Can India be a breakout nation?

By Ruchir Sharma | Dec 9, 2012, 08.05 PM IST In my day job as an investor I wander the world, kicking the tires of emerging economies to see how fast they can go, but I've been a writer for as long as I have been an investor because I see my job as more art than science. I find many of the popular theories about why emerging nations grow amusingly academic and overconfident, for example in their attempt to forecast decades into the future by looking decades into the past. I try and travel to at least one emerging market every month not because I love planes but to get a first-hand grip on the unique mood and feel of a country to understand where its economy is likely to head in the next five to ten years, the period that matters to practical people. The glory that was India or China in the 18th Century can't tell you much about who the next leaders will be or what they will do for prosperity. Loosely speaking, in the last decade economists have tried to explain and forecast which nations will succeed or fail by focusing on one key factor. The hottest one right nowbased on a US bestseller that I didn't writefocuses on institutions, the basic idea being that countries with stable and open banks, courts, legislatures and other institutions create an environment in which entrepreneurs can build businesses and innovate, one of the keys to a competitive economy. Like all such grand theories, this one gets one clue right but starts to fall apart as soon as you try to apply to it every mystery, case by case. If open institutions are the magic key, how do you explain the many success stories in Asia, especially China, where most institutions are intensely secretive yet also quite competent? And neither does China have very clear property rights - a favorite factor of many development economic theorists. Another set of these ideas focuses on geography, arguing that nations fail because of remote or landlocked locations, off the beaten path of global trade, or isolated in the deserts of equatorial Africa. Sounds plausible enough, but some of the most out-of-the-way nations of Central Asia were among the world's fastest growing economies in the last decade, including Kazakhstan and Tajikistan. These theories miss a lot of facts on the ground, much like the movie "Borat", which was spoofing Kazakhstan as hilariously backward at a time when it was booming. The fastest growing province of China is now Inner Mongolia, long a punch-line synonym for the back of beyond. A close cousin of the geography theories is the idea that culture determines growth, but this one had for the most part fallen off the map until Mitt Romney revived it during the presidential campaign, when he suggested that "culture makes all the difference" in describing the very different fates of Israel and Palestine. The origins of this theory go back to German philosopher, who suggested that the protestant work ethic explained the economic success of northern Europe, compared to Catholic nations of southern Europe or the Confucian and Buddhist nations of Asia. Later, ignoring Weber, the culture theory was revived to explain the rise of Korea and China as a function of the superiority of the Confucian work ethic. But where was this much talked about work ethic in China under Chairman Mao? The whole thing started to fall apart when Buddhists and Hindus began to prove that they, too, can work up an economic boom. To apply it to Islamic cultures today ignores the strong growth in the most populous parts of the Islamic world, including Indonesia and Turkey, which will be the next two economies to join the exclusive club of a one-trillion dollar economies that so far has only 15 members. A theory that is especially popular in India right now focuses on the "demographic dividend", and suggests that the fastest growing economies will be found in the countries with the best demographics, meaning the youngest, fastest growing population and labor force. Indians came to love this idea because it transforms their booming population which was feared only a decade ago as a "population time bomb"into a competitive advantage. Both the fear and the euphoria are irrational, because the impact of population growth depends on how government handles it. For many decades, until very recently, a booming population was a huge advantage to China, because the government found work for all those youths in export factories. And for many decades, also until very recently, a booming population was a huge disadvantage for Africa, where the economies weren't generating jobs, and all those youths were so many more mouths to feed. These one-dimensional theories are often based on historical records going back decades and look forward for

equally long periods. As a result, they tend to miss what is going to happen over the next few years. Global growth is slowing, and so is growth in emerging nations, with wider gaps between winners and losers. Spotting winners in this new era will require looking at many factors, and traveling to see what is happening on the ground, not relying on theory or numbers alone. I like to get out and travel, to try to understand the individual storyline in each country, which is why I am as much a writer as an investor. As an investor I find it useful to work as a journalist, because writing for the public forces me to clarify the basic national plotlines in my own mind, and as a journalist I find it useful to work as an investor, because managing other people's money forces me to seek the true story, not only the provocative one. What I'd like to offer you today are some of the rules I've learned over the years about how to spot a country that is preparing to take off, or crash land. There is a place for wonky data analysis in my other world, but here I'd like to focus on simple rules any smart traveler or writer can understand and apply on the ground. Below I consider India's prospects using my rules for spotting breakout nationsthose that can grow faster than rivals in their income class, and expectations for that class. 