In my Money Week column last week, I looked at how London escaped the recession, and what lessons we should learn from that. Here's a taster.
The classic 1960s war film ‘The Great Escape’ was based on the break-out of a group of Allied prisoners from a camp in the town of Zagen, in what was then Germany but is now Poland. But if you wanted to re-make it, with a financial rather than military escape, you’d probably set it in London.
At the height of the credit crunch, everyone was forecasting that London’s economy was doomed. The City, and the ancillary industries that fed off it, would come crashing down to earth. The rich would flee, and the bankers would soon be applying for jobs at MacDonald’s.
It hasn’t happened. The financial services sector has recovered sharply. London has emerged from the recession in better shape than the rest of Britain. Employment is stronger, growth is better, and house prices have bounced back. If anything the gulf between London and rest of the UK has grown wider.
There are important lessons in that. If the rest of the British economy was anything like as strong as London and the South-East, the whole country would be roaring ahead. Instead of talking about re-balancing the UK economy, we should be learning the lessons of London’s success, and trying to get the rest of the country to perform as well as it does.
The figures make it quite clear that, of all the regions in the UK, London and the South-East, have emerged best from the downturn. A CBI report released on Monday showed that financial services firms expanded strongly in the latest quarter. The big banks such as HSBC and Barclays are making huge profits again, and the City is doing well. A study by the London School of Economics, led by Henry Overman, the director of its Spatial Economics Research Centre, concluded that London had comes back stronger from the recession than any other region, and it suffered less in the downturn as well.
For example, London’s income per capita fell by 2.5% between 2008 and 2009, while it fell by 2.9% in England as a whole – and of course London was already a lot richer before the recession began. There were fewer job losses as well. The UK saw peak-to-trough falls in employment of 3.9%, whereas London saw only a 2.6% fall. And house prices bounced back quicker than anywhere else in the country. Indeed, Savills reports that prime London properties grew in value by 5% this year, whilst prices were still stagnant or falling in the rest of the country.
True, London benefited a little from government policy. The Olympics is a massive building project. The bail-out of the banks primarily helped the London economy rather than anywhere else. Against that, the massive run up in government spending did nothing for London. The South-East has far lower government spending as a percentage of the economy than other regions: in Wales for example, state spending accounts for more than 70% of the economy, whereas in the South-East it is around half that, at an estimated 36%. And of course London is harder hit by the tax rises than other parts of Britain – the new 50% rate will hit a lot of Londoners but not many people elsewhere.
In fact, the evidence of the recession is that London and the South-East have a hyper-resilient, hugely competitive economy. What we need to do is try and make the rest of Britain more like London.
There are four important lessons from the capital’s success.
First, and most obviously, London is plugged into the global economy far more than any other part of the UK economy. What happens to the rest of Britain or indeed Europe doesn’t matter that much. London’s bankers, lawyers, consultants and accountants are servicing the BRIC economies more than anything else. Russian and Far Eastern companies are flocking to raise capital on London’s markets, and that means paying lots of expensive fees. London had connected itself into booming markets – not locked itself into declining ones.
Next, London has specialised in professional services, and made itself a world-leader in selling those to the rest of the world. There is a lot of talk about reviving specialist manufacturing or creating other new industries for the UK. But the truth is, we don’t have many sectors where we can compete with Germany on quality, nor where we can compete with Eastern Europe on manufacturing costs. Maybe the best policy would be to recognize where our strengths lie – and get the rest of the country to try and do more of the things that London does so well.
Thirdly, London has a highly-skilled and hyper-flexible labour market. According to the Labour Force Survey, for England as a whole, professional and service occupations were hit less badly by the recession than administrative, trade and basic occupations. That was good for London, since professional occupations account for a larger proportion of its labour force – nearly 50%, compared with under 40% in the Midlands and the North. There was more flexibility on wages as well, partly because bonuses (which go down as well as up) are a bigger part of pay. That helped London’s workers keep their jobs through the downturn.
Finally, the state accounts for a far lower share of the London and South-East economy than it does for the rest of the country. Working for the government may be relatively secure during a recession, and that provides some protection for the regions. But the state sector also has low productivity, low growth, and it doesn’t export anything. It consumes rather than generates wealth – and it is only in London and South-East that it is small enough to allow the rest of the economy to flourish.
