Limits of government policies

While investors around the world wait breathlessly for the next stimulus from governments, the reality is that government policy options are quite limited. The paradox is that the one policy that politicians will not follow is the one policy that would actually work; the path of true reform

As a result of the recent elections in France and Greece the latest mantra among European leaders is that their policies have to change from austerity to growth. There is one problem. One has to wonder what exactly do they expect to use to stimulate growth? There are two standard ways. One would be to try and stimulate their economies using fiscal policies. They could either cut taxes to encourage people to spend or the governments could increase spending on government programs. Both would stimulate the economy, but for most European countries these two options are out because they already have exceptionally high debt.

Another way to stimulate growth is to use monetary policy by cutting interest rates or more exotic programs with less proven records like quantitative easing. These might work except that all of the countries have already used these tools. Interest rates are near zero and the European Central Bank (ECB) pumped a trillion euros into the European economy over the winter.

Perhaps the best way to promote growth would be to require structural reform and limit government over regulation especially of the labour market. But this has two problems. First it would take time to show results and second no self respecting European would ever continue working after the age of 62 or give up her/his spa leave. So it is politically impossible. So Europe’s policy makers and central bankers are trapped. Without viable solutions, Europe will be subject to an inevitable slowdown. Not to worry, emerging markets will save us.

Since the beginning of the Great Recession in 2008 the emerging markets have been the engines of the global growth. With youthful populations, relatively low debt levels and expanding middle classes, these countries seem set to drive global growth indefinitely. But there is a problem. Despite the happy predictions of analysts and economists all over the world, no economy can escape from business cycles and some of the economies in emerging markets are showing distinct signs of stress.

While inflation is not an issue in the developed world, it is in many emerging markets. One of the worst is Vietnam. Vietnam is one of the fastest growing countries in Asia. Its GDP (gross domestic product) increased by over 8% a year from 2003 to 2007. While it has slowed recently, it is still expanding at 6%, a rate that would be the envy of most governments. Sadly the price to pay is Asia’s highest inflation rate. Last year it topped 20% for the second time in three years.

Turkey and Poland are two large emerging markets on the periphery of Europe. Unlike Greece and Portugal, these two countries have been growing rapidly. Poland did not even experience a recession. Turkey declined in 2009 but bounced back to growth over 8% for 2010 and 2011. Both countries have benefited from large investments in foreign capital, but both countries have large exposures. Turkey is now running a scorching inflation rate of 10.4%. But the real problem is its current account deficit in excess of 10%. This makes Turkey vulnerable to capital flight.

Poland’s inflation rate is only 4%, but it is heavily dependent on its exports especially to Germany. So it is not only exposed to European problems but also problems in one of Germany’s largest trading partner, China.

It is not just the smaller emerging markets that are experiencing problems. India’s economy is slowing. The Reserve bank of India (RBI) felt secure enough in March to try and stimulate the economy with its first interest rate cut in three years. Sadly the RBI’s actions were premature. Inflation increased from 6.89% in March to 7.23% in April, so any further monetary stimulation is probably not in the cards.

And then there is China. China’s growth, upon which much depends, is definitely slowing, perhaps more than investors expect. What investors do expect is that if China slows, the government will step in and use its control of the economy to get it restarted. But like other countries China is also limited in it policy responses. New loans or ending real estate market restrictions would lead to more unaffordable empty houses and increase the mountains of bad debts.

While investors around the world wait breathlessly for the next stimulus from governments in developed countries and emerging markets alike, the reality is that government policy options are quite limited. They cannot undertake a fiscal or monetary policy to make things better without making other things worse. European stimulus wouldn’t ignite inflation, but it would exacerbate sovereign debt problems. Most emerging markets don’t have the debt problems, but they do have severe inflation, which has to be tamed. The paradox is that the one policy that politicians will not follow is the one policy that would actually work; the path of true reform.

