Why we must stop talking about "emerging markets"

Is it time to re-define emerging markets? The answer is a pretty straightforward "Yes", at least for some of them. Across the board, for the world's 190-plus poorer countries the answer is probably “No”, but for the largest ones that are helping re-shape our wonderful, exciting world, the answer is straightforward.

It is now nine years since I had the good fortune of thinking up the acronym BRIC, which has become synonymous with the remarkable rise of those four countries – Brazil, Russia, India and China – as well as some others, and their influence on the world economy. It is also more than seven years since my group first published an outlook to 2050 in which we suggested that over that timespan, these four economies could collectively be bigger than the G7 economies, and along with the U.S. would constitute the five biggest in the world, based on the likely dollar value of their gross domestic products. It is also more than five years since we first introduced another acronym, the “Next 11”, or the “N11” as it has become known. That phrase was a simple description to bracket the eleven largest countries by population and to see what their BRIC like potential might be. It is my contention that most of the positive momentum behind the world economy is being driven from these 15 countries, or at least by the majority of them. This is in turn affecting the lives of all of the world’s 6.5bn citizen’s, not just those of their own people. The result of this is that many profound changes are occurring, not least of which is that globally we are probably seeing the largest and fastest rise of people out of poverty for many generations. As a consequence, to describe many of these countries as “emerging markets” seems not only a bit inappropriate but quite possibly insulting.

China last year overtook Japan as the second largest economy in the world, probably around $5.5 trillion in size. China is about the same size as the other three BRIC countries collectively, which in aggregate puts them at around $11 trillion, some 80% of the U.S. If you observe their collective growth rates for 2010, on average they grew by around 8.5% can you imagine what we would all be thinking if the U.S. had grown by around 8.5%? That is close to what the four BRIC countries alone have done last year. In 2009, arguably the worst world economic performance for decades, the BRIC countries collectively grew by around 5.5%.

Brazil is close to reaching the size of Italy, and both India and Russia are not far behind. Within the N11, Indonesia and Turkey are growing at rates which encourage some to believe that I should change the BRIC acronym to include them.

Looking at domestic demand in the BRIC countries, the growth rate is even more impressive. In 2010, they probably grew by close to 10%, and in some cases, China most of all, their own consumers appear to be more and more important. The collective dollar value of BRIC consumers can currently be estimated conservatively at just over $4 trillion, and possibly $4.5 trillion. The U.S. consumer is worth around $10.5 trillion, more than double the level of the BRIC consumer, but the BRIC consumer is currently growing at an annual rate in dollar terms of around 15%, which means an annual rate of about $600bn. If this pace is maintained, then by the middle of this decade their collective consumers will be adding another $ 1 trillion to the world economy. And by the end of the decade, their consumers will be worth more than that of the U.S. consumer. How can we call them Emerging Markets?

In line with all this, at some stage in this decade the four BRIC economies will become as big as the U.S., with China alone reaching about two-thirds the size of the U.S. economy. The four will be responsible for at least half of the real GDP growth in the world, possibly as much as 70%.

Looking around the world as a whole, amongst the likely top ten contributors to global GDP growth this decade, others in addition to the BRIC countries may well include Korea, Mexico and Turkey. Only the U.S. is guaranteed from within the so-called developed world, and others that might be in there, could include Indonesia. The top 20 could also include Iran, Nigeria, the Philippines and Vietnam.

With this in mind, how should we think about the phrase “Emerging Markets”?

A few weeks ago, I decided along with my colleagues to pursue the phrase “Growth Economies” a bit more scientifically. At Goldman Sachs, the firm adopted this phrase at the start of 2010 to describe how we treated many of the world’s most dynamic economies. I thought we might go one step further, and actually define what constitutes a growth economy? At its most simple, I think it should be regarded with one that is likely to see rising productivity that combined with favourable demographics suggests they are likely to grow at a faster rate than the world’s average.

