We're not living beyond our means!

As a general rule I am not one for predicting what the Chancellor might say during his budget speech, but I would not be at all surprised if the phrase “living within our means” crops up at some point tomorrow. George Osborne said it ahead of the 2016 budget; Philip Hammond used the phrase at the Conservative Party conference in October and he was at it again over the weekend, telling the Sun on Sunday that we must “ensure we get back to living within our means.”

We all know that this is just another way for Chancellors to say that they intend to reduce the budget deficit further. But as a statement of economic fact, it’s nonsense. Over the years, Chancellors have told the public that “we must live within our means” as if somehow state finances are the equivalent of running a household budget or a corner shop. And the public continue to fall for it. But there is a major difference between an entity with a limited lifespan, such as a household or a one man business, and a state with a much longer lifetime – if not infinite, then close enough for the purposes of investors. Households operate under a lifetime budget constraint in which all current spending and borrowing have to be paid out of the finite lifetime income which it generates. A sovereign state such as the UK will (hopefully) still be around in 100 years’ time (notwithstanding the Scottish secession threat). There is thus a pretty strong likelihood that an entity which has never defaulted outright on its debt will still be around to pay its dues. For the UK, living within its means implies thinking over a much longer time horizon.

Let’s look at the counterfactual by supposing that “living within its means” requires the sovereign state to fund its commitments out of current income. How would we finance investment? Is it right that today’s taxpayers should provide all the funding for a long-lived project – such as a housebuilding or hospital expansion programme – without requiring future generations that benefit from them to pay anything? And while we are at it, how do governments fund wars? After all, UK government debt rose by 100 percentage points relative to GDP between 1939 and 1947 – proportionally way more than anything we have seen in the last decade. Imagine history’s reaction if Churchill’s government in 1940 had said something along the lines of “obviously, we are committed to freedom and democracy but we are not prepared to fight for it because we have to live within our means.”

So as statements of economic policy go, this is just dumb. However, I guess most Chancellors know it but since they are politicians first and foremost, they have to get the message across in ways that people understand. Of course, it is not just British politicians who are guilty of this fallacy. German finance minister Wolfgang Schäuble remains committed to maintaining budget balance despite the fact that Germany saves too much and invests too little (that, after all, is why it runs a huge current account surplus). Yet his message goes down well with an electorate that sees saving as a virtue – which it is, though not as an end in itself.

I am not as such opposed to a degree of consolidation in public finances – though as I noted on Sunday, we may be overdoing it in the UK. What I object to is the misrepresentation of the government’s budget problem as though it were managing a household budget for it gives a misleading impression of how state finances operate. We are living within our means if we can finance most current spending from current income and have to rely on a small sub from the markets for the rest. After all, markets lend to governments because they know they will be compensated – though not terribly well at present – and get their money back. Nobody is forcing them to do so. We know we are living beyond our means when markets cease to buy government debt. And despite record low interest rates, there is no sign of that happening just yet.

Running out of road on austerity

Next Wednesday will see the occasion of the annual UK parliamentary set piece otherwise known as the presentation of the annual budget. The principle of parliamentary approval of the budget plans date back to the late seventeenth century when the nation’s finances were squandered once too often by a spendthrift monarch. The final straw came during the reign of Charles II in 1667, whose navy was laid up due to a lack of funds and which was subsequently caught unawares by a Dutch raid.

Budget presentations in their current form began in the early eighteenth century, with the word budget itself derived from the French "bougette", which was the little bag from which the Chancellor of the Exchequer would reveal his plans. Incidentally, this explains why the Chancellor "opens" his Budget. The UK is just one of a handful of countries whose fiscal year begins in April (of which Japan is the only one not a former British colony) reflecting the historical fact that when the economy was primarily based on agriculture land tax was collected in April, hence budgets are held in spring.

Over the years the budget became one of the main parliamentary events of the year although its importance in recent years has dwindled somewhat. Nonetheless, it provides us with a good opportunity to focus on the state of UK government finances and fiscal policy. The good news from a macro perspective is that the budget deficit has fallen sharply, from a peak of 10.1% of GDP in FY 2009-10 to an expected 3% in 2016-17 (it reached exactly 3% in calendar 2016, chart). The previous policy of targeting a surplus by the latter part of this decade has been abandoned in favour of a rule which requires reducing the structural deficit below 2% of GDP by 2020-21 and ensuring that the debt-to-GDP is on a downward trajectory ratio by the end of this parliament – both of which seem highly achievable.

