Davos 2020: Asia Bagged Half Of World’s Investment In The Last Decade, Says McKinsey’s Oliver Tonby
Asian companies have the largest share in G5000—the world’s largest 5,000 largest firms by revenue.
Asia captured $1 of every $2 in new investment in the past decade. Yet, the capital influx has not resulted in higher economic profit, according to Mckinsey & Co.’s Oliver Tonby.
A lot of the investments, however, have been into value-destroying sectors, Tonby, a senior partner and chairman for Asia at the global management consultancy, told BloombergQuint on the sidelines of the World Economic Forum in Davos, Switzerland. From 2005-07 to 2015-17, economic profit dropped from $726 billion to an economic loss of $34 billion and “half of that drop has happened in Asia”, he said.
The investments helped the region rapidly scale, McKinsey Global Institute said in its report—Future of Asia Corporate Asia: A Capital Paradox. Asian companies have the largest share in G5000—the world’s largest 5,000 largest firms by revenue. Asia accounts for 43 percent of the world’s top 5,000 firms by revenue and is the only region whose representation has risen over the past ten years.
Chinese companies doubled their share of the G5000 in the decade to over 900 firms and India’s representation also doubled from a lower base of 85 to 142, the seventh-highest share, the report said. Now, Bangladesh also has a company in the G5000 for the first time.
“Although Asian firms outperform on growth in invested capital, they have underperformed when turning it into economic profit,” the report said. According to Tonby, three things led to this drop—the cyclicality of returns in the energy and materials sector, Europe’s underperforming financial sector and China’s allocation of capital to value-destroying sectors. One-third of all investments happen in China and 80 percent of that has been in value-destroying sectors, Tonby said.
In the past decade, the energy and materials sector turned from being a large contributor to economic profit to the largest reason for lost economic profit over the period, the report said. It accounted for $500 billion of the slump.
However, Tonby said that value is still being added in some pockets. Information technology globally has been a value creator, he said. “We see pockets in Japan—the capital goods sector which means investments, heavy manufacturing, automotive and chemicals. That has been value-creating. We see that tech investments into Japan, Korea and China have been value-creating.”
The coming decade will perhaps reap the benefits of these investments, Tonby said. “We hope these investments are now sunk. They have been put in place so, we now hope to start seeing the returns on some of these over time,” he said. In the Asian context, the ‘Troubled 200’—the 200 largest companies that have destroyed more economic profit than others—need to be turned around, he said.
At the same time the ‘Terrific 200’—companies that have created a disproportionate amount of value—should get disproportionate investments in order to reverse global economic profit destruction, he added.
‘Asia For Asia’
The global economy will see a rise in trade pacts such as the Regional Comprehensive Economic Partnership as globalisation, the way the world knows it, has run its course, said Tonby.
“What we have seen over the last few years is a shift in globalisation and how that is playing out,” he said. “In Asia in particular, we’re seeing increasing regionalisation.”
And these treaties will help smooth trade and are considered positive, he added. “In the long term, we do see a positive benefit from reducing trade barriers.”
Optimistic On India
Even though India has just 142 companies in the G5000, Tonby is positive about Asia’s third-largest economy.
“In the G5000 India has 140 odd companies, that is correct, but on the positive, that’s a doubling over the last ten years. So, it’s significant growth,” he said. India now has more unicorns than Germany, he said, adding, “If you look at the innovation that’s happening, if you look at technology, if you look at the growth, the increase in consuming class in India—these are all factors that lead you to be optimistic.”
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Read the full conversation here:
You just put out an Asia report at McKinsey. I thought that there were some interesting details in that. For instance, Asia accounted for over one for every two dollars in new investment over the past decade but that was mostly dominated by China?
It is dominated by China, but not only China. So, you are right. We just released our report. It is called the Corporate Asia- A Capital Paradox. The reason we say that is— there has been a huge amount of investments globally but also in Asia. 1 out of every 2 dollars has been invested in Asia for the last 10 years. A significant part has been in China. If you look globally, about one third of the money has gone to China. But that means there is still a lot of investment has gone into rest of Asia. The paradox is that, a lot of it has been into value destroying sectors.
India is in fact among those countries which have seen a considerable amount of those value disruptions. So, let me put that in context on the basis of the numbers you have put in. Asia accounts for half of the global deterioration of economic profit, the deterioration is somewhere from $726 billion to now, negative $34 billion. There are sectors that have contributed to this deterioration and then, there are countries that have dominated this. So, let’s talk a little bit in detail about what your insights are on this.
First, I think it’s important to understand what is that we are measuring. So, we’re talking about economic profit which is basically the profits generated by companies minus their cost of capital. You’re right, over the past ten years, we look at a two-year period 2005 to 2007 versus 2015 to 2017. In that timeframe, the economic profits have dropped from positive $700 plus billion worldwide to a negative $30 plus billion worldwide. Half of that drop has happened in Asia. Now, if we stay at the global level first, there are three things that have disproportionately led to this drop. Number one is, energy and materials investments globally anywhere in the world. Those have by and large in most countries been value-destroying. We used to have a super cycle in 2005 to 2007, now those have been value-destroying in that timeframe that we looked at. Secondly, is European financial institutions. They account for another large part of the decline and thirdly is China in itself. It also is a huge part of the downward drive.
