C&B Notes

Rethinking Lazy Macro Labels

Categorizing economies as ‘emerging’ versus ‘developed’ is a lazy label of convenience that masks nuances and subtleties that meaningfully differentiate countries, their economies, and the businesses domiciled within them. An investor cannot gain a true and full understanding of any of these in aggregate but rather must do so on a granular level in each place.

When Matteo Ricci, the Italian 16th century Jesuit missionary, traveled to China to win converts to his faith, he found that his European maps, which showed China relegated to the cartographical margins, failed to endear him to his hosts.  So he redrew them.  The resulting world map of 1602 placed China at its center, an accommodation that is said to have helped him win influence among the Middle Kingdom’s elite.  Ricci’s revisions were made on woodcuts and paper.  Now, commentators say, it is the world’s mental map that is in dire need of an overhaul, particularly when it comes to the practice of categorizing countries as “emerging” or “developed” markets.

The current economic hierarchy, which places emerging nations at the periphery and developed markets at the core of world affairs, no longer accurately describes a world in which EM countries contribute a bigger share to global gross domestic product than their developed counterparts, when measured by purchasing power parity.  Nor does the capacious category, which lumps together countries of such diverse economic strengths as China and the Czech Republic, serve to illuminate crucially different realities between these nations.

“The EM term has outgrown its usefulness,” says Michael Power, strategist at Investec, a fund management company.  “The term today embraces big and small, developed and under-developed, industrialized and agrarian, manufacturing and commodity-based, rich and poor, deficit runners and surplus runners, and I could go on,” he adds.  At issue are not merely the niceties of symmetry and order.  Emerging markets is one of the most powerful definitions in the world, with an estimated $10.3tn invested in emerging financial markets via an alphabet soup of equity and bond indices.  But these indices embrace such a collection of incongruous assets, that they misdirect investors and potentially reduce returns to pension funds, insurance companies and other financial institutions…

Even accepting prevailing classifications, it is often unclear why one country has been awarded emerging status while another merits a developed tag.  Chile has a bigger economy, a bigger population, less debt and lower unemployment than Portugal but is classed as emerging, whereas the European nation remains part of the developed world.  Similarly, on a per-capita income basis, Qatar, Saudi Arabia and South Korea are wealthier than several developed countries, but are still consigned to the emerging camp.

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This leads to the curious situation in which emerging nations, which need to invest their reserves in large liquid debt markets, have ended up bankrolling years of deficit-financed excess in large developed countries.  China, for instance, was the biggest foreign buyer of U.S. Treasury debt for six years until early 2015.  But aside from the various ways in which the EM tail appears to be wagging the developed dog, the broad inclusion of scores of countries glosses over crucial differences between emerging nations, misleading observers to construe equivalence where none exists.

Sree Ramaswamy, senior fellow at McKinsey Global Institute, says that key determinants of a country’s economic dynamism and resilience often come down to “economic structure, industry dynamics, corporate landscape and role of government or social and political make-up”.  “When it comes to these indicators, the differences between emerging markets outweigh their similarities,” Mr. Ramaswamy argues.  “For instance, capital investment makes up 20 per cent of GDP in Mexico, but 45 per cent in China.  Household consumption makes up 50 per cent of GDP in South Korea but 70 per cent in Turkey,” he adds.  “The populations of China and India are similar in size but their demographic trends are very different.  So is the corporate landscape; 60 per cent of Latin America’s corporate revenue is held by family controlled firms but in India it is 50 per cent and in China 30 per cent.”