Anil Gupta, an expert on globalization and strategy, on the domino effect unleashed by several global megatrends: from the turmoil in the energy markets and the crisis in Greece, to the challenges being faced by the Chinese economy.
Global financial markets have been in turmoil all this week. On Monday night, following the biggest single-day slump in the Chinese stock markets since 2007, all major indices around the world went into a tailspin. In the US, the Dow Jones Industrial Average Index shed more than 500 points (3.57%); in Europe, the FTSE 100 dropped 3.25% to below 6,000, the lowest since early 2013; in Asia, the Heng Seng Index lost almost 5% to a two-year-low, while the Nikkei 225 Index fell by more than 4%.
Although markets in Europe and Asia largely started to rebound later on, “Black Monday”, triggered by factors not only in China, but also in different parts of the world (including the expectations of the Federal Reserve to raise interest rates and feeble oil prices), signifies a more synergized and sensitive global economy. Therefore, for investors as well as policy makers to fully understand what is happening in one particular economy today requires an all-round perspective, and understanding of the major trends and risks globally.
Anil Gupta is one of the few experts who can shed light on virtually all aspects of the global economy. A professor at the Robert H. Smith School of Business at the University of Maryland, Gupta is a renowned scholar on strategy, globalization and emerging markets.
In this wide-ranging interview with CKGSB Knowledge, Gupta shares his opinions on the many parts of this extremely complex puzzle: from the debt crisis in Greece and turmoil in energy markets, to China’s economic reforms and the future development of the US-China relationship, among other issues.
Q. We’ve seen a lot of turmoil around Greece in the last few months. How do you think the situation will evolve the next few years?
A. We have to, of course, see how the game plays out. But the way I see is that if the Eurozone were to break up, that would have seriously negative consequences for all the major European economies—forget about Greece, but Germany, France, Italy and so on. So for the major European economies that are really determined in the direction of Europe and the Eurozone, they are likely to keep pushing for integration, but obviously integration with some boundary conditions.
When it comes to fiscal management, the member countries have to “behave”, that’s where the whole big challenge was with Greece. Particularly if you look at Germany and Greece—Germany has a huge stake in keeping the Eurozone together, but at the same time you can’t let a member country get away with basically profligate spending. So the question is, how much can you tolerate, how much restriction should you put?
The Greek Prime Minister, even [though] he is a leader of the Syriza party, and he campaigned against the agreement with the European Union, very soon after the referendum, changed his perspective. I am glad that he did. And Greece has agreed, clearly, of course with the help of the opposition party, to many of the tough measures. The signal it sends to other countries I think is a good signal, which is yes, the powers, for example Germany and France, they do see a huge stake in keeping the European Union together; but at the same time it’s not that they’ll accept any type of profligate spending by the member country. So I think it’s a dual message, but it’s the right kind of message.
Q. We see a lot of turmoil in countries that primarily control oil production. How do you think the energy market will perform over the next few years? What are the developments that we should follow to discern the trends in this market?
A. Perhaps the most important statement I’ve heard and read fairly consistently [about the energy industry] is that the cure for high oil prices is actually high oil prices. What high oil prices do is that they trigger two types of responses, which are very powerful.
One is, they trigger response on the part of very powerful and tech-savvy companies to look for energy efficiency, whether it’s energy efficiency of cars or of buildings. If you look at cars on the roads in the US, according to figures, the average efficiency of cars on American roads today is actually two times that of the late 1980s. So if you assume that the number of cars is roughly the same, actually the auto sector is consuming half as much petroleum as it was in 1990 or mid-1980s, so obviously what energy efficiency does is reduce the demand.
The second kind of action that high oil prices trigger is incentivize the search for new sources of energy. That could be non-traditional resources of energy like solar and wind, or traditional sources like fossil fuel, oil and gas. So even though the global GDP has being growing, even though the emerging markets have been growing—at a somewhat slower pace, but still at about 2-3 times pace of the rich economies—the energy intensity of worldwide GDP is coming down, and the availability of energy supplies, both traditional and non-traditional, has gone up. It’s hard for me to imagine the next 5-10 years [and whether] these trends will reverse, or why they should reverse. So I think we can count on it that for the foreseeable future, energy prices—oil prices for example—will remain soft.
Q. Regarding the pace of change in terms of energy efficiency or looking for alternate sources of energy—like solar and wind—and the impact it’s having, just how fast is that happening?
