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Important disclosures appear at the end of this document. Dreaming With BRICs: The Path to 2050 Dominic Wilson Roopa Purushothaman 1st October 2003 Global Economics Paper No: 99 � Over the next 50 years, Brazil, Russia, India and China—the BRICs economies—could become a much larger force in the world economy. We map out GDP growth, income per capita and currency movements in the BRICs economies until 2050. � The results are startling. If things go right, in less than 40 years, the BRICs economies together could be larger than the G6 in US dollar terms. By 2025 they could account for over half the size of the G6. Of the current G6, only the US and Japan may be among the six largest economies in US dollar terms in 2050. � The list of the world’s ten largest economies may look quite different in 2050. The largest economies in the world (by GDP) may no longer be the richest (by income per capita), making strategic choices for firms more complex. Economic Research from the GS Financial Workbench® at https://www.gs.com Many thanks to Jim O’Neill, Paulo Leme, Sandra Lawson, Warren Pearson and our regional economists for their contributions to this paper. Global Paper No 99 2 1st October 2003 SUMMARY � Over the next 50 years, Brazil, Russia, India and China—the BRICs economies—could become a much larger force in the world economy. Using the latest demographic projections and a model of capital accumulation and productivity growth, we map out GDP growth, income per capita and currency movements in the BRICs economies until 2050. � The results are startling. If things go right, in less than 40 years, the BRICs economies together could be larger than the G6 in US dollar terms. By 2025 they could account for over half the size of the G6. Currently they are worth less than 15%. Of the current G6, only the US and Japan may be among the six largest economies in US dollar terms in 2050. � About two-thirds of the increase in US dollar GDP from the BRICs should come from higher real growth, with the balance through currency appreciation. The BRICs’ real exchange rates could appreciate by up to 300% over the next 50 years (an average of 2.5% a year). � The shift in GDP relative to the G6 takes place steadily over the period, but is most dramatic in the first 30 years. Growth for the BRICs is likely to slow significantly toward the end of the period, with only India seeing growth rates significantly above 3% by 2050. And individuals in the BRICs are still likely to be poorer on average than individuals in the G6 economies, with the exception of Russia. China’s per capita income could be roughly what the developed economies are now (about US$30,000 per capita). � As early as 2009, the annual increase in US dollar spending from the BRICs could be greater than that from the G6 and more than twice as much in dollar terms as it is now. By 2025 the annual increase in US dollar spending from the BRICs could be twice that of the G6, and four times higher by 2050. � The key assumption underlying our projections is that the BRICs maintain policies and develop institutions that are supportive of growth. Each of the BRICs faces significant challenges in keeping development on track. This means that there is a good chance that our projections are not met, either through bad policy or bad luck. But if the BRICs come anywhere close to meeting the projections set out here, the implications for the pattern of growth and economic activity could be large. � The relative importance of the BRICs as an engine of new demand growth and spending power may shift more dramatically and quickly than expected. Higher growth in these economies could offset the impact of greying populations and slower growth in the advanced economies. � Higher growth may lead to higher returns and increased demand for capital. The weight of the BRICs in investment portfolios could rise sharply. Capital flows might move further in their favour, prompting major currency realignments. � Rising incomes may also see these economies move through the ‘sweet spot’ of growth for different kinds of products, as local spending patterns change. This could be an important determinant of demand and pricing patterns for a range of commodities. � As today’s advanced economies become a shrinking part of the world economy, the accompanying shifts in spending could provide significant opportunities for global companies. Being invested in and involved in the right markets—particularly the right emerging markets—may become an increasingly important strategic choice. � The list of the world’s ten largest economies may look quite different in 2050. The largest economies in the world (by GDP) may no longer be the richest (by income per capita), making strategic choices for firms more complex. The world economy has changed a lot over the past50 years. Over the next 50, the changes could be at least