Russia's Winter Olympics party hides the economic truth

President Putin's willingness to blow $50bn on the Sochi Games shows a weakness shared by those other emerging markets: Brazil, India and China
  • @TheIndyBusiness

Russia is on display this week, with all its strengths and weaknesses exemplified in the Sochi Olympics. There is certainly a self-confidence in a country that can blow $50bn (£30bn) on a party, and that President Vladimir Putin should choose to do so catches the mood of many Russians that it has staged a great comeback from its impoverished post-Soviet years.

However, any country can throw cash at grand projects. On any value-for-money calculation, the Sochi Games look a disaster. That demonstrates the weakness. This is not a country you want to put your money in, or at least not unless you know a huge amount about the place and are prepared to kiss the money goodbye. But if you want risk, with appropriate potential reward, then Russia is for you.

There is wider point here about the relationship between the developed and the emerging world. For most of the past decade, ever since Goldman Sachs developed its econometric model projecting future emerging market growth – and coined the acronym Brics to describe its four largest economies – we've been in thrall to the notion that the old world was being overtaken.

The fact that this new world, taken as a whole, had no recession in 2008/9 whereas we had a whopper highlighted the shifting balance of economic power. China became the world's second largest economy; India became the second largest investor in the UK; a surge in the Brazilian real drove the country briefly to pass the UK in economic size – and you are reading a newspaper owned by a Russian family.

Now there is something of a reassessment going on. Growth having resumed in most of the developed world, we have recovered a little self-confidence. Whether that is justified is a separate matter, but for the moment we are reassured, relieved even, that we can fix our problems.

The weaknesses of the emerging countries, by contrast, have become more evident. The economic difficulties in the past few weeks have struck very different countries and for very different reasons. There is no common theme in the difficulties of Argentina, Turkey and Thailand. As for the Brics, they all face different problems too. Brazil has slowing growth, a falling currency, climbing inflation and 10.5 per cent interest rates. In Russia, growth has stalled and is expected to be only about 1.4 per cent this year. India has decent growth, but inflation at 9.9 per cent and a weak rupee are eating away at the savings of the middle class. Everyone is waiting to see how the new governor of the Reserve Bank of India, Raghuram Rajan, and the new government, to be determined after elections in April, will tackle this.

As for China, well, there is some sort of slowdown happening, and we really cannot say how serious this will be. The data is confusing, but we know the state-supported banks are carrying huge amounts of property loans that may or may not be repaid, and that hard indicators such as energy use suggest the economy will struggle to grow at its planned 7.5 per cent.

Pull all this economic stuff together, stir in the sharp fall in emerging equity markets over the past year and it is very easy to explain the disenchantment among Western investors. But wait: China's growth rate is "only" 7.5 per cent? India's "only" 4.5 per cent? Even Brazil is expected to achieve 2.5 per cent. The gap in growth between the developed world and the emerging world is likely to be the lowest since 2001, but there is still a gap. Notwithstanding all these very different headwinds, the harsh truth remains that the emerging world is still outpacing us.

This leads to a couple of commonsense conclusions. One is that we should be much more careful when we bundle together countries with utterly different economic structures, governmental systems and cultural traditions into neat acronyms. The concept of the Brics vs the G7 was useful because it focused attention on a massive structural change sweeping across the world. It made us, in the complacent West, wake up.

But at a profound level it is misleading. The G7 economies are very different in size, for the US is some 10 times bigger than Canada, but our wealth per head, economic structure and systems of governance are broadly similar. The Brics are totally different. They are at different stages of economic development, different growth prospects, different political systems and different ideas of how to run a country.

The other conclusion is that risk and reward balance out. At the end of the 19th century and the beginning of the 20th, investment funds flooded out of Europe to places such as Russia and Argentina because they offered higher returns. There were higher risks, though buyers of Russian tsarist bonds did not quite appreciate how high. We have come through a period where we overplayed the rewards, or at least the growth potential, and underplayed risk.

Now we are seeing things in better perspective. We can see we have strengths in the West and we see the fragilities of the emerging nations. Russia has unintentionally demonstrated one of those weaknesses right now. We are capable of making pretty bad investment decisions, but when it comes to wasting money on an industrial scale, the Russians get the gold.