A. If we take one of the world’s large economies that’s fast-growing—India, as a case study on this question, its total energy production is somewhere around 280 gigawatts in the whole country. And out of that, solar, wind etc. today actually account for only less than 10 gigawatts, so that’s about 2-3%. And [Indian Prime Minister] Mr. Modi is pushing in an absolutely passionate way for solar energy, say maybe within 10 years, to be 100 gigawatts. Hopefully India’s energy production should go to somewhere around 600 gigawatts [by then], so 100 out of 600 would be 16%. So compared to 3% today, it would be significantly higher. But can we expect in the next 10 years, solar and wind, in most of the major economies, to account for 40%-50% of energy sources? Probably unrealistic.
But one of these disruptions—we still have to see how it plays out—is the ‘Uber-ization’ of many things including driverless cars and electric cars and all of that. And some seriously smart auto industry analysts are saying that as these developments play out, we should expect to see a significant reduction in auto ownership. So if that happens, and the efficiency of cars, because of all of these developments, goes up dramatically, it might be that the growth in energy demand [will be] nowhere near what we currently expect.
Q. Would there be any short-term geopolitical impact of this changing landscape?
A. Yes. From a geopolitical point of view, of all the major economies in the world, the economy that is suffering the most, is Russia; and it’s very hard to imagine how Russia [will] get out of it, because there’s nothing that I can imagine that Russia can do to somehow boost energy demand around the world or to slow down the pace of the renewable developments in solar and wind. Therefore from the economic point of view, what Russia needs to do is to figure out how to reduce some of the challenges by exporting more oil and gas to, for example, China and other markets, but that’s not really going to solve Russia’s economic problems.
What they need to do is to figure out the way to diversify their economy. Russia’s economy clearly is suffering in a major way because of Western sanctions, but even if Western sanctions had not happened, Russia’s economy would still be in very deep trouble, which it actually was in two years back.
Q. Countries like Russia, Brazil, etc., have been facing different economic and political challenges; and others like Qatar, the UAE, etc. are doing relatively well. There’s a discussion about whether the term “emerging markets” still makes sense. Should there be a better way to group such countries?
A. In my view, much of the discussion that we have seen in the last few weeks is really off the mark. To me it doesn’t make sense. It’s like we now call this particular fruit a banana, and say, “Hey banana is not the right term, we need to call it an apple.” But what difference does it make? The point is that the world consists of rich economies, middle-income economies and low-income economies, and even if we threw the terminology “emerging markets” into the sea, the fact is that the heterogeneity across countries will remain.
Among the rich economies, you have the US on one side, then you have Italy, Spain, Ireland or Greece on the other hand, and these are not exactly identical to each other; similarly in the middle-income economies, the big ones of course you have the BRICs and among the four BRICs, Russia and Brazil are a whole lot more resources-dependent, commodities-dependent, while China and India are commodity importers, so clearly there are significant differences among the BRICs. So some people say, instead of calling them emerging markets, we should group countries in terms of level of risk.
But the heterogeneity across the 200 economies of the world is multi-dimensional, some are culturally closer to each other and distant from others, some are economically closer to each other but distant from others in terms of country risk. Some countries are low risk and others are higher risk; some countries are commodities rich and others are commodity importers, and one can’t pick any one of these dimensions and forget the rest.
So to me, coming back to the central question of emerging markets, the original idea is to look at countries that are rich, and technologically advanced versus countries that are not. And the countries that are not, if we go back to the period before 1980, they used to be called “the third world” or “underdeveloped”; the most charitable term that one would use before 1980 for the low-and-middle-income countries would be “developing”.
But what happened is as they embraced more liberalization, more global integration and more entrepreneurship, these economies, whether it’s China, India or others in Africa, started to grow at a much faster pace, and that’s why the term “emerging” makes sense. Emerging doesn’t mean that they have emerged; it doesn’t mean that every country is emerging at the same pace. But I still think the term “emerging markets” continues to make the most sense.
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Q. There’s been a lot going on in the last few weeks in the Chinese economy. What do you think is the most promising aspect of the Chinese economy? What are the most challenging sectors that the government will encounter and how should they deal with them?
A. Perhaps one can look at this question at two levels, one is the macro and the other is micro. At the macro level, some of the major strengths of the Chinese economy are the sophistication of China’s infrastructure, the quality of Chinese education, both in terms of basic literacy and some of the top-tier universities, the basic entrepreneurial character of the Chinese population, and the very high rate of savings—so all of these are major pluses.
Coming at the macro level to the challenges, China has come a long way over the last 35 years since the opening up and reform era, and given where the Chinese economy is, the sustainable rate of growth for China is more like 5-5.5%. And that’s where South Korea was in the mid-to-late 1980s; and if China continues to grow at 5-5.5% for the next 20 years, it would still become a high-income economy and that would be a sustainable, healthy rate of growth.