Forget everything you read a couple of years ago about how this would be a middle-class recession that hit London harder than anywhere else. It just hasn’t happened. Instead, London is pulling further ahead – and as the government spending cuts start to bite, that will become more and more obvious. But there is nothing that special about London. It is part of the same country as Manchester and Cardiff and Birmingham. If those regions could learn where the capital was doing so well, the UK would be doing a lot better than it is.
Sunday, 17 April 2011
Friday, 8 April 2011
Shadow Force In The Northern Echo
There's a great review of Shadow Force in The Northern Echo by Nigel Burton. A few choice quotes.
"IF you're a fan of modern military thrillers you're going to have fun with anything Matt Lynn writes..."
"I'm not ashamed to say that I read Shadow Force in one sitting - starting at 6pm I couldn't put it down until the last page shortly after midnight.
Great stuff.
"IF you're a fan of modern military thrillers you're going to have fun with anything Matt Lynn writes..."
"I'm not ashamed to say that I read Shadow Force in one sitting - starting at 6pm I couldn't put it down until the last page shortly after midnight.
Great stuff.
Saturday, 2 April 2011
Goudhurst Prison Blues
One of my favourite records of all time is the Johnny Cash ‘Live At San Quentin’ album: a set that captures the rugged, outlaw sound of the man to perfection. So I couldn’t help thinking about that as I did my first prison gig a couple of weeks ago.
I wasn’t actually in San Quentin. I was at Goudhurst Prison, which is my local jail down here in Kent. It’s actually set among idyllic English countryside, and is in a pleasant enough old building, but the fact it has barbed wire all around it, and you have to hand in your mobile and show your passport at the door to get in, reminds you that this is indeed a jail.
I resisted the temptation to bounce onto stage saying, “Hello, my name is Matt Lynn’ before kicking into the opening chords of ‘Wanted Man’.
Instead, I just gave a version of my standard library talk, where I chat for a while about where the ideas for the ‘Death Force’ series of books came about, how they get written, how publishing works, and all the usual things that people like authors to talk about.
It was a different audience, however. They were younger, and, of course, all men. Quite a few of them had read the books, and enjoyed them which was gratifying, and the library service had bought some books to give away as a competition prize, which made a nice end to the event. They were more interested in money and contracts than most audiences, and maybe that says something about the kind of people they are.
I was struck by how intelligent most of the men were, and how articulate. Obviously something had gone wrong with their lives to end up in prison, but they were men with a lot of potential.
I came away, as one does from these kind of experiences, thinking about how narrow the line is between the safe, comfortable, easy lives that most of us lead, and the far darker, more troubled routes that some people take.
I wasn’t actually in San Quentin. I was at Goudhurst Prison, which is my local jail down here in Kent. It’s actually set among idyllic English countryside, and is in a pleasant enough old building, but the fact it has barbed wire all around it, and you have to hand in your mobile and show your passport at the door to get in, reminds you that this is indeed a jail.
I resisted the temptation to bounce onto stage saying, “Hello, my name is Matt Lynn’ before kicking into the opening chords of ‘Wanted Man’.
Instead, I just gave a version of my standard library talk, where I chat for a while about where the ideas for the ‘Death Force’ series of books came about, how they get written, how publishing works, and all the usual things that people like authors to talk about.
It was a different audience, however. They were younger, and, of course, all men. Quite a few of them had read the books, and enjoyed them which was gratifying, and the library service had bought some books to give away as a competition prize, which made a nice end to the event. They were more interested in money and contracts than most audiences, and maybe that says something about the kind of people they are.
I was struck by how intelligent most of the men were, and how articulate. Obviously something had gone wrong with their lives to end up in prison, but they were men with a lot of potential.
I came away, as one does from these kind of experiences, thinking about how narrow the line is between the safe, comfortable, easy lives that most of us lead, and the far darker, more troubled routes that some people take.
How People Power Can Curb Bonuses
In my Money Week column this week, I'm looking at how people power may be able to curb bonuses. Here's a taster....
