How can entrepreneurship affect emerging economies

Emerging market expert: "The West never sleeps"

FundResearch: Professor Gu, investment experts are constantly warning that you shouldn't lump all emerging markets together. It is not "the" emerging countries, but a very heterogeneous group. How do you identify the differences between the individual states or regions?

Professor Gu: The groups are very differentiated. There are around 200 countries and territories worldwide, a maximum of 30 of which are emerging markets. They try to free themselves from poverty and strive for prosperity - following the example of Europe and North America. But even these 30 states can be differentiated according to two aspects: According to the weight of the economic volume and according to their political-economic influence. This allows the emerging markets to be divided into three broad groups. The first group is the most powerful. These are the BRICS countries - Brazil, Russia, India, China and South Africa. These states cooperate and also play a strong role in the G20 forum. The second group consists of so-called regional powers, which are not as well organized as the BRICS states. You are represented in the G20, but otherwise loners. The third group includes less powerful and less important states. They represent “key countries” in their areas. That is the clear majority of all emerging countries. However, the top of the emerging markets are the BRICS countries, followed by regional powers such as Argentina, Indonesia, Mexico, Saudi Arabia, South Korea and Turkey.

FundResearch: The BRICS countries are the most “mature” economically. The previously extremely strong growth is slowly declining.

Professor Gu: Yes, the growth of the BRICS countries is slowly declining. However, this should no longer apply to India. The country has the greatest prospect of further stimulating growth - beyond seven or eight percent. China has slight problems with double-digit growth. But 6.5 to seven percent should remain so in the years to come. The other three countries face greater challenges. Russia is a special case. South Africa has problems adapting. The country is currently at the level of two to three, a maximum of four percent, when it comes to growth. Therefore one has to differentiate strongly among the BRICS. According to my analysis, India and China should not be written off. These two countries will remain the engine of global economic growth in the years to come.

FundResearch: Then let's stick with China. Economic growth is around seven percent, the country is one of the world's leading economic powers and political influence is also increasing more and more. Isn't it actually a joke to refer to China as an “emerging country”? Has it not long since made its way into the ranks of the developed economies?

Professor Gu: No, I do not think so. A mirage fools the country. But in order to answer your question, it is important to define what actually constitutes emerging markets.

FundResearch: What would that be?

Professor Gu: An emerging market is a country that has not yet passed 100 percent of poverty and at the same time has not yet reached the level of prosperity that exists in Western Europe and North America. There are a maximum of 15 countries in the world that can be described as so-called "industrialized countries". In other words, countries that have achieved a per capita gross domestic product of more than 30,000 US dollars. China is far from that. The GDP per capita is around $ 10,000. There is still a long way to go. In terms of volume, China is strong, but not in terms of wealth or individual living standards.

FundResearch: According to the prominent Peruvian economist Hernando de Soto, China has recognized in the past 18 years that the planned economy does not work. Instead, entrepreneurship was built up and poverty was successfully combated.

Professor Gu: That's true. But it is not enough. There are at least 100 million people in China who live below the poverty line according to the UNO standard. As long as China does not manage to free these 100 million people from poverty, the country cannot be called an industrial state. China will always be at a level half that of Western Europe or North America. I really have my doubts that the Chinese will change that. There are technological reasons in particular.

FundResearch: Then the question for you is not when China will become an industrial state, but whether it will succeed at all?

Professor Gu: Absolutely. It is far from certain that China will ever do it without radical innovation. The decline in economic growth also has to do with it. The government has recognized that the strong but coarse growth is detrimental to people's quality of life. Much more important is the quality of growth that ensures lasting prosperity. Behind this is the new philosophy that has established itself in China, preferring to grow more slowly, but more qualitatively.

FundResearch: Seven percent growth is still a lot in comparison.

Professor Gu: Of course, that is a lot compared to other countries. This seven percent growth means that China produces as much every year as Switzerland and the Netherlands. China has a GDP volume of around ten trillion US dollars. Seven percent a year is worth $ 700 billion. In the whole world there are only 20 states that reach this level. Hence, of course, China is powerful. But on the other hand there is poverty.

FundResearch: The emerging countries were exposed to a severe currency crisis in 2013, from which they recovered last year. Where do you currently see the greatest risks in investing in emerging markets?

Professor Gu: In a capital flight. If the US Federal Reserve ends quantitative easing in the third quarter or by the end of this year at the latest, there will be a massive flight of capital from emerging markets. To put this risk into perspective, the emerging markets would have to devalue their currencies. The devaluation of one's own currency could lead to inflation and social problems. Many projects in the emerging markets are financed by outside capital. If that were to be withdrawn, quite a few of these projects would have to be ended and companies closed. I see a huge problem there.