The challenge comes if the country is not willing to accept that the days of 10% are gone for good, that the days of even 7% are gone for good. If the country can really accept that, then the leadership won’t feel the pressure to put in place policies to somehow ‘forcefeed’ the growth to be higher. So I think that’s the challenge at the macro level.
And at the micro level, if I look at different sectors, I think everything that has to do with construction, be that steel, cement or construction machinery, suffers from massive overcapacity. I don’t see how that sector is going to get out of trouble anytime soon.
And another sector that has been a major contribution to economic growth in China is automotive. I’ve been saying this for the last three years that the days of double-digit growth—forget about 30% growth rate that took place from 2000 to 2010–are gone for good; and in fact one should expect, at best, a low single-digit growth rate. So the brutality of competition in the auto sector can be expected to become much worse. So I wouldn’t be in anyway sanguine about the profit margins for auto companies in China, whether it’s at the luxury level or at the mass market level.
On the plus side, service sectors like healthcare and financial services are huge areas. Of course tourism is another. And as the labor pool begins to shrink, things like industrial automation and robotics—these would be sectors where I would anticipate growth to continue at a pace higher than the GDP.
Q. International investors are paying lots of attention to the marketization of the Chinese financial system. What are your thoughts on the current progress and challenges?
A. I would say two different perspectives. One is, if I look over the last 10 years, China has been opening up and embracing the market. However, what happened in the last two or three months… that troubles me. Because in terms of the opening up of the financial sector, the government, if you look at the stock market for example, the government has seriously got into the act of intervening in capital markets, both in terms of cheerleading the formation of a bubble in a way, and then when the bubble bursts, intervening to prevent it from finding the new normal. So what that has done is really create a scare among the minds of people such as myself—is the government ready to embrace the market? And does the government get cold feet when the market begins to do its own thing?
On the currency front, I believe the devaluation of the yuan is very much in line with what the market forces signaled, but I think still, the intervention by the government is more than what it should be. Perhaps “schizophrenia” is the right word—in the financial sector the country needs to move to a stronger market orientation, but at the same time when it begins to do that there’s a fear of losing control.
Q. What do you see is the future of China and Japan? Do you see more conflicts happening between the two countries and other countries in the South China Sea?
A. I am worried because with each passing day, the risks of conflict escalating are going up. The reason the risks are increasing is because neither side, whether China or Japan, China or the US, China or Vietnam or the Philippines and other countries—nobody is backing down. I think the risks of escalation are increasing, and if, God forbid, somebody’s plane gets shut down, it would be hard, in the current environment, to claim that this was an accident. Therefore, the risks of any such incident becoming bigger are high.
Q. China and the US are the two largest economies in the world, but they don’t necessarily see eye to eye. We’ve seen flashpoints on cyber security, or the Asian Infrastructure Investment Bank. How do you think this relationship will evolve in future? Do you see it getting worse or will it improve?
A. The economic relationship, to some extent, is affected by the geopolitical relationship. On the geopolitical side I don’t see in the foreseeable future prospects for geopolitical harmony between China and the US. It’s not just because of the South China Sea tensions, but also if you look at cyber warfare—I think it’s fair to say that cyber warfare is already on and there’s no indication that either side is backing down or even coming to an agreement on the terms of engagement. So I think the geopolitical tensions continue and may increase—the probability is higher than 50% that the geopolitical tensions will increase.
What it means, of course, is that in the technology sector, the Chinese government has taken a very explicit perspective that on security grounds, it doesn’t trust Western technology companies, like IBM, Oracle, EMC, HP or even Microsoft and so on. When I talk to people in these Western technology companies, the executives tell me that in China across the board, their life has gotten tougher in terms of what they can sell, how much they can sell, to whom they can sell. In reverse, in the technology sector, if it’s commodities [or] things like IBM wanting to sell its server business to Lenovo, that’s not an issue. But if a Chinese company wanted to acquire a US IT company, which is not just a commodity player, for example—Huawei is pretty much blacklisted in the US, in terms of the network equipment.
So I think the engagement between US and Chinese companies in the IT sector, other than PCs and smartphones, consumer products like that, is pretty much at a standstill. And it’s hard for me to see how China would feel about cyber security a year from now. That aside, [in many other sectors], I think the engagement will continue at a fairly robust pace. I see a deep engagement for example in the pharma sector, I see continuing deep engagement in lots of services sectors, including in financial services, in travel, in tourism… including investments by Chinese companies because obviously outbound FDI (foreign direct investment) from China will probably surpass the inbound FDI. So I think that is likely to continue and other than in the IT-related high-tech sector, outbound investment from China is likely to continue to be very welcome.