Building Brics

An uncle - himself a successful business man - told Binny that he simply must launch a company; that too many young Indians with Binny’s qualifications were becoming consultants or investment bankers, content to criticise or crunch numbers rather than get their hands dirty and create wealth. Uncle Sachin sweetened his observation by putting Binny in touch with one of the growing number of business angels who were springing up in India's leading cities. That helped provide extra seed capital for Binny's idea to run an e-commerce outfit selling specially-printed T-shirts to the newly-affluent of Delhi - well, actually, more to their sons and daughters.

So the business was launched in September 2009 - and, happily, it is thriving, although not without having to negotiate many unnecessary obstacles along the way. Which is a key point of this feature. The idea is to examine the economies of the so-called Bric countries - Brazil, Russia, Indian and China - with the aim of assessing which one is likely to be the best home for a chunk of your investment capital in the long term, the really long term. And a major determining factor will be how each country treats its entrepreneurs.

Entrepreneurs may even be the vital factor, which is why we will hear more of Binny's trials, as well as the hurdles faced by business people in the other Bric countries. Their importance also shapes the way we have constructed the table 'The Brics compared', see below, which is the centre piece of this feature. It aims to assess the potential of each Bric nation, layer by layer. It starts with the basics – how wealthy each economy is now and how it is performing. Then it looks at the infrastructure, but mostly it focuses on the people - on their abilities and their shortcomings; and on their potential to create wealth. The people of these nations, and how they are treated, will be key. To understand why, read the box: The importance of the middle class.

It is not sufficient simply to compare the Bric countries with each other. We need to know where they aspire to get to and, besides, it is helpful to have familiar points of reference. That's why the table includes data on the UK - the economy that most of us know best - the US - the world's biggest economy - and South Africa. The springbok nation is there partly because it aspires to be a Bric country and, on some reckonings, already is (that would make them the BricS). Also, South Africa is by a long chalk Africa's biggest and most successful economy. It beats the Brics on some measures and lags them on others, but helps make the comparison richer. With that, let's discuss the sub-headings of the main table in some detail.

THE POPULATION

Starting with population helps us understand why the Brics are so important. With China and India, we have the world's two most populous nations. Roughly speaking, two out of every five people on the planet are Chinese or Indian. Meanwhile, Brazil is the fifth most populous country and Russia is the ninth.

Given their respective land areas, it could hardly be otherwise. All four are big countries. Russia is the world's largest; China the third; Brazil the fifth and India the ninth. Combine those land areas with their size of population and, almost inevitably, you have big - and therefore important - economies.

But their differences are telling. Russia is the old-world nation with the old-world population. Actually, it's worse than that - it's shrinking by 700,000 a year, with a death rate double that of the developed world and a life expectancy for men of just 60. By 2025 Russia's workforce will be 15m less than today's 86m and its demographic nightmare will only intensify because the next generation that reaches child-bearing age will be smaller than the present one. Trying to create wealth with that demographic burden will be like dragging a sleigh through Russia's frozen steppe lands - but without reindeer.

China is almost as badly off. Thanks to the persistence of Mao Zedong's one-child policy, its population is static and by 2030 there will be more old folk dependent on their children than there will be children dependent on their parents. The Chinese already have a name for this - they call it the four-two-one syndrome (four grandparents, two adults and one child). The other gruesome consequence of the one-child policy is that by 2025 young men may outnumber young women by about 40m. That may cause huge social disorder that will spill beyond China's borders. Meanwhile, China faces the worry of getting old rather than getting rich.

As you might expect of a fun-loving country, Brazil has a young population, with - as it were - another generation coming through. True, its fertility rate - the number of children born to women of child-bearing age - has fallen sharply (it was above 4.0 in 1980); even so, its demographics are okay.

However, the potential lies with India. Its population is still young and growing - by 2050 it will be bigger than China's. That means millions are flooding into the workforce, bringing with them a wealth-creating momentum. Granted, they bring problems, too. India is already heaving. Despite having a land area 13 times the size of the UK's, its population density is almost 1.5 times higher. That implies considerable poverty. Indeed, two-thirds of India's population live on less than $2 a day, so it is possible that too many subsist below the income threshold at which living hand-to-mouth is replaced by the building blocks of wealth creation - saving, planning for the future and a little discretionary spending. Yet Indians have been crossing that threshold in their tens of millions. According to the World Bank, 120m Indians crossed it in the 15 years to 2005 so, most likely, as many again would have done so since then. So, if a young, bustling, energetic population is a prerequisite for creating wealth, then India has it by the overcrowded lorry loads. The winner is: India.