Banking bonuses are like cockroaches. Nobody much likes them. They can do a lot of damage. And short of an all-out nuclear war, they appear to be just about indestructible.
The financial collapse of 2008 didn’t do anything to curb the way the financial sector rewards itself. Nor have the attempts at greater regulation made much progress. Even higher taxes don’t work.
But how about people power?
In Holland, ING was forced to abandon a bonus scheme after a Twitter-led campaign against the bank that threaten to turn into a mass boycott. In France, last year, the former footballer Eric Cantona led a campaign for mass withdrawals from the banks. In this country, the UK Uncut campaign, has achieved a lot of impact with its protests against financial institutions.
In the end, banking pay, like just about anything, needs permission from society. Banks can’t operate unless millions of ordinary people are willing to put money into them, and use them to shift funds around. It may be that only direct action from ordinary people can finally bring the banking industry back under control.
There is little question that financial sector pay has got out of hand. The sector routinely pays its staff rewards that are far and above what other people earn, and which bear little realistic relation either to the success of the banks they work for, or to the contribution they make to the economy.
Just take a look at the latest revelations about pay at The Royal Bank of Scotland. Last month, the bank revealed that it paid out around £1 billion in bonuses. More than a hundred of its staff were paid more than £1 million. And this is despite the fact that RBS went spectacularly bust, is still majority-owned by the tax-payer, and is still losing money. It is far from alone. HSBC revealed that it paid 253 of its staff more than £1 million last year, 89 of them in London. Right across the board, bonuses have bounced straight back to 2007 and 2008 levels.
There is nothing wrong, of course, with people earning lots of money. If they are working hard and creating wealth they deserve it. But all the evidence suggests that the banking industry has become a cartel that operates against the public interest. The banks are too big, they take on too much risk, they require too much in the way of hidden subsidies from the taxpayer, and they pay themselves too generously. According to research by Harry Huizinga, an economics professor at the University of Tilburg in the Netherlands, twelve banks have liabilities of more than $1 trillion, and thirty banks have a ratio of liabilities to GDP in excess of 0.5, meaning in effect that if they go bust they may well bring down the country with them. Furthermore, the same banks pay consistently lower returns to shareholders than banks that are smaller, and less systematically important. In short, the mega banks aren’t very useful to anyone, except for their lavishly paid staff. We’d be better off without them.
But how do we bring them under control? There have been plenty of regulatory initiatives but none of them seem to get anywhere. Governments don’t appear very effective – they are too easily brow-beaten by the argument that the banks are vital for the economy.
But maybe people power can make a difference.
In Holland, ING last week agreed to scrap a bonus scheme that would have paid its chief executive Jan Hommen 1.25 million euros. ING was bailed-out by the Dutch government in 2008, and although it has since re-paid five billion euros of the money it received, there is still another five billion euros to pay back. The sober-minded Dutch objected to the sight of bankers who still owed the government billions paying themselves vast rewards. A Twitter-led campaign mobilised public opinion against the bank. People were threatening mass withdrawals from their accounts, creating the potential for a run on the bank. Although by last week only a few hundred people had taken their money out, it was enough to rattle ING. By the end of last week, it had decided to withdraw its bonus scheme, replacing it with something far more modest.
The footballer Eric Cantona tried something similar in France. At the end of last year, he launched the ‘Bankrun 2010’ campaign. The campaign threatened a mass withdrawal of money from the banks. Tens of thousands of people signed up for the Facebook campaign, in France, Britain, the US and elsewhere. The French banking unions warned of an economic catastrophe if it happened. In the end, the event was a bit of a damp squib. Some accounts were closed. But no banks went out of business. And probably those accounts that were closed were opened up somewhere else a few days later.
Still, there are signs that things are stirring.
There is no question that ordinary people feel deeply uneasy about the way that the financial sector rewards itself. They don’t buy into the argument that the banks are engaged in a fierce war for talent that means they have to pay everyone huge salaries. And they suspect, almost certainly correctly, that the way the banks reward themselves makes the system more risky, not less – and that they may have to end up paying for it.