1. The growth-is-not-easy rule The longer a boom lasts, the less likely it is to continue. In the last decade, emerging markets took off as a pack, creating the illusion that rapid growth is easy, and normal. Nothing could be farther from the facts. Rapid growth is extremely difficult, and rare. It is unusual for an emerging nation to post even one decade of fast growth, much less to extend that boom into a second decade, and even less into a third, fourth or fifth decade. Only two countries since World War II have grown at an annual pace of more than five percent for five decades, South Korea and Taiwan. What this means is that, in the big picture, emerging nations are not, contrary to widespread belief, catching up to rich nations. On the whole, the average income in emerging nations is just as low, relative to developed nations, as it was in 1950. So if a boom lasts as long as a decade, the probability that it will continue shrinks rapidly with each passing year. Typically, pundits and the public assume the oppositethat one good decade spells good times foreverso when you see that overconfidence, you know the end is near. This is what happened to India, which came to believe it was destined to be the next China before its run of 8 to 9 percent growth suddenly slowed last year. Now, India may be coming to understand the harsh reality, which is that the normal state of economic competition is chaos, with more losers than winners, and that this is true not only for nations but for the states of India. Chaos is the rule for competition between nations, and even for states within big emerging nations. A big exception is China, where the same southern coastal provinces where the boom began in 1980 have tended to dominate the ranks of the fastest growing states. In recent years, growth in China has spread steadily into the interiorlikely due to the consistent control of a heavily centralized national government. The states of India, in contrast, tend to rise and fall quite dramatically, depending in part on who the state leader is. If you divide up the last quarter century into five year periods, only one Indian state, Maharashtra, has remained among the top five fastest growing states for even three consecutive periods, while in China five different provinces have achieved this kind of run. One hope for India is the growing evidence that its structure is evolving from one single economy into a federation of state economies, with many of the poorer states like Bihar now leading the country in terms of the pace of economic growth. But the lesson of the chaos rule is simple: India just put up a decade of very strong growth, which reduces the likelihood of strong growth going forward. 2. The regime rule The political system doesn't matter, but leaders do. The success of command-and-control capitalism in China has set off a vigorous debate over which political system is most likely to produce growth, which I think misses the point. It's not the type of system that matters, it is the stability of the system and, even more important, whether the leaders running it understand the basics of economic reform, and have the street credibility to push tough reform. Whether those leaders work in a democratic or authoritarian system makes no difference. If you look at each of the last three decades, only a few dozen nations grew at an average annual rate of 5 percent or more for the full decade, and about half of these were democracies, and half authoritarian states, including monarchies and military regimes In India it is popular to argue that China has been able to grow faster because its authoritarian system can push tough reforms more easily. However, a closer look at countries that have posted high economic growth over the past three decades

shows that 52 per cent were democracies. What matters most is not the system, but whether the political leaders understand economic reform. This signal is mixed for India, because faltering leadership at the national level is balanced by the rise of dynamic state leaders. 3. The leadership cycle rule The longer a regime lasts the less likely it is to take smart steps to promote economic growth. Over time leaders get settled and self-satisfied, they shift focus from the national interest to protecting vested interests, or they simply run out of progressive ideas. As Ralph Waldo Emerson said, at last every hero becomes a bore. In an established democracy, such heroes will be eased out by their own party, even if they were seen as dynamic forces of reform. Britain has done this twice in recent decades, to Margaret Thatcher on the right and Tony Blair on the left. The worst case of stale heads of state is in the former Soviet republics, from Belarus to Turkmenistan and Kazakhstan to Russia itself, where Vladimir Putin seems to have anointed himself leader-for-life, changing his titles but not his dominant role. George W Bush tells a great story about how Putin changed in office: the first time they met, Putin was focused laser like on bringing down Russia's debt, but the second time they met, eight years later, Putin was fall of bravado, trying to figure out ways to but American debt, and cracking jokes about how his dog was bigger, better, faster than Bush's