But the fiscal improvement has come at a significant cost. Total managed expenditure (the sum of public sector current expenditure, net investment and depreciation) fell from a peak of 45.3% of GDP in 2009-10 – the highest since the mid-1970s – to current levels just below 40%. At the same time, receipts have risen by less than 1% of GDP which is a clear indication of the extent to which the squeeze on public finances has come from spending cuts. Additional spending cuts are already baked in thanks to measures taken by former Chancellor George Osborne. One of the measures which most worries me is the reduction in central government grants to local authorities, which by 2019-20 are set to fall by 80% relative to 2008 levels. This is without a doubt the key reason why local authorities are having to cut frontline services, and I remain of the view that this savage austerity was one of the reasons why the electorate voted to stick two fingers up to the government last June.

Former minister David Laws has already warned that the UK is “reaching the socially acceptable limits to public sector austerity,” and the Institute for Government reported last week that public services are reaching a breaking point (here). It suggests that whilst “the 2010 Spending review was largely successful” in achieving its objectives, “the Government is struggling to successfully implement the 2015 Spending review … [with] clear signs of mounting pressures in public services.” Newspaper headlines over the winter have highlighted the strains on the NHS and the IfG notes other areas where strains on public services are mounting. The report makes four key points which the Chancellor ought to take note of when framing his budget plan: The government:

• is failing to develop alternative strategies despite the clear warning signs in the data
• is continuing to pursue approaches that are no longer working
• is being forced into emergency actions in response to public concern
• is providing emergency cash to bail out deeply troubled services.

In other words, austerity has gone as far as it can. Moreover, there has been no recognition from the UK government (or, for that matter, from most European governments) that fiscal multipliers have proven to be far higher than expected before the financial crisis. Fiscal austerity has had a bigger adverse impact on European growth than policymakers expected. Undoubtedly Chancellor Hammond will point out that the UK has been one of the better performing growth economies in recent years. But that is not how it feels to many people outside the south east of England. Employment growth has been very strong in the last four years but real wages remain below pre-crisis levels. Workers have priced themselves back into a job but their position feels a lot more precarious than it once did.

I am not convinced that Mr Hammond is going to substantively address these concerns next week. His is a government which has an ideological conviction that deficit reduction is an end in itself. But it is not: After all, it’s not government money – it’s ours and we hand it over to the government to facilitate the running of the state. The government thus has a duty to use that money to manage the economy in the best interests of its citizens. And despite the evidence from the macro numbers, I remain as convinced today as I was in 2008, that fiscal policy has a key role to play in helping to make life better for taxpayers.

Brexit: More on the exit costs

It has widely been suggested that the European Commission will try and extract a high price from the UK in terms of the Brexit bill when it finally departs the EU which I looked at last week (here). But a report published today by the UK House of Lords (here) makes the point that “the UK will not be legally obliged to pay in to the EU budget after Brexit.”

The argument hinges on what happens if the Article 50 legislation expires without an agreement. One school of thought argues that under international law (the Vienna Convention on the Law of Treaties, established in 1969) “obligations undertaken when the UK was still bound by the EU Treaties would not disappear at the moment of Brexit.” But another interpretation is that Article 50 offers no provision for measures to be applied in the event that the UK and EU fail to come to an agreement. Indeed, there is no provision to decide who is the competent jurisdiction to adjudicate on post-Brexit matters or conflicts. So if the Article 50 negotiations fail there is no way that the UK can be held to account.

The problem is, of course, that there is no simple legal answer to the question and like economists, lawyers tend to offer a range of different opinions. Prime minister May has already suggested that the UK will be willing to make some form of contribution so the idea of making no payment is unlikely. Equally, however, it suggests that the €60bn bill which Michel Barnier, the EU’s chief negotiator, is reportedly aiming for will be rejected outright by the UK. But this is when matters start to get tricky because a large part of the time available under the Article 50 arrangements will be wasted trying to resolve this problem. This, of course, plays to the EC’s advantage because even if it has no realistic possibility of securing a €60bn payout, it can tie the UK in knots for months. Then when it does finally get round to discussing trade arrangements, the UK will have little time to respond and may be forced to accept an arrangement which can only be described as a second best option.

