How Did We Come to Be?
The conventional account of the current financial industry’s concern with what are referred to as the Emerging Markets begins in the Cold War at the World Bank Group. The World Bank was founded after the Second World War as an umbrella organization to “end extreme poverty and promote shared prosperity” by making leveraged loans to countries ravaged by war and to countries whose poverty could be attributed to other reasons (usually their non-democratic political orientation). From this arise the questions economists are asking today: What exactly causes a market to “emerge”? What markets actually belong to this group?
There are some more recent reasons why we have begun to rethink our understanding of emerging markets. After the financial and global economic crisis in 2009, the countries within the Emerging Markets category, responded differently from the developed economies as well as from each other (see figure 1). Even still, current discussions about a great “de-coupling” of markets operate under the old assumptions that led to the surprise market performances in the first place.
The financial industry’s concern with emerging markets is divorced from a context that relates our own understanding of these places with the realities of the people living in them. By examining both, we can reveal possibilities and establish a foundation for challenging the status quo. This article sets the stage for a series of pieces to come in the future on emerging markets and relevant issues.
Figure 1: Response to 2009 Global Financial Crisis. Image Source: Bloomberg.
A Rose by Any Other Name
The Emerging Markets are all about access. Specifically, the degree to which outsiders can tap into domestic markets. The term “Emerging Markets” is attributed to Antoine van Agtmael of the International Finance Corporation, a branch of the World Bank Group who coined the term due to the opening of formerly closed countries to foreign direct investment. By the 1980s, opportunities were increasing for international business in Third World countries and van Agtmael wanted to set up a fund that would give investors a line in on the coming fortune. But investors were not interested in a “Third World” fund; the term’s connotations were too negative. “Emerging Markets”, on the other hand, depicted an inevitable prosperity, nations emerging from the depths of economic depravity into the warm embrace of their developed brethren. The exact same countries were at play; only the pernicious charge of “Third World” was relegated to the trash bin of politically incorrect.
It is helpful to remember that the terms “First”, “Second”, and “Third” were designed to describe a country’s access to nuclear weapons and their ideological placement on the democracy-socialism spectrum. The United States was the paradigm of the First World, a nuclear capable democracy, “Second World” was used less often as the term “Soviet Reds”, perhaps a more common way of describing that sphere. The Third World, then, was comprised of countries up for ideological grab. Because our own political identity is very much wrapped up in our economic identity, and since we were “developed” and the Third World was not, the term evolved to be less concerned with nuclear status and more so with economic status. It began to describe nations of closed markets and abject poverty (regardless of nuclear capabilities) thereby linking economic orientation to physical well-being in the Western culture while ignoring the devastating effects of imperial and colonial legacies on the economies in question.
Photo: Victor Grigas. Image Source: Wikipedia
Institutions like the World Bank, in addition to providing the funds to rebuild Europe after the war, were set up to nudge those Third World countries closer to the free market, but more importantly, away from the socialist end of the spectrum. The successfulness of their endeavors is another topic in and of itself, but what is important to take away is that the name change from Third World to Emerging Markets was done in order to soothe the worries of the Western investor. These were individual countries, grouped together in a Western cultural imagination. With the US the clear victor in a war that drew in the entire world, considering its system as the best for organizing resources, knowledge and power was an entirely understandable conclusion. Had it not just been proven on the global battlefield? Therefore, it did not matter that Brazilians and Chinese would not, under ordinary circumstance, put themselves in the same group. For Western purposes, the only relevant characteristic was the freeness of Brazil or China’s markets. Since both were closed and now starting to open, it was only a matter of time until they caught up with the rest of the developed world.
To a certain extent this is true, and the opening of markets has been the fastest way to raise living standards but when we look at particulars we start to see some problematic assumptions underlying this understanding of the world. Mainly, that in the course of our entire existence as human beings, two cultures rarely develop the exact same way and thinking that they do has led to calamitous policies and events. Justin Yifu Lin, a former chief economist of the World Bank, has shown how it is possible to develop economies within structured economies, citing China’s mix of special economic zones where free markets can develop but the economy as a whole is controlled. One may philosophically disapprove of the Chinese Communist Party but cannot ignore the country’s meteoric economic growth.
Another way to look at it is that around the world, humans perform similar actions but attribute vastly different meaning to those actions. For instance, humans figured out how to ferment grain into alcohol while separated by oceans and deserts. In some situations, consuming alcohol is a social activity and in others, religious. The same object: alcohol, the same activity: imbibing, but totally different meanings. We can say the same thing about the creation of money and the operation of the market resulting in totally different formulations of meaning. If we consider a market a place where two parties exchange things of value, why these two parties are involved is rarely a question asked by economists. On the other hand, for most people (and institutions), why they are spending money is dearer than how they must go about it.
In the US, the freeness and distinctiveness of markets (the idea that the market is separable from other aspects of our life) is central to our understanding of the world. This is why economists are unconcerned with why two people may want to meet in the market. That is the efficiency of the market in and of itself. But ours is not the only way to make meaning nor is it the only way markets are used. To expect everyone to hold meaning the same way we do is to ignore the vast formulations of human perception.
All of this is a long-winded way to say that arguing over what we should call this group of previously non-open markets is counter-productive and ultimately the wrong question to be asking. What we name something is integral to formulating our own cultural understanding of the world. By naming these disparate countries as one, we therefore think of them as one. Changing the name from “Third World” to “Emerging Markets” doesn’t change any of the underlying assumptions. Instead, we should look at the places we currently do have the opportunity to invest and think critically about each individual place. By focusing on the more discrete actors, by taking the economies as their own, we can better analyze their intricacies, networks, and global implications.
One of the reasons Emerging Markets are included in portfolios is precisely because they were supposedly unconstrained by the limits of emerged markets. Then came globalization and we assumed that the world would act in unison. Anthropologists have been showing how the increase in global flows, communication, technology, materials, knowledge, etc. does not necessitate a uniform culture. People must still respond to local forces. To group them all together, therefore, is to put oftentimes competing and chaotic forces into the same basket and then wonder why they acted in such a way.
We can see this in the reactions of the individual parties to the drop in oil prices last year. Some stock markets were unaffected; others tanked. It wasn’t the degree to which a market was open or closed, how long it had been “emerging” or any such factor, but the degree to which it was exposed to the oil industry. A logical conclusion, but holding the whole basket would have left the investor drooping under its weight. A lot of people bailed out of emerging markets as a whole during the oil drop. Evaluating each market on their own terms would have allowed the investor to determine which markets to stay in (China, India) and which may not make the best long term investment (Russia).
Figure 2: Oil Market Comparison. Image Source: Veronica Peterson via TradingView.
The emerging markets, as a group and individually, are volatile. They are places that most Western investors are unfamiliar with. The name of companies don’t ring any bells and cultural factors have implications for the market that may not be so obvious; the month long Spring Festival in China artificially depresses economic data in January or February depending on where the lunar cycle falls. Yet never before have there been so many ways to selectively invest in the so-called Emerging Markets and often in surprising ways (plenty of global corporations are exposed to markets that are generally closed to outsiders).
The less that is known about an investment, the greater the chance of price inefficiencies. It takes time, effort, and the ability to look at each market through the lens of its participants to find these inefficiencies and test your convictions. Questioning the conventional explanations and worries of the industry (including the media) will form a strong foundation that can be applied to any type of investment but serve especially well when entering less familiar investment territory.