Interview with Wim Naudé: The opportunities and risks of investing in emerging markets

Professor Wim Naude

Wim Naudé is Dean Director, Director Research and Professor of Development Economics and Entrepreneurship at Maastricht School of Management, and Professorial Fellow at UNU-MERIT and its School of Governance. Naudé is also a member of DARE – the Dutch Academy of Research In Entrepreneurship. His research and teaching focus on the economic development challenges of emerging countries and fragile states, including in the areas of business, entrepreneurship and trade. In an interview with SCOPE|FOCUS, Wim Naudé examines the opportunities and risks associated with investing in emerging countries.

You have pointed out that, regardless of industries, companies with headquarters in emerging countries grow faster and have higher returns than companies established in the West. What are the reasons for this difference?

Investing in emerging markets is a ‘safe bet’ over the medium to longer term; in fact there are very few other ‘bets’ available. Emerging markets offer high rates of return at present largely because their economies are growing fast and catching up with the advanced economies. They are slowly but surely closing the productivity gap with the West. The fundamental reason why emerging markets will remain important is because of market size and labour market demographics. There are substantial numbers of young people and increasingly productive workers in emerging countries, in contrast to the more advanced countries where labour forces are shrinking due to ageing populations.

Already as we speak more than half of the world’s consumption demand comes from emerging and developing countries. In these countries the middle class has grown very fast over the past 10 years. There are a million millionaires in China, almost the same amount in India and numbers of wealthy consumers in these markets are growing. Among the top 10 of the richest women in the world, five are from China. Not only does this mean that purchasing power is rapidly rising but that the patterns of demand globally are changing with production following, to meet the demand for new goods and services from these markets. Look at construction materials and technology, including household articles and consumer electronics: the high population and urbanization growth rates in emerging and developing countries are resulting in 10 cities the size of New York coming into existence every year.

How long do you think the rapid growth rates of the emerging countries will continue?

I am not concerned about the sustainability of growth. Economic growth in the emerging markets will continue because of demographic trends and improvements in institutional capacities. In countries such as India and Indonesia, and in much of Sub-Saharan Africa, population growth will continue because their populations are young, even though these countries and region already have almost two billion inhabitants put together. This means that for the next 20 to 30 years, there will be young people working, and as their productivity increases, they will be earning higher wages and demanding more consumer goods.

Although China’s population is not growing and in fact getting older and its labour force is getting more expensive, it still has a huge consumer market, which will continue growing in value as households start spending more in future – traditionally Chinese households have been saving 30 to 40 percent of their incomes. If these households now start to spend that money, there could be a domestic-led consumption boom in China. So we may see a different type of growth in China but that growth will still be there for some time. Hence if you combine this internally generated growth in a future China with the demographically pushed growth in India, Indonesia Sub-Saharan Africa and other emerging countries, then at least for the next generation emerging economies will remain the global hotpots for business development.

Economists argue that poor institutions in emerging countries, which entrench inequality, will hamper the path to prosperity. Do you share their opinion?

This is a reasonable point to make and there are concerns about institutional frameworks, such as the rule of law and protection of property rights, in many emerging and developing countries. These institutions are very important for economic growth and development. Fortunately we have seen promising improvements in institutional development over the last two decades as well. India, Indonesia, South Africa, Brazil are examples of emerging and even robust democracies, not perfect, but stable and evolving. People in these countries, as we have seen in the Arab Spring, are increasingly standing up for their rights. They realise that corruption and inequality are damaging the development prospects of their countries, and they are using new technology (such as social media), international agreements (such as on trade and investment) and frameworks (such as the UN) to press for their rights. So we see that indicators of governance and institutional equality are improving in the emerging economies. There are still some hazards and some problems, but the situation is definitely improving.

Investors in emerging markets are taking on many risks compared with the U.S. where risk taking is largely cyclical rather than structural, according to Sharmin Mossavar-Rahmani, the chief investment officer of the Private Wealth Management Group (PWM ). Is it true in your opinion that the risks are significantly higher when investing in emerging markets?

I would not make such a general statement in this case. Risks tend to be sensitive to the sector, location, business model, and timing, among others. For instance, it is possible to make very safe investments in emerging markets and very risky investments in advanced economies. Many investors do well in Afghanistan or Iraq, and many thousands fail in the USA. Having said this, we need to remember that there is a risk-return trade-off in all markets, hence if an investor aims for a higher return, whether in the USA or an emerging market, the investment will entail higher risk. The issue is one of appropriate risk management. In this regard knowledge is power (or profit). There may be a need for more information about emerging markets and how to do business in them, from the point of view of a Western-based investor.

Indeed we need to understand that investment risk and return in emerging markets are ultimately intertwined with those of advanced economies. This is clear from the fact that globalised outsourced production makes it difficult to break up the world market into niches and to say “Well, we invested in the USA and therefore we face less risk.” The fact of the matter is that business opportunities in the USA depend increasingly on the global value chain and vice versa. This means that the business education of international schools such as the Maastricht School of Management and Maastricht University’s School of Business and Economics is important to manage the risks of global business.