Precisely because the UK government wishes to maintain close ties to the EU, it will be almost morally obliged to make some sort of payment. Ingeborg Grässle MEP, Chair of the European Parliament Budgetary Control Committee, suggested in testimony to the Lords that a figure as low as €22bn might be sufficient to cover the UK’s obligations. I reckon that is the sort of figure the government could live with.

Looking further ahead, there is the question of how much the UK will have to continue to pay in order to maintain access to certain EU projects. On a per capita basis, calculations presented in the Lords report suggest that at €115 per annum, Norway pays around 45% more than the UK does now (€79). Of course, Norway pays for access to the single market which PM May has already ruled out for the UK. But if the UK wants to continue accessing the EU market it will need to pay – either in the form of an annual membership fee or via tariffs. As Richard Ashworth MEP noted in his Lords testimony, a regular annual payment to the EU budget might work out far cheaper than paying tariffs. In his view, “the tariff  that will  be  paid ... seems to be a very, very substantial sum of money indeed ... I do not think it has dawned on people yet quite how big that sum is going to be.”

That being the case, the prospect that the UK continues to pay an annual fee for tariff-free access to the EU is a realistic one. But how high would the subscription cost be? Let us start from the premise that the UK will pay no more than half its current net cost. That would put the upper limit at around £5bn per annum. The government could claim that this represents a significant saving on its current bill (almost £20bn) and that it has saved £15bn per year. However, the reality is that since the UK receives back almost half its gross contribution in terms of rebate, agricultural subsidies and other items, the actual savings are relatively small. Continuing to pay a contribution to the EU is not what Brexit supporters had in mind during the referendum campaign. But if the UK is able to get away with a £5bn (€5.8bn) annual contribution and a one-off exit payment of €25bn, that would count as a good deal in my book. If I were on the UK negotiating team, that would certainly be an outcome I would be pushing for.

I robot, you taxman

When in 1940 Isaac Asimov wrote the first in a collection of stories which was later published as “I, Robot” he could barely have dreamed how far we would advance in the subsequent decades. One of the biggest economic and social challenges of the coming years will be how to deal with the rapid surge in automation which threatens to destroy jobs on an unprecedented scale. Will we find alternative means of employment? Or will we be cast aside as the second machine age (as Brynjolfsson and McCaffee so memorably called it) gains pace?

I have long been fascinated by the application of computers to automate routine tasks and recall a lecture I attended more than 30 years ago when I was introduced to the concept of artificial intelligence. AI had first surfaced in the 1950s when computer applications were developed which could perform fairly routine tasks very well – and indeed, in some cases better than humans. But the difficulties in getting computers to think and act like humans had been underestimated and by the mid-1970s interest started to languish. By the time I became acquainted with the subject, interest had been rekindled by so-called expert systems which utilised programs based on ‘if-then’ rules rather than highly structured procedural programming. A new wave of AI was kicked off in the 1990s by improvements in computing power and advances in deep learning technology, which is a statistical technique designed to allow systems to learn from observational data. By 1997, the world chess champion, Garry Kasparov, was being beaten by a machine and by 2011 IBM’s Watson computer was able to beat human contestants in the TV general knowledge quiz Jeopardy!

There are a number of different strands to the technological revolution incorporating software and hardware innovations which have fuelled concerns that many of us will be replaced by a machine in the not-too-distant future. Indeed, much of the talk today is of how far technology will advance in the coming years with apparently simple skills such as driving now able to be replicated with a high degree of accuracy by machines, That said, a reasonable degree of accuracy is not yet good enough – machines will have to do as well as, or better than, humans in order to displace them. But with 3.5 million people in the US alone employed driving trucks, that is a lot of workers who could potentially be displaced. It is against this backdrop that Bill Gates recently suggested that a tax should be levied on robots in order to safeguard the jobs of humans.

One of the motivating notions behind the idea is that those with access to capital, who employ robots in the first place, would be enriched at the expense of those whose jobs are displaced. The idea is thus to levy a tax in order to reduce inequality. Another motivation is that since it takes decades for the full impact of a major technological revolution to work through, the imposition of a tax will slow the widespread adoption of automation rather than stop it in its tracks, thus giving the workforce time to adjust.