Despite local demand, Chinese and other emerging market firms have not established their own brands. Instead they have often tried a short cut, purchasing western brands. The main problem for the emerging markets is learning the art of protecting their local brands

The growth of emerging markets is having an enormous impact on everything. However, marketing and brand management in these markets can be a bit of a challenge. This is true for both multinational companies attempting to sell into these markets as well as for emerging market companies competing with them and attempting to expand internationally.

One of the most interesting examples are brand named luxury goods. The sales of these products grew 13% in 2010 to $228 billion and another 10% in 2011 to $252 billion, renewing the growth trajectory that started in 2007 when sales hit a previous record of $224 billion. As with all things concerning emerging markets, sales in China have led the way. Sales of branded personal luxury items purchased by Chinese globally add up to a whopping $52 billion. This is 80% of the $63 billion in sales of the largest market, the United States.

But China is not alone in its tastes for brand names. Latin Americans led by Mexicans and Brazilians are raiding the posh stores of New York, Milan and Paris with reckless abandon. Local markets are growing, as well. Sales in Brazil grew 50% from $2 billion in 2009 to $3 billion in 2011. Sales grew in the same period by 12% in the Middle East and by 25% in Korea.

But catering to these markets often means adapting to local tastes, which are often quite different than in Europe or the US. For example Chinese women’s taste for whisky and sports cars is higher. In China, Maserati sells 30% of its cars to women, while in the west women buy only 2% to 5%. In contrast, Chinese men purchase more far more grooming products including face creams than in older markets. They also are large consumers of luxury bags. Coach sells $1.7 billion worth of leather bags in China, 45% to men compared with 15% globally.

Despite the local demand, Chinese and other emerging market firms have not, with a few exceptions, established their own brands. Instead they have often tried a short cut, purchasing western brands. This process has even been sanctioned by the Chinese government.

But government encouragement does not necessarily mean success for the Chinese any more than it did for their Japanese predecessors who did the same thing 30 years ago. The computer firm, Lenovo Group, purchased IBM’s personal computer business in 2004. Lenovo now sells computers under its own brand and the only thing left of the IBM brand is the name ThinkPad.  The problems with the IBM brand have not stopped the Chinese from buying others. The Chinese car company Geely bought Volvo last year and a Chinese bulldozer manufacturer bought the Italian luxury yacht maker Ferretti, owner of the legendary Riva boat brand. Not to be outdone, one of India’s largest industrial group, Tata, purchased the famous British tea company Tetley and more recently Jaguar Land Rover.

Still marketing success has proven elusive even on their home turf. Chinese car companies have been unable to pry the more lucrative parts of their own market away from VW and General Motors. The foreign-branded cars are seen as more reliable, stylish and a better value than their Chinese competitors. This leaves the Chinese car makers with the low end of the markets where competition is only on price and margins are razor thin.

Emerging market governments are all ambitious to make their mark in the world and have no problem supporting their locals. In China this means reviving a bit of socialist history with the Mao era Red Flag limousine. Like its Soviet counterpart the Zil, it was originally produced for the communist leadership in 1958. But it fell out of favour with the Chinese leadership who preferred the more polished Audi, which dominates 30% of the market. Discontinued in 2010, it is now back as the first choice of the upper echelons of the party.

But the main problem for China and other emerging markets in learning the art of marketing is the protection of the brands themselves. The Chinese governments, usually local governments in trying to protect home grown industries, have been ruthless in slandering foreign brands. Luxury brands including Hermès, Hugo Boss and Tommy Hilfiger Chanel, Armani, Christian Dior, Zara and Burberry have been attacked as substandard. Wal-Mart in Chongqing found itself the scapegoat for high pork prices, while Coke, Heinz, Procter & Gamble General Mills, Lipton Teas, Colgate-Palmolive all have been accused of selling adulterated products.

Besides slander, the Chinese are notorious for intellectual property violations and trademark infringement. This consistent disregard for property rights was supposed to damage multinational firms, but the real losers are in China, for without these basic protections, the locals can only hope to produce basic commodities and leave the more profitable higher end to foreigners.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected]).

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