The Big 5: Necessary Ingredients Of Economic Success

|
Includes: BIK, BKF, EEB, FNI
by: Invesco US

Summary

Since the Industrial Revolution, successful economies have exhibited five common attributes.

The absence of any one of these Big Five has resulted in a substantial shortfall in performance.

Comparing the BRICS on the basis of these five criteria, my subjective view is that Brazil and South Africa are best placed for long-term success, while India is not far.

By John Greenwood, Chief Economist of Invesco Ltd.

greenwood-blog-0220_chart

1. The rule of law provides for the protection of freedom and property rights by ensuring the equality of individuals and companies before the law. The rule of law emphasizes the supremacy of law itself rather than of men. If governments and politicians are subject to the law, this reduces the risk of arbitrary confiscation or imprisonment. In addition, the rule of law ensures that legitimate contracts - for example between buyers and sellers, or lenders and borrowers - can be enforced through the courts, and that society does not become hostage to the arbitrary rule of political parties, criminal gangs or other unscrupulous operators.

2. An independent judiciary, police and civil service are critical to the impartial enforcement of the rule of law. The key is that these agents of the state need to be loyal to the system, not to the ruling party. A one-party state that purports to maintain the rule of law often restricts personal freedoms to certain spheres of activity (e.g., sports, business, or entertainment), while outside those areas the individual is effectively subservient to the wishes of the ruling party. In such a society, what appears on the surface to be a framework of laws and freedoms turns out to be illusory.

3. Private ownership is crucial to economic success. Unless land, capital, homes and businesses are overwhelmingly in private hands, the prices of those assets cannot be realistic, and assets are unlikely to be used efficiently. As an example of the consequences of different types of ownership, consider risk-taking. If a person of talent invents a new device, or a new way of offering a service, but cannot introduce it into the economy under his or her own label due to the domination of state-owned enterprises, what incentive will there be to innovate? This is why state-directed economies are often the least creative - they can copy but they cannot innovate.

4. Free market prices act as signals conveying information about the relative abundance or scarcity of goods and services, labor and capital in an economy. No one person or government agency could ever conceivably coordinate prices to produce the right quantity or quality of goods and services. Such coordination is essential to ensure full employment output and the appropriate allocation of income (i.e., the rewards going to those whose output society truly values). In the absence of free market pricing, there will be shortages or excesses of production, and hence losses to society.

5. Stable money ensures that prices remain broadly stable, permitting businesses to plan for the future and consumers to budget their spending. Nowadays this implies a framework for monetary policy whereby the government sets an inflation target, while the central bank is given the independence and day-to-day responsibility for achieving the target. In broad terms, economies with low inflation have generally had better performance than those with high inflation. Conversely, countries with very high inflation have frequently suffered turmoil and even revolution.

NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
Click to enlarge

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is a US distributor for retail mutual funds, exchange-traded funds, institutional money market funds and unit investment trusts.

Invesco unit investment trusts are distributed by the sponsor, Invesco Capital Markets, Inc. and broker dealers including Invesco Distributors, Inc. These Invesco entities are indirect, wholly owned subsidiaries of Invesco Ltd.

©2014 Invesco Ltd. All rights reserved.

blog.invesco.us.com

Additional disclosure: The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.