Whilst these are laudable aims, there are serious difficulties involved in imposing a robot tax. The most obvious problem is that it impedes innovation. Imagine where we would be today if the automobile had been taxed to the hilt in order to preserve the jobs of horse carriage drivers. But the sheer range of jobs which can be automated suggests that new technology threatens to displace workers not seen on a scale since the start of the industrial revolution – and even then, displaced agriculture workers were able to find jobs in the rapidly growing urban areas. A bigger problem is that it is difficult to differentiate between technologies that substitute for labour and those which complement it. The introduction of the personal computer in the 1980s had a dramatic impact on the world of work but this has not prevented the numbers of people in employment in the US and UK reaching record highs. A combination of human effort and new technology has facilitated a whole new range of jobs that were previously unimaginable.

So if taxing robots is not necessarily practical, is there anything else we could do? The blogger and economist Noah Smith suggests introducing a wage subsidy for low-paid workers – perhaps by cutting payroll taxes – which will raise the cost advantages of human labour versus capital. Another suggestion might be to distribute capital income more widely by using tax revenue to buy assets (real and/or financial) and distribute the profits to the wider population. The idea is that this gives citizens a stake in society and allows them to share in the profits generated by the new robot labour force.

Although this idea may be anathema to those who believe in ever smaller government, and that the displaced will have to find new ways to compete in a new technological world, the reality is that the pace of change may be too rapid for many. Indeed, unless we start to think about ways to cope with the problem today, modern industrial societies could be overtaken by events. And if we think people are dissatisfied today, wait until they are replaced by machines, with no hope of finding a new job. It could make the Trump/Brexit revolution seem like a picnic.

Taking Europe's temperature

For all that many of the claims made by the UK Brexiteers are absurd, there is a rising tide of dissatisfaction across the whole of Europe towards the EU. This is a danger of which politicians and bureaucrats in Brussels must surely be aware. After all, the evidence comes from the European Commission’s own Eurobarometer survey. The survey, which is conducted biannually, has shown that since late-2011 more than 50% of respondents have registered a lack of trust in the EU whereas prior to the onset of the financial crisis in 2008, distrust levels were running at significantly less than 40%.

Ironically, there are seven countries above the UK in the latest Eurobarometer survey indicating high levels of EU distrust. Perhaps not surprisingly Greece tops the list with 78% of respondents expressing dissatisfaction. Worryingly, given the proximity of the French presidential election, France is in third place with 65% whilst Italy is sixth at 58%. The UK’s 56% dissatisfaction reading is only slightly ahead of Germany (53.2%) which also happens to be around the EU average (53.9%).

However, it is one thing to be dissatisfied with the status quo – it is another thing for voters to opt for departure as has happened in the UK. In a bid to assess the degree of Euroscepticism, perhaps we ought to pay closer attention to the degree of optimism shown by voters towards the future of the EU, on the basis that those who are the most pessimistic are the most likely to want to leave. Here, the picture is slightly different. On the whole, EU citizens show a moderate balance of net optimists (53%, if we exclude those expressing no opinion). But again, Greek citizens show the greatest degree of hostility with only 32% recording optimism regarding the future, whilst the French are in third place (42%) with the Brits fourth (44%).

On the basis that French optimism levels were lower than those of the UK even before the Brexit vote, this suggests that we should take the threat of Marine Le Pen more seriously than we are today. Although the generally accepted view is that Le Pen has no chance of winning the second round, there is a danger that too many pundits are looking back at 2002 and arguing that a coalition will form to stop the Front National (FN) winning the presidency at any cost – just as happened to her father. This view, which is expressed both in France and abroad, might be a touch complacent. Marine Le Pen is not the antagonistic figure that her father was (indeed, still is even in his eighties). If Le Pen continues to hammer home the message that the EU is the root cause of many of France’s ills, she may well run her challenger far closer than the expected 60-40 defeat that the polls currently predict. This is not to say she will win, but if the result is a close run thing, it does suggest that the FN is likely to be a force to be reckoned with in the years to come and that their popularity may not necessarily peak in 2017.

In any case, what has changed since 2002 is that immigration policy is far higher on the list of voter concerns than it was 15 years ago. The Eurobarometer survey indicates that at the EU level it is far and away the biggest concern, followed by terrorism issues, whilst the economic situation trails in a poor third. French voters apparently believe that unemployment is the biggest single domestic issue with immigration some way behind. If the FN manages to convince voters that the EU is partially responsible for the lack of jobs, it will only bolster their standing in the polls.

