BRIC BY BRIC

Ever since I first wrote about the BRICs, people have suggested I modify the acronym—some jokingly, many seriously. I have been told it should be CRIBs, as these were economies in their economic infancy. Or that I should drop one of the letters. Did the R deserve to be in there? Or the B? India and China were obvious inclusions, though over the years and through several serious economic wobbles, there were times when I wondered if the vision I’d laid out for them would ever come true. I’ve occasionally thought I might be woken from sleep one morning by the U.S. Securities and Exchange Commission, threatening me because I predicted China would be the biggest economy in the world. But that’s the reality of making a big, long-term forecast like this. There are bound to be bumps along the way.

Our models were designed to accommodate different rates of growth, as the BRICs reached different stages of development. GDP is, after all, a headline number that can conceal many aspects of growth, especially its quality. Many people looking at China in 2011, for example, compare it to Japan in the early 1990s, and there are headline similarities. Back then, many people were saying it was only a matter of time before Japan overtook America to become the largest economy in the world. Instead, Japan’s investment bubble popped. Property values plummeted. A low birth rate coupled with a refusal to admit immigrants meant Japan’s population stagnated. There was no one to fuel fresh growth.

Today, we see some fast-rising asset values in China and hear talk of it soon overtaking the United States as the world’s largest economy. The difference with Japan in the 1990s is that China still has lots of room to grow. Hundreds of millions of people have yet to become part of the economic transformation in the country, urbanization is probably only half complete and all these people are yet to become wealthy consumers. The correct comparison for China would be the Japan of the 1960s or 1970s, when there were still huge opportunities for productivity improvement. The headlines may lead some analysts to compare the Japan of 1990 and the China of 2011, but dig deeper and you find significant differences.

China and the other BRICs have a long way to go before they need to settle for the mature, Western, steady-state growth rate of around 2.5 percent. Our model for BRIC growth to 2050 averages Chinese growth at 5.5 percent over the period, though it falls to 3.5 percent in the final decade. We know that as countries develop and their populations stabilize, their growth rate naturally slows. This will occur in the BRICs, as it does everywhere, but not for many years to come.

The collective growth numbers, of course, are only one piece of the puzzle. To understand fully what the BRICs are all about, it is necessary to examine each country individually.

BRAZIL

The first time I went to Brazil was in 2003 to give a speech about the BRIC dream. Just as I was about to speak, the man who had invited me whispered in my ear, “The only reason you included Brazil was so you had a nice-sounding acronym.” Even Brazilians could not believe that the long-impossible economic dream had a chance of becoming reality.

Because expectations were so low, the moment I got home from that trip, I decided to buy some Brazilian reals. After about three months, I sold them, but that was a mistake, because over the past six years it has been a spectacularly strong currency. If I had told any of those foreign currency traders I hung out with in the 1980s that one of the strongest currencies this decade would be the Brazilian real, they would have laughed at me. But of course that is what has happened.

Brazil today is the most popular of the BRICs so far as foreign direct investment is concerned, and I am constantly invited to speak at forums in São Paulo and Rio. Investors, ranging from global private equity firms to hedge funds, are battling it out to acquire Brazilian assets. I would frequently visit Tokyo and used to meet representatives of various Japanese retail banks, who told me that conservative Japanese housewives, the mythical Mrs. Watanabes, were very excited to invest in the real. This has now been the case for years. Some time ago, I met the head of a South African bank who told me he was considering investing in a Brazilian bank. The whole world now sees that Brazil’s economic transformation, from hyperinflationary basket case to a potential twenty-first-century Latin American superpower, finally had legs.

Just as China proved its maturity during the 1997 Asian financial crisis, Brazil showed its mettle in the 2008 global one. In the past, Brazil would have been guaranteed to be at the heart of the storm, its currency, interest and inflation rates careening all over the place. But Brazil did not succumb to the crisis. Instead, the country cut rates on the back of it, managed its way through it and recovered quickly and easily. Stable policies over the previous decade allowed the country’s leaders to implement expansionary policies at a time when other countries were being backed into a corner. This was virtually unheard of for a major developing economy, and certainly for Brazil. The boom we saw in Brazil in 2008–2009, while so much of the world suffered, surprised many, adding to the intensity of the markets’ rising love affair with the country.

As I’ve said, the decision to include Brazil among the BRICs was far from automatic. I wasn’t necessarily looking for a Latin American companion for the other three, but Brazil, with its population exceeding 180 million and its policymakers finally prepared to target inflation, stood out. Many were skeptical and some, including some Brazilians, even begged me not to include it. Our 2003 paper laying out the path to 2050 for the BRICs included a large, separate section on Brazil, setting out conditions and reasons to consider Brazil separately from Russia, India and China.

Goldman’s own Brazilian economist, Paulo Leme, shared the concerns of many. Paulo had very good historical reasons to be worried for his country. Brazil, after all, had always been “the country of the future” that somehow never got there. Its vast territory and abundant natural resources reeked of economic potential. For much of the twentieth century it was one of the fastest-growing countries in the world, and attracted millions of immigrants. In the 1950s foreign investment began to pour in and multinationals set up offices in the country. In the 1960s people predicted that Brazil and Argentina would soon be the biggest economies in the world. Inflation and inept, highly centralized political leadership killed that dream. Brazil was undone by perpetual economic and political crises, alternating between democracy and military dictatorship; periods of vibrant economic growth were followed by extreme slumps. Governments would point to the high levels of foreign investment and the success of Brazil’s soccer team and talk of their country in superlatives: Brazil had the world’s longest bridge and the world’s largest hydroelectric plant. But these boasts could not conceal the fact that the country rarely achieved the stability essential for making serious economic progress. Its growth was uneven and unequally shared. Living conditions for the country’s rural and urban poor were a stain on its reputation. Its cities became notorious for their violence. A dismal low was reached in São Paulo when 8,092 people were murdered in 1997, an average of nearly one murder per hour. In my professional lifetime, Brazil has had four different currencies, a reflection of the economic chaos that has plagued the country. The problems of corruption and inefficiency were endemic. And for ordinary people, that manifested itself in runaway inflation that made shopping a nightmare and saving impossible.

Since 1950 the country had grown at an annual rate averaging 5.3 percent, but between 1995 and 2005 that slowed to 2.9 percent. This was a consequence of a painful economic readjustment that transformed Brazil’s economic destiny. In the 1990s alone, Brazil went through three financial crises. But a group of key politicians and economists, notably Fernando Henrique Cardoso, the president who first took office in the mid-1990s, identified hyperinflation as Brazil’s curse and decided to fight it. After decades of relying on external financing, Brazil finally engaged in the hard work of stabilizing its currency. Its government’s harsh cost cutting lowered investment in infrastructure and reduced the country’s capital stock. Inflation was finally brought under control. But the benefits of this macro stabilization plan took time to feed through into higher growth. We argued in 2003 that Brazil still had important reforms to make, such as opening itself up to trade, cutting its debt-to-GDP ratio and allowing the private sector into the debt markets, and raising its investment and savings rate. Without these, we feared, Brazil might continue to underperform the other BRICs. As we wrote in 2003, our hopes for Brazil “may still prove too optimistic without deeper structural reforms.”

Everything else about Brazil was immensely appealing: its culture, its sport and its resources. It has always been an easy country to love. Once its economy turned, the world was ready to embrace it. Brazil’s rise as an economic power has happened far more quickly, at least in U.S.-dollar terms, than we envisaged back in 2001 and 2003. While this is largely due to the remarkable rise of the real against the dollar and many other currencies, it is also recognition of the more stable and improved growth rate. By the end of 2010, Brazil’s economy had reached $2.1 trillion. This has happened much sooner than we expected. In our 2050 projections, we assumed some real appreciation of the BRIC currencies, but not to this degree. There is the danger that the real in 2011 is overvalued, which brings its own risks, notably increasing the cost of all-important exports—and the risk at any moment of a large and messy reversal in the real. Its upward trend may need to be reversed in the coming years for Brazil’s growth to be more sustainable.

But turning back again to the macro framework, the basic economic facts about Brazil are stunning. It is probably the fifth largest population in the world, and it’s one that’s young and growing. As the growth of the United States has demonstrated, having a rising young population can lead to very strong and prosperous economic growth. And as the 2050 projections show, Brazil has the potential to be much bigger. It has the capacity to become an economy close to $10 trillion, about five times bigger than it is today. On a relative basis, Brazil has the potential to overtake Germany and Japan—although it is unlikely that it could ever reach the size of the United States or, of course, China. While Brazil’s economy is the second largest of the BRICs today, India will likely overtake it at some stage in the next decade or so, just because of the sheer number of Indians. But if Brazil can continue down the path of the past ten to fifteen years, then its population has a good chance of delivering genuine GDP growth and allowing the country to match its economic potential.