terrier, Barney. Power goes to the head. In recent years, the general success of emerging markets helped convince many leaders that they are personally responsible for their nation's success. From Cameroon and Nigeria to Bolivia and Venezuela, incompetent or corrupt leaders have fought successfully for the right to extend the deadline on their terms in power. A related dodge is stepping down in favor of your spouse. This is how Nestor and Cristina Kirchner extended their hold on Argentina, which has been so badly run it was demoted from the list of nations Wall Street tracks as "emerging markets" and into the lower class of "frontier markets." Roughly speaking, leaders seem to go stale as an economic force after roughly seven or eight years in power, which is what we are seeing in India. From the first term of Prime Minister Singh and the Congress party coalition to the second, economic growth has slowed, inflation has risen significantly, and so has the deficit. But in an increasingly federal India, the longevity of the central government is balanced by the rise of new state leaders, for whom strong state economic growth has become a necessary condition for reelection in virtually every state ballot since 2007. So this rule sends another mixed signal for the country. 4. The tough reform rule Watch for complacency. The economies that grow rapidly for many years or decades have a sense of urgency about catching up with the developed world, and to do that they generate steady momentum behind economic and political reform, even in good times. Among the star reformers today are Poland and the Czech Republic, still driven to catch up with the West after so many decades of forced stagnation under Soviet rule. But those are the best-case exceptions. Most nations reform only when they are in crisis; so the more useful question is, when a country's back is to the wall, does it push the kind of tough reform and austerity measures that will promote long term growthlike South Korea after the Asian crisis of 1998or does it simply spend money to cushion its population against feeling any painlike Japan after its property bubble popped in 1990? India is a classic case of the reluctant and erratic reformer, but at least when crisis hits, it tends to adopt or at least accept real competitive reform that open its doors to outsiders, and allows it to grow when the global economy gains speed. There is, in fact, a steady ten year cycle of crisis and reform in India. What happens is India falls into some kind of financial crisis, usually because it can't scrape up the dollars to pay its foreign bills, and has to scramble its way out. In the early 1980s and early 1990s, this meant running hat in hand for a loan from the IMF, which forced India to cut back at home and open up to trade abroad. In the early 2000s, however, following the dotcom meltdown, growth slowed sharply and India took presented a couple of reformist budgets that, among other things, freed up trade in farm goods, rationalized the interest rate structure and also increased the focus on key sectors such as roads and telecom. . This helped set the stage for India to participate in the global boom that was to come. Now, as growth slows in the wake of the global debt crisis and capital flows are scarcer, India has once again begun to roll out reformincluding opening its doors to foreign retailers and mending its subsidy payout system. So, for the moment at least, India is headed in the right direction on reform.

5. Reaction to inequality rule Watch for angry populist protests against inequality, because it is a signal of imbalance in the economy that can also stop reform in its tracks. These days, inequality is a hot button issue from Seoul to Santiago, and you can hear citizens just about everywhere complain that the global economy is profiting the plutocrats, expanding the ranks of the poor and squeezing the middle class. While in countries like Mexico, popular resentment has long driven the superrich to seek a low profile; in others such as India, the superrich were recently feted as a symbol of growing economic prowess, but now they face tough questions about what they contributes to that success. Development economic theory holds that inequality will at first increase due to market forces being at play but will then decrease after a certain level of income is achieved. Our research shows that the tipping point is around $5,000 - that's when inequality should start to decrease. Of course, even before that inequality should not run well ahead of per capita income levels or that too can lead to a backlash against the reforms. Longer growth spells are robustly associated with more equality in income distribution. Korea - the country I call the gold medalist of growth because of the way it achieved sustained economic success in an almost unparalleled way - was one of the least unequal developing countries during its period of high growth and there was not much explicit use of welfare policy to reduce inequality. Research shows that land reform carried out in the late 1940s and the total destruction of industrial assets during the Korean War made Korea an unusually equal country at the very beginning of its growth process in terms of income and wealth. It then forestalled the rise of inequality primarily by creating one of the strongest systems of universal education, for rich and poor, in the world. On the other hand, poorly designed incentives could grossly distort incentives and thereby undermine growth, hurting even the poor. Watch then for how governments address inequality. Right now, many emerging nations are addressing the problem by ramping up welfare states