Most of all, they feel powerless to do very much about it. But that, of course, isn’t really true. A bank such as RBS depends on its millions of retail depositors. Without them, it would be sunk. A pure investment bank depends less on ordinary customers, but there are not many of those left – and, in truth, the retail banks are the original source of the money the investment bankers play with.
The Cantona campaign didn’t work. But the ING protest was far more successful. And if the idea of depositors mobilising against banks take off, it could pose the most potent threat yet to the system. After all, for any bank there is nothing scarier than a run. Regulation won’t curb bonuses. It is unlikely that politicians or central bankers will manage to either. But people power might just do the trick.
Banking bonuses are like cockroaches. Nobody much likes them. They can do a lot of damage. And short of an all-out nuclear war, they appear to be just about indestructible.
The financial collapse of 2008 didn’t do anything to curb the way the financial sector rewards itself. Nor have the attempts at greater regulation made much progress. Even higher taxes don’t work.
But how about people power?
In Holland, ING was forced to abandon a bonus scheme after a Twitter-led campaign against the bank that threaten to turn into a mass boycott. In France, last year, the former footballer Eric Cantona led a campaign for mass withdrawals from the banks. In this country, the UK Uncut campaign, has achieved a lot of impact with its protests against financial institutions.
In the end, banking pay, like just about anything, needs permission from society. Banks can’t operate unless millions of ordinary people are willing to put money into them, and use them to shift funds around. It may be that only direct action from ordinary people can finally bring the banking industry back under control.
There is little question that financial sector pay has got out of hand. The sector routinely pays its staff rewards that are far and above what other people earn, and which bear little realistic relation either to the success of the banks they work for, or to the contribution they make to the economy.
Just take a look at the latest revelations about pay at The Royal Bank of Scotland. Last month, the bank revealed that it paid out around £1 billion in bonuses. More than a hundred of its staff were paid more than £1 million. And this is despite the fact that RBS went spectacularly bust, is still majority-owned by the tax-payer, and is still losing money. It is far from alone. HSBC revealed that it paid 253 of its staff more than £1 million last year, 89 of them in London. Right across the board, bonuses have bounced straight back to 2007 and 2008 levels.
There is nothing wrong, of course, with people earning lots of money. If they are working hard and creating wealth they deserve it. But all the evidence suggests that the banking industry has become a cartel that operates against the public interest. The banks are too big, they take on too much risk, they require too much in the way of hidden subsidies from the taxpayer, and they pay themselves too generously. According to research by Harry Huizinga, an economics professor at the University of Tilburg in the Netherlands, twelve banks have liabilities of more than $1 trillion, and thirty banks have a ratio of liabilities to GDP in excess of 0.5, meaning in effect that if they go bust they may well bring down the country with them. Furthermore, the same banks pay consistently lower returns to shareholders than banks that are smaller, and less systematically important. In short, the mega banks aren’t very useful to anyone, except for their lavishly paid staff. We’d be better off without them.
But how do we bring them under control? There have been plenty of regulatory initiatives but none of them seem to get anywhere. Governments don’t appear very effective – they are too easily brow-beaten by the argument that the banks are vital for the economy.
But maybe people power can make a difference.
In Holland, ING last week agreed to scrap a bonus scheme that would have paid its chief executive Jan Hommen 1.25 million euros. ING was bailed-out by the Dutch government in 2008, and although it has since re-paid five billion euros of the money it received, there is still another five billion euros to pay back. The sober-minded Dutch objected to the sight of bankers who still owed the government billions paying themselves vast rewards. A Twitter-led campaign mobilised public opinion against the bank. People were threatening mass withdrawals from their accounts, creating the potential for a run on the bank. Although by last week only a few hundred people had taken their money out, it was enough to rattle ING. By the end of last week, it had decided to withdraw its bonus scheme, replacing it with something far more modest.
The footballer Eric Cantona tried something similar in France. At the end of last year, he launched the ‘Bankrun 2010’ campaign. The campaign threatened a mass withdrawal of money from the banks. Tens of thousands of people signed up for the Facebook campaign, in France, Britain, the US and elsewhere. The French banking unions warned of an economic catastrophe if it happened. In the end, the event was a bit of a damp squib. Some accounts were closed. But no banks went out of business. And probably those accounts that were closed were opened up somewhere else a few days later.