An important change in Brazil has been the transformation in its political culture. Many people worried that when Luiz Inácio Lula da Silva, the head of the Workers’ Party, became president in 2003, he might reverse the economic policies of his predecessors. He was feared by many to be a left-wing fanatic who would undo President Cardoso’s economic policies in favor of populist measures that would excite his supporters. I might have shared their worries, but Lula did two things that reassured me. He promised his support for a policy of inflation targeting, and then he delivered it in the form of a new Growth Acceleration Program (although no longer through Arminio Fraga, the early driver of the policy, who had been replaced by Henrique Meirelles as head of the Brazilian central bank). That was enough for me. In retrospect, he looks like the greatest G20 policymaker of the first decade of the twenty-first century. He succeeded in persuading the lower classes in Brazil that Western policies are good for them. Whatever pain inflation targeting might bring in terms of monetary discipline, it was certainly better than never knowing the value of the money in your pocket. Lula had grown up poor and knew how devastating hyperinflation and constant financial insecurity could be. He made a convincing advocate of the policies necessary for a developing economy to grow.

In September 2010, the Financial Times’s weekly “Lunch with the FT” featured an interview with Fernando Henrique Cardoso at a restaurant in São Paulo.¹ I was asked to write a short piece to accompany the interview, which gave me a chance to compare his legacy with that of Lula’s. I started by saying that few things would give me more pleasure than to have my own FT lunch, sipping caipirinhas on the beach at Ipanema and listening to a debate between Cardoso and Lula. Though very different men, Lula is in many ways Cardoso’s heir. Cardoso gave him the platform to succeed and Lula was smart enough to keep most of what he inherited while translating the benefits of stability to the many, enabling people to rise up the income scale. This in turn gave policymakers the credibility needed to persist with stability-oriented policy. As Cardoso put it in his interview, “I did the reforms, Lula surfed the wave.”

In 2010 the political mantle passed to Lula’s successor, Dilma Rousseff. The challenge for her lies in improving Brazil’s growth environment scores to ensure the country can continue to grow. In 2011, Brazil’s scores were the highest among the BRICs, but there is a danger that the country’s economic success may have, to use Cardoso’s word, “anesthetized” Brazil to the need to keep the reforming momentum. Brazil is now home to giant companies such as Petrobras, which in September 2010 launched the world’s largest share offering of $67 billion to fund exploitation of some of the world’s largest oil reserves. Yet in 2010 Brazil ranked just 127 out of 183 countries in the World Bank’s yearly Doing Business survey. The country still needs reforms in areas ranging from taxation to infrastructure. Brazilian democracy will require large-scale new programs to improve the quality of health care and education, and increase the use of technology. For all its successes, Brazil’s growth environment score is still two points lower than that of South Korea, perhaps a sign of how far it has to go before it can be considered a fully developed economy.

At some point, the country will have to reverse the spending unleashed to counter the effects of the financial crisis, increase its role in international trade and expand private sector investment. Despite an encouraging rise in foreign direct investment, Brazil remains more closed to world trade than it should. The government ought to be encouraging its companies to explore more international opportunities. Boosting private sector investment will be difficult, given that interest rates are still extremely high, despite the long and successful battle to stabilize inflation. Whether this is because Brazilian citizens doubt the longevity of low inflation or it is a symptom of “crowding out” by government spending is debatable, but both are possibly true. Reversing the postcrisis increase in government spending might help lower interest rates and ease some of the upward pressure on the real.

As I’ve already said, the strength of the Brazilian currency is another challenge. I suspect that the relatively high level of interest rates is helping sustain it, especially given the lack of yield available in most other major markets. If Mrs. Watanabe is buying the real for its yields, then you can assume a lot of other people are. But there may be other reasons for the real’s strength. It may reflect the desire of businesspeople all over the world to invest in the country when they’d ignored it in the past. The only way of knowing for sure would be if Brazilian interest rates fell. It could be that Brazil’s interest rates are where they ought to be, and that it’s the rates in other countries that are too low. According to this argument, rates around the globe will eventually rise, narrowing the differential between Brazil’s levels and the rest of the world’s. In any case, high interest rates have not stopped Brazil from growing strongly in recent years and so cannot be seen as an insuperable obstacle.

But the most important thing Ms. Rousseff can do, in my judgment, is to make sure that the central bank stays independent and is allowed to pursue its own path for keeping inflation low and stable. Brazil’s life as a BRIC has created the potential for its economic rebirth. Low and stable inflation gives every Brazilian the chance to plan more sensibly for the future, an underestimated plank of sustainable growth. As I write this in mid-2011, Brazil’s average wealth is around $10,000 per head, a dramatic rise in the past decade. Tens of millions of Brazilians have risen out of poverty. By 2050 Brazil’s wealth may approach levels currently enjoyed by the best of the developed countries, at least four times those of today. This would not only make Brazil one of the wealthiest of the increasingly inappropriately so-called developing economies, but at last a country of today and not just of the future.

In 2010 the mayor of Rio de Janeiro, Eduardo Paes, visited me in my office in London. Rio will be holding the Olympics in 2016, four years after London in 2012, and the mayor wanted to learn from London’s preparations. He invited me to come and talk at a BRIC conference in Rio. The proposed date wasn’t going to work, but he is a charismatic man and he persisted. He said, “How about we organize it the week of the Rio Carnival?” As it turned out, that coincided with a holiday period for me and my wife.

Although I was in Rio primarily for business, we made sure I had time for a personal holiday. Naturally, part of it involved my second ever visit to watch a game at the Maracanã, the city’s great soccer stadium. I also had the opportunity to visit Rio’s largest favela, one of the urban areas most people think of as desperate slums. I had visited Rio for the first time in 2003, and had read endless stories of the city’s crime and poverty, of violent thefts along the streets around Copacabana. I had always been intrigued by the favelas, so visiting Rio’s biggest was an exciting experience. We were surprised by how organized and reasonably normal it seemed. Compared with slum areas of cities in India, it didn’t seem too bad to us.

It was a blazing hot day, and at one point we stopped for a drink in a tiny bar. As I was sitting there, I noticed a travel agency next door. In its windows were advertisements for flights around Brazil and the world. When I asked some of the locals about this, they said that the presence of a travel agency within a favela was just another sign of their country’s progress. Of course, this was just one favela, we visited during the daytime and Rio is not necessarily representative of Brazil. But overall this trip significantly influenced my perceptions of the country, adding texture to the raw economic data.

I left full of admiration for the diversity and tolerance of the Brazilian people. I had never properly appreciated what a melting pot Brazil is, with so many people of different colors and ethnic and national origins, living happily alongside one another on the beaches of Copacabana and Ipanema and throughout the city.

Eduardo Paes and his team have a plan to make Rio the City of the Southern Hemisphere, a competitor to Sydney and Cape Town, as well as to Latin American rivals such as Buenos Aires. It’s a challenge. But given the city’s natural beauty—provided they can improve its infrastructure, notably its airport, expand its facilities and reduce crime—it’s a fantastic goal that is perhaps achievable. It will certainly be helped by the 2014 World Cup in Brazil and the 2016 Summer Olympics in Rio. These will be huge opportunities to highlight Brazil’s strengths and spur the country to ever more improvement. The Chinese certainly viewed the 2008 Beijing Olympics that way. At the very least, the sporting events should improve Rio’s hotel situation. Along the sixteen kilometers of Copacabana and Ipanema beachfront, there are still just two five-star hotels. Contrast that with Miami, where luxury hotels line almost the entire oceanfront.

When my host whispered to me in 2003 that Brazil was included among the BRICs only to make the acronym sound better, it made me realize how low expectations were for the country. It didn’t have to improve that much to surprise people. In fact, over the past few years Brazil has surprised people a lot, and while there remain many challenges, Brazil still looks to have lots of exciting potential ahead.

RUSSIA

It is hard to find people quite so optimistic about Russia. In fact, it is the one country many think should be dropped from the BRICs. It is not a view I share. But the argument goes that Russia’s unfavorable demographics, excessive dependence on energy and raw materials and its poor record in governance and legal structures make it an unworthy recipient of the power bestowed by its status as a BRIC. I frequently receive e-mails explaining to me why BRIC should in fact be BIC.

What I tell these critics is that, while Russia does have serious challenges, it also has the potential to have a higher GDP per capita than the other BRICs, and even higher than all other European countries. If Russia fulfills its potential, it will create all sorts of interesting and complex political and social issues for the European Union and the world, besides the obvious economic ones. For the EU to have a wealthier neighbor on its borders would be quite remarkable. Provided it does not provoke conflict, it could raise the possibility of Russian membership in the EU.

At the core of Russia’s present challenges are its demographics. It is widely believed that Russia has a troubling economic future as its population may decline sharply owing to excessively high mortality. This widespread expectation is at the core of why so many doubt Russia’s worth to be regarded in the same context as China, India and even Brazil. Anecdotes about Russia’s poor life expectancy abound. I was once told a story by a Russian academic that 60 percent of all Russian males over the age of forty die drunk. True or not, it feeds a certain prejudice about Russian life. During my many discussions about Russia over the years, one of the statistics that hooked people’s attention was that the average Russian male lived to only fifty-nine. That’s twenty years less than the average American man. At a BRIC conference in London in May 2010, I had the pleasure of interviewing First Deputy Prime Minister Igor Shuvalov, who told me that male life expectancy had risen closer to sixty-five as a result of major policy initiatives to reduce the consumption of very low-quality alcohol, especially vodka. When I discussed these comments with academics, they questioned the degree of improvement, but agreed that life expectancy was on the rise. Smarter taxation to discourage consumption of low-quality vodka was cited by them as a critical variable.