as dramatic. We have highlighted the importance of thinking about the developing world in our recent global research, focusing on key features of development and globalisation that we think are important to investors with a long-term perspective. A major theme of this work has been that, over the next few decades, the growth generated by the large developing countries, particularly the BRICs (Brazil, Russia, India and China) could become a much larger force in the world economy than it is now—and much larger than many investors currently expect. In this piece, we gauge just how large a force the BRICs could become over the next 50 years. We do this not simply by extrapolating from current growth rates, but by setting out clear assumptions about how the process of growth and development works and applying a formal framework to generate long-term forecasts. We look at our BRICs projections relative to long-term projections for the G6 (US, Japan, UK, Germany, France and Italy)1. Using the latest demographic projections and a model of capital accumulation and productivity growth, we map out GDP growth, income per capita and currency movements in the BRICs economies until 2050. This allows us to paint a picture of how the world economy might change over the decades ahead. The results of the exercise are startling. They suggest that if things go right, the BRICs could become a very important source of new global spending in the not too distant future. The chart below shows that India’s economy, for instance, could be larger than Japan’s by 2032, and China’s larger than the US by 2041 (and larger than everyone else as early as 2016). The BRICs economies taken together could be larger than the G6 by 2039. Our projections are optimistic, in the sense that they assume reasonably successful development. But they are economically sensible, internally consistent and provide a clear benchmark against which investors can set their expectations. There is a good chance that the right conditions in one or another economy will not fall into place and the projections will not be Global Paper No 99 3 1st October 2003 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 UK US France Germany Japan G6 Italy France Germany Italy Germany Japan Russia Brazil India China BRICs Overtaking the G6: When BRICs' US$GDP Would Exceed G6 Italy France *cars indicate when BRICs US$GDP exceeds US$GDP in the G6 GS BRICs Model Projections. See text for details and assumptions. Germany 1 Any decision to limit the sample of countries is to some extent arbitrary. In focusing on the G6 (rather than the G7 or a broader grouping), we decided to limit our focus to those developed economies with GDP currently over US$1 trillion. This means that Canada and and some of the other larger developed economies are not included. Adding these economies to the analysis would not materially change the conclusions. realized. If the BRICs pursue sound policies, however, the world we envisage here might turn out to be a reality, not just a dream. The projections leave us in no doubt that the progress of the BRICs will be critical to how the world economy evolves. If these economies can fulfil their potential for growth, they could become a dominant force in generating spending growth over the next few decades. A Dramatically Different World We start with some key conclusions that describe the way the world might change over the next 50 years. The big assumption underlying all of these projections is that the BRICs maintain growth-supportive policy settings. The charts throughout the text illustrate these points. Our conclusions fall under five main topics: 1) economic size; 2) economic growth; 3) incomes and demographics; 4) global demand patterns; and 5) currency movements. Economic Size � In less than 40 years, the BRICs’ economies together could be larger than the G6 in US dollar terms. By 2025 they could account for over half the size of the G6. Currently they are worth less than 15%. � In US dollar terms, China could overtake Germany in the next four years, Japan by 2015 and the US by 2039. India’s economy could be larger than all but the US and China in 30 years. Russia would overtake Germany, France, Italy and the UK. � Of the current G6 (US, Japan, Germany, France, Italy, UK) only the US and Japan may be among the six largest economies in US dollar terms in 2050. Economic Growth � India has the potential to show the fastest growth over the next 30 and 50 years. Growth could be higher than 5% over the next 30 years and close to 5% as late as 2050 if development proceeds Global Paper No 99 4 1st October 2003 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000 2000 2010 2020 2030 2040 2050 BRICs G6 2025: BRICs economies over half as large as the G6 By 2040: BRICS overtake the G6 BRICs Have a Larger US$GDP Than the G6 in Less Than 40 Years GDP (2003 US$bn) GS BRICs Model Projections. See text for details