Still, there are signs that things are stirring.
There is no question that ordinary people feel deeply uneasy about the way that the financial sector rewards itself. They don’t buy into the argument that the banks are engaged in a fierce war for talent that means they have to pay everyone huge salaries. And they suspect, almost certainly correctly, that the way the banks reward themselves makes the system more risky, not less – and that they may have to end up paying for it.
Most of all, they feel powerless to do very much about it. But that, of course, isn’t really true. A bank such as RBS depends on its millions of retail depositors. Without them, it would be sunk. A pure investment bank depends less on ordinary customers, but there are not many of those left – and, in truth, the retail banks are the original source of the money the investment bankers play with.
The Cantona campaign didn’t work. But the ING protest was far more successful. And if the idea of depositors mobilising against banks take off, it could pose the most potent threat yet to the system. After all, for any bank there is nothing scarier than a run. Regulation won’t curb bonuses. It is unlikely that politicians or central bankers will manage to either. But people power might just do the trick.
Monday, 28 March 2011
Great Review of Bust
There is a great review of Bust in Canada's Financial Post. "Public finance seldom makes for a juicy read. But Matthew Lynn, a financial journalist who, as a sideline, writes military thrillers, turns central banking into a seesaw of ghastly revelations and roaring hilarity," it says. "Bust is solid macroeconomics, practical trade theory, and fiscal policy that anybody can understand. It’s valuable reading for anyone investing in euro-denominated assets and a morality tale too."
Tuesday, 8 March 2011
Amazon Reviews....
There’s a lovely piece in The Guardian today by Christina Martin about Amazon reviews. Apparently, there has been more controversy about authors writing their own reviews (how could they – the cads!) and whether the reviews are really reliable.
She makes the valuable point that they may or may not be real. It doesn’t really matter. You can fairly easily tell which ones are genuine and which ones are fakes by the way they are written, and whether the person has reviewed similar books. And they open up the debate about books to lots of new voices. After all, before we had to rely on the reviews on the back of book jackets – and they were often fairly fictitious as well.
Most authors have an ambivalent attitude to Amazon and other online reviews. Personally I like them. I’ve had good ones and stinkers, and although none of us like being criticised, I can take that in good spirit. The internet is full of nasty stuff, and there is no reason why authors should be exempt. Online reviews are one of the few ways we have of getting feedback on our work, and of judging how much impact it is making on the world.
The more of them the better – even if they aren’t real.
She makes the valuable point that they may or may not be real. It doesn’t really matter. You can fairly easily tell which ones are genuine and which ones are fakes by the way they are written, and whether the person has reviewed similar books. And they open up the debate about books to lots of new voices. After all, before we had to rely on the reviews on the back of book jackets – and they were often fairly fictitious as well.
Most authors have an ambivalent attitude to Amazon and other online reviews. Personally I like them. I’ve had good ones and stinkers, and although none of us like being criticised, I can take that in good spirit. The internet is full of nasty stuff, and there is no reason why authors should be exempt. Online reviews are one of the few ways we have of getting feedback on our work, and of judging how much impact it is making on the world.
The more of them the better – even if they aren’t real.
Why Investors Should Prefer Democracies...
In my Money Week column this week, I've been looking at why investors should prefer democracies to autocracies. Here's a taster....
For anyone investing in the Middle Eastern markets, the last few weeks have been a heck of a ride. The Dubai market, one of the more developed in the region, plunged all the way back to 2004 levels during the past month. The Saudi market was shakier than a palm tree in a hurricane. The Egyptian stock market closed as the country ousted its long-serving President Hosni Mubarak, and won’t re-open for another week.
Right across the world, investors have pulled back from emerging and frontier markets. The darlings of the global investment community until a few weeks ago, they are now about as popular as Colonel Qaddafi in Benghazi.