Improving Russia’s demographics has certainly been on the minds of its leaders. In 2006 Vladimir Putin, then president, now prime minister, called demography “Russia’s most acute problem today” and the situation “critical.”² Its population had been falling since the collapse of the Soviet Union owing to a combination of emigration, rising death rates and falling birth rates. HIV had also taken its toll. In 2004, just 10.4 babies were born for every 16 Russians who died. All across Russia, it was rare to see a family with more than one child. Economists and sociologists argued over the causes. Some blamed the sudden disappearance of the Soviet welfare system and its replacement by a more anarchic free market. One scholar wrote that “the Russian crisis is not due to a single disease, or even a small set of microbial horrors, [rather] a constellation of occurrences that include not only infectious disease, but alcoholism, drug abuse, suicide, trauma injuries, astounding levels of cardiovascular disease, male/female estrangement and loss of family cohesion, declining physiological fertility, ugly environmental pollution and micronutrient starvation.”³ Whatever the causes, if Russia had failed to act, its population might have fallen to below 100 million by 2050. Putin proposed a wide range of subsidies and financial incentives to increase Russia’s birth rate, including raising the child benefit (payable for eighteen months) to $53 a month for a first child and about $107 for a second child, longer periods of maternity leave and investment in prenatal care, maternity hospitals and kindergartens. Parents who had a second child were promised $10,000 from the government. The goal was to reverse Russia’s annual population decline of 700,000 per year.

By 2007, the government was claiming progress.⁴ The health minister reported that the number of two-child families had risen by 8 percent in a year. Some Russian methods for promoting fertility could seem amusing to outsiders. A monument to motherhood was erected near Moscow. In 2007 the City of Ulyanovsk organized a day of conception, on which workers were encouraged to go home and have sex. Prizes including a 4x4 car were given to those who gave birth on June 12, Russia Day, the following year.

In April 2011 Prime Minister Putin returned to the issue, promising to spend over $50 billion to increase Russia’s birth rate by up to 30 percent by 2015. Preliminary results from a national survey in 2010 showed that Russia’s population had fallen by 2.2 million since 2002, to just under 143 million. When I highlighted this speech to a number of my colleagues at Goldman Sachs Asset Management, it was, as Russian policies usually are, met with skepticism by most. Interestingly, the skeptics did not include Clemens Grafe, the GS Russian economist. He suggested that boosting the birth rate by 25 percent by 2015 would be easily attainable as it was already 20 percent above 2006 levels.

If Russia can pull off this demographic shift, its economic prospects will improve dramatically. Our forecasts for 2050 will suddenly look far too pessimistic, and the “lazy consensus” will be in for a shock.

Based only on our conservative consensus demographic assumptions, Russia’s GDP could grow to $7 trillion by 2050, around four times where it is today. If its population simply stops declining, Russia could quite easily become as large as Brazil, at around $10 trillion in 2050. To reach the potential we outlined in 2003, Russia needs “only” to grow annually by around 3 percent. This is important to bear in mind in view of the “gloom” about Russia’s potential. Russia doesn’t need dramatic growth rates. It just needs to avoid crises. If it were to achieve this, its GDP could overtake that of Italy as soon as 2017, and in the decade 2020 to 2030 steadily sweep past France, the UK and ultimately Germany. It is quite something to imagine that within twenty-five years from 2011, Russia could have an economy larger than Germany’s.

Nonetheless, I notice a high degree of antipathy toward Russia—and it is understandable how casual observation can lead to this sort of view. In fact, particularly in the case of both Russia and China, spending so much time on the BRICs encourages me to think about what kind of government is best suited both for economic growth and for the different stages of the growth evolution. In the West, former president Gorbachev is regarded as a hero for ending Soviet communism. But in Russia he is considered weak, a failure as a leader. Meanwhile Putin is seen by many in Russia as strong and decisive. His authoritarian methods are commonly accepted there as essential to Russian strength.

A Russian friend once told me that I need to understand two things about Russian political leadership. The first was that there were a lot of tools from the Soviet state still lying around, and the temptation to pick them up and use them was great; Russians over forty will remember well all aspects of the Soviet days, including many of those who were employed to keep order. The second was that, if Russia is to progress toward a more Western model of democratic society, it needs to take three steps forward, then two steps back. Without the occasional reversal, he argues, Russia can’t drag its people onward. It might be too rapid a change for them to deal with. Russia’s history has been so chaotic and volatile that it simply could not be ignored if the country were to hurtle on unchecked. Russia needs to be nursed forward in a way consistent with its past, not violently shoved into an uncertain future as it was under Yeltsin. Putin’s and Medvedev’s approach reflects that need.

Yet Western investors often fail to take all this into account. All they see is political regression. In 1997 Russia became part of the G8. The G7 decided that Russia, under President Yeltsin, might quickly become a Western-style democracy and acquire all the trappings of a G7 nation. Its 140 million people had been recently released from decades of communism and seemed eager to realize their economic potential. By 2001, though, there was growing apprehension among Western politicians about Russia’s ability or willingness to join the capitalist ranks. Yeltsin’s successor Putin had put a halt to some of the more aggressive free-market policies. His authoritarian methods seemed a throwback to tsarist rule. Such doubts have only intensified since then.

Nevertheless, Russia is still bursting with potential. Its population dwarfs that of Europe’s largest country, Germany. If it can embrace the best of Western technology and become a more hospitable home for foreign investment, it could still grow very quickly.

In early 2011 I attended the St. Petersburg Economic Forum, a kind of Russian version of the World Economic Forum, which meets annually in Davos in the Swiss Alps. At a discussion about the Internet, one of my fellow panelists pointed out that two of the Russian Internet companies that had gone public in the previous twelve months were among the most highly valued technology companies in Europe, the Middle East and Africa. The UK, France and Germany cannot boast similar successes. During this same discussion, President Medvedev himself came in to participate, an indication of Russian interest at the highest level. The Skolkovo Innovation Center being developed just outside Moscow is intended to nurture a Silicon Valley–style technology cluster, and both Apple and Cisco have invested. I believe Russia has one of the best national technology policies in the world, with the raw intellectual talent to make it happen. Russia’s history of strong centrally guided education with very high standards in both math and science enable it easily to increase both its use of modern technology and its innovative application. Not only is this apparent in business, it is also appealing to the country’s policymakers.

Technology, however, is just one element of the growth environment score. On the others, Russia clearly needs to do better. Out of the 180 countries we track, Russia’s GES ranks 110th. It is third among the BRICs, ahead of just India. High commodity prices over the past decade have allowed Russia to shore up its fiscal and external accounts, though the sharp fall in crude oil prices in 2008 revealed its vulnerability. With luck, this crisis will persuade Russia’s leaders to diversify and reduce their reliance on natural resources.

At a micro level, Russia is strong in education (better than India) and communications: telephones, computers, the Internet. Its weaknesses, aside from low life expectancy, are political stability, the rule of law, corruption and the general creep of government into important aspects of everyday decision making. Russia’s failings in these areas tend to kindle an emotional hostility in the West. But it is important to keep some perspective. After all, Italy arguably has had weak rule of law for a long time, but its economy has rolled along for years. I think there are some grounds for optimism in Russia. Those policymakers I meet tend to be highly intelligent, literate people who understand Russia’s situation and its options. The same goes for the so-called oligarchs. In any other country, these men would be known simply as businessmen, perhaps “moguls” or “tycoons.” The fact that when they’re Russian we call them “oligarchs” reveals our own fanciful, romantic prejudices about the country. I’ve met a number of them one-on-one and they’re no different from any number of successful European or American businesspeople.

What strikes me on my frequent trips to Russia is that Russians don’t seem to crave Western democracy in the way we think they might. Outside Russia, Vladimir Putin is often portrayed with disdain as an autocrat. At home he is popular, despite a deep recession following the global credit crisis. Foreign observers need to remember that past presidents Yeltsin and Gorbachev were never seen as popular leaders inside Russia, and they are still not regarded with anything like the admiration or reverence they received in the West. Under them, Russians did not see their wealth climb. They led during unstable and difficult times.

Of course, I’m not blind to the challenges Russia presents. In 2003 I visited Moscow to meet Bill Browder, an American investor who was hugely enthusiastic about investing in Russia. He told me what a great thing Russia was, and he was a keen evangelist for its inclusion among the BRICs, as it helped him raise money for his funds. Bill was an active investor in individual stocks and often made public pronouncements about how companies were being run, and how some might be better run. Some years ago, he had his visa revoked and would probably face tough consequences if he tried to return there.

There is no better illustration of the debate about growing state corporatism than the story of Yukos Oil. In the early 2000s it seemed as though Yukos might become one of the biggest and best oil companies in the world. Today it doesn’t exist. In 2003 its former CEO, Mikhail Khodorkovsky, was arrested and charged with fraud. Yukos was accused of avoiding enormous tax liabilities, its assets were sold off cheaply at auction and the company was declared bankrupt. Most of its top executives fled the country, but Khodorkovsky, who had once been the wealthiest man in Russia and the sixteenth richest man in the world (according to Forbes magazine), was tried, convicted and sent to jail. From prison he has been a thorn in the Kremlin’s side, writing letters and speeches accusing Putin and Medvedev of running a corrupt political and legal system, and warning Westerners against investing in Russia.