that they cannot afford, providing subsidies that support the poor, but don't help them join the middle class. When I warn, for example, that Brazil's government is now spending as much, relative to the size of its economy, as the richest welfare states of Europe, I've been attacked as a typical Wall Street type who could care less about the poor. That attack quite misses the point, which is that to sustain growth nations have to maintain a kind of Zen balance in the economy appropriate to its stage of development and trying to carry a fat welfare burden at an early stage won't get the job done. To this day South Korea spends very little on social welfare, for a nation in its income class, and I would in fact argue that Korea needs to spend more on welfare in areas such as child care so that more of its women can get to work. Korean women are well educated but their participation in the labor force is relatively low because the support system for child care is weak forcing more women to stay at home to look after the children. Among those nations that are overspending right now: Brazil, Russia, Thailand and India. At nearly 30 percent of GDP, total government spending in India is very high for a country at its income level, which is way out of balance and a bad sign. 6. The billionaire balance rule Read the list of top billionaires. It can provide a quick bellwether for the balance of growth, across income classes and industries. If a country is generating too many billionaires and outsized fortunes, it's out of balance. If the same tycoons dominate the list for years, it's a sign of stagnation. Healthy economies should produce billionaires, but they want good billionaires who face real competition and make money in productive industries like technologythe industry that produced the most billionaire wealth worldwide in the 1990s. As Warren Buffet put it in a 2006 letter to shareholders: "If you want to get a reputation as a good businessman be sure to get into good business". Unfortunately the 2000s saw the global rise of the bad billionaires, who rely on government connections to corner monopolies in industries like oil, which now dominates the billionaire lists. Russia, the world capital of the bad billionaires, scores badly by ever measure, with the same oil tycoons dominating the top of the list year in and year out, piling up outsized fortunes. Russian billionaires are now so powerful they are squeezing out both the middle class and the millionaire class: Russia a rank second in the world for billionaire, sixth for people worth more than $100 million, and doesn't even make the top 15 for millionaires. India is not in Russia's league, but until recently its billionaire lists made for gloomy reading, too. There has been little turnover among the top ten billionaires, and when changes come they tend to replace the 1990s generation of

tech entrepreneurs with provincial tycoons who cut political deals to corner unproductive industries like mining or real estate. Along with Russia, India is one of the few nations where the average wealth of the top 10 billionaires is in excess of $10 billion. With no wealth or inheritance taxes, India has long been top heavy with billionaires, but this class now controls assets equal to 12 percent of GDP, compared to 3 percent in China. The billionaire lists are likely to grow more useful as the sample for emerging markets, many of which had few tycoons even 15 years ago, increases. It's clear what to look for: Billionaires should face competition that limits their control of the economy, that promotes turnover at the top, and that generates wealth in industries that are productive, not politically connected. On the upside, the 2012 top 10 list for India include two who weren't there five years ago, with at least from a dynamic and productive industry: pharmaceutical magnate Dilip Shanghavi. What matters for a country's future is not how good or bad the current situation is, but whether the direction of change is for the better or worseso even these marginal changes in the billionaire list could be a good sign for India. 7. The corruption matters rule In absolute terms, India scores not that badly on corruption perception indexes, at least compared to countries of similar per capita income like Vietnam or Nigeria. There is a clear link between wealth and corruption. Simply put, the richer a country is the less corrupt it tends to be. But like the chicken and egg story it is still not clear which comes first: do countries tend to be less corrupt because they are rich or does corruption hold back a country's growth prospects. The answer probably again lies in the balance. Corruption is normal at low income levels but if there is too much corruption relative to a country's per capita income or if perceptions about corruption begin to worsen dramatically over a short span of time than that can retard growth. In 2010, I was struck by how quickly India was falling in the perception rankings, and by how loudly Indian businessmen were complaining that they could not do business at home, because of all the graft. For this reason, I wrote a cover story for Newsweek in September 2010 on ho corruption could end up being India's fatal flaw and it ended being one of the better-timed stories I had written. I don't see a lot of improvement in the mood. While at 94 out of the 174 countries tracked by Transparency International, India's ranking is not that low given its relatively low per capita income of $1,500 with other countries with a similar per capita income such as Nigeria and Vietnam ranking even lower, what's troubling is how sharply India's corruption ranking has