WEALTH

More so even than with their populations, focusing on the wealth of the Brics emphasises their importance. By gross domestic product (GDP) - roughly speaking, the output generated - we are discussing the world's second and third biggest (China and India) and sixth and seventh biggest (Russia and Brazil). True, these figures are based on GDP by 'purchasing power parity', a measure that corrects for differences in standards of living. The effect on India's ranking is marked. Simply based on output in dollars, India's economy is the world's ninth largest, according to United Nations' data. But adjust for the fact that a dollar goes a long way in Mumbai, and India's output shoots up to third, just beyond Japan's. Russia also benefits. Its ranking rises from 10th to seventh.

From an investor's perspective, however, per capita wealth is probably more relevant. It tells us how much spending power a country's population has. Although they are labelled 'developing' economies, the Brics lie somewhere between the newly-developing nations of Africa and the developed world. They are not really poor, but they are far from being rich. For example, even the per capita GDP for Russia - the highest of the Brics - is much less than half the UK's, using purchasing-power-parity accounting. Yet Russians are rich compared with Albanians, who, in 90th place, occupy the median ranking in the World Bank's lists with per capita GDP of $9,443 (£6,254).

The exception, of course, is India, which is in 133rd place. Yet even that puts it above all the sub-Saharan countries bar South Africa and Botswana (58th place).

The winner is...there is no winner in this category, it just reminds us of where the Brics want to be.

HOW EACH COUNTRY IS DOING

Not nearly as well as the recent past, but not at all badly. Sure, growth this year and next will be well below the average rate of the years 2004-10 (see table) and it's unlikely that China's growth will ever again be consistently in double figures year after year. Yet, bar Russia, growth in the Brics should be well in excess of anything that the developed economies are likely to produce and, if it's currently below trend, then it could pick up again in the next five years or so.

Allied to this, each Bric has either excellent finances (in the case of China and Russia) or acceptable finances (the other two). Thus India's current account balance is in deficit to roughly the same degree as the UK and the US. India might have more difficulty financing such a deficit than those two, yet not so long ago it would have been considered perfectly normal that a fast-developing country should be importing more than it was exporting (and funding the gap from its growth). Meanwhile, the Indian government's deficit is coming under control (and likely to be about 7 per cent of GDP in 2013-14) and overall levels of government debt are highish for a state that does limited spending, but not worryingly so.

Ditto Brazil, whose past average growth is the lowest of the Brics. Future growth may exceed Russia's, but it won't challenge the other two. It is a potential problem that Brazil's government spends at the rate of the rich world but gives its citizens services closer the poor world (hence all those street protests) and inflation is stubbornly high. But whatever growth Brazil generates, it should not be constrained by the national finances.

If this section focused on the future, then Russia might be a problem. Its sclerotic economy is desperately dependent on oil and gas, which has served it well in the past decade - hence those fat foreign-exchange reserves - but may not do so well in the next one. Nor does it help that its hugely self-serving state apparatus gets so involved in the economy to so little effect. True, this is a generic problem among Brics, but Russia is in a league of its own (more on that later).

However, if we focusing on recent performance there is only one winner. Possibly nothing in economic history matches China's rise from poverty in the past 30 years. If two metrics in the table demonstrate that, they are GDP growth and foreign-exchange reserves. Think of the reserves as sort of retained profits and currently China has roughly a third of all the world's - wow! The winner is: China.

Investment opportunities: the Brics

WHERE OUTPUT COMES FROM

Better data might generate a better discussion. Broadly speaking, though, the breakdown of Brazil's and Russia's economies are close to the developed world's, while China's and - especially - India's are closer to frontier economies.

However, within Brazil's and Russia's services sectors, a disappointingly high proportion of output comes from the state. For example, in Russia 25 per cent of the workforce is employed by the state, while the Brazilian state machine is notorious for its bloat.

