In pursuit of prosperity

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In this episode of the McKinsey Podcast, Simon London speaks with McKinsey Global Institute (MGI) director Jonathan Woetzel and MGI partner Anu Madgavkar about their recent research on emerging economies that outperform others based on pro-growth agendas and successful companies that help propel them.

Podcast transcript

Simon London: Hello, and welcome to this edition of the McKinsey Podcast, with me, Simon London. Why do some countries develop economically while others remain poor? Is economic development determined by geography or demography? Is it even possible without democracy? And what’s the role of free-market principles — whatever those might be? To answer these questions, I caught up with the coauthors of a new report from the McKinsey Global Institute entitled Outperformers: High-growth emerging economies and the companies that propel them. Jonathan Woetzel is a McKinsey partner based in Shanghai. Anu Madgavkar is a partner based in Mumbai. For this conversation I was lucky enough to intercept them both in New York.

Anu, Jonathan, thanks for being here today.

Jonathan Woetzel: It’s great to be here. Thank you, Simon.

Anu Madgavkar: Great to be here. Thanks.

Simon London: The obvious first question is, who are the outperformers?

Anu Madgavkar: We looked at over 70 emerging economies and we set a threshold of which economies have delivered sustained per capita GDP growth over long periods of time. Over 50 years this amounted to a set of seven economies, which includes China, South Korea, Hong Kong, Singapore, and then a set of economies in Southeast Asia, which are Malaysia, Indonesia and Thailand. These seven did it over 50 years and then there’s another set of 11, which delivered high growth over a shorter period of about 20 years [Exhibit 1].

Simon London: All of those seven are clustered in Asia. They’re the names we know, but they’re all in Asia. So is there a sense in which geography is destiny? Is that part of the message?

Anu Madgavkar: It’s interesting to look at the recent outperformers, which is the set of 11 that took off and delivered growth over the last 20 years. Because that’s actually a more diversified set. You do have countries in Southeast Asia, like Vietnam and Cambodia. You do have India. And then you have a set of countries which are in Central Asia, which are Kazakhstan, Uzbekistan and so on. And then one African economy. There is a bit more of regional or geographic diversity in that set. But it probably is true that there are strong advantages of having growth taking off in the form of, let’s say, a big anchor economy or an economy that leads in a region. We have seen some of that. But growth has actually been more diversified in the last 20 years.

Simon London: And in Asia presumably that’s China. China is the big anchor economy. And there is a sense in which some of the other economies have been able to go on the coattails of China, is that right?

Jonathan Woetzel: China trade — “China-south” and “China-north” — trade has been the fastest growing piece of global trade. It is an anchor, as you say.

But more broadly, as Anu was saying, I think we do say that there is an approach to growth. There is an approach to outperformance which is common to these East Asian economies. But it is more than that. It goes beyond borders. And it’s something that any country can achieve. That’s the message: there’s an approach and there’s an agenda that is open to all.
Simon London: Let’s double-click on that. Having an anchor economy close by is helpful, but there is a recipe here. There’s commonality across countries that achieve growth over the long term. What’s the recipe?

Jonathan Woetzel: We think it has two parts. Let’s talk about the policy, which I’m hesitant to call policy — but let’s say the agenda, the things that we all agree on in an outperforming economy. And essentially the main thing is we agree on growth. And it’s quite surprising in some cases that some economies do not agree on growth. So it’s apparently not well aligned.

But in a high-performing economy, what we see is an alignment around productivity, income, and demand [Exhibit 2]. These are the three aspects that drive economic growth.
Productivity to enable better resource-allocation decisions. Income to create return of that productive investment to the people who created it, the workers or the investors and the shareholders. And demand being the reinvestment of that income into new productivity.
These things go together: productivity, income, and demand. And that is the first and most important takeaway from why these economies outperform. They agreed on that, and they created policies and mechanisms to support that.

The second thing we note is that large competitive global companies are a hallmark of these outperforming economies. We can argue whether it’s causal or correlated. But we can certainly say that these companies have to be there. We need to see large, globally competitive companies emerging to 50 percent, 60 percent revenue as a share of GDP, or 40 percent value added as a share of GDP, in order for us to see an outperforming economy. Those two things: a pro-growth agenda and globally competitive companies.

Anu Madgavkar: These two things are not just the common features that we saw across these outperformer economies but also went hand in hand. So just like Jonathan said, it’s not clear which was the cause and which was the effect. But there was something like a shared vision that was created around the idea of the importance of growth, the importance of creating a climate in which savings and investment could happen, and that these companies could actually invest, accumulate capital, build productive capacity, and open up to the rest of the economy.

It did take some doing. This is not something that happened automatically or naturally or easily, perhaps, but with a concerted set of actions that actually had policy makers sitting with the private sector charting out what could be done, let’s say, to drive up exports in a certain sector or economy-wide. Then they followed a shared agenda around that with the right incentives in place — a fairly concerted set of actions to bring these multiple different actors together.

Simon London: I know we don’t want to get too deep into policy making. It’s up to the countries to decide, clearly, but what are the common levers around something like encouraging a high savings rate within an economy and capital accumulation? What are some of the things that we see consistently across high-growth economies?

Jonathan Woetzel: I think you put your finger first of all on a very important one, which is savings rates and the ability to mobilize savings, which implies two things. One is a belief in the value of those savings. That the savings will go to create some future wealth in store. And the second is the security of those savings. Those savings are not something that you have to keep under your mattress at home but you will actually put into a bank account.

The policy first of all is to create the financial system that allows that. So you have to have financial inclusion. You have to have some type of a very broad-based financial network that allows for everybody, farmers to workers to rich and poor, to have security against those deposits.

Then you need to have a way of insuring that what that savings is used for can ultimately create value. The return on that investment, that’s where you see the takeoff in manufacturing. The ability to start small-scale manufacturing enterprises, which have access to the marketplace. You see investments of course in real estate. The ability to secure title and see that there’s a medium-term opportunity for you to get this money back so you’re willing to put the investment into the savings vehicle.

It boils down to saying, “Yes, we have to have a broad-based financial network. And we have to have the security for the investor.” Those two things add up to an incentive to save. Without those we of course see very low savings rates, and those are characteristics of the non-outperformers.

Anu Madgavkar: One of the myths I think about emerging economies is that a lot of the investment is led by FDI.

Simon London: FDI being foreign direct investment.

Anu Madgavkar: Foreign direct investment. And while that is true, FDI has played an important role particularly in bringing new know-how and new technology and linking local companies to global markets. But just in terms of quantum of capital accumulation, it’s really domestic savings that dominate across all the cases that we’ve seen.

There is no substitute in the medium to long term to building the financial institutions, trust, credibility, and financial inclusion and to deepening your domestic savings and investment markets. There really is no substitute for doing that.

Jonathan Woetzel: If I could add one other that I think is just incredibly important: the productivity aspect of policy. Productivity sometimes is thought of more as, first of all, an automation and a job-cutting mechanism and I think that, of course, technological innovation and renovation is an aspect of it. But that’s in turn impelled by pro-competition policies.

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