What Is Emerging Economies?
Emerging economies refer to nations that are rapidly progressing from a developing status towards becoming developed economies, characterized by fast economic growth and increasing integration into the global economy. This concept falls under the broad category of global economics and investment, providing a framework for understanding and analyzing the dynamic shifts in the world's financial landscape. These economies typically exhibit characteristics such as improving infrastructure, a rising middle class, growing industrialization, and evolving financial institutions and capital markets.
History and Origin
The term "emerging market" was coined in 1981 by Antoine van Agtmael, an economist then working at the International Finance Corporation (IFC), the private-sector arm of the World Bank. At the time, developing countries were often referred to as the "Third World," a label that van Agtmael found off-putting and detrimental to attracting foreign investment. He sought a more positive and dynamic descriptor for a new equity fund focused on promising developing economies, leading him to invent the phrase "emerging market," which has since become widely adopted in financial circles.7,6 This new terminology aimed to highlight their potential for growth and attract much-needed capital.
Key Takeaways
- Emerging economies are nations in a transitional phase, moving from lower-income, developing statuses to more advanced, industrialized economies.
- They often feature rapid economic growth, increasing industrialization, and a rising standard of living.
- These economies are characterized by evolving financial markets, including growing stock market and bond market activity.
- While offering high growth potential, emerging economies can present greater investment risks due to factors like political instability and currency fluctuations.
- Various international organizations and index providers classify emerging economies based on criteria such as gross domestic product (GDP), per capita income, and financial market development.
Interpreting the Emerging Economies
Interpreting the status of emerging economies involves assessing a country's economic indicators, market development, and integration into the global financial system. Key factors include the rate of GDP growth, the level of per capita income, and the liquidity and accessibility of its equity and debt markets. An economy's transition often involves strengthening its regulatory environment and increasing its participation in international trade. For instance, an increase in foreign direct investment (FDI) can signal growing confidence in an emerging economy's prospects.
Hypothetical Example
Consider "Agraria," a hypothetical nation with a predominantly agrarian economy that has recently discovered significant natural resources. To diversify its economic base, Agraria begins investing heavily in manufacturing and technology sectors, attracting substantial foreign direct investment. Its government implements reforms to improve its legal framework and reduce bureaucracy, aiming to enhance investor confidence. As a result, its GDP shows consistent high growth, a burgeoning middle class fuels domestic consumption, and a nascent stock market begins to attract international capital. Agraria's trajectory, marked by rapid industrialization and increasing global integration, positions it as an emerging economy.
Practical Applications
Emerging economies are a significant consideration in global asset allocation strategies for investors seeking higher returns. They often present opportunities in various sectors, from consumer goods to infrastructure, driven by burgeoning populations and expanding domestic markets. For instance, the demand for technology and financial services typically rises as these economies develop. Foreign direct investment plays a crucial role, bringing capital, technology, and management expertise into these nations. However, recent trends suggest that geopolitical tensions can lead to fragmented foreign investment, potentially impacting these economies unevenly.5 Despite such challenges, many emerging countries have shown strong performance, with some outpacing developed markets in terms of equity returns.4
Limitations and Criticisms
While offering significant opportunities, investing in emerging economies comes with inherent limitations and criticisms. These markets are often susceptible to higher volatility compared to developed markets. Risks include inflation, currency fluctuations, and potential geopolitical instability. The regulatory frameworks in some emerging economies may be less mature or transparent, leading to concerns about corporate governance and investor protection. Historical events, such as the Asian financial crisis of 1997, highlighted how sudden capital outflows and weaknesses in financial systems could severely impact these economies, leading to sharp currency depreciations and economic contraction.3 Policymakers in these nations must balance the pursuit of economic development with maintaining fiscal policy discipline and strengthening financial oversight to mitigate such risks.
Emerging Economies vs. Developed Economies
The distinction between emerging economies and developed economies lies primarily in their stage of economic development, market maturity, and institutional strength. Developed economies typically possess high per capita incomes, mature and highly liquid financial markets, diversified economic structures, and stable political and regulatory environments. In contrast, emerging economies are characterized by lower (though growing) per capita incomes, less developed but rapidly evolving financial markets, and economies that are still undergoing significant industrialization and diversification. While both types of economies participate in global trade and finance, emerging economies often exhibit higher growth rates but also greater susceptibility to economic shocks and market volatility due to their transitional nature. The International Monetary Fund (IMF) and other institutions classify economies based on various criteria, noting that the classification is not static and evolves over time.2,
FAQs
What defines an emerging economy?
An emerging economy is typically defined by its rapid industrialization, high economic growth rate, improving per capita income, and increasing integration into the global financial system. They are generally transitioning from lower-income economies to more advanced ones, with evolving financial markets and infrastructure.
Are emerging economies good for investment?
Emerging economies can offer significant investment opportunities due to their high growth potential. However, they also carry greater risks, including potential political instability, currency fluctuations, and less mature regulatory environments. Investors often consider them for portfolio diversification, balancing the higher risk with the prospect of higher returns.
Which countries are currently considered emerging economies?
The list of countries classified as emerging economies varies slightly among different organizations like the International Monetary Fund (IMF), MSCI, and FTSE Russell. Generally, countries such as India, China, Brazil, Mexico, and South Africa are frequently cited examples, among many others. The classification is dynamic and subject to review.
How do international organizations classify emerging economies?
International organizations like the IMF classify economies into categories such as "advanced economies" and "emerging and developing economies." This classification is based on a range of factors including per capita income levels, export diversification, and the degree of financial integration with the global economy. These classifications are not rigid and can change as economies develop.1