What is perhaps most concerning for politicians across the continent is that the degree of dissatisfaction which began to take hold in 2008 is gaining momentum. There is little doubt that the economic crisis of 2008, which morphed into a full-blown Greek debt crisis in 2010, has been badly handled. Greek voters are resentful that they have been forced to accept austerity whilst voters in other EMU countries are less than keen to continue providing support. The apparent inability of the EU to defend its borders, with the result that huge numbers of immigrants from the Middle East and North Africa have entered Europe, has also caused resentment. The German government’s policy of throwing open its doors in 2015 is widely perceived to have exacerbated the problem because it has raised tensions in other countries on the transit route that were not consulted.

All this is happening at a time when Europe lacks leaders unable to sell a vision of what the EU can achieve. At least in the days of Kohl and Mitterrand we knew the direction in which Europe was travelling even if not everyone agreed. Without strong leadership, the EU as we know it is doomed – at best to irrelevance, at worst to further fragmentation. The Eurobarometer surveys make it clear what EU citizens are concerned about. But is anyone in Brussels listening?

Brexit: The cost of divorce

One of the motivations advanced by Brexit supporters for the UK to leave the EU is that it will be able to save billions of pounds each year in budget contributions which can be put to more profitable use at home. But it is becoming increasingly clear that the UK will not be able to reduce its EU budget contributions as quickly as many Brexiteers believe. Indeed, it is increasingly likely that the EU negotiating team will announce that settling the UK’s account will be the key item on the EU’s list of negotiating points once the Article 50 legislation is triggered. Moreover, it may decide that it will not discuss matters such as trading arrangements, which is the UK’s number one priority, until agreement on this issue has been reached. I can imagine the spluttering outrage from the UK press already.

Various estimates have been bandied about but the consensus is increasingly homing in on a range between €40bn and €60bn, which equates to around 4 to 6 years of current net contributions. In order to understand where this figure comes from, I am indebted to a paper (here) by the FT’s Alex Barker, which breaks the costs down into their constituent parts.

According to Barker, the UK’s obligations can be broken down into three main areas: legally binding contributions to which Britain has already signed up; pension contributions and contingent liabilities that would only become payable in certain circumstances. It is far from clear of the extent to which the UK will actually be liable for financial contributions after departure. Some form of agreement is likely on areas such as project commitments which have been made but not yet paid for. But a considerable chunk of the EU’s outlays form cohesion payments designed to reduce regional income inequalities, which have so far only been promised and will not become budget commitments until the 2020s.

Barker makes a very insightful observation when he notes that the EU’s budget differs hugely from the system of accounting used in UK public finance discussions. The EU splits its accounts into commitments and payments, in which the former measures what the EU plans to spend on a particular project whilst the latter represents what it actually pays in a given period. This is a political workaround to balance out what the EU wants to spend against what its members are willing to pay. By contrast, the UK operates on an accruals basis whereby payments appear on the budget only when they are actually made, and future plans only include what the government actually intends to commit. Under the British system, the government cannot commit to paying something which is not already budgeted for. The balance between actual and planned commitments on the EU budget is expected to reach €241bn by 2018, of which the UK’s share would be €29-36bn according to Barker’s calculations.

The next biggest item on the agenda is existing structural fund commitments. These appear as a liability on the EU accounts which in Brussels’ view must be paid. By end-2018, the EU’s commitments are expected to total €143bn, of which the UK will be on the hook for between €17 and €22bn. It is unlikely that the UK will be able to dodge much of this bill. But the most contentious part of the exit bill will undoubtedly be pension payments to EU officials. The EU operates an unfunded defined benefits scheme with liabilities of almost €64bn. Barker quotes Eurostat calculations which suggests that “in 2014, the average retirement benefit was €67,149 a year” which is a very comfortable sum. Whilst the UK might offer to cover the pension costs of British nationals working for EU institutions, the Commission will almost certainly argue that officials of all nationalities worked on behalf of all EU members. As a consequence, the UK will be liable for a pension bill of between €7.5bn and €9.5bn.

Allowing for other small liabilities, and the offsetting impact of the UK’s share of EU assets, we arrive at the likely bill of between €40bn and €60bn. Barker’s paper outlines the legal issues in some detail and interested readers are advised to have a look. In summary, the UK is likely to argue that it cannot be held liable for unfunded commitments if the EU chose to live beyond its budgetary means, and thus should not be required to pay for the gap between commitments and payments. However, it has always struck me as odd that the UK argued that the “international law principle of equitable division” would be applied in the event that Scotland voted to leave the Union in 2014 whereas today it is trying to get away with paying as little as possible.