and assumptions. BRICs Share of GDP Rises 0 20,000 40,000 60,000 80,000 100,000 120,000 140,000 160,000 2000 2010 2020 2030 2040 2050 G6 share of combined BRICs and G6 GDP BRICs share of combined BRICs and G6 GDP 28% 33% 39% 45% 50% 56% 60% GDP (2003 US$bn) GS BRICs Model Projections. See text for details and assumptions. The Largest Economies in 2050 0 5000 10000 15000 20000 25000 30000 35000 40000 45000 50000 Ch US In Jpn Br Russ UK Ger Fr It GDP (2003 US$bn) GS BRICs Model Projections. See text for details and assumptions. successfully. � Overall, growth for the BRICs is likely to slow significantly over this time frame. By 2050, only India on our projections would be recording growth rates significantly above 3%. Incomes and Demographics � Despite much faster growth, individuals in the BRICs are still likely to be poorer on average than individuals in the G6 economies by 2050. Russia is the exception, essentially catching up with the poorer of the G6 in terms of income per capita by 2050. China’s per capita income could be similar to where the developed economies are now (about US$30,000 per capita). By 2030, China’s income per capita could be roughly what Korea’s is today. In the US, income per capita by 2050 could reach roughly $80,000. � Demographics play an important role in the way the world will change. Even within the BRICs, demographic impacts vary greatly. The decline in working-age population is generally projected to take place later than in the developed economies, but will be steeper in Russia and China than India and Brazil. Global Demand Patterns � As early as 2009, the annual increase in US dollar spending from the BRICs could be greater than that from the G6 and more than twice as much in dollar terms as it is now. By 2025 the annual increase in US dollar spending from the BRICs could be twice that of the G6, and four times higher by 2050. Currency Movements � Rising exchange rates could contribute a significant amount to the rise in US dollar GDP in the BRICs. About 1/3 of the increase in US dollar GDP from the BRICs over the period may come from rising currencies, with the other 2/3 from faster growth. � The BRICs’ real exchange rates could appreciate by up to 300% over the next 50 years (an average Global Paper No 99 5 1st October 2003 China Overtakes the G3; India Is Close Behind 0 5000 10000 15000 20000 25000 30000 35000 40000 45000 50000 2000 2010 2020 2030 2040 2050 China India Japan US Germany GDP (2003 US$bn) GS BRICs Model Projections. See text for details and assumptions. India Shows Most Rapid Growth Potential of the BRICS 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 Brazil China India Russia GS BRICs Model Projections. See text for details and assumptions. real GDP growth (%yoy) $521 $1,594 $4,517 $1,137 $656 $470 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000 2010 2030 2050 BRICs G6 Annual increase in US$GDP (2003 $USbn) Incremental Demand From the BRICs Could Eventually Be Quadruple G6 Demand GS BRICs Model Projections. See text for details and assumptions. of 2.5% a year). China’s currency could double in value in ten years’ time if growth continued and the exchange rate were allowed to float freely. How Countries Get Richer Our predictions may seem dramatic. But over a period of a few decades, the world economy can change a lot. Looking back 30 or 50 years illustrates that point. Fifty years ago, Japan and Germany were struggling to emerge from reconstruction. Thirty years ago, Korea was just beginning to emerge from its position as a low-income nation. And even over the last decade, China’s importance to the world economy has increased substantially. History also illustrates that any kind of long-term projection is subject to a great deal of uncertainty. The further ahead into the future you look, the more uncertain things become. Predictions that the USSR (or Japan) would overtake the US as the dominant economic power turned out tobebadly off the mark. While this makes modeling these kinds of shifts difficult, it is still essential. Over 80% of the value generated by the world’s major equity markets will come from earnings delivered more than 10 years away. Developing strategies to position for growth may take several years and require significant forward planning. The best option is to provide a sensible framework, based on clear assumptions. As developing economies grow, they have the potential to post higher growth rates as they catch up with the developed world. This potential comes from two sources. The first is that developing economies have less capital (per worker) than developed economies (in the language of simple growth models they are further from their ‘steady states’). Returns on capital are higher and a given investment rate results in higher growth in the capital stock. The second is that developing countries may be able to use technologies available in more developed countries to ‘catch up’ with developed country techniques. As countries develop, these forces fade and growth rates tend to slow towards developed country levels. In Japan and Germany, very rapid growth in the 1960s and 1970s gave way to more moderate growth in the 1980s and 1990s. This is why simple extrapolation gives silly answers over long timeframes. As a crude example, assuming that China’s GDP growth continued to grow at its current 8% per year over the next three decades would lead to the prediction that China’s economy would be three times larger than the US by 2030 in US dollar terms and 25 times larger by 2050. Countries also grow richer on the back of appreciating currencies. Currencies tend to rise as higher productivity leads economies to converge on Purchasing Power Parity (PPP) exchange rates. There is a clear tendency for countries with higher income per capita to have exchange rates closer to PPP. The BRICs economies all have exchange rates that are a long way below PPP rates. These large Global Paper No 99 6 1st October 2003 Japanese GDPGrowthDeclinedAsthe EconomyDeveloped 10.4% 5.0% 4.0% 1.8% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 1960-70 1970-80 1980-90 1990-00 Average yoy%growth BRICs Exchange Rates Could Appreciate By Close to 300% 289% 281% 208% 129% 0% 50% 100% 150% 200% 250% 300% 350% China India Russia Brazil Real exchange rate appreciation (%) GS BRICs Model Projections. See text for details and assumptions. differences between PPP and actual exchange rates come about because productivity levels are much lower in developing economies. As they develop and productivity rises, there will be a tendency for their currencies to rise towards PPP. The idea that countries experiencing higher productivity growth tend to appreciate is an important part of both our GSDEER and GSDEEMER models of equilibrium exchange rates. Breaking Down Growth To translate these two processes into actual projections, we need to develop a model. The model we use is described in more detail in the Appendix but the intuition behind it is quite simple. Growth accounting divides GDP growth into three components: � Growth in employment � Growth in the capital stock � Technical progress (or total-factor productivity (TFP) growth).2 We model each component explicitly. We use the US Census Bureau’s demographic projections to forecast employment growth over the long term, assuming that the proportion of the working age population that works stays roughly stable. We use assumptions about the investment rate to map out the path that the capital stock will take over time. And we model TFP growth as a process of catch-up on the developed economies, by assuming that the larger the income gap between the BRICs and the developed economies, the greater the potential for catch-up and stronger TFP growth. We then use the projections of productivity growth from this exercise to map out the path of the real exchange rate. As in our GSDEER framework, we assume that if an economy experiences higher productivity growth than the US, its equilibrium exchange rate will tend to appreciate. By varying the assumptions about investment, demographics or the speed of catch-up, we can generate different paths for annual GDP, GDP growth, GDP per capita (in local currency or US dollars), productivity growth and the real exchange rate. Because both the growth and currency projections are long-term projections, we ignore the impact of the economic cycle. Effectively, the projections can be interpreted as growth in the trend (or potential growth) of the economy and the currencies’ path as an equililibrium path. Where economies peg their exchange rates (as in China), it is even more important to view the exchange rate projections as an equilibrium real rate. In practice, real exchange rate appreciation might come about through a combination of nominal appreciation and higher inflation, with different mixes having different implications. We abstract from inflation, expressing all of our projections in real terms (either 2003 local currency or 2003 US dollars).3 Generally speaking, the structure of the models is identical across the four economies. We make two minor alterations. We assume that the ‘convergence speed’ of TFP in Brazil and India is slower than in Global Paper No 99 7 1st October 2003 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 -6 -4 -2 0 2 Deviation from purchasing power parity* GDP per capita relative to the US* Higher Income Per Capita Moves Exchange Rates Closer to PPP *expressed in logs 2 We do not explicitly allow for increases in human capital (education), which are implicitly picked up in the technical progress/TFP term in our model. 3 Higher inflation in the BRICs would raise nominal GDP forecasts in local currencies and nominal exchange rates, but would not change the forecasts of real GDP or of US dollar GDP under the standard assumption that higher inflation would tr