There is a lesson to be learned from that. It is far better to invest in democracies than autocracies. In the last few years, the markets have fallen for the idea that autocratic governments are more stable and more efficient. There may be some truth in that in the short-run. In the medium-term, however, a revolution will destroy your investment. In practical terms, that means avoiding China and much of the Middle East, staying suspicious of Russia, and focussing instead on India, Eastern Europe and South Africa as well.
Before the tidal wave of change swept across the Middle East investors could be forgiven for believing that the nature of the regime didn’t make much difference to the case for putting money into a country. True, the people in charge of a country might be a shady bunch of gangsters and thugs, but so long as oil was being pumped, minerals dug out of the ground, and new factories getting built, it didn’t matter very much.
Emerging and frontier markets have been booming for the last ten years, pretty much regardless of whether the government in question was stable or not. According to calculations by IJ Partners, the Pakistani market rose by 449% in the last decade, measured in dollar terms. The Egyptian market rose by 430% over the same period. That was a better performance than gold or oil, and way better than traditional stock markets. The FTSE-100 was only up by only 12% over the same period and the S&P 500 by just 2%. And yet Pakistan is widely regarded as a failed state. And the Egyptian government has just collapsed.
The premium that investors used to demand to invest in emerging markets all but disappeared over the 2000s. We all know the reasons for that. Growth has largely ground to a halt in the developed economies. It was only by taking on more and more debt that the illusion of prosperity was maintained. The frontier markets offered far better prospects. They were growing fast, they had healthy demographics, and usually high savings ratios and low deficits as well. They looked a far more attractive home for your money.
But investors forgot the one thing that in the past kept them out of emerging markets – political risk. After all the 400%-plus gains you might make in a market such as Egypt don’t count for much if the bourse then gets shut down, and a new revolutionary government seizes foreign assets. You can only invest where there are secure property rights – and that ultimately depends on a stable government.
That lesson is being re-learnt very quickly. Globally, investors poured $95 billion into emerging markets funds during 2010. In the first week of February alone, as the Middle East crisis broke, they pulled more than $7 billion of that back, the biggest withdrawal in more than three years. Where once investors were piling indiscriminately into new territories, now they are abandoning them just as rapidly.
Neither is the right response.
What investors need to do is discriminate between stable and unstable emerging markets – and remember that in the medium-term it is only democracies that offer security.
There is a temptation to look at an autocracy and think it is rock solid. After all, a leader such as Mubarak hung around in power for three decades. Dictators are usually pro-business and anti-union. There is none of the messy business of populist politicians demanding tax rises, or threatening to take control of foreign investments.
But it is an illusion. Under the surface, terrible tensions are always building up. When they break to the surface, there is violence and chaos. A very radical, anti-capitalist regime can easily emerge.
It is far better to focus on the democracies – and avoid the remaining autocracies. True, the democracies might appear messier. But so long as there is a commitment to free speech, fair elections, and property is protected, over the medium-term they are far more stable. It is very rare for a democracy to be thrown out by a revolution – and it is very rare for an autocracy not to be.
So, be wary of China. True, it has great growth prospects. But it is still ruled by an authoritarian Communist Party that shows little sign of relaxing its grip on power. There are tensions between regions that are growing at very different rates. The whole of the Middle East looks off-limits as well. States such as Saudi Arabia and Dubai will face their own revolutions in time, no matter how wealthy they might appear to be. And stay suspicious of Russia. It is slowing slipping from democracy back towards autocracy, and that will make it less stable in the medium-term.
Against that, India has been a remarkably successful democracy for a very long time, particularly considering its size and relative backwardness. Brazil is a reasonably free country and so are South Africa and Turkey. Nearly all of Eastern Europe, although its markets have not shone in the past couple of years, is far more democratic than anywhere in the Middle or Far East.
There will be bumps along the way, and elections that hit the markets. But over the medium-term, it is only countries that have already created functioning democracies that offer any chance of decent returns.
For anyone investing in the Middle Eastern markets, the last few weeks have been a heck of a ride. The Dubai market, one of the more developed in the region, plunged all the way back to 2004 levels during the past month. The Saudi market was shakier than a palm tree in a hurricane. The Egyptian stock market closed as the country ousted its long-serving President Hosni Mubarak, and won’t re-open for another week.