Whilst the question of the Brexit bill is a matter for negotiators (not to mention accountants and lawyers), the British public has not yet been made aware of the fact that it will have to pay a hefty price to leave. It is not as simple as ceasing payments upon exit as we enter a land of milk and honey. Apparently, around 42% of marriages in the UK end in divorce. Every one of those people knows that aside from the emotional issues involved, there is a hard reckoning to be had as assets and liabilities are divided up. This is exactly what will be involved in the Brexit negotiations. They did not tell us anything about this during the referendum campaign, but watch out for a press backlash coming to a tabloid near you as we discover that divorce is costly, protracted and often bitter.

Rationality, not greed, trumps fear

The evidence of recent days suggests that financial investors are more inclined to take the risk of investing in emerging markets rather than the developed world. It is not exactly a new phenomenon: After all, the hunt for yield has been a recurrent theme of financial investing for much of the past eight years. But what is different today is that the EM universe is less stable than it was once perceived to be.

Non-agricultural commodity producers have suffered badly as the price boom of recent years appears to have come to an end. The election of President Trump, which threatens a round of US protectionism, will do nothing to help countries which depend on exporting to the west. Rising US interest rates, and the upward pressure this will impose on the dollar vis-à-vis EM currencies, will raise debt servicing costs. Moreover, the impact of rapid growth in raising wages in many EMs has reduced their competitive advantage at a time when many companies are looking to shorten their global supply chains. 

The travails of the BRICS countries are symbolic of all that has changed in recent years. Brazil has laboured under the burden of a corruption scandal that has seen the president replaced and the economy fall into recession. Russia suffers from sanctions imposed in the wake of the Crimea incursion – an event which has been exacerbated by the decline in energy prices. India is the one exception to the general trend, although even here the strange decision to demonetise large parts of the economy points to a government capable of following economically harmful policies which will impact on growth this year. Chinese growth has slowed sharply, although the much-feared boom and bust is not immediately apparent. 

Meanwhile South Africa – which does not deserve to be mentioned in the same league as the other BRICS countries – is being hammered by falling commodity prices and exceptional economic mismanagement. We can also add in Turkey for good measure, another market previously viewed positively by investors, which has undergone radical political change since last year’s coup attempt and where the government’s exertion of even more pressure on a nominally independent central bank has done nothing to support investor confidence. 

Faced with all of these problems, why are investors even contemplating going back to these markets? First of all, many EMs are cheap following the sharp collapse in key emerging currencies in the wake of the 2013 taper tantrum, so it is still possible to find value if investors are prepared to take the risk. But perhaps what has prompted investors to look further afield is the fact that the stability which traditionally favoured developed markets is being eroded by the rise of populist politics. The unity of the EU is threatened by Brexit, and faced with a lack of returns and mounting political uncertainty in continental Europe, it may pay to look beyond the safe haven trade for the time being. Indeed, the Trump rhetoric has not proven to be as damaging to EMs as was feared in November. It may yet prove to be the case, in which case fund flows will reverse, but there is simply no point in hanging around waiting for an event which may take years to materialise – if indeed it does so at all.

But perhaps the crucial point is that there appears to be evidence that growth in EM economies is beginning to pick up. The Institute for International Finance last week reported that its EM growth tracker in January pointed to the fastest rate of monthly activity growth since June 2011. As emerging markets increasingly become bigger consumers rather than simply exporters of low cost goods to the west, they will continue to gain in importance.

A report published a couple of years ago by PwC (here) highlighted that current trends in demographics, capital investment, education levels and technological progress suggest that by 2050, seven of the world’s top 10 economies will be what we currently describe as emerging economies. According to the report, those with the greatest growth potential are those with demographics on their side. Thus, India is projected to grow by an average of 5% per annum between 2014 and 2050 to propel it to second place in the global standings on a PPP-adjusted basis whilst Nigeria can grow at a rate of 5.5% per year to take it into the world top 10. We should always take such projections with a grain of salt, but they do make the point that there is a huge degree of untapped potential in many of these countries: population size alone suggests that Indonesia, Nigeria and even Pakistan have the potential to become significant economies.

What all economies require to grow rapidly, however, is institutional stability. If they cannot achieve stable government, many of the big EM economies will remain stuck in low gear. But whilst in the next few years we may not see the stellar growth across the EM universe which characterised the period 2002-2012, these economies continue to offer great catch-up potential. Investors ignore them at their peril.