to their citizens will
gain support for tough policies, while leaders such as those in the United States
and southern Europe who deny the problem’s depth will find that the sense of urgency
recedes and that citizens are less willing over time to make the needed sacrifices.
Åslund also urges that countries facing economic crises should embrace new leaders
with new ideas. Vested interests associated with old leadership will be most likely
to cling to failed policies, while new leaders are able to pursue the cuts in government
spending needed to restore fiscal health.

Åslund also recommends that the emergency economic responses be clearly communicated,
front-loaded, and weighted more to spending cuts than tax increases. Citizens will
support policies they understand but will be ambivalent about the need for spending
cuts if politicians sugarcoat the situation and prolong the process. He also says
that “credible culprits are useful.” In Latvia’s case, three oligarchs dominated the
economy in 2006, and 51 percent of the seats in parliament were held by parties they
controlled. Reform politicians campaigned against their corruption, and by 2011 the
oligarchs’ representation had shrunk to 13 percent. The United States also had corrupt
bankers as ready-made culprits but chose to bail them out rather than hold them accountable
for the precrisis excesses.

Finally and most important, Åslund emphasizes that the restructuring process must
be equitable and take the form of a social compact. All societal sectors, government
and nongovernment, union and nonunion, must sacrifice to restore vigor to the economy.
With regard to Latvia, he writes, “
The government prohibited double incomes for senior civil servants . . . and cut salaries
of top officials more than of junior public employees, with 35 percent salary cuts
for ministers.” Again, the process in the Baltics contrasts sharply with that of countries
such as the United States, where government spending has increased since the crisis.
In the United States, public union and government employee salaries and benefits have
mostly been protected, while the brunt of adjustment has fallen on the nonunion private
sector. Åslund concludes by noting that these recommendations were mostly followed
in the Baltics and disregarded in the southern periphery, with the result that the
Baltics are now growing robustly while Europe’s southern periphery is stuck in recession
with uncertain prospects.

The BELLs’ success in quickly restoring growth and competitiveness contrasts sharply
with the GIIPS, which have stretched the process out over six years and still have
a considerable way to go to achieve fiscal sustainability. Reports from the Baltic
region are overwhelmingly positive on the economies there. Reporting on Estonia in
2012, CNBC’s Paul Ames writes, “
Shoppers throng Nordic design shops and cool new restaurants in Tallinn, the medieval
capital, and cutting-edge tech firms complain they can’t find people to fill their
job vacancies.” The BELLs have
also made good use of their human capital and a relatively well-educated workforce.
Estonia in particular has become a high-tech hub centered on its most successful company,
Skype, which has more than four hundred employees in a worker-friendly campus near
Tallinn.

The New York Times
published a story on Latvia in 2013 that accurately captured the trajectory of steep
collapse and strong recovery that used to be typical of business cycles but is now
mostly avoided by Western governments at the expense of long-term growth:

When a credit-fueled economic boom turned to bust in this tiny Baltic nation in 2008,
Didzis Krumins, who ran a small architectural company, fired his staff . . . and then
shut down the business. He watched in dismay as Latvia’s misery deepened under a harsh
austerity drive that scythed wages, jobs and state financing for schools and hospitals.