But the chief point of this part of the table is to show the continuing potential in China and India to switch more workers away from comparatively unproductive agriculture and into manufacturing and services, where their output would be more valuable. In India about 50 per cent of the workforce is still working on the land, yet it generates only 19 per cent of India’s output. The proportions in China are similar - 40 per cent of the workforce produces 10 per cent of national output. Even in an agricultural powerhouse such as Brazil - the world's biggest exporter of coffee, sugar, chickens, beef and orange juice - it takes 17 per cent of the workforce to generate 6 per cent of the nation's output.

True, having shifted workers away from the land, there remains the challenge to create jobs in manufacturing and services. For India, in particular, the top priority is to conjure up millions of low-skilled jobs for its similarly low-skilled, but fast-growing, workforce. That said, simply by focusing on the potential to shift output to more productive areas of the economy, the winner is: India.

THE STATE OF INFRASTRUCTURE

On some reckonings, China is really just one giant infrastructure project. Forget about the plastic toys, the cheap fashion wear, the electrical goods and the telecoms equipment that China sells to the world. The real economic miracle of China these past 30 years is the construction of a nation whose infrastructure is the equal of the developed world's and, in so many areas, leaves the rich world far behind. It's not just the mind-boggling scale of projects such as the Three Gorges Dam across the Yangtze River (which generates over four times more electricity than the Drax power station, the UK's biggest coal-fired plant). More relevant to wealth creation is that China's infrastructure works, and one figure that reveals that best is the proportion of electricity generation that is lost in transmission. At just 6 per cent, China's output losses are as good as the US and better than the UK's

In contrast - and worryingly so - India's electricity transmission losses are by far the worst of the Brics. Then again, so much of India's power infrastructure is a mess - during peak times, its system can only supply 90 per cent of demand and about 300m Indians are not on the grid at all. Such shortcomings are repeated throughout the country's infrastructure. Worst of all, about half the country's 1,200m population still lacks basic sanitation.

In a new book, An uncertain glory: India and its contradictions, two economists - Amartya Sen, a Nobel Prize winner, and Jean Drèze - point out that all successful countries grow on the back of big public spending on infrastructure because having the basics that work allows business to function efficiently. Victorian Britons knew this only too well (and modern Britain still runs on much of their work), Deng Xiaoping realised this when he allowed market forces to play a role in China in the early 1980s. India - and to a lesser extent Brazil - may not have yet grasped the point.

Admittedly, there is a danger that China has taken its obsession with infrastructure too far. Conventional wisdom has it that 25 per cent of output is a good proportion for a developing country to spend on capital projects (much, though not all, of which will be for infrastructure). In China, the proportion is verging on 50 per cent. That could mean much of the investment will be unproductive. Either that will result in chronic overcapacity or massive bad loans for lenders. Yet that contention is debatable. It is also possible that China still needs to build lots more of everything, so it does not matter too much in which order it builds its infrastructure. Besides, compared with its output, China's capital stock - about 2.5 times output - is about the same as the US's and less than Japan's.

However you argue it, if the quality of infrastructure is a cornerstone that supports sustained economic growth, then the winner is: China.

ABILITY OF THE WORKFORCE

It's crucial - the health and training of a workforce will shape its ability to run a successful economy. The better its health and training - call it ability - then, other things being equal, the greater its potential to create wealth. But how to measure that? A leading development economist, Mahbub ul Haq, was convinced that a single index number was needed to convince policymakers of the need to make decisions that best fostered human potential. And so the Human Development Index (HDI) became a key feature of reports from the United Nations Development Programme.

Setting aside the maths, the index is the geometric average of three sub-indices, which are based on life expectancy, education and income. So it attempts to quantify the obvious - that an enjoyable life will be one with health and longevity, decent education and acceptable income. True, the HDI is criticised as simplistic, but there is no escaping the fact that developed democracies congregate around the top while undeveloped dictatorships cluster around the bottom.

Of the Brics, Russia has easily the highest HDI ranking. Not surprising as it is the richest of the four and has long had a sophisticated education system. But the HDI takes no account of Russia's horrible demographics (mentioned earlier), nor its terrible health. Put bluntly, Russians - especially the men - drink themselves to death. Male life expectancy is just 60 and a researcher at Russia's Institute of Psychiatry estimated that 30 per cent of all men die of causes related to alcohol consumption.