FundResearch: Are certain regions particularly affected by this or is there a risk in all emerging countries?

Professor Gu: Here, too, one has to differentiate. Countries with sufficient foreign exchange reserves have the potential to limit this impact. Countries that are dependent on foreign exchange, on the other hand, are likely to run into considerable problems. This applies to South Africa, Turkey and Russia, for example. For India, on the other hand, not at all, as an extraordinary inflow of capital in the context of foreign direct investments into the country is to be expected.

FundResearch: And where do you see the advantages of the emerging markets? Why is it worth investing there?

Professor Gu: Various factors are important for growth: A young population, because demographic development affects and can influence all three core elements of production - labor, capital and technology. The young population has the advantage that sufficient and cheap labor is available. An aging society needs a lot of money from the state to feed the population and to provide them with the necessary infrastructure for medical and health care. That slows down the development of the economy. From a technological point of view, too, not much can be expected from an aging society. Older people tend to be conservative and not very innovative. Technologies are mostly developed by younger people. Therefore, the demographic development is a great advantage of the emerging countries, as is the ability to reform. Implementing reforms is difficult in industrialized countries. France, for example, has been behind Germany for 20 years because the labor market reforms cannot be implemented. Emerging countries are mostly governed by authoritarianism. Reforms can better be implemented according to the top-down principle. At the expense of individual freedom, of course. In addition, there are also price advantages with a view to the emerging markets.

FundResearch: Last year there were elections in some - especially large - emerging markets. Most prominent were certainly the elections in India, in which Narendra Modi won. Since then, India has been back on the road to success. How do you rate the choice of Modi? Which way is India going under him?

Professor Gu: I'm not a big fan of modes. But if you look at it soberly, I think that a lot can be expected from India under his leadership. He is quite a godsend for the country. It is astonishing that within a few months he has brought all the great powers to himself and negotiated major geostrategic deals with them. He was in the US and Japan, the Chinese and Russian presidents were with him. In other words, Modi has understood how to develop India further in cooperation with the great powers. That only works if you bring foreign capital into the country. India has had significant problems in attracting direct foreign investment compared to China over the past 20 years. Now it looks like India could raise at least $ 40 billion each year and next. In terms of domestic policy, Modi has announced that it will introduce liberalization measures. That would also mean that the old socialist structures in India could be partially overcome and infrastructure will be built. That, in turn, should drive economic development further. Modi is therefore not only a beacon of hope for the Indian population, but also for all countries that would like to invest in emerging markets.

FundResearch: Do you think India will develop into an industrial nation?

Professor Gu: No, I do not think so. There is of course enough growth. But poverty is also the big problem in India. Despite growth, poverty will remain. The country's political and economic elite have no interest in the lower class of the population doing better. It only drives the motivation to bring the wealth of the educated elite to world standards. At the same time, she is very nationalistic and ambitious to stimulate India and develop it into the top of the world. But liberating India from the status of a developing country is a long way off. There will of course continue to be growth. However, this is not to be equated with leaving behind the status of an emerging market. In my opinion, this applies to all emerging markets. None of these states will ever become an industrial state without radical innovation.

FundResearch: Emerging Markets Forever?

Professor Gu: Yes, they will remain emerging markets if they only imitate technologically. At least as long as they cannot overcome the technological lead of the West. Value is only created where there is an industry that has the core technologies for the production of vital products. And there is no such thing in the emerging markets.

FundResearch: But at least in China this sector is growing more and more, isn't it?

Professor Gu: Yes, but the West is not sleeping. China can manage to develop new products through innovation or imitation. But of course you don't know where the USA and Germany will be in ten years. It is no secret that the western industrialized countries only want to have their technology produced in those emerging markets that will no longer be competitive in ten or 15 years. In the drawers of the western countries there are ideas that are unknown. That is why the Chinese have to be significantly more innovative. Unless they can suddenly develop products for market segments that are absolutely new. Which then, in the sense of Schumpeter's “creative destruction”, smash old market structures and allow new ones to emerge. Then China has a good chance. But the Chinese are far from that.

FundResearch: Brazil also voted last year. President Dilma Russuf was confirmed in office. What do you expect from Brazil? Are reforms being tackled there? After all, all of South America depends on the development of Brazil.