By the year 2050, countries like China or India will wave overtaken the USA in terms of GDP. Does their rapid economic growth present a threat to Western economies?

No, I do not think that growing emerging markets are threatening Western welfare. In fact one can argue exactly the opposite. If Europeans want to maintain the welfare that they achieved, only in the last three to four hundred years, the development and growth of emerging markets are a great opportunity. Europe is fortunate in that it has the giant markets of Asia on its eastern doorstep and the growing dynamism of Africa on its southern doorstep.

Furthermore, global issues such as energy, access to fresh water, food security and climate change will impact more proportionately on the emerging and developing world, and it is really in the interest of Europe to see these regions develop fully and continue to become more prosperous. Demographic growth in the emerging markets is not a threat to Europe. The more people you have on the planet who trade with each another and have a mutual benefit to trade, the more costly any conflict becomes.

People often ask: “Will there be a conflict between the USA and China?” I don’t think there will be, because there is so much business between the countries and hence so much at stake economically for the two countries that it will be too costly for them to provoke a war. And therefore, the more countries that trade with one another and benefit from that trade, the less likely it is that countries will engage in conflicts.

What is however changing is the global influence of the West and specifically of Europe. The colonial period and its aftermath are over for good, and Europe will not be able to punch above its weight in world affairs any more. This may require a change in attitude of European-based companies and politicians, but it is not a fundamental threat to the welfare of Europe.

Which countries do you consider the most relevant emerging countries to invest in?

Considering the fundamental drivers of development and productivity, such as demography, institutions, geography and technological progress I consider countries like India, Indonesia, Turkey, Brazil and Mexico as doing well on all of these scores. India for example, has got a very good geographical location being close to Asia, Europe and Africa. It has a huge sea front facing the aptly named Indian Ocean, the harbour of world trade. It also has a demography in its favour because it has a young population. According to estimates, there are 160 million people in India between the age of 18 and 30 years, this is double of the population of Germany. And these are generally very well educated people, who are very productive. In fact because of these reasons India will overtake China as the most populated country and also in terms of GDP it will be the largest country of the world by 2050 according to expectations. It is also technological advanced and making huge technological progress. It for example launched its own robot space programme to Mars recently. In terms of ICT services and also in automobile manufacturing Indian companies are taking over Western-based companies, Jaguar being an example.

Likewise Indonesia is very well located, it has plenty of natural resources, a young population, it is strategically located, and has a developing democracy. Mexico likewise is very centrally located, has a huge population and is strategically important to the USA. Therefore I think that these countries will be very important in the world’s economy.

China will remain important – as I mentioned it has a huge internal market. But it will become relatively less important over time. It will not dominate the world as the next superpower, or eclipse the USA in this regard. The reasons are that its population is declining; it faces fundamental resource challenges in terms of agriculture, water and food production. Institutionally it still faces significant challenges; the lack of fundamental freedom in country and the state-dominated business sector will make it increasingly difficult for foreigners to do business with and in China. Ultimately these factors will make China less dynamic than the other emerging countries I mentioned before.

You have been a lecturer and research officer at the University of Oxford, namely in the Centre for the Study of African Economies. How do you evaluate the economic growth in the sub-Saharan region?

Yes, in the early 1990s I worked for the Centre for the Study of African Economies at the University of Oxford. The main question, also at that time, was: “Why is Africa the poorest continent in the world and what can be done to develop Africa?” Africa has got all of the fundamental resources to develop: it has largely young and hard working people who are very entrepreneurial and it has incredible natural resources. It is very close to Europe, at least the northern part of Africa. Therefore the question is, “What is keeping Africa behind?” The answer is simple: institutional development has lagged in Africa, for many reasons including the fact that the colonial legacy has been so terrible. But these institutional weaknesses are slowly but surely being addressed.

We have seen a real improvement in governance in many African countries in the last 10 to 15 years. Africans are demanding their democratic rights and calling for an end to corruption in many countries, which is a wonderful development. We have also seen improvements in macroeconomic management by African governments. This has resulted in African countries being less severely affected for instance by the 2008 financial crisis, as compared to some European countries where prolific spending during the boom years of the 2000s caused them to run up their government debts to unsustainable levels.

During the surplus years of the 2000s many African governments saved and built up currency reserves and limited the build-up of debt. Many European countries did the opposite, spent too much money and increased debts. Now we have the debt crises in Ireland, Greece, Spain, Cyprus, and in Portugal. So we have seen better governance and better macro-economic management in Africa. Africa has also greatly benefited from trade with China and other countries in the developing world.

Nevertheless many challenges still remain. There is still great inequality in Africa, as not everyone benefits from the growth. Too many countries remain embroiled in civil conflict. Terrorism has been rearing its ugly head. There are still hundreds millions of poor people, especially in rural areas. Africa’s agriculture is not as productive as it should be: the continent needs to double its agricultural output to feed all the people in the next 10 to 15 years. In summary, Africa has got huge potential, has made important progress, but faces fundamental challenges.

By Arjun Malhotra
Multimedia Committee 2013

Source: SCOPE|FOCUS Magazine, January 2014

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