The arguments over Yukos continue. Many in the West believe Khodorkovsky’s claims that Yukos was dismantled simply as an act of political revenge, as it had become too big and powerful for the Kremlin. Russian commentators, especially those close to the Kremlin, accuse Western observers of not recognizing the illegal behavior of Yukos, supposedly including its systematic tax avoidance. Somewhere in the middle are those who say that even if Yukos didn’t pay its taxes, its punishment was extreme and indicative of the many problems facing anyone trying to do business in Russia. The relationships between Russia’s politicians and the so-called oligarchs remain mysterious and worrying to outside investors. The baffling deaths of businesspeople, politicians and journalists who oppose the Kremlin don’t help either.

These things probably explain why Russian equities have underperformed compared to other BRIC markets since the financial crisis, and appear to be relatively “cheap.” The Russian market trades at a lower valuation than other BRIC markets because the expected profit one year ahead is much harder to forecast owing to uncertainty about Russia’s future. In the early years of the BRICs, Russia traded at a premium to Brazil, but it now trades at a significant discount.

Another major concern about Russia is its overreliance on oil and natural gas. In one sense, it is a great blessing for a country to have large energy and mineral resources that it can sell. But it risks inducing laziness. It is wonderful when commodity prices are rising, but when they fall an economy can quickly look vulnerable. This happened to Russia in 2008 during the global financial crisis, when its GDP fell by 8 percent as a result of the fall in oil prices, and the value of its stock market fell a staggering 70 percent. No country likes to experience such volatility. If Russia is to achieve its ultimate BRIC potential of multiplying its 2010 GDP several times over by 2050, it has to move beyond energy and develop other industries, and to widen economic wealth ownership in its populace. President Medvedev’s plans for reducing the importance of energy announced in 2009 linked to his goals to boost the technology industry are definitely a step in the necessary direction. A well-educated and technologically literate population should make this goal attainable.

Russia should also do more to encourage foreign consumer multinationals, especially those with strong brand names, to enter Russia. Keeping ownership of the natural resource companies is perhaps understandable, but in terms of satisfying rising consumer aspirations of Russians, allowing foreign companies access to its market would make more sense than trying to develop homegrown Russian rivals. Pepsi’s acquisition of Wimm-Bill-Dann, Russia’s biggest food company, in late 2010 might be an important positive sign in this regard.

Russia could become very wealthy. Russian GDP per capita could rise from $10,000 today to $20,000 by 2020 and perhaps close to $60,000 by 2050. Its demand for consumer products could grow to match that of many developed countries today. In 2010 there were already believed to be more car owners in Russia than in Germany, mainly due to its larger population, but also due to the rapidly rising wealth. If Russia’s political leaders could provide a supportive environment, they will probably attract the big multinational motor manufacturers.

Russia could also become a desirable location for other multinationals seeking to export to the former Soviet states as well as to Iran, Iraq and other Middle Eastern nations. This is certainly a policy that those in government are increasingly eager to explore. They are also keen to develop Moscow as a regional financial center. At the 2011 Goldman Sachs BRIC conference, Andrey Kostin, the president and CEO of VTB, one of the two most powerful Russian banks, told me that he saw Russia becoming an important center for financial trading for the former Soviet republics.

There is much that Russia needs to sort out in order to improve its chances of success and to reach the 2050 scenario we have laid out. There are likely to be plenty of opportunities for them to see how well they are doing.

At some stage oil prices will probably fall sharply again. If oil prices fell to $15 a barrel and stayed there, that would almost certainly be a nightmare for Russia, at least in the short term. The sharp drop in oil prices in 2008 to around $30 shows how vulnerable economically Russia can quickly become. But ultimately, actions to force Russia to become less dependent on high oil prices would be good for the country, and force it to develop a real economic base, not one purely dependent on selling its natural resources. Before the 2008 crisis, Russia outperformed our expectations because of the price of oil. Smart policymakers would have known the reasons for its growth and prepared for what came next.

In early 2008, just before the crisis hit Russia, I visited the country to deliver a presentation on Russian growth prospects up to 2020. It turned out my projections were only half as optimistic as the internal Russian numbers. I could sense some irritation in my audience. During the ensuing discussion, I told them: “You’ve just had seven years of BRIC life in which oil prices have gone up fivefold. I can guarantee they won’t go up fivefold over the next seven years.” Within three months, oil prices had halved and Russian GDP plummeted. It was obvious to me that this was going to happen at some point. What’s not clear yet is whether Russia drew the right lessons from the experience.

Russia has to improve its infrastructure too. Like Brazil, Russia is soon to host both an Olympics (the Winter Olympics in Sochi in 2014) and the FIFA World Cup (in 2018). As with Brazil, these sporting events offer Russia a chance to show itself off to the world, as China did in 2008, and to make progress in those simple areas of life that to many are the most important. St. Petersburg, for example, is Russia’s second largest city and one of the most architecturally beautiful places I have ever visited. Yet when I go there each year I am shocked at the crowding and disorganization at the airport. It recalls the Soviet era. If Russia is ever going to become really successful, surely its airports and other infrastructure must improve.

When I attended the Champions League final in Moscow in 2008, to see Manchester United play Chelsea, I flew in privately with a group including several Chelsea fans and my son, an avid United supporter. We had been warned that due to the number of people coming in and out of the city, the public flights would be chaotic. We had a great time enjoying Moscow before the game, which ended happily, after penalties, in the right result: a United victory. We celebrated through the night before blearily heading for our early flight home. Fourteen hours after boarding, we were still sitting on the tarmac, along with a couple of dozen other private planes. The twelve of us on the plane never imagined we would have such an opportunity to get to know one another so well! Frustrated by the lack of information, four of us eventually took a car and traveled to the other side of Moscow and boarded the scheduled British Airways flight at six forty a.m. the following morning. Our original flight took off shortly afterward. It was an expensive and exhausting trip, and an eye-opener into some of Russia’s issues.

During our long wait, my travel companions asked me why on earth there was an R in BRICs, and I have to say that trip had me wondering. At various times we heard that the airport simply couldn’t cope with so many flights. Or that President Putin had closed the airspace over Moscow so he could visit one of the former Soviet republics and return the same day. Whatever the truth, it was a reminder that in certain mystifying ways Russia is yet to behave with the transparency and efficiency of a fully developed country. To this day we still don’t know why we were kept waiting!

I realize that it’s wrong to draw too many conclusions from a single experience, and I have been to Russia a number of times without experiencing such difficulties. There is also a danger with Russia, as with all the BRICs, of letting our Western biases affect our views of its progress. Provided we remind ourselves of Russia’s past, then our judgments of its present and our forecasts for its future will be more grounded in reality.

INDIA

India is the greatest mystery among the BRICs.

Its demographics are astonishing, the most favorable in the world. Over the next twenty-five or thirty years, its working population might increase by the same number of people as currently live in the United States, 300 million. Its population in 2011 is already 1.2 billion and by 2050 could reach 1.7 billion—that’s 10 to 20 percent more than China’s, and with far more young people. Such an expansion would make India’s labor force almost as large as the combined labor forces of China and the United States. These are irresistible facts and alone will make India one of the biggest influences on the world.

India also has the great advantages of a credible legal system, many English-language speakers and homegrown technology companies that are expanding globally. It has been provoked to action by the rapid growth of China and has no desire to be left behind by its largest neighbor. In theory, India could overtake Japan in the next twenty to thirty years to become the third largest economy in the world and, given its demographics, has the potential to increase its real GDP faster than any of the other BRICs. By 2050, India could be more than thirty times bigger than it is today in economic terms. However, of the four BRICs, India has the lowest growth environment score, a fact many visitors would find surprising. But such is the scale of the challenge for India that when people propose I drop the R from BRICs, I point out that, for all its faults, Russia is stronger than India on a broad list of variables for sustainable growth, such as our GES. India is the most vibrant, beautiful, creative, inspiring place I have ever seen. But the scale of poverty is astonishing, and the difficulties of getting things done are equally so.

I will never forget my first trip to Mumbai. As my plane landed I looked out and saw the slums pressing up to the edge of the runway, stretching out for miles. After I passed through the airport, an adventure in itself, my journey into town was remarkable. It was night, and seeing so many bodies asleep in the street, I thought at first that they were dead people.

By day, Mumbai is an endless traffic jam. Child beggars bang on the cars and demand money. It is like living theater. Despite the appalling poverty, there is an excitement about this vast, limitless city. I love the fact that every time I visit Mumbai, people have different estimates of its population. The official tally is 15 million, but several people have told me it is twice that. I have walked around Mumbai’s slums with the people in charge of slum clearance and development, who tell me the most extraordinary stories. In their efforts to clear the slums, the city authorities offered people apartments in new, suburban developments. Many took up the offer but, within weeks, lacking any sense of deep community or friendship, would leave their new homes and return to the slums to build a new shack for themselves and their families. You can read some fabulous books about life in Mumbai and Delhi, but there is nothing like visiting.

