Industry the Jan/Feb 2013 issue

Global Warning

Nations reshuffle the economic stage, changing lives and business.

Depends on whom you talk to.

Maybe the 19th century Danish philosopher Søren Aabye Kierkegaard had it right: “Life can only be understood backwards, but it must be lived forwards.”

Living forward, everyone agrees the economic and political order for the past 20 years is changing. Asia is rising. The axis of trade, money and geopolitical clout is shifting east and to some degree south. The capitals of Europe don’t matter quite like they used to. Even the United States—unchallenged atop the global heap since the end of the Cold War—is mulling a future where it is one among several interconnected powers, not the world’s indispensable nation.

Some powerful trends are reshaping the world’s economy, and while they’ve been building for some time, they’re picking up speed. Just look at the events of the last five years. While the so-called Great Recession that started in 2008 socked the U.S., the U.K. and Germany, countries like China, India and Vietnam kept chugging along. Since the recession eased, Europe has sunk into a debt crisis and the U.S. seems perennially stuck in first gear, unable to create many jobs and just starting to face its own mountain of debt on the horizon. Yet emerging economies continue to power ahead.

Of the 60 fastest-growing metro area economies last year, 45 were in Asia, Latin America or the Middle East, according to a recent study by the Brookings Institute. Only one, Houston, was in the U.S. Brookings ranked 300 metro area economies, and European cities dominated the bottom of the list.

Some of this movement is cyclical, the normal ebbs and flows of the global economy. Indeed, some big emerging markets show signs of cooling off. But much of the economic shifting is rooted in trends that will outlast any particular business cycle. The biggest trend, however, boils down to simple numbers.

There are 7 billion people in the world today. Six billion live outside the “developed” economies of North America, Europe and Japan. Over the next 40 years, the planet is expected to add about 2.6 billion more, according to the Population Reference Bureau. Nearly all of them will live in developing countries.

And unlike their grandparents, most will live in cities, where they’ll fuel factories and launch companies and generally be more economically productive than any generation before them. Their productivity will help to gradually close the gap that has long split the global economy into haves and have-nots.

Today, most people on planet Earth live in poverty. But a recent study by the National Intelligence Council predicts that the emerging global economic shift will lift a majority of the world’s people out of poverty for the first time in history. They will be better educated, be more independent and have greater access to global communications, the council finds. “The middle classes will be the most important social and economic sector in the vast majority of countries around the world,” reports the study.

For decades most of the world’s wealth resided in the most productive and developed economies—mainly in the United States, Europe and Japan. As recently as 2000, those three places accounted for 60% of global economic activity. In 2011, for the first time on record, that share dipped below 50%. In 2030, those three regions—today’s centers of global business—will amount to one third of the global economy, predicts the Organization for Economic Co-Operation and Development. By 2060? Just 28%.

In their place will rise ever-bigger emerging powers, chief among them China and India.

China could overtake the United States as the world’s largest economy by the end of this decade, and the OECD predicts it’ll outweigh the United States, Europe and Japan put together by 2060. By then, India’s economy will be larger than America’s, and other large emerging economies will be higher on the world’s economic food chain than they are today.

We’re essentially headed toward a two-speed global economy, with the developed world in one gear and developing countries in another, says Anand Rao, a partner at the Insurance Advisory Service at PricewaterhouseCoopers.

“It’s quite evident that the Western world is basically in a steady or even recessionary state,” he says. “Not much growth. Mature markets. But when you look at Asia and Latin America, they’re booming. You see disproportionate GDP increase and the opportunity for more.”

“When you look at Asia and Latin America, they’re booming. You see disproportionate GDP increase and the opportunity for more.”
Anand Rao, PricewaterhouseCoopers

China

This kind of trajectory inevitably affects the balance of political power. European countries face financial and demographic constraints that are already causing them to pull back their military commitments. Many in the United States, weary from a decade-plus of costly war, would like to do the same. Meanwhile, new regional powers from Brazil to Turkey to South Africa are rising with stronger economies and broader ambitions.

Then, of course, there’s China.

The United States hasn’t had a true rival since the fall of the Soviet Union. But China, with its sprawling hybrid of communism and capitalism, with its billion people and $1.1 trillion in U.S. Treasurys, comes close. China is huge, and it is ascendant. It also increasingly is making its presence felt on the global stage. 