Happily, Russians are still far short of western levels of obesity, which makes you think that, if they quit the booze, they would make a smart workforce. Well, that much is a given. Stalin modernised Russia in 20 years on the back of the country's intelligentsia. The trouble is they remained - and remain - outside Russia's ruling elite. If they had a state machine that helps, rather than exploits, them, Russia would be a different proposition. But that's for the next - and vital - section of the table. If we are focusing on ability alone, then, the winner is: Russia.

The Brics compared

POTENTIAL TO CREATE WEALTH

So far we have focused on the backdrop to wealth creation - where the Bric nations start from; their infrastructure; the skills of their workforce. Now we are getting down to the nitty gritty: a country's potential to create wealth. Here we quantify how feasible it will be for entrepreneurs to get stuck in and, in particular, we are addressing the question: to what extent does the state - its regulations, its institutions and the people who run them - help or hinder business people?

The assumption behind this is that in the long run - the really long run - a nation's wealth - and therefore its attractiveness as a place for investment capital - will depend on how it treats entrepreneurs. That may be so, but there is more than one way to grow, particularly from a low base. China especially - but Brazil and Russia to a lesser extent - have relied on state-owned (or state-controlled) enterprises (SOEs) as an alternative route. SOEs have shown they can be effective in the earlier stages of modernisation. However, there are reasons to question whether an economy built around SOEs can progress all the way to developed status (and to understand why, see the box: State-controlled limitations).

For some years yet that won't matter much in China. Nor for even longer will it affect growth in India, which, on some reckonings, could do with the discipline that well-run SOEs could bring to the capital intensive parts of its hotchpotch economy. But for capitalism to bring its biggest benefits - and for a nation to be a great in place in which to invest for the long haul - business people need to operate in a system that is fair: where they are free to start a business; free to innovate; free to disrupt entrenched operators; free to keep most of their profit; and - like it or not - free to face competition from new upstarts.

So how are the Brics doing? Let's not kid ourselves - none is doing well; on average, all are doing badly.

Most of this section of the table is based on country-by-country surveys that provide global rankings. That makes them fun, but the findings are mostly based on 'expert' opinion, although it's not clear who the experts are.

First up is the Global Innovation Index, which is mostly produced by management consultant Boston Consulting Group and does a fair job of summarising the sections that our table has covered so far. Of the Brics, China ranks the highest - 34th in 2012 - so we might say that, going into this crucial section, China leads.

Then it slips back. The Economic Freedom Index, which is produced by The Heritage Foundation, a US think-tank, is largely a quantitative index (rather than based on surveys) and it aggregates some of the wealth-creating factors tackled by other indices in this section. Its data aims to test what the foundation rightly calls the "pillars of economic freedom" - the rule of law, limited government, regulatory efficiency and open markets. Of the 185 countries ranked in the 2012 index, China ranks 136th. But none of the Brics does well, and none has done well in the 18 years that the index has been calculated. All lie below the global average for economic freedom. Brazil got above average in the early 2000s, but has slipped back. Russia has usually been the worst performer. India shows the most progress. In 1995 it was the bottom of the four; now it is almost on a par with Brazil.

Democracy and economic freedom are closely linked, which is why the Democracy Index, produced by the Economist Intelligence Unit, is especially important. It focuses on the political processes of a state, using 60 indicators grouped into five categories: electoral processes, civil liberties, the functioning of government, political participation, and political culture.

In the 2012 survey of 165 states, no prizes for guessing that China and Russia come bottom of the Brics. Even so, it is worrying for business people that in the five surveys conducted since the first in 2006, Russia has become steadily more authoritarian. Meanwhile, Brazil and - especially - India offer hope that, if a lively democracy is a pre-condition for economic success, then they should continue their climb towards affluence (in Brazil's case) and out of poverty (in India's).

Corruption - the potential for employees of the state to use their job for personal gain - usually slinks along with anti-democracy. So it is no surprise to see that the Brics fare poorly in the Corruption Perceptions Index, an annual survey produced by Transparency International, a Berlin-based pressure group. This matters. Corruption is a dead-weight tax on enterprise. It also correlates closely with poor property rights - a major obstacle to endeavour - and a large 'black' economy, whose effect is to slow growth by keeping companies small, inefficient, under-capitalised and labour intensive.