Contradictions abound concerning India. At Goldman we started to think seriously about the country only after we’d started the BRIC analysis. It wasn’t until our first 2050 scenario was published in 2003 that we considered employing a full-time India economist. In this sense the BRIC concept led us to India rather than the other way around. Our 2050 projections for India certainly took me and others aback. Both inside and outside India, people were stunned by the scale of our projections.

The good news about India over the past ten years is that it hasn’t had a major economic crisis. It hasn’t done anything either spectacularly positive or negative. In vital areas, it remains fifteen or twenty years behind China. Urbanization is one good example. There are lots of new cities sprouting up all over India, and in Delhi and Mumbai you can see the infrastructure improving. But the pace isn’t always quick. I remember having to drive from Delhi to a satellite town called Gurgaon, a booming technology center, to meet an adviser to the Indian government. My meeting was scheduled for nine a.m. and I was keen to be on time. My driver said it would take anywhere between forty-five minutes and two hours. I decided to assume the worst. The trip ended up taking two and a half hours. Within minutes of leaving my hotel, we were stuck in traffic. They were building a new motorway, and as they did so, the existing one had been reduced to one lane, where we jostled with carts and animals as well as other cars. There were hundreds of construction workers doing nothing as far as I could tell, scores of police trying to create order out of the mayhem. I remember sitting in the car with animals pressing in on the sides staring at these beautiful skyscrapers off in the distance. Here were lots of symbols both of India’s economic progress and of its dangers all in one anecdote.

I told myself that I would return here on future visits and use this journey as an indicator of India’s progress. The new road was eventually finished and the journey from Delhi to Gurgaon now takes half an hour. The Delhi subway and airport were also upgraded on time.

Indian politicians have the will to pull their country forward, but there are moments when I think they want to frustrate this process, as if they are not completely convinced that economic growth is a good thing. Among Indian elites, I often find a resentment of Western practices, development among them. Some simply don’t want this vast change. Not long ago, I was attending a meeting in Simla as part of a UK-India Round Table. I got into a big argument with a well-known Indian philosopher, who told me that economic growth only causes damage. He talked about pollution and the dangers of financial markets. Both can be consequences of growth, of course. But I told him that what I felt he was really saying was that he didn’t want any of his fellow Indians to escape poverty.

As I have said, I believe keeping control of inflation should be at the core of BRIC macroeconomic policy. There is no better, simpler, clearer way of showing people what is driving government thinking. But Indian politicians tell me that inflation targeting is too complicated, that creating a consumer price index is too difficult and that anyway the volatility of food prices makes it unreliable. I wonder if these are the real reasons, or if it’s because some Indian leaders would rather government policy remained a mystery. They don’t want it to seem clear.

India has other problems China doesn’t have. Its regions are very autonomous, so central government cannot dictate policy. It is a democracy, with all that entails: bickering parties, an antiquated caste system, competing faiths, not to mention a complicated colonial heritage. There are clashing voices and opinions in India, not the single purpose that is present in China. This is not a judgment about the relative merits of democracy and Chinese communism as political systems, merely an observation about the differences in economic policy as implemented in the two countries.

From an investment perspective, I was worried about India in 2010 and 2011. Equity market valuations were very high. For most of the past few years, in fact, India has traded at a premium, partly, I think, because of its very positive potential and image overseas. People see all these Indian billionaires and think that’s the whole story. Some Indian companies and individuals have taken advantage of this mispricing to float their companies and use the capital they raise to buy Western equivalents at half the price. Some very astute investors believe that India is a more balanced GDP story than the popular perception of it allows. They believe that its economy is not so dependent on the rest of the world. This makes it more resilient in the face of crises elsewhere, and an excellent defensive investment play. If you’re worried about the world economy blowing up, these people believe that you should invest in India, because its economy is driven by its own consumption, not exports or foreign investment. It is a much more self-sufficient economy than those of the other BRICs. Evidence of this is that over the past decade we have seen India bear the brunt of rising commodity prices. It has weathered this just as Brazil weathered the economic crisis and falling commodity prices. If you are comparing the four BRICs, you could say that it was impossible to judge the strength of the growth in Russia and Brazil until commodity prices fell. Inversely, India has shown its robustness by growing even as a net commodity importer in a decade of ever rising commodity prices.

Almost every person I know who does business in India, Indian or not, from the most powerful on down, complains about the slow bureaucracy. Ordinary permits and approvals can take months to come through, gumming up even the simplest procedures.

I recently heard about a proposed meeting for a visiting UK minister with some Indian officials. The minister’s staff was rather baffled when asked if this would be the first time the minister had met one particular Indian official, as if not, it would have to be the last. According to the Indian civil service, only two meetings with people of the minister’s stature were permitted; the official would not be allowed to meet a foreign politician formally a third time, which seems more than a touch bureaucratic.

India attracts the least foreign investment of the BRICs partly because of this mystifying bureaucracy. If India were ever to allow Tesco or Walmart into the country, it would undoubtedly improve productivity in retail and reduce agricultural waste. But the politicians worry about the effect on Indian society, so they revert to protectionism and block foreign companies.

Reflective of this, to the surprise of many in the West, who are used to meeting highly educated and tech-savvy Indians, India has poor growth environment scores for both technology use and education. At the top end of its educational system, India produces large numbers of well-trained, English-speaking technical graduates, who have driven the success of its service industries. They are also highly computer literate. The vast bulk of its population, however, remains uneducated with very limited access to technology. Hundreds of millions have little or no formal education. The difference between government statistics and reality is large, but it is believed that 20 percent of children between the ages of six and fourteen do not attend school at all, and that the dropout rate is high. India’s literacy rates are by far the lowest of the BRICs, with female literacy lower than 50 percent. India struggles at all levels of the education ladder, from primary through tertiary. Any list of the world’s top universities these days would probably include many from China, but one at most from India. The Indian government has promised to make large investments at every level of education and must do so simply to meet domestic demand for an educated workforce. By 2020 it hopes to have quadrupled the number of universities.

My personal interest in educational charities has allowed me to meet those with similar interests in India, and these discussions have given me further reason for hope. There are many exciting initiatives. These include Pratham, founded in 1994 with the help of UNICEF to make sure more Indian children go to school, and Teach for India, an offshoot of the UK’s TeachFirst, which sends recent graduates from Britain’s top universities to teach in secondary schools in deprived areas. For India to have any chance of achieving its remarkable potential, educational standards and opportunities have to be increased dramatically.

This is also a business opportunity; for example, education-related businesses could become a major export for the United Kingdom. Another initiative we discuss at the UK-India Round Table is to “offshore” the better Western universities. If I were in charge of one of these universities, I would be spending a lot of time exploring opening a “branch” in the most densely populated urban corners of India.

Just as with charitable educational initiatives, if I were a technology entrepreneur, I would be looking at ways of helping India’s poorest to get access to basic technology. Access to the Internet and mobile telephones, paired with education, will really help India to get moving. Add this to India’s rapid urbanization, and it is easy to imagine its real GDP growth rate rising above that of China. It would also be easy to imagine India having over a decade of 10 percent growth or more. Failure to invest in education and technology, though, could leave India staggering along as it did from the 1950s until the 1980s, when it was limited by protectionist, interventionist and socialist governments to what was disparagingly called the “Hindu rate of growth,” a dismal 3.5 percent a year.

As well as targeting inflation, the Indian government has several macro and micro issues on its hands.⁵ It is not nearly as open to international trade as it should be. This has been a long-standing problem for India. Manmohan Singh, the prime minister since 2009 and an academic economist, wrote his doctoral thesis at Oxford in 1962 about India’s export trends and the role they would play in his country’s growth. In 1991, when he was appointed finance minister at the urging of the International Monetary Fund, India’s trade-to-GDP ratio was a paltry 15 percent. Thanks to Singh’s reforms and the boom in global trade, it has improved to over 35 percent. The country has built new export sectors in services and manufacturing, from energy, pharmaceuticals and gems to the widely familiar IT outsourcing.

Since 2000 in particular, Indian trade with the rest of the world has ballooned. Its share of world exports has risen from 0.6 percent in 1993 to 1.5 percent in 2010. As 2011 unfolds, Indian exports continue to rise sharply. After having risen by nearly 40 percent to $246 billion, easily outstripping government forecasts, exports grew by more than 50 percent in the first few months of the 2011–2012 fiscal year. The Congress Party–led government dreams of $500 billion in annual export revenues within three years, representing growth of 30 percent a year. Indian exports are in the process of a large-scale rebalancing. As I write this in 2011, just 13 percent of its exports go to the United States compared to 21 percent in 2000. Two-thirds of Indian exports now go to markets other than the United States and the European Union, mainly to Asia and several African countries.

Amid all this excitement, though, one should recall that Indian exports are rising from a very low base. There is much more trade that India can do, particularly with its neighbors. Along its northern borders are China, a fellow BRIC, and Pakistan, a country with close to 200 million people. Because of their tense political relationship, India and Pakistan scarcely speak to each other, let alone trade. To the northeast is Bangladesh, a country with more than 100 million people. If India’s leaders could only shed their fears of free trade, they could propose a free trade area in the subcontinent by 2020. Increased trade between India and Pakistan may even turn out to be the key to ending their mutual hostility. I am always shocked in India by the disdain for Pakistan and told I am naive for imagining free trade could be the answer. But as a European I look at the way France and Germany—fierce foes in two world wars during the twentieth century—are now partners at the heart of the European Monetary Union. Their intention never to fight again drove them together economically. India and Pakistan might one day be the same.