Chinese state-owned companies have been investing heavily in Africa to secure rights to the copper and minerals needed to power their economy. China has deepened trade relationships from Europe to South America to the Caribbean, and delegations of Chinese investors looking for buying opportunities have become regular visitors even to smaller U.S. cities such as Madison, Wis., and Montgomery, Ala. China is taking a more assertive role closer to home, too, helping to lead the Chang Mai Initiative, a $120 billion Asian alternative to the International Monetary Fund.

And after decades focused inward on its own “peaceful rise,” Chinese foreign policy is growing muscles, too. Those African nations where China is buying copper mines are also getting Chinese cash and military aid to prop up their governments. Chinese warships are combating Somali pirates in the Gulf of Aden and showing the flag in disputed portions of the South China Sea.

The turn of events has prompted the United States to pivot toward Asia. Early in his first term, President Obama proclaimed himself “America’s first Pacific president,” and he’s spent four years bolstering alliances with democracies in Southeast Asia, while navigating a sometimes-delicate back-and-forth on trade with China. The United States has shifted military resources to the Pacific as well, both to hearten our allies there and to counterbalance China. And Secretary of State Hillary Clinton has declared it will continue to do so.

Swing States

Such a scenario likely means the United States will continue its wary dance with China, engaging in trade while maintaining a skeptical eye on issues such as currency rates and intellectual property. It also means cultivating relationships with other rising nations, as China is not the only emerging country with ambitions.

India, for example, is spending $70 billion to modernize its Air Force and, while it fields a Foreign Service corps about the same size as tiny Singapore, is beginning to play a bigger role in global diplomacy.

Turkey has emerged as a key Western ally in the Middle East and a central player in the Syrian revolution. Brazil, while holding back on military spending, has used “soft power” to become an increasingly influential voice on everything from climate change to global finance.

These three countries, along with Indonesia, the world’s largest majority-Muslim nation, were the subjects of a recent report by the Center for a New American Security on so-called global swing states. These big emerging democracies can be a counterweight to the rise of China and Russia, argue co-authors Daniel Kliman and Richard Fontaine. They could be leaders on issues ranging from trade to human rights to nuclear proliferation—the way European nations long have been. But the West needs to give them a nudge in the right direction.

“American decisions today will influence whether Brazil, India, Indonesia and Turkey contribute to the global order tomorrow,” they wrote.

“American decisions today will influence whether Brazil, India, Indonesia and Turkey contribute to the global order tomorrow,”
Daniel Kliman and Richard Fontaine, Center for New American Security

World Middle Class

These countries already contribute to the global economy. Indonesia’s gross national income per capita, a key measure of economic well being, has more than doubled in the last five years, to $2,940. In Turkey, it’s up 60%, crossing the crucial threshold of $10,000, which to many thought leaders signifies the global middle class. It spells the difference between subsistence living and disposable income, which means more people who can go out to eat, buy better furniture or finance a car. And their numbers are growing. That equates to new generations of customers and tremendous opportunities for global companies to sell to them.

The McKinsey Global Institute predicts $10 trillion in new annual spending by urban consumers in the emerging world by 2025. That’s like adding most of another entire U.S. economy to the global economy, and those consumers will be stepping up to products they couldn’t previously afford. They also will buy more insurance to cover those new homes, autos, boats and other trappings of a middleclass lifestyle. As demand for products and services increase so will the need for insurance to cover the businesses selling those products.

“There are a lot of people who sell consumer goods who are eyeing these markets closely,” says Philip Levy, a senior fellow on the global economy at the Chicago Council on Global Affairs. “You’d expect a selling opportunity there.”

To be clear, the United States and Europe are still huge and highly profitable markets, and will remain so. Per capita income may have topped $10,000 in Turkey, but it’s more than four times that in the U.S. Even China is predicted to peak at around $18,000 per person—“more like a giant Poland than another U.S.” is how a Bain & Co. report put it—and even if India eventually overtakes America in sheer economic size, it’ll be spreading that wealth across four times as many people.

But the Poles—and the Chinese—buy a lot of consumer goods. Increasingly it’s goods Americans already have. So for many companies, the fast lane for growth runs through emerging markets.