fallen over the past decade. It ranked 70th in 2001 and normally as a country moves up the per capita income curve its ranking should increase not fall. Therefore, this is a bad sign. 8. Factories first rule Look for the factories, because economic miracles begin in and are typically driven by manufacturing. As economist Dani Rodrik has shown, virtually all of the most successful economies of the postwar era were exceptionally good at moving workers from the farm to more productive jobs in urban factories. The trick is finding a niche in global manufacturing, because once a country gets in the game, productivity and growth take off even in countries with meddling government, incompetent institutions, and remote locations. One reason, Rodrik writes, is that it is relatively easy to copy factory assembly lines from a cutting edge country like Sweden, but it can take years if not centuries to copy Swedish institutions. India ranks poorly by this rule, because it has gone at the development path backwards. Most long-term economic successes began developing with a focus on low-end manufacturing, which put rural workers into more productive factory jobs, improving their skills and creating a pool of capital to deploy when the manufacturing boom ends, and the economy began to shift to services. India went the opposite way, starting by moving workers into IT service industries like software and call centers, which require fewer workers and are not that much more productive than the farms those workers came from, Rodrik argues. In India the manufacturing share of GDP has stagnated over the last 10 years and slipped a bit in the past five, to just 14 percent, which is a good five to 10 points lower than it should be at this stage of development. And it could be increasingly difficult for India to get in the manufacturing game: because modern factories employ fewer and fewer people, it will be difficult for upcoming emerging markets to move great masses of labor from farms to factories, the way China did. This is a tough obstacle for India. 9. The currency rule

Economists have all kinds of fancy ways to measure the competitive strength of a currency, but when a country is pricing itself out of the competition; you can feel it on the ground. Until very recently, the rapid increase in the price of oil and other raw materials was driving up the value of currencies in countries that rely on exports of commodities, from oil to iron ore and coffee. The rising value of these currencies, including the Brazilian real, the Russian ruble, and the South African rand, was inflating the price foreigners pay for every other kind of good these commodity-driven nations try to sell, from cars to consulting services to hotel rooms. In early 2011 the major Rio paper, O Globo, ran a story on prices showing that croissants were more expensive than in Paris, haircuts cost more than in London, bike rentals more expensive than in Amsterdam, and movie tickets sold for higher prices than in Madrid. I developed an index comparing the price of rooms in business hotels in the major emerging market capitals, which showed that Moscow and Sao Paulo were more expensive than even most developed world capitals. India, however, ranked rather well by this measure. Its room prices were 14 percent below the average for major emerging market capitals in late 2011 and have fallen by 37 percent since then, as the rupiah weakened. This is a good sign. If the local prices in an emerging-market country feel expensive even to a visitor from a rich nation, outsiders aren't going to stay long, and they aren't going to invest much in factories or farms either. 10. The locals know best rule Watch the locals, they know the economic scene best, they get the news first, and they will be bringing money home to a nation on the rise and fleeing one in decline. In a financial crisis, the first to flee are the large local investors, who in many emerging markets must move money through underground channels because of rules limiting capital flows. The use of back channels means that this flight of money will not show up in the standard national accounting categories, but often produces a marked rise in the catchall category called "errors and omissions." In normal times, the largest movements of money are captured as net capital flows, which will be deep in the red if locals are voting with their feet and moving money out of the country. Right now, this indicator is flashing red in Russia, where capital has been flowing out at a stunningly high rate for several years, and this year will reach about $74[e2] billion or 4 percent of GDP this year. South Africa is also in the red zone, with net capital outflows equal to 2 percent of GDP. India looks pretty good by this measure: capital is flowing into the country, equal to about 4 percent of GDP. And there is no sign locals are sneaking money out of the countrythe usual warning sign of a balance-of-payments crisis A good sign. 11. The going global rule The sight of local companies "going global" is often celebrated in headlines as a national success, but the accurate read on this signal depends on the circumstances. Going global can be a sign of corporate strength or of national weakness. If more than 50 percent of a nation's corporate earnings are coming from abroad, it could be reason for concern. In Singapore, where businesses can't make all that much money at home because the population is so small, it is not alarming that more than 50 percent of earnings are made overseas. In nations with sizable domestic markets like Mexico and Russia, it can be read as a vote of no confidence in the local economy. South Africa is