India and China are showing marked progress in their trading relationship. In 2010, China promised to buy more Indian goods in an attempt to reduce its trading surplus with India. Corporate data suggest that this is working as China buys ever more iron ore, cars and pharmaceuticals from its neighbor. Even so, India’s bilateral trade with China was worth just $56 billion in 2010, compared to $80 billion with the European Union.

The rest of the world certainly seems enthused about India. In 2010, U.S. president Barack Obama, UK prime minister David Cameron and French president Nicolas Sarkozy all led large delegations to India. Businesses in their countries are extremely excited about India’s prospects. India’s trade officials, led by the commerce minister, Anand Sharma, are among the most active in the world these days, traveling all over the Middle East, Africa and Latin America, as well as Europe and Asia, to strike bilateral deals. The world is responding. In Britain, Chancellor George Osborne said in 2010 that “India’s policies of trade and investment liberalization are reintegrating it into the world economy, allowing it to regain an influence it had three centuries ago.”

There is still plenty of work for India to do. It remains far too low on the World Bank’s indices for ease of doing business, anticorruption and transparency. According to the World Bank’s rankings, anyone trying to export goods from India must file eight documents over an average of seventeen days for each shipment. Contrast this with Singapore, where just four documents are filed over five days. India’s infrastructure requires colossal levels of investment, and a more evolved public and corporate bond market to fund it. It also needs to bring down barriers to imports and foreign direct investment.

Its imports are rising, but its politicians remain far too worried about foreign competition and cutting tariffs. To achieve its potential, India needs to import a lot, whether it is Australian and Indonesian natural resources or British education. The easier it makes this process, the faster it can grow. Improving its infrastructure and health care systems will be essential to boosting everything about India’s future.

Foreign investors may be eager to get involved in India, but they are scared off by rules and legal threats that make it hard for them to take significant stakes in Indian companies. India’s political leaders understand the need for foreign direct investment to stimulate growth, but seem frightened by the popular reaction to admitting more foreigners to their markets.

Agriculture and retail are two glaring areas that could benefit from foreign expertise and investment. Walmart, Tesco and Carrefour have been keen to enter the Indian market for years, but have been barred from doing so in any meaningful way. A powerful group of middlemen, who link farmers to Indian consumers through tens of millions of small shops and pushcarts, have persuaded politicians not to let in the big Western chains. Their participation has been limited to offering technical support to Indian retailers. What may finally be changing this attitude are persistently high food prices. Foreign companies could wring stupendous efficiencies from India’s food supply chain, reducing waste and lowering prices, through simple advances such as better refrigerated transport. But it remains to be seen whether the politicians have the nerve to take on the traders who prosper under the existing system, taking commissions from farmers and pushing up prices for consumers without offering much in the way of supply chain improvement.

I once discussed this with a senior official in India’s finance ministry, who told me bluntly that the battle over Tesco and Walmart had nothing to do with growth, but with the risk of Indians losing their jobs. Such short-term thinking is regrettable: admitting foreign investment would undoubtedly improve the consumer experience for Indians and enhance the efficiency and productivity of its agricultural industry.

The more I travel to India and think about its challenges, the more I find myself concluding that, as with so many issues in life, its problem is one of state of mind. The problems of raising educational standards and achievement, spreading the use of technology, boosting trade and foreign investment and increasing agricultural productivity all boil down to one issue: leadership. It is perhaps as simple and as difficult as this. India must wrestle in so many areas to change and advance because it is such a complex nation to lead and govern.

I find the contrast to China so illuminating: two countries with similar populations and yet China, in theory at least still a communist country, strides ahead, while India, the world’s biggest democracy, often struggles.

CHINA

On my first visit to Beijing in 1990, I arrived via what was also my first ever trip to Taiwan. I remember thinking I had it all the wrong way around. Taiwan, a democracy, seemed more like a communist country, its capital, Taipei, all tall gray buildings and order. In contrast, walking the streets near my hotel in Beijing, I found street markets and lots of people buying and selling. It was the first time I sensed that Chinese communism wasn’t anything like my vision of it from living in the West. My idea of communism had been very much shaped by the Soviet Union. On that first trip, the communism I saw on the streets of Beijing seemed nothing like the evil tyranny I was expecting. There was more subtlety and nuance to this story.

I love traveling to China and sharing its people’s optimism. It’s a change from the cynicism and negativity I hear constantly in the West, where people seem to have lost their excitement about the future. I love being in a place surrounded by 1.3 billion people yearning and striving for more than what they have. People tell me from time to time that I should consider taking the C out of BRICs because China is of such huge relevance on its own. Of course, some say that if I took the C out of BRICs there would be no story about the others. They have a point. China is the greatest story of our generation. I’ve visited China more times than I’ve visited the other three BRICs put together.

There is simply no overstating China’s importance to all of us, not just to 1.3 billion Chinese. The entire planet, all 6.5 billion of us, is invested in China’s success. When I joined Goldman Sachs in 1995, China’s economy was worth around $500 billion. It has grown more than tenfold in just fifteen years, averaging more than 10 percent real GDP growth throughout that period. By 2001, China’s GDP was around $1.5 trillion, smaller than that of the United Kingdom or France. Now it dwarfs both, and in 2010 overtook Japan to become the second largest economy in the world. It could conceivably continue to grow at close to 10 percent in the decade up to 2020, the way it did between 2000 and 2010. I suspect it will get harder to sustain quite this degree of growth, and it may be better for it to slow down somewhat as policymakers focus more on the quality of growth rather than just the sheer quantity. It will certainly be critical for all of us. We might worry often about the debt crises in the eurozone, but anything that happens in China is far more important to the fate of the world economy.

Like all the BRICs, China is rife with contradictions, and no experience captures these better than a visit to Mao’s mausoleum in Tiananmen Square in Beijing. A friend of mine, a journalist for The Times, told me that if I wanted to understand modern China, I had to pay it a visit. It was like going to a soccer match, with thousands of poor Chinese crowding around, pushing and spitting on the ground. It was a little scary at first. The police herd you and you worry you might get trampled. Near the entrance is a shop where you can buy flowers for three renminbi, and so many people were buying a bunch to present before the embalmed body of China’s Great Helmsman. As we came to the mausoleum, we saw banks of flowers rising up around Mao. But then I noticed a man picking up the flowers and taking them back around to the store to resell them. So we had huge crowds coming to pay their respects to a man who had authorized the killing of millions of people, and buying flowers knowing they would be resold the moment they laid them down.

Capitalism, communism and Chinese ancestor worship were all being practiced in one crowded spot in the heart of Beijing. Within a few hundred yards of the mausoleum there is a Lamborghini showroom, where China’s new rich buy sports cars with cash. If you can process this mass of confusing images, then you have a chance at understanding modern China.

In our 2003 paper forecasting the growth of the BRICs, we predicted that China would be the biggest economy in the world by 2039. Professor Niall Ferguson, now at Harvard, was one of the many who ridiculed us. He said our projections were some of the silliest things he had read. Like many others then and since, he assumed that we expected China to just extrapolate past growth. We didn’t do that. (I have got to know Niall well since. Of course, he has changed his mind, although I am not sure it has anything to do with me.) China, we wrote, does not have to keep growing at 10 percent for its GDP to pass the size of the United States. It can grow at more modest rates and still become number one.

Since then, on a couple of occasions we have changed the period in which China might challenge the United States. In 2008 we said that China could become the world’s largest economy by 2027. A few months later The Economist one-upped us, saying China might overtake the United States by 2020. To achieve this it would have to grow by 10 percent a year all the way to 2020, which is possible but unlikely. If the renminbi were to appreciate against the U.S. dollar at an even faster rate than it has been doing, so that the dollar value of any Chinese growth would be greater, then it could happen on paper, but it will be tough for it to occur quite that soon. At the end of 2010, China was still only about one-third the size of the United States in comparable U.S.-dollar terms.

We deliberately called our 2003 paper “Dreaming with BRICs” partly to make it clear that our projections carried no guarantee, but also to encourage people to consider the likelihood that China and the other BRICs could ascend to challenge the G7’s worldwide economic supremacy and influence. Eight years on, the idea that China might become the world’s biggest economy is more widely accepted.

The first people in the West to understand the China story were the international businesspeople, those who ran multinational corporations, the big brands of retail, product and communications empires. They went to China frequently and could see what was happening on the ground. But the changes should have been apparent to any regular visitor. When I first visited China in the early 1990s, I was one of the few people being picked up from the airport in Beijing in a black limousine. Most of the traffic going into the city was bicycles and carts. I vividly remember having to stop and wait in the car after two of these bike-powered carts collided and fruit and vegetables were thrown all over the road. The last section of the seventy-odd-kilometer road to Badaling, where the Great Wall comes closest to Beijing, used to be a dirt track. On a more recent visit I went to Badaling with my wife, and saw the dirt track had become a highway. We stayed at a boutique hotel right beside the Wall. When I first visited, Beijing had one giant ring road looping around the city. Today it has eight, the outermost running close by the Great Wall.