If this were the only necessary condition, then it would likely include many countries beyond just the BRIC and N11. But is it sufficient? Probably not, especially from a business and investing perspective. It also probably needs to be an economy that has sufficient size and depth that allows investors and business sufficient scale and liquidity to not only to invest and develop, but also perhaps to exit as and when appropriate. An amusing phrase a colleague told me many years ago to describe the commerciality of emerging markets was that “submerging” would be more appropriate, and he added for good measure that the only time to get involved was when they were on the verge of collapsing because then a lot of money could be made. With this in mind, perhaps another way of thinking about what is no longer an emerging economy or market is one where if things turn for the worse, you can exit and not worry about submergence!

With this sort of framework in mind, we studied more closely the size of some of the BRIC and N11 economies, their likely growth rates over the next decade and beyond and their productivity performance and attributes. We then decided that somewhere we would need to make an arbitrary decision, so we opted for the following:

Any economy outside the so-called developed world that is at least 1% of current global GDP or more, should be defined as a growth economy. At this size, currently around $600bn or more, it should be large enough to allow investors and business in general to operate along the same general principles as in the more advanced economies, yet are likely to grow more. All others, we would somewhat arbitrarily still define as emerging markets.

Under this definition, eight countries currently satisfy our criteria; the BRIC countries including Russia along with Korea, Indonesia, Mexico and Turkey.

We also explored our future projections to see how the list might be expanded to include those countries that we forecast might account for at least 1% of global GDP in the next 20 years. Among those that could be added. Saudi Arabia, Iran, Nigeria and the Philippines came up.

With this in mind, we at Goldman Sachs Asset Management (GSAM) are now treating these eight countries not as emerging markets, but as growth economies.

It is also about time that investors started to benchmark their investing portfolios more appropriately. In the past few decades, it has become convention for equity investors to base their investing around neutral benchmarks determined by the market capitalisation of companies and indices. But this gives much more weight to the U.S. economy and its companies, and less to so called emerging markets than would GDP. An alternative approach that some investors adopt is to use a current GDP weighted benchmark, and for a few, bold and aggressive investors, a future predicted GDP weighted benchmark. This gives a lot more weight to emerging markets, and especially to the growth economies.

When we studied this approach in detail, despite its obvious appeal to us, we thought it was perhaps a bit extreme to encourage investors to adopt, as it might over-correct. Nor it would account for the larger share of revenue growth that many Western or developed companies are witnessing as a result of their own expansion into the new exciting world around us. So, we have decided to incorporate this aspect directly into our research, and as a result are developing benchmarks that take all of these things into account. The consequences will be that “neutral” investors will need to invest more in the emerging world especially the growth economies, but not dangerously so, and we also incorporate volatility characteristics as another constraint.

The index that Goldman Sachs calculates every year for around 180 countries is called a Growth Environment Score (GES) and is used to monitor productivity and likely sustainable growth. The index level goes from 0 up to 10, with 13 sub-indices for overall growth and productivity. Currently, Korea’s GES score at 7.5 is higher than that of the U.S. at 6.9. For countries that are still rather small and have low GES scores, it is almost definitely appropriate to treat them as emerging markets with lots of risk. While they may grow significantly and escape from their current situation, it also keeps them somewhat vulnerable to adverse developments at the centre and core of developed markets and their financial markets, especially the U.S. I believe that this should not be forgotten in the rush to embrace all that is so exciting about the world.

Another way of looking at this is that countries with low GES scores need to undertake policies which will allow them to rise. Nigeria is an interesting case because we forecast that within the next 20 years Nigeria could-not will, could! – become as big as 1% of global GDP. Its current GES score of 3.9 is significantly below the average of the BRIC and N11 countries, and so needs to rise. On the other hand, it has already nearly doubled over the last 13 years, and if it maintains this progress it will before 2030 no longer be an emerging economy. As Nigeria accounts for around 20% of Africa’s population, that could be an exciting development.

Comment by Matthew Hulbert: Emerging markets emerged