Professor Gu: This is true. South America has the problem that on the one hand it lives in the shadow of the USA and on the other hand it has still not freed itself from the status of the raw material supplier. Raw material delivery is the only calling card for Latin American countries with which they participate in globalization. It is currently a difficult phase because of falling commodity prices. This development is not necessarily favorable for Latin America. I therefore believe that Brazil will have problems - despite the will to reform and the ability to implement reforms. But on a global level it will be difficult for Brazil.

FundResearch: Do you expect raw material prices to rise in the foreseeable future?

Professor Gu: No, not really. Japan is sick, growth is slowing in China. Europe is still not completely out of the crisis. Only in the USA is it looking a little rosy. But nobody knows how permanent the growth will be there either. That means: The global framework conditions for rapid growth in the emerging countries do not exist. Therefore, the demand for raw materials is also falling. But many emerging countries live from this. In the medium term, I expect raw material prices to remain stable, but not an increase. Unless the financial world gets involved even more intensively. Because the commodity prices are not just a game between supply and demand. If it were, it would be a lot easier. In between, many institutions are involved in the game - banks and mutual funds, for example. With their great financial power, they can manipulate and influence the price.

FundResearch: You referred to Russia as a special case at the beginning. The war in Ukraine is in full swing - albeit currently with a ceasefire, Russia has been sanctioned by the West and the economy is suffering from these sanctions. What is your outlook for Russia?

Professor Gu: As long as Vladimir Putin is President of Russia, the country has no real prospect of joining the mainstream of globalization. I understand Putin's behavior. He is of course disappointed with the Western policy towards Russia. And of course he's annoyed by NATO's infinite eastward expansion. Putin is disappointed with the signals that are being sent from Washington to Moscow. Russia has a problem relegating itself from superpower status to BRICS status. It is unreasonable for a former superpower to join a group with South Africa. It takes some time to get rid of this offense. And that is exactly Putin's job. However, this is at the expense of the country's globalization connectivity. Russia has three problems: Financially, it is dependent on Western investments. Technologically, Russia has nothing to offer with the exception of military technology. In addition, the economic structures are one-sided and focused on energy resources - the prices of which have fallen. For these three reasons, I believe that Russia has no geo-economic chance of recovering in the years to come. This new “Cold War” cannot be eliminated overnight. Russia won Crimea, but lost Ukraine and the whole of the West. That is the price Moscow has to pay. Putin obviously seems ready to do so. Let's see how long he can hold out.

FundResearch: Would that be different with a new president?

Professor Gu: Well, the problem is that no responsible government in Russia would be willing to move Crimea back out. But to expect the West to accept the annexation of the peninsula is also an impertinence. With all due respect for Germany's and France's attempts at reconciliation: as long as Washington doesn't play along, you can forget that.

FundResearch: You identified falling oil prices as a problem for Russia. Is it a coincidence that oil and energy prices fell just as the crisis in Ukraine really broke out? If you consider that the USA and Saudi Arabia - an ally of the USA - as the largest oil exporters could of course also have an interest in bleeding Russia to death. Perhaps the Americans want the oil price to drop so that Russia can hit really hard?

Professor Gu: With regard to Russia, the falling oil prices are, in my opinion, a coincidence. I see the competition between the USA and Saudi Arabia as the reason. It's about market share. It can even be pointed to the competition between new technology and traditional oil production technology. Saudi Arabia is not prepared to accept the new fracking technology at the expense of its own market share.The only way to prevent the success of fracking and thus maintain the market share of the OPEC countries is to force US companies to stop producing them. But that only works if the price of oil is so low that it is no longer worthwhile to extract it through fracking. And in my opinion that is a market economy development. The fact that the Ukraine crisis broke out at this point naturally intensifies the effects. The decisive question, however, is who will play first fiddle in determining the oil price and market shares in the future: the USA or Saudi Arabia?

FundResearch: What do you think?

Professor Gu: Difficult ... In the long term, of course, Saudi Arabia has the advantage that profitable production is possible there even with an oil price of 20 US dollars. This is not feasible in the USA through fracking. So you have to wait and see who has the longer breath. You can't say that today.

Professor Dr. Xuewu Gu has held the Chair for International Relations and Director of the Center for Global Studies at the Rheinische Friedrich-Wilhelms-Universität Bonn since 2009. Since 2006 he has also been chairman of the board of the Society of German Professors of Chinese Origin. Born in China, studied in Wuhan and Cologne, completed his doctorate in Bonn and qualified as a professor in Freiburg, Gu is one of the leading experts in China's economy, energy, politics and culture.