The key, of course, to China’s extraordinary growth has been its population. Once its government decided to engage with the rest of the world in the early 1980s, economic changes were triggered that have gathered ever more pace in the 1990s and 2000s. Millions moved into cities, contributing to and benefiting from China’s surge as a global manufacturer. As we found out, though, in 2008 the world couldn’t really cope with this status quo anymore. And from a global perspective, just having the world’s largest population might not be enough. They also need to be the right people.

As I discussed in the last chapter, a large working population boosting its productivity is the key recipe for achieving persistent stronger growth. China does have some challenges in this regard. Its working population is aging and may soon peak, which could land China with the kind of challenges faced by Italy, Japan and perhaps Russia. In April 2011, China released its 2010 national census, which reported that, excluding Hong Kong and Macao, its total population was 1.34 billion, an increase of about 74 million from the previous census, taken in 2000. It has been growing by just 0.6 percent a year since 2000, compared to 1.1 percent a year between 1990 and 2000. While the head of the National Bureau of Statistics bullishly attributed the slowdown to China’s one-child policy, this highlights a more troubling aspect. The number of young people is falling sharply. Only 16.6 percent of the population is under fourteen, around half the number of twenty years earlier. At the same time the number over sixty-five years old is 9 percent, nearly twice the figure of twenty years ago. If China were to follow the same trend over the next twenty years, its demographics would change dramatically, with its working-age population dropping and its GDP growth rate slowing abruptly. China’s growth rate will not be as strong in the future as it has been in the past twenty years.

It will slow; it is just a matter of by how much and how smoothly. The government announced a lower target of around 7 percent for real GDP growth in its twelfth five-year plan, starting in 2012. Its previous five-year plan aimed for 7.5 percent real GDP growth, though it turned out to be closer to 11 percent. It is unlikely that the gap between the target and the actual outcome in the next five years will be as wide. Government assumptions for the five-year growth target are just broad desires, not hard targets, but for the current administration to assume a lower target is recognition of some of their challenges, and possibly reflects a desire for somewhat softer, better-quality growth.

No demographics are definite. Rising wealth may lead to improved health, longer life expectancy and a desire for more children. There are already signs that the government appears to be relaxing the one-child policy in the more prosperous urban areas, notably Shanghai and Beijing, where families with more than one child are a fairly common sight. In a number of areas it seems that, provided you can pay for a second child, you can have one, especially if the first child is a girl, given China’s shortage of women.

China might also be able to make up for its population slowdown in other ways. According to the census, the ratio of Chinese citizens living in urban areas has risen from 36.2 percent to just below 50 percent. If other advanced economies are any guide, there are still another 260 million Chinese, or 20 percent of the population, yet to move into cities. This is almost the equivalent of urbanizing the entire population of the United States. As I have written, I believe urbanization has a great positive effect on GDP growth, as people compete to improve their lives and share knowledge at a swifter rate.

In any case, growth is also about the productivity of those working, not just the fact that they work. The number of Chinese people receiving a tertiary education is rising quickly, which should also lead to stronger growth. The remarkable speed at which Chinese researchers are starting to be among the most successful scientists and engineers in the world is a strong sign that productivity in key areas is on the rise. As China urbanizes more of its people, boosting their productivity—perhaps also helping their individual flexibility and creativity—will be vital.

With some continued modest appreciation of the renminbi, by 2050 Chinese GDP could be worth $70 trillion, with GDP per capita around $50,000, around twelve times its 2011 level. The Chinese would still be far from the world’s wealthiest people, but at this level of GDP China would certainly have the most billionaires.

Our opinion in the 2003 paper that China could one day be the world’s largest economy sent many Westerners into a spin and is still not universally accepted, despite subsequent experience. The world has become so used to American economic dominance that the idea of another country, let alone a communist one, taking its place is unsettling to some. But it is worth asking: what difference would it actually make? China has long had the world’s largest population, so it shouldn’t be that surprising that it could also have the world’s largest economy. Indeed, it has been the biggest economy before, albeit many centuries ago, so why not at some stage in the future? Luxembourg does not complain about having a smaller economy than Germany, so why should the rest of us worry about China? What do we find so frightening about the idea of China reaching its economic potential?

The first anxiety is political. Most in the West are conditioned to mistrust any form of authoritarian rule. The Chinese, evidently, do not feel the same way. Provided their government delivers rising prosperity, they seem accepting of its current form. My own hunch is that whether China ultimately becomes a democracy is less important than whether it evolves into a more open version of what it is today, allowing people the rights corresponding with their greater wealth. Byron Wien, vice chairman of advisory services at the Blackstone Group, wrote an amusing account of a visit to India and China in the spring of 2011, during which he asked a group of Chinese people how they felt about not being able to vote. One of them told him: “What’s the big deal about voting? In the U.S. everyone can do it and only half the people do. If voting were that great a thing, like sex, for example, everyone would do it.”

The second reason for the West’s anxiety about China’s ascent is its reluctance to recognize its own importance. Its leaders are so focused on their internal problems that they show little interest in shaping world affairs. Like the former colonial powers, they go to Africa to sign commodities deals, but it is not obvious that the reason they do so is because they care about Africans. There is some evidence that the United States was similarly loath to accept the global role befitting its economic status in the first half of the twentieth century. It took the Second World War to really drag it out of its shell. It is the case today that China is more focused on China than on its external responsibilities, which is not what others would perhaps want. I expect this to change as it achieves more sustained progress and advancement.

Third, many seem to believe that China’s gain must mean the West’s loss. This is just not true. (I return to this apparently thorny issue later, in Chapter 7.) China’s long-term sustainable growth has nothing to do with where its GDP stands in relation to that of the United States. International trade means that both the United States and China will benefit from China’s rise.

A glance at China’s growth environment scores reveals why. Its general macroeconomic scores are promising. China scores well for its stable inflation rate, its external financial position, government debt, investment levels and openness to foreign trade. On the micro side, China also exceeds the average for big developing countries. The only two areas where it falls just below the average are corruption and, in some areas, the use of technology. The latter is undoubtedly changing quickly.

It is distinctly possible that China’s GDP will never overtake that of the United States. In the 1980s it seemed Japan was destined to become the world’s largest economy. Its companies were storming the world, its investors buying Rockefeller Center in New York and setting new price records for Impressionist paintings. Rather than being signs of strength, however, these turned out to be omens of Japan’s asset bubble. Once that imploded, Japan embarked on two decades and counting of deflation. There are many who look at the frothy prices of Chinese real estate and say China is heading for a similar fate.

Like the Japanese in the 1980s, the Chinese have also been reluctant to let their currency float. The Japanese kept the yen artificially low to protect their manufacturing export sector. The Americans had to threaten to shut Japanese products out of the U.S. market before Japan allowed the yen to rise. A similar situation could arise with China, which until 2005 was keeping the renminbi artificially low. If U.S. industrial production shows no sign of substantial recovery in coming years and unemployment remains high while China continues its apparently strong growth, the United States could threaten to ban Chinese goods, which would leave Chinese exports facing a huge slowdown.

While there are some grounds for thinking that China could fail for similar reasons as Japan, I tend to doubt such simple comparisons. There are some very big differences too. Japan seems, even today, after the tragic earthquake of 2011, a more formal and closed society. In the past on many visits to Tokyo, I used to stay at the Okura Hotel, next door to the American embassy. To use the hotel gym, you’d have to sign in with one person, receive your gym uniform from another and be shown in by a third—you worked as hard to get in as you did once inside. The Japanese attention to detail has always been fantastic, but the flip side is a large waste of human resources in the service sector. The English language is hardly ever used in Japan and it is consequently tricky to get around the place.

The Chinese, by contrast, are doing much more to communicate with the outside world, whether it is in business, politics or tourism. I am constantly impressed by the people I meet when I visit China. An obvious contrast to Japan for a Western visitor is that so many Chinese speak English or are rapidly acquiring the skill, so we can converse without a translator. Visitors appreciate the way the Chinese are so eager to communicate. You can experience it in many aspects of life. A couple of years ago, my wife and I were bicycling along the Yulong River near Guilin, and as we entered a small village I noticed a big billboard on a dilapidated wall that read, “Success in English equals success in life.” There in one simple message was all of China’s eagerness to embrace another language as a means to achieve its ambitions. It points to a broader willingness to engage with the world, and not hide behind a closed cultural identity.

This is one of the most powerful illustrations I have seen on my many trips, and has such important resonance for all of us the world over.

Another thing that impresses me is how worried the Chinese are that everything could go wrong. Normally, it’s my job to worry. But the Chinese, I’m delighted to say, do a lot of my worrying for me. They seem constantly worried. A couple of years ago, I was giving a talk to a group of midlevel policymakers and regulators. Afterward, three of them came up to me and asked if I was worried about a property bubble in China. This was exactly the fear expressed by many Western investors, and I was pleased to see the Chinese took it just as seriously.

