What is an Emerging Market?
An emerging market economy is the economy of a nation that is not only growing but is also engaging economically with both neighbors and global trading partners.
As a nation with an emerging market grows, it will take on more of the characteristics of a developed nation—namely, a modern, industrialized economy and a higher average standard of living for its citizens.
Emerging Markets and Growth
Emerging markets are often of particular interest to investors. The economies of large, developed nations represent economic prosperity and profitability, but they are also generally stable and somewhat predictable.
With some notable exceptions, the economic circumstances of many developed nations do not change wildly in a short period.
Emerging markets, on the other hand, have a lot of room to grow. As a national economy shifts away from traditional economic activities such as resource extraction and agricultural production and builds toward industrial manufacturing, economic growth is sure to follow.
Savvy investors rightfully spot this huge growth potential that can’t be found in more developed, stable economies. By “getting in on the ground floor,” so to speak, investors can generate massive returns as an emerging market catches up to other global industrialized nations and raises the standard of living for its citizens.
Emerging Markets and Risk
As is true with many high-reward investment opportunities, investing in emerging markets carries considerable risk that investors can’t ignore.
The same structural elements that produce the opportunity for tremendous growth also bear inherent, systemic risk within the country’s economy.
Political instability, crumbling or inadequate infrastructure, and a lack of a common currency or extreme currency volatility are just some of the possible systemic risks that produce external pressures on businesses.
Additionally, robust financial markets and open, liquid equity markets may be lacking in emerging markets.
This inherent systemic risk is often also exacerbated by the fact that these markets may not have the same level of regulatory rigor or standardized accounting practices.
Classifying Emerging Markets
There is no formal agreed-upon classification standard for countries with emerging markets. As such, different institutions may not all agree on which countries constitute emerging markets.
For example, the International Monetary Fund currently classifies twenty-three countries as emerging markets. Morgan Stanley Capital International, on the other hand, classifies twenty-four.
These lists aren’t static—they can change over time. If a country is successful in industrializing its economy, it may be upgraded to the designation of a developed nation. If it is unsuccessful, it may be downgraded to the designation of a frontier nation.