perhaps the leading example of this negative -phenomenon, but India is not far behind. Driven abroad in part by the rising cost of meeting payoff demands from corrupt officials, Indian businesses have been cutting investment at home, from 17 percent of GDP in 2008 to 12 percent, while the overseas share of Indian corporate profits has risen fivefold in just five years. Given the potential of the domestic marketplace, Indian companies should not need to chase growth abroad. But just over half the earnings of India's top-fifty companies are now "outward facing" or dependent on exports, global commodity prices, and international -acquisitions. When emerging nations start spending too little on investment at home, the big risk is a spike in inflation. As investment dries up, the nation is not putting enough money into the new factories and new roads that are required to make and deliver the goods desired by an increasingly prosperous middle class. Supply falls behind growing demand, and prices start to shoot up. That's why graft is inflationary: it channels money away from productive investment. In 2010 and the first part of 2011, inflation in India was running at more than 9 percent, up from 5 percent during the 2003-2007 boom. 12. The helicopter rule One measure of success in an emerging nation is how fast you can drive across town in the national capital at rush

hour. This really matters. The larger the traffic jams, the less the country has been spending on new roads, bridges, and other basic hardware of a modern economy. The low investment rate doesn't just lead to annoying delays. It also means the economy can overheat at a very low rate of growth, like a weak engine. If a nation's supply chain is built on aging factories and potholed roads, supply cannot keep up with demand, and prices will rise. A big reason China could grow at a double digit pace for so long without much inflation was that it was investing about 10 percent of its GDP each year on new infrastructure. In contrast, a nation like Brazil overheats at a much slower rate of growth in large part because it invests just 2 percent of GDP on new infrastructure. I call this the helicopter rule because one clear sign of underinvestment is when private citizens and businesses start coming up with artful ways to dodge around or fly over the weak public networks of roads, power lines or communication facilities. In Paulo, CEOs exasperated with the clogged roadways have developed an alternative transport system: a network of landing pads on the rooftops of office skyscrapers, so that top executives can hopscotch from one corporate headquarters to another by helicopter. In African markets including Nigeria, it is common for businesses to install elaborate backup generators with fuel storage tanks, to keep the power running during frequent blackouts. By this rule India doesn't rate very high. It investments about 7.5 percent of GDP on new infrastructure, which is more impressive than the results, in part because an increasingly large share of that money is spent not by private companies but by the government, which is not doing a great job of building the roads, bridges and airports that India needs. In all this is another mixed signal for India. 13. The inflation rule This is one is especially critical for India because so many top officials are getting it backward. They explain India's high inflation by saying that rising prices are normal for a prospering economy, as demand grows for fancier cars, better food, and pricier homes. Now, these are smart people with prestigious academic credentials, but they simply have the facts wrong. The rule is that low inflation is a hallmark of long economic booms, because strong investment creates the extra capacity that allows the economy to meet rising demand without higher prices. And when prices do begin to rise, it's a sign that the boom is over. The Growth Commission Report sponsored by the World Bank details 13 economic success stories of countries that were able to sustain an average growth rate of 7 percent or more over at least a 25-year period. During their respective boom periods, inflation in these countries was lower than their emerging market average 70 percent of the time. Further, Brazil skews the average. In other countries, inflation decelerated steadily through the high growth periods and was, in fact, lower at the end of the boom than at the start. 14. The market mirror rule The stock market may seem like a casino to many people, but it is also the best real time reflection of the economic scene. Just a glance can tell you more than you might think. If the market lists few companies and has a total value representing only a small fraction of the economy, this is a country with a lot of room to grow rapidly. If the market has hundreds of listings representing a widely diverse array of industriesas is the case in South Korea or Indiait is a sign of healthy balance in the economy. If the stock market does not list even one manufacturing company, as is in Moscow, it is a very bad sign. Stock market growth normally mirrors growth in the economy, and if it does not, that is a sign of serious distortions in the economy's structure. In Mexico, for example, the stock market grows much faster than GDP because the economies are dominated by monopolies, which are highly profitable (which is good for stock prices) but also highly unproductive (which is bad for growth). In China over the last 10 years, the stock market has actually been shrinking even as the economy boomeda symptom of investor distaste for unprofitable state companies. In India, the big and diverse and growing market mirrors economic growth not only in India but across the emerging markets, a very good sign as this also helps in a more efficient allocation o capital. 15. The second city rule Check the size and growth of the second city, compared to the first city. In any big country the second-largest city usually has a population that is at least one-third to one-half the population of the largest city. This ratio reflects