B. Ravikumar, an economist at the Federal Reserve Bank of St. Louis, has an interesting way to illustrate this opportunity. In his presentations on the Indian economy, he runs a graphic that tracks cell phone adoption in the United States, China and India over the last two decades. It pops first in the U.S., then in China and then India, and grows rapidly in each. By 2010, the United States has nearly full adoption, while in India it hits 60%.

“That’s 40 people per 100 who don’t have one,” Ravikumar says. “That’s 400 million more cell phones. That’s more than all the people in the U.S. It’s a huge market.”

And it’s not just gadgets that all these people are buying. Even people who make the sort of goods that have been around forever see their biggest opportunities selling to more affluent consumers in emerging markets.

Take beer. As a product, it’s nothing new. It has been brewed nearly everywhere for centuries, and most beer-drinking countries have their own national brands. But as more money finds its way to more people, a handful of the biggest brewers see a chance to get consumers to trade up from workaday domestic labels to something more global, more prestigious—and more profitable. Something like Budweiser.

Since it bought Anheuser-Busch five years ago, the Belgian-Brazilian behemoth now known as Anheuser-Busch InBev has rolled out the King of Beers in a series of big emerging markets. First Russia. Then Brazil. Most recently the Ukraine. It has beefed up Bud’s presence (and marketing) in China and the U.K. and bought sponsorship rights to the 2014 World Cup as a way to sell “America in a bottle” to consumers around the world.

So far it has worked. Today just under half of all Budweisers are consumed overseas, compared to 28% just five years ago. That’s a pace the company expects will continue. Last summer, Anheuser-Busch InBev bought the half of the Mexican brewer Grupo Modelo that it did not already own in a deal that will allow the company to expand its brands, such as Corona, into new countries.

All of this puts pressure on the business community to innovate to maintain a global advantage. So who will be the next innovators as global markets converge? Will it be anyone in the insurance industry? It certainly has the global reach, but does it have the innovative mindset?
And what does all of this all mean for the comfortable residents of the richest economies in the world? The unwelcome answer: They will probably have to share more.

Cheap Labor

So far, much of the rise of emerging economies has come via relatively low-skill labor—Chinese factories, Indian call centers—while the high-value, high-wage jobs have stayed in the West. While an iPhone is assembled in China, Chinese labor accounts for only about 2% of the value of one. Most of the money you pay at the Apple Store stays in the U.S.—or in Japan, Europe or South Korea—where the profitable work of developing, designing and marketing the phones takes place.

This is one way in which globalization has actually helped the U.S. economy, allowing it to specialize in high-end goods and services, including insurance, sold around the world. But there’s a limit to how much this arrangement helps the countries at the low end of the equation, and developed economies are starting to bump up against it.

“They get to a certain point where China says: ‘We don’t want to be cheap labor any more. We want to create the next Apple,’” says Levy. “The Chinese very much want to advance and become an innovation hub.”

So they’re trying to build their own globally competitive companies, to lure Western partners, and to train 6 million college graduates a year, in a bid to develop high-tech industries that are more than just basic manufacturing.

India is thinking the same thing. Those fighter jets it’s buying to upgrade its Air Force? It plans to make sure they’re assembled in India, by Indians, as a way to develop a domestic aerospace industry and create thousands of well paying jobs at home, and not just on Boeing or Lockheed Martin assembly lines in the United States.

This is part of a long trend that’s stretching out the global labor market. Much low-level manufacturing in the United States is long gone, of course. Higher-skilled white-collar professions like journalism, law and medicine have experimented off and on with off-shoring what work they can outsource. And multinational companies with lots of customers overseas are now deciding it’s easier to do more of their engineering and advanced manufacturing work there as well.

Even for all the talk lately of “on-shoring”—moving some manufacturing back to America—it’s worth noting that the jobs involved are fewer, and less lucrative, than they used to be.

This global labor market is part of the reason U.S. incomes have flattened in recent years. The median household income in 2011 was $50,054, according to the Census Bureau, a bit less than it was in 1996 when adjusted for inflation. Even before the recession that hit in 2008, incomes never regained their peak at the start of the decade.

And speaking of inflation, all these Chinese and Indians and Turks and Brazilians who aspire to live like Americans are starting to drive up the cost of what it takes to live like an American by increasing consumer demand for higher-end products.