This was very different from Japan in the late 1980s, when policymakers refused to acknowledge the bubble building up in almost every asset class in the country. The Japanese policymaking machine at the time was in complete denial about the problems that have since held the country back. In a similar spirit, ten years ago the Chinese knew that their banking system needed to evolve. So they appointed a commission made up of six eminent banking specialists from around the world to advise them. This willingness to reach out, to address problems as they emerge—this practical, realistic approach—I find refreshing in China.

It was fascinating reading the news reports about the ninetieth anniversary of the Communist Party of China in the summer of 2011. The Chinese are very proud of the fact that they don’t make judgments about how other nations behave, that they focus on themselves and their internal stability and prosperity. Critics might say that China does not judge others for fear of being judged itself. This may be right. But what I see is a set of leaders determined to look clinically at their challenges and address them without prejudice.

China’s challenges, like everything else about the country, are monumental. I’ve seen rivers choked with rubbish. I’ve been in Beijing on days when it has been impossible to see the sun because of the pollution. In Shanghai one hears of people dying of illnesses related to the polluted environment. And this is just what the occasional visitor picks up on.

First, there are significant doubts about the accuracy of Chinese official data. China’s national accounts are frequently revised to reveal an economy bigger than officially reported in the past. My old economics colleagues in Hong Kong have expressed significant doubts about how the investment data are collated. They believe that the government’s counting of data ends up overestimating the size of official investment and underestimates the size of services expenditure in relation to the overall economy and as a share of GDP. If so, the accurate and truer share of investment spending as a percentage of GDP is being overestimated in the official numbers. A related oft-quoted concern among hedge fund investors and others is that China fiddles its economic data out of malice or a desire to misrepresent reality. I can’t see any reason for the government to do this. We need to check our own biases before questioning China’s data accuracy or tarring China’s investment spending as unprofitable. GDP data in the UK often strike me as less accurate even than China’s, but do people question that? The Chinese may simply not share the short-term view of profitability we have in the West.

Given China’s political and social structure, it is more likely that the success or failure of the investment buildup in the past years will be judged only over the next decade or so. Much of the investment has gone into infrastructure. Is the recently expanded Beijing airport a good investment or bad? Is it more wasteful than the investment in Terminal 5 at Heathrow? Or comparable terminal extensions in U.S. airports, which, I believe, have often added little to the ease and comfort of travel? As someone who flies frequently, I would suggest that the expanded Beijing airport is a positive initiative. Similarly, while many of China’s new roads outside the major urban cities are traffic free, they are very unlikely to stay that way. As I mentioned earlier, 50 percent of China’s population now live in cities, and another 20 percent are likely to follow: another 260 million people needing housing and transport infrastructure. I already hear stories that Beijing airport is not big enough, despite the fact that it was expanded only in 2008. When you live in London and see how difficult it is for Heathrow to add a runway, or suffer the daily challenge of the M25 motorway encircling the city, you wonder whether the UK might not profitably use some of China’s approach to infrastructure investment.

Yes, there are buildings standing empty, but I don’t share the concerns expressed by many about them, for they will eventually be filled as the Chinese urbanize. If China were closer to 70 percent urbanized, I would be a lot more worried about the notion of excessive investment: as China urbanizes more, the pace of investment needs to slow. As things stand, though, China’s investments have set it up for more growth, and it has achieved this without so far succumbing to crippling inflation or destroying its balance of payments, and it seems set to continue.

Many of the same points could be made about fears of a Chinese property crash. Jim Chanos, an American hedge fund manager and famed short seller, is a well-known pessimist regarding the economic outlook for China. He has called its property bubble “Dubai times 1,000—or worse.”⁶ I can’t think of an odder comparison. China remains far from fully urbanized and there seems to be huge latent demand for housing. Dubai’s internal population is tiny, and watching that bubble develop made it a lot easier to question. China’s leaders plan for the future and are ahead of their population when it comes to housing and infrastructure, so at times there will seem to be excess capacity, but it is soon filled up. Visitors to Beijing will often talk of the empty office blocks. But I have seen empty office blocks in China for years, and they quickly fill up.

If I choose to be paranoid, I look at the fact that urbanization of China’s youth is now reaching 60 percent, closer to capacity than the national average. Within six or seven years, there may be no young people left in the countryside. Given China’s gender imbalance and low birth rate, that could become a significant problem. If it’s true that the countryside is nearly emptied out, urbanization is complete and there is no one left to fill the housing and offices being built in cities, then I will worry seriously about overcapacity. But someone needs to persuade me that this is the case.

One thing that is impossible to ignore is the fact of fast-rising Chinese wealth. I read in late 2009 that 5 percent of China’s population, or 65 million people, now have incomes of around $35,000 per year, and these are concentrated in the major cities. This would be equivalent to the wealth of a UK or France. If true, it explains property prices in certain areas of Shanghai and Beijing. This affluent new class does not have the range of investments available to their peers in Europe or North America. China’s poorly developed financial markets mean that property is often the best of a limited set of investment choices. Then again, the Chinese government is also taking measures to prevent a crash, and is certainly doing more than the U.S. government did between 2001 and 2007 to pop its own real estate bubble. Since 2009 the Chinese have limited the percentage that can be borrowed to buy a second home, and certain cities have imposed other restrictions on speculators. These appear to have taken some of the heat out of the market.

Another recurring issue is China’s dependence on exports for economic growth. Certainly in the 1990s and 2000s China took advantage of its low-cost labor to attract multinationals from all over the world, eager to satisfy the insatiable appetite for cheaper consumer goods in the West, and in the United States in particular. The surge in China’s exports together with buoyant investment has been key to China’s remarkable rise over the last two decades. For a brief moment in 2007, China was exporting the equivalent of 12 percent of its GDP just to the United States. This, of course, was unsustainable. A severe external jolt, such as occurred with the global credit crisis, was bound to knock such an economy off course. Sure enough, China was badly hurt by the downturn in the United States.

But I think that, over the long haul, the shock will have done it good, forcing the Chinese to adopt more policies to boost domestic consumption and develop a more balanced economy. China could not depend on growth sustained by exports and public investment as the dominant rising share forever, and a shift to a model involving broader and stronger domestic consumption has to be a good thing for China, and almost definitely for the rest of us too.

Since 2007 a lot has changed. China’s trade surplus has declined sharply: in 2010 it slowed to 3.8 percent of GDP, compared to around 11 percent in 2007. Moreover, the notion that China grows at the expense of other countries is simply wrong. In 2010, China imported nearly $1.4 trillion worth of goods and services, an increase of $400 billion over the previous year. The United States imported $2.3 trillion worth of goods and services in 2010. At the current pace, China’s imports could exceed those of the United States within five years. When China starts running much lower trade surpluses, this will knock the wind out of those critics who blame its exports for the loss of Western jobs and threaten protectionism.

It seems clear that, during the next five years, Chinese policymakers are going to choose quality over quantity of growth. Quality will mean increased private consumption as a share of overall GDP; measures to improve health care and pensions, and the rights of migrant workers in the cities; and improved energy efficiency with a focus on alternative energy, which I will discuss in Chapter 5. At every turn in its story of economic growth, there will be new challenges for China. Imagine being Chinese in 2030, and having seen your wealth quadruple, from $6,000 to $24,000, in just twenty years. Social change will inevitably accompany rising wealth.

In July 2011 two high-speed trains collided in eastern China, killing thirty-five people. This disturbing event was taken by many in the country as a powerful sign that perhaps the Chinese authorities can’t rush everything, and the understandable backlash from the middle-class passengers who ride the trains will surely force policymakers to think more carefully about pursuing too many grand projects too quickly in the future. When I saw the early response to this accident, it confirmed a growing belief of mine that China is about to enter a new phase of growth, more to do with quality and sustainability.

My broad experiences in business have taught me that problems and crises are inevitable. What matters is how they are dealt with. With regard to its environment, the problem is so severe that the Chinese government is taking equally severe and drastic measures. It is perhaps the most aggressive country in the world in its pursuit of clean technology. China is determined to reduce its use of oil and gas. The major short-term policy issue for China is inflation. Inflation could push China’s economy into problems. On a recent trip I had a guide taking me from meeting to meeting. We were talking on our way back to the airport and he started moaning about the rising price of food and apartments. For a Chinese to complain to a foreign stranger means the problem is probably serious. This explains why Chinese policymakers are currently doing a lot to reduce excessive stimulus to the economy, slowing the rate of money supply growth and trying to reduce inflation. If they fail, some of the wealth created in recent years will very quickly evaporate and life will be tougher for many.

I recently read an article saying that the Communist Party of China, with its 80 million members, is not just the world’s largest political party but also its biggest chamber of commerce .⁷ It pursues its economic interests with remarkable efficiency. Not having to worry about voters, elections or rival parties allows the Chinese government to act with the kind of speed and decisiveness rarely found in a democracy. It does occasionally worry me when I sometimes meet Chinese corporate types who seem like government transplants. I get irritated when I hear their speakers rambling on and deviating endlessly from prepared remarks for more than their allotted time. It suggests a dangerous lack of creativity, and there might be excessive bureaucracy about the nation and its people. The other BRICs aren’t like this. But perhaps it is generational. When I meet young Chinese people and hear them talk and sense their energy, then I am back to being optimistic again. I remain as intrigued about China’s future as I was that first time I visited Beijing.