regional balance in the economy, and it holds true for many of the nations that were breakout stories in recent decades: Sao Paulo and Rio de Janeiro in Brazil, Seoul and Busan in Korea, Moscow and St. Petersburg in Russia, as well as Taipei and Kaohsiung in Taiwan. It's a red flag if a country is stuck in violation of this rule, but it's a good sign if a capital-centric nation is moving toward greater balance. It's even better if the country is producing new cities with populations of one million or more, which suggests that growth is lifting all regionsnot favoring the elite in the capital city. Much of the recent political trouble in Thailand stems from the simple fact that Bangkok is ten times larger than the next most populous city, and its dominance of political and economic life has provoked the rural revolts that have stymied growth in recent years. By contrast, Indonesia has both a strong second city in Surabaya, with a population roughly one-third that of Jakarta, and there is a growing number of cities of 1 million, increasingly the healthy geographic spread of growth. India scores poorly on the second city rule: it appears to have a strong second cityDelhi is only slight less populous than Mumbaibut in a nation this sprawling, it is probably more accurate to say that power is concentrating in a string of megacities, and that its first cities now dwarf its second cities and its small cities. In India 16 percent of the population lives in cities of more than 10 million people, compared to 5 percent for China. China has far more strength in mid-size cities and particularly in small cities. Between 1950 and 2010, 23 cities in China saw population grow tenfold to 1 million or more, compared to just six in India: Dhanbad, Aurangabad, Bhilainagar, Ranchi, Guwahati and Chandigarh. So this rule exposes one vulnerability of India. 16. The cluster rule Take note of how locals get along with the neighbors. It's only natural for nations to trade most heavily with their neighbors, and it's also important for any nation that wants strong growth. One of the striking characteristics of the rare postwar economic success is that they tend to appear in geographic clusters: the oil nations of the Gulf, the nations on the southern periphery of Europe after World War II, the nations of East Asia in the same period. For most of East Asia, trade within the region has been growing faster than trade with the rest of the world. Indeed the success of East Asia has been driven in no small measure by the willingness of China, Japan, Taiwan, and South Korea to leave old wars in the past, at least when they are cutting business deals. In contrast there is no region in the world with weaker trade among immediate neighbors than South Asiaincluding India, Pakistan, Bangladesh, and Sri Lanka. Isolation, lawlessness, and old grudges have made it difficult to move across borders, and trade within South Asia has stagnated at 5 percent of total trade with the world. Indeed South Asia could learn a lesson from Africa, where there are at least five separate efforts underway to create regional common markets modeled on the early stages of the European Union. For now, however, bitterness among the South Asian neighbors is preventing the rise of regional economic power. Not a good sign. So, what do these rules tell us about the direction of India? We have seven negative signals, four positive signals and five mixed signals. I don't try to weight these signals for importance or assign some spuriously precise score to the results, but the general picture suggests that India has about a 50/50 chance of being one of the few winners in global economic competition over the next five to ten years. Those of you familiar with Breakout Nations will know India is one of very few countries that I place in this gray area. That brings to mind a phrase that Prime Minister Singh is said to be very fond of, which is that whatever you say about India, the reverse is also true. There's something to that. I define winners as those nations which grow faster than rivals in the same per capita income classso that India compete against nations like Indonesia and Philippines with incomes lower than $5,000and also the growth expectations for the country and the class. Expectations surprises some people, but lots of research shows that satisfaction is derived less from how rich you are, than how rich you are relative to your neighbors, and to what you had hoped for. So while India's growth has slowed sharply, but so has growth for all other emerging nations, and so have India's expectations. In a national economy that seems to be breaking up into its component states without falling apart, those expectations now vary widely between fast growth states like Gujarat and slow growth states like West Bengal. But no one talks about India being the next China anymore, which should make it easier for the nation to reach its goals. There's not a lot of fear or euphoria. If there is one big theory in the rules, it is that balance is good, and India's hopes are in balance right now. Ruchir Sharma is managing director and head of the Emerging Markets Equity team at Morgan Stanley Investment Management, and author of 'Breakout Nations: In Pursuit of the Next Economic Miracles'