Global commodity prices have nearly doubled since 2005. Food prices in particular are near all-time highs. While that’s partly due to short-term events like last summer’s Midwestern drought, it also reflects rising global demand for everything from soybeans to steak.

So consumers in developed nations will be hit with a double whammy. Global demand for some consumer products will increase due to a growing worldwide middle class and in many cases increase the cost to the consumer. And cheaper global labor in many instances will continue to hold down wages in developed nations. If this results in consumer prices trending up while wages remain stagnant, living standards in developed nations may be affected—and that could inevitably affect business opportunities for all types of businesses, including insurance.

Bumps in the Road

Growth in China’s economy, mighty though it may seem, has been slowing. GDP growth there has fallen by half in the last five years—from double-digits to about 7.5% in 2012—with no one seeing a big rebound on the horizon. That slowdown stems in part from Europe’s woes and in turn has a chilling effect on trading partners from Brazil to sub-Saharan Africa.

Meanwhile the country is wrestling with deepening concerns about corruption and cronyism, an aging population, and growing unemployment among all those young college graduates in its cities—even while cheap manufacturing migrates to Thailand and Bangladesh as China becomes too expensive.

And China is hardly alone. India faces massive demographic challenges and overtaxed infrastructure. Brazil continually battles inflation, and Turkey sits in a dicey corner of the world where Middle Eastern conflicts can disrupt its economy.

The Western powers certainly face their challenges too, writes former Treasury Secretary Henry Paulson in a recent essay on U.S.-China relations. But they also have more resources and experience to deal with them.

While America faces “significant problems,” Paulson writes, “the challenges we face are less daunting than those confronting China and virtually every other major nation.”

Rules Matter

And when it comes to doing business, Western nations tend to have well established rules of the road. But those rules can’t be assumed even in places that are becoming global capitals.

Each year, the World Bank ranks every nation in the world on the ease of doing business. Near the top sits Singapore and Hong Kong, the U.S. and U.K. and places like Denmark and Korea. But some important economies are far down the list. Of 185 nations, Brazil ranked 130th, India 132nd and the Ukraine 137th. That’s doing about as well as the West Bank and Gaza Strip.

These countries are still wrestling with how best to open up their economies, says Levy. Many regulators realize they have to meet global standards if they hope to attract foreign investment and world-class companies. But in many places, there are a lot of powerful people who like the status quo just fine.

“In developed markets—Japan, Europe, North America—there’s a lot you kind of take for granted,” Levy says. “The actual laws may differ, but the extent to which you have rule of law is not going to differ. You can rely on contracts being enforced, that sort of thing. That is not as certain in the emerging world.”

Still, standards are rising. In the decade it’s been doing this survey, for instance, the World Bank says business regulations are “gradually but noticeably converging” toward the more efficient norms of the developed world. As countries from sub-Saharan Africa to Eastern Europe adopt the business models of the U.S. and U.K., investors from those wealthy countries will grow more comfortable putting their money there.

Their confidence will continue to make the West, the East and the Global South even more interdependent than they are today. It’ll help create more jobs and opportunities in developing countries as well. And as their populations keep growing, and growing more affluent, the rise of the “emerging” world starts to look inexorable.

“It is not hyperbole,” according to McKinsey in its report on global consumers, “to say that we are observing the most significant shift in the earth’s center of gravity in history.”

Although the United States will not dominate the world economy in the future, no other single nation will either, says the National Intelligence Council. Instead, economic power will shift to multiple coalitions throughout the world. But that means America will no longer be the economic engine that keeps most other economies humming. Instead, it will become just one of many.

And what do the economic changes mean for the average consumer in many of the developed economies, who have enjoyed a lifetime of advantages simply for being born on favorable real estate? They could feel a pinch, maybe even a squeeze as wages struggle to keep pace with living expenses, thanks to the economic supply-and-demand pressure of a growing global middle class. For the insurance industry, however, there are opportunities for growth in the emerging countries as the middle class grows. Many brokers and insurers have found lucrative markets in Latin America to help offset flat demand in the U.S. and Europe. But it involves a long-term strategy and persistence to reap the rewards.

And as everyone notes, everything is subject to change. All it takes is another war somewhere, another 9/11 attack, to set economic predictions on their head. Living forward may enable 20-20 hindsight but not the ability to predict the future. 

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