Rule of law

I was hearing Joseph Stiglitz (nobel laureate in economics) at a friend's house - http://www.youtube.com/watch?v=jCT_1MDzdCQ&feature=related. He mentioned that most developing countries were saving trillions while US was spending with borrowed money. What he did mention was that global growth was fostered with US consumer spending. Consumers leveraged their home and put the money to work all across the world. On the flip side, foreign countries saved their money and put it to work in US home mortgages and debt because they thought this was a safe place.

This makes sense. I believe this has to do with the rule of law. In most of the developing countries, rule of law is poor. People get easily ripped off by businesses and there is no easy recourse. So people think twice before buying. Other way around is also true. If people get a loan, they may not repay and it is hard to trace people. So it is difficult to lend and premium is high. End result, lack of spending and lack of leverage. On the contrary, in countries with good rule of law, it is easy to leverage and easy to spend.

Now let's look at what happen next in US. US consumers should probably have learnt by now that over-leverage is bad. US Govt's effort to add liquidity, making loans easy etc. will probably help in easing consumers' mind. It remains to be seen if consumers will forget this lesson (along with dot com crash). But, I am pretty sure, the lending practices will be tight, regulations will be tight leading to a subdued leverage. If leverage is tight, this means slow spending  not only for the consumer but also for the businesses. In turn, this means a slow moving economy for the coming years. Also, foreign countries may not be so willing to invest back into US assets anytime soon. I wouldn't expect DOW, S&P to hit their highs anytimes soon, maybe in a decade. With US consumers leverage and spending down, fuel for global growth has dried up. This means that global growth is also not on horizon anytime soon without a new driver.

So what happens next? Countries like India and China that depended on US consumer will need to look for something new to drive their growth. China has a large manufacturing base that focused on developed countries but will need to shift worldwide on internally for growth. My instinct tells me that it will be difficult for growth to come from internally unless their government starts paying more to their workers. Selling worldwide will not get them the same margin as selling in developed countries for obvious reasons. So, I would expect their economy to slow down unless they focus internally because they have over a billion people. And this may actually happen. China has already changed some laws for people to own homes. Some more changes may actually foster their internal growth.

For India, it could be much harder. India relied on software exports a lot which will slow down drastically because the developed countries aren't doing as well. Shifting to other countries may prove to be difficult. Lately however, there has been increased focus on the internal consumer. Home loans, credit cards being more accessible. With sixth pay commission, many govt employees will be in a better position to spend. They are also the ones that will get the loans easy. This could be a driver for growth in India albeit not a very strong one. On the flip side, sixth pay commission timing may have been a little off. Govt may not have same revenues as before so where do they pay the increased salaries for the employees. If the Govt cannot pay them, they may have to print more money i.e. inflation. Govt may be forced to tighten its tax net. Anyway, let's keep that aside as inflation is something India has lived for a long time.

Consumerism is on the rise in India. There is new middle class. People are taking loans, buying cell phones. Thanks to China, latest stuff is available for cheap. Multi-nationals are focusing on selling their products in India. Now, this slowdown may have put a damper on the spending, Indians still think the property prices will go up although properties in cities are already down. Compared to global markets, they are already way up. For lack of good rule of law, lending was already tight and people didn't leverage a lot as the interest rates were already high. So, it wasn't the leverage affect that hit Indian markets. It was actually the pulling away of foreign investments that led to the downturn in Indian markets.

Going forward, there may be a lot less foreign direct investment (in market), because of all the measures the US and european countries are taking. But not to the same level. There will be lack of credit for home loans and credit cards because of the global freeze (although still available to govt employees). This will put a damper on the spending of the new middle class. However, this may not be as much of an issue because interest rates were stil higher to begin with. So, overall Indian economy recovery may be faster than say US, but probably not at the same place. But symptoms look good for an internal growth to happen.

Overall, this may be a turning point where developing countries have a better recovery than the developed countries and not have to look back.