Definition of the emerging market economy
What is an emerging market economy?
An emerging market economy is the economy of a developing country that increasingly engages with global markets as it develops. Countries classified as emerging market economies are those that exhibit some of the characteristics of a developed market, but not all. As an emerging market economy progresses, it generally becomes more integrated with the global economy, as evidenced by the increase in liquidity in local debt and equity markets, the increase in the volume of trade and foreign direct investment; and the national development of modern financial and regulatory institutions. Currently, some notable emerging market economies are India, Mexico, Russia, Pakistan, Saudi Arabia, China, and Brazil.
Importantly, an emerging market economy is shifting from a low-income, less developed, often pre-industrial economy, to a modern industrial economy with a higher standard of living.
Key points to remember
- An emerging market economy is an economy in the process of becoming a developed economy.
- Emerging market economies typically have a unified currency, stock market and support system, and are industrializing.
- Emerging market economies may offer superior returns to investors due to rapid growth, but also offer greater exposure to some inherent risks due to their status.
Understanding the Economics of Emerging Markets
Investors look to emerging markets for the prospect of high returns, as they often experience faster economic growth as measured by GDP. However, higher returns usually come with much higher risk. The risk to investors in emerging market economies may include political instability, problems with national infrastructure, currency volatility and illiquid stocks, as many large companies may still be “run by the state” or private. In addition, local stock exchanges may not offer liquid markets to outside investors.
Emerging markets generally do not have the level of development of markets and regulatory institutions found in developed countries. Market efficiency and strict securities accounting and regulatory standards are generally not comparable to those of advanced economies (such as the United States, Europe and Japan), but emerging markets generally have physical financial infrastructure, including banks, a stock exchange and a unified currency. A key aspect of emerging market economies is that over time they adopt reforms and institutions closer to those of modern developed countries, which promote economic growth.
Emerging market economies tend to shift away from agriculture and resource extraction activities to industrial and manufacturing activities. Governments in emerging market economies typically pursue deliberate industrial and business strategies to encourage economic growth and industrialization.
These strategies include export-led growth and import-substitution industrialization, although the former is more typical of economies considered “emerging” as it promotes increased engagement and trade with the global economy. They also often pursue national programs such as investing in education systems, building physical infrastructure, and enacting legal reforms to secure the property rights of investors.
How emerging market economies are ranked
Emerging market economies are categorized in different ways by different observers. Income levels, quality of financial systems, and growth rates are all popular criteria, but the exact list of emerging market economies may vary depending on who you ask.
For example, the International Monetary Fund (IMF) classifies 23 countries as emerging markets, while Morgan Stanley Capital International (MSCI) classifies 24 countries as emerging markets; there are some differences between the two lists. Standard and Poor’s (S&P) ranks 23 and Russell ranks 19 countries as emerging markets, while Dow Jones ranks 22 countries as emerging markets.
At the discretion of any of these institutions, a country can be removed from the list by upgrading to developed country or downgrading to border country. Likewise, developed countries may be downgraded to an emerging market, as was the case with Greece, or border markets may move to an emerging market, as was the case for Qatar and Argentina.