Emerging Market Economy Definition, How It Works, and Examples

What Is an Emerging Market Economy?

An emerging market economy is the economy of a developing nation that is becoming more engaged with global markets as it grows. Countries classified as emerging market economies are those with some, but not all, of the characteristics of a developed market.

Characteristics of developed markets may include strong economic growth, high per capita income, liquid equity and debt markets, accessibility by foreign investors, and a dependable regulatory system.

As an emerging market economy develops, it typically becomes more integrated with the global economy. That means it can have increased liquidity in local debt and equity markets, increased trade volume and foreign direct investment. It can develop modern financial and regulatory institutions. Currently, some notable emerging market economies include India, Mexico, Russia, Iran, Saudi Arabia, China, and Brazil.

Critically, an emerging market economy is transitioning from a low income, less developed, often pre-industrial economy towards a modern, industrial economy with a higher standard of living.

Understanding an Emerging Market Economy

Investors seek out emerging markets for the prospect of high returns because these markets often experience faster economic growth as measured by gross domestic product (GDP). However, along with higher returns usually comes much greater risk.

Risks of Emerging Markets

This risk can include political instability, domestic infrastructure problems, currency volatility, and illiquid equity, as many large companies may still be state-run or private. Also, local stock exchanges may not offer liquid markets to outside investors.

Emerging markets generally do not have as highly developed market and regulatory institutions as those found in developed nations. Market efficiency and strict standards in accounting and securities regulation are generally not on par with advanced economies (such as those of the United States, Europe, and Japan).

Signs of Progress

However, emerging markets typically have a 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 like those of modern developed countries. This promotes economic growth.

Emerging market economies tend to move away from activities focused on agricultural and resource extraction toward industrial and manufacturing activities. Their governments usually pursue deliberate industrial and trade strategies to encourage economic growth and industrialization.

These strategies include export led growth and import substituting industrialization. The former strategy is more typical of economies that are considered emerging since it promotes more engagement and trade with the global economy.

Emerging market countries also often pursue domestic programs such as investing in educational systems, building physical infrastructure, and enacting legal reforms to secure investors' property rights.

How Emerging Market Economies Are Classified

Emerging market economies are classified in different ways by different observers. Levels of income, quality of financial systems, and growth rates are all popular criteria but the exact list of emerging market economies can vary depending on who you ask.

For example, the International Monetary Fund (IMF) classifies 20 countries as emerging markets while Morgan Stanley Capital International (MSCI) classifies 24 countries as emerging markets. Standard and Poor's (S&P), FTSE Russell, and Dow Jones also vary slightly in their classification of countries as emerging markets.

At any of these institutions' discretion, a country can be removed from the list by either upgrading it to developed nation status or downgrading it to a frontier nation. Likewise, developed nations may be downgraded to an emerging market, as was the case with Greece. Frontier markets may be upgraded to an emerging market, as was the case for Qatar and Argentina.

The Bottom Line

Countries classified as emerging market economies are those with an economy that is transitioning into being developed. These countries have a unified currency, stock market, and banking system, and they're in the process of industrializing.

Although emerging market economies, due to their rapid growth and greater returns, are attractive to investors, they also offer involve greater exposure and risk due to political instability or currency fluctuations, among others.