Morgan Stanley

How does one country stand out from another if they’re all suffering low growth? Ruchir Sharma offers a system of 10 rules for distinguishing the good economies from the average and the ugly, in his new book The Rise and Fall of Nations.

It’s never been harder to know which countries are succeeding and which aren’t. Using GDP growth as a typical economic indicator it seems that none of them are. Every region in the world has suffered a slowdown since 2008, and 2016 marks the seventh year in the weakest global economic expansion cycle in modern history.

In his new book, The Rise and Fall of Nations: Forces of Change in the Post-Crisis World, Ruchir Sharma, Morgan Stanley Investment Management's Head of Emerging Markets and its Chief Global Strategist, argues that success in today’s post-crisis world is achievable, but requires a radical change in mindset. Economic, demographic and political trends are moving in a direction so different from the pre-crisis world, that one needs to apply new benchmarks for what constitutes economic failure or success.

“It's time to rethink success and every nation needs to downscale its ambitions," Sharma says. For example, he argues that annual economic growth of 5% for China should be considered a success, rather than the 7% or higher rate that many still expect. For developed nations, the benchmark should drop from 3% growth to 1.5%.

Sharma distills the forces behind slowing global growth to what he calls the 4Ds: De-globalization, where slower growth in global trade and shrinking capital flows are stunting the global economy; de-population, by which slower growth in the working age population is depleting the workforce; deleveraging, where nations must at some point begin to pay down the $50 trillion in debt amassed since 20081, de-democratization, with economic distress driving more countries to seek relief in autocratic rule which, Sharma’s research shows, only raises the risk of economic instability.

Given this backdrop and extensive data analysis on political, economic and demographic trends, Sharma proposes a new system of 10 rules to gauge a country’s future prospects.

A New Set of Indicators

1. Demographics: Economies almost never grow rapidly without strong growth in the working age population. Says Sharma, "My research shows that if the working age population is growing at less than 2% a year, the economy posts rapid growth—faster than 6% a year—in just one out of every four cases." Today, only two countries, Saudi Arabia and Nigeria, have labor force growth above 2%. In countries where the working age population is shrinking, GDP growth has historically averaged just 1.5%.

2. Billionaire lists:  Sharma uses a close reading of the Forbes lists to identify countries most vulnerable to political revolt over inequality. He tracks billionaire wealth as a share of GDP, and the share of billionaire wealth coming from inheritance and traditionally corruption-prone industries, because billionaire wealth is most likely to generate popular anger when it is rising as a share of GDP, and is generated from family or political ties.

3. Cover Story Curse: Mainstream forecasters are often behind the economic times. When mainstream general news publications are upbeat about any one economy, that country may slip into a downturn sooner rather than later.

4. Asset Price Inflation: Fear of global deflation may be distracting governments from the real indicator of ensuing recession: asset price inflation. Japan's long and painful battle with deflation is unique in the postwar era, and a low risk as a result, according to Sharma. But there’s an increasingly tight link between asset bubbles and recession. “The Federal Reserve and many other central banks are thus ignoring the clear threat of asset price inflation to focus on one that may not exist,” he says.

5. Kiss of Debt: The debt crisis of 2008 sparked a hunt for signals of the next one, and Sharma’s research offers a powerful insight: countries where private debt has been growing much faster than the economy for five years should be put on watch for a serious slowdown, possibly a crisis as well. The country that now bears watching most closely: China.

6. The Second City Rule: In midsized countries, the capital city is typically no more than three times more populous than the second city. Countries like Thailand, where the capital dwarfs the rest, face a particularly high risk of rural rebellion.

7. Follow the Locals: Though currency crises are often blamed on the flight of foreign capital, Sharma’s research shows that locals typically flee first. Locals have superior inside knowledge of looming trouble, so keep an eye on domestic capital outflows.

 8. Stale leaders: The general rule is that high impact economic reform is most likely in a leader’s first term, less likely in the second, and unlikely beyond that point. Markets sense this process of decay, and Sharma’s research shows that even under successful emerging world leaders, who survive at least two terms, nearly all (90 percent) of market gains were concentrated in the first two years.

9. Good vs. Bad Binges: The impact of an investment bubble can be measured by what it leaves behind. Investment spending on real estate tends to leave behind empty houses and indebted families. But spending on manufacturing or technology leaves behind assets that will boost productivity when the economy recovers. So be aware that not all binges are created equal.

10. Cheap Is Good: Sharma shows how technical measures of a currency’s value are subject to manipulation, which is why investors need to trust how expensive a currency “feels” to visitors, whether buying coffee or companies. It is a good sign for emerging markets that many feel strikingly cheap just now.

For more information visit Morgan Stanley Investment Management.