As I mentioned, one third of all investments happen in China, almost 10 trillion dollars is of investment in China, 80 percent, of that has been value destroying sectors. So, that gives you a little bit of a picture of the global what causes the global downdraft, so to speak. Having said that, we see value creation in pockets and all countries—there are pockets, some sectors in most countries and we see some sectors globally that have been very positive. For example, in the IT, in the tech space globally we’ve seen that has been a value creator, globally. We see pockets in Japan—the capital goods sector which means investments into heavy manufacturing, automotive and chemicals has been value-creating. We see that tech investments into Japan, Korea and China have been value-creating. Even if you take energy materials, which I mentioned was a large reason for the downward drop, in some places like Southeast Asia has actually been a positive value creation contributor.
What does this data tell us about what this decade could mean in being able to improve some of that value creation or the economic returns of the investments that Asia has dominated over the last years? Are there sectors Asia could do better in, are there areas that countries could do better in? Is there any way to extrapolate this data to what the future might hold?
That’s an excellent question and it’s very difficult to predict the future, but I would say two things. Number one, now we hope these investments are now sunk. They are they’ve been put in place so we now hope to start seeing the returns on some of these over time, so the picture will change quite a bit. But, I would zoom in on two things in Asia particularly. Number one is what we call the ‘Troubled 200’— these are the two hundred largest companies that have destroyed more economic profit than others. We somehow need to find a way to turn around these and we’ve seen that turning around some of these ‘Troubled 200’ has been more stubborn in Asia than the rest of the world. At the other side of the curve, are the ‘Terrific-200’. These are the companies that really have created a disproportionate amount of that value. Many of them are either in tech, in consumer and pharma. We expect to see those continue to drive and that is actually true across many countries. So, for at a country level you would hope and want the country to disproportionately invest in some of these sectors going forward.
Could this be the decade in which we might be able to reap the fruits of the investments that have gone into play in the previous decade and have not yet paid off as much but that could be a big growth booster for Asia this decade?
You would hope so, you would hope so. But as I mentioned, some of these companies have been proving quite stubborn and very tough to turn around but you would hope so.
Okay, I want to talk a little bit about trade in within Asia and Asia in the rest of the world. I think that brings me to RCEP, which is the most important trade treaty that many Asian countries are currently in the process of either signing up sans India or implementing it in some ways. What do you make of the impact this could have in the way Asia trades with the rest of the world?
So, first of all what we’ve seen over the last few years is a shift and globalisation and how that’s playing out as we well know. In Asia in particular, we’re seeing increasing regionalisation. So, we’ve done a lot of research looking at all kinds of flaws—not only capital, not only trade but also in technology inflows of people and so forth. We’re increasingly seeing Asia for Asia in these flows. Just a couple of examples—we see that travellers—now Asia is responsible for a huge number of travellers worldwide and more than 70 percent of those travellers are actually within Asia—they travel within Asia. Asia is responsible for 48 percent of international students. A number of them are intra-Asia, but most of the trades is actually happening, almost 70 percent of the trade is happening within Asia, capital inflows, capital goods is happening within Asia. So, we see Asia for Asia. So, that’s one of the chapters of globalisation going forward.
RCEP and such treaties I think will increase that regionalisation because some countries have opted out as you know but many countries still are in. We are positive to these trade treaties. We believe that they help smooth trade and that’s generally a good thing. We’re not going to second-guess any countries and what different countries do, they’re looking after their people as best as they can. But in the long term, we do see a positive benefit for reducing trade barriers.
Do you think then India missed a step by not signing up at this stage or are you hopeful that it will eventually happen in a year or two down the line?
That’s for up to others to decide, I’m not an expert and I don’t second-guess any government. I think India’s government is doing what they think is right for India and I can understand that there are pros and cons here.
Two specific data points about India that interested me, one I think India had only 142 companies in the G5000 as you call it or the 5000 largest firms in the world. China had 900 which again goes to underscore the contrast in size and fact that China’s been moving at an incredible speed which India has not yet been able to achieve.
Secondly, in your description in the report on the destruction of economic value, India did seem to be among the two or three countries that had probably the highest numbers with regards to that. How do you see the position of India in Asia? Of course, we’re among the largest and all of that and what the next few years might speak of India’s role in Asia?
So, if I’m allowed to have two thoughts at the same time. I am of course, I am like many others, worried about a number of things when it comes to the world and also to India. When you look at topics such as sustainability, environmental sustainability, inequality and those have got you worried when you look at things such as the recent slowdown that we see globally but also affecting India. When you look at what’s happening in geopolitics worldwide and tensions—also tensions in respective countries, you do get worried. The other half of me though is, that I am optimistic. You’re right, in the G5000 India has 140-odd companies, that is correct, but on the positive that’s a doubling over the last ten years. So, it’s a significant growth. Let’s also be clear many regions and other countries have actually reduced a number in there.
It’s also positive when you look at India. Look at the number of unicorns. If you look at the innovation that’s happening, if you look at technology, if you look at the growth, the increase in consuming class in India—these are all factors that lead you to be optimistic. So, on the unicorns India now has more unicorns than Germany has as an example, and one of the highest in the world. So, I think as I said, I’m of two minds. One of long-term I come down as a hopefully realistic, but an optimist, so a realistic optimist I would hope.
And short-term?
Short-term, there are worries and I hope that we can resolve them hopefully, some here in Davos. But, I am an optimist by nature.