So it is predictable - although depressing - that Russia does badly; disappointing that China has barely improved its percentile score since it was introduced into the index in 2003; but heartening that India and - particularly - Brazil have improved their showing. Brazil's percentile score has risen from 51st in 2001 to 39th in 2012 (ie, 69th out of 176). For a country that is surprisingly unfriendly towards business and, as a result, suffers a big 'informal' economy, that is encouraging.

Yet Brazil still has far to go. As measured by incomes - the gap between the highest and the lowest - it remains the most unequal of the Brics. Even that has its positive aspect. As measured by income differences, in the early 1980s Brazil was the most unequal society in the world. Income inequality matters because it measures the extent to which an entrenched elite is extracting 'rents' - ie, something for nothing - from the rest of society. It carries the implication that the elite will resist the changes that enhance overall wealth because their own wealth will be damaged.

That also explains why the Press Freedom Index is in the table. This index, based on a questionnaire produced by Paris-based Reports Without Borders, is a proxy for the extent to which a state is willing to put up with the disruption that innovation brings (the logic being that, at its best, the press is disruptive, intrusive and lacking in deference – just like the best entrepreneurs). Granted, it's a poor proxy and the results look odd. In particular, India, which has a vibrant print media, is ranked close to the bottom quartile of the 179 countries surveyed.

Let's conclude this section by looking at two absolute measures - the days needed to register a business and the number of cars per 1,000 population. The first is a loose proxy for business friendliness (of which more in a moment). The second indicates another sort of potential - the potential to grow simply by becoming less poor. Nothing reflects growing wealth better than car ownership, it's the dream of every Indian labourer who swaps his pushbike for a second-hand Honda Shine. So it is a good indicator of the gap to be bridged between rich and poor. On this measure, all the Brics have the potential to be wealthier (compare even Russia's car ownership levels - the highest of the Brics - with the US's). For China the potential is vast. But where is it greatest? Because of its relative poverty but thanks to its - flawed - democracy, the winner is: India.

EASE OF DOING BUSINESS

Okay, like Binny Desai in India, Maria Rocha in Brazil or our other entrepreneurs, you take the plunge - you start, then you run your mixture of dreams, necessity and sheer hard work that's called 'a company'. In which Bric country would you most want to be - where is the bureaucratic drudgery least burdensome? The World Bank attempts to find the answer with its Ease of Doing Business indices. These comprise a host of indices that rank nations for various aspects of business friendliness. We have selected five key indicators - starting a business, getting credit, protecting investors, paying taxes, enforcing contracts - plus the overall rank for the Brics. None shines, though they have bright spots - China and (surprisingly) Russia in enforcing contracts; India in getting credit. Yet here there is no winner. This last concluding section of the table only serves to make a point that has been barely below the surface of our feature - that the Brics still have far to go.

For all the progress of Brazil, India and China, the Brics have yet to demonstrate that they can turn themselves into affluent and innovative countries. In some ways this does not matter. Especially in India and China there remains the potential for lots of growth as these countries use up their demographic endowment of cheap labour. China has the infrastructure to use its fast-dwindling cheap labour efficiently. India still has massive resources of labour but lacks the infrastructure to exploit it effectively and therein lies a problem.

There is also an argument that, actually, innovation won't matter much for the Brics because they rely on a new version of capitalism that is driven by their state-owned enterprises. Yet not even the Brics' leaders believe that. Back in 2007, China's then-president, Hu Jintao, told the 17th National Congress of the Communist Party that his top priority was to improve the country's ability to innovate. Meanwhile, in Russia there is much excitement about the Skolkovo Innovation Centre in the outskirts of Moscow, which - should it ever get finished - will drag Russia's industry into the 21st century, or at least that's the theory.

So, sooner or later - maybe later - investors are going to need proof that a Bric or two can cross the divide between being a 'developing' economy and a 'developed' one. Alternatively, a Bric will need to show that it won't regress to being a poor-country version of Argentina (a rich country that failed) but can be a bigger version of South Korea (a poor country that became rich).

It is not clear which will be the winners. But, based on the findings of our table, we can suggest intuitive probabilities of success. These are: India 0.4; China and Brazil, both 0.3; Russia 0.1. And those, conveniently, might be the weightings that an investor could give to a Bric portfolio. However, of the Brics we can say one thing for certain: that they still face much construction before they are truly built.