Right across the world, investors have pulled back from emerging and frontier markets. The darlings of the global investment community until a few weeks ago, they are now about as popular as Colonel Qaddafi in Benghazi.
There is a lesson to be learned from that. It is far better to invest in democracies than autocracies. In the last few years, the markets have fallen for the idea that autocratic governments are more stable and more efficient. There may be some truth in that in the short-run. In the medium-term, however, a revolution will destroy your investment. In practical terms, that means avoiding China and much of the Middle East, staying suspicious of Russia, and focussing instead on India, Eastern Europe and South Africa as well.
Before the tidal wave of change swept across the Middle East investors could be forgiven for believing that the nature of the regime didn’t make much difference to the case for putting money into a country. True, the people in charge of a country might be a shady bunch of gangsters and thugs, but so long as oil was being pumped, minerals dug out of the ground, and new factories getting built, it didn’t matter very much.
Emerging and frontier markets have been booming for the last ten years, pretty much regardless of whether the government in question was stable or not. According to calculations by IJ Partners, the Pakistani market rose by 449% in the last decade, measured in dollar terms. The Egyptian market rose by 430% over the same period. That was a better performance than gold or oil, and way better than traditional stock markets. The FTSE-100 was only up by only 12% over the same period and the S&P 500 by just 2%. And yet Pakistan is widely regarded as a failed state. And the Egyptian government has just collapsed.
The premium that investors used to demand to invest in emerging markets all but disappeared over the 2000s. We all know the reasons for that. Growth has largely ground to a halt in the developed economies. It was only by taking on more and more debt that the illusion of prosperity was maintained. The frontier markets offered far better prospects. They were growing fast, they had healthy demographics, and usually high savings ratios and low deficits as well. They looked a far more attractive home for your money.
But investors forgot the one thing that in the past kept them out of emerging markets – political risk. After all the 400%-plus gains you might make in a market such as Egypt don’t count for much if the bourse then gets shut down, and a new revolutionary government seizes foreign assets. You can only invest where there are secure property rights – and that ultimately depends on a stable government.
That lesson is being re-learnt very quickly. Globally, investors poured $95 billion into emerging markets funds during 2010. In the first week of February alone, as the Middle East crisis broke, they pulled more than $7 billion of that back, the biggest withdrawal in more than three years. Where once investors were piling indiscriminately into new territories, now they are abandoning them just as rapidly.
Neither is the right response.
What investors need to do is discriminate between stable and unstable emerging markets – and remember that in the medium-term it is only democracies that offer security.
There is a temptation to look at an autocracy and think it is rock solid. After all, a leader such as Mubarak hung around in power for three decades. Dictators are usually pro-business and anti-union. There is none of the messy business of populist politicians demanding tax rises, or threatening to take control of foreign investments.
But it is an illusion. Under the surface, terrible tensions are always building up. When they break to the surface, there is violence and chaos. A very radical, anti-capitalist regime can easily emerge.
It is far better to focus on the democracies – and avoid the remaining autocracies. True, the democracies might appear messier. But so long as there is a commitment to free speech, fair elections, and property is protected, over the medium-term they are far more stable. It is very rare for a democracy to be thrown out by a revolution – and it is very rare for an autocracy not to be.
So, be wary of China. True, it has great growth prospects. But it is still ruled by an authoritarian Communist Party that shows little sign of relaxing its grip on power. There are tensions between regions that are growing at very different rates. The whole of the Middle East looks off-limits as well. States such as Saudi Arabia and Dubai will face their own revolutions in time, no matter how wealthy they might appear to be. And stay suspicious of Russia. It is slowing slipping from democracy back towards autocracy, and that will make it less stable in the medium-term.
Against that, India has been a remarkably successful democracy for a very long time, particularly considering its size and relative backwardness. Brazil is a reasonably free country and so are South Africa and Turkey. Nearly all of Eastern Europe, although its markets have not shone in the past couple of years, is far more democratic than anywhere in the Middle or Far East.
There will be bumps along the way, and elections that hit the markets. But over the medium-term, it is only countries that have already created functioning democracies that offer any chance of decent returns.
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