Martyn Davies Is Bullish on (Some) Emerging Markets
Martyn Davies is bullish on resource-poor developing countries, particularly those in Asia and East Africa, but he stresses that governmental reform is necessary for emerging markets to diversify and enter the next phase of development.
“Resources confer no competitive advantage in an economy long-term,” Davies, of Deloitte Frontier Advisory, told Lauren Foster during a recent Take 15 interview.
Rather, the key to success for emerging markets is to reform institutions to compete for talent and capital on a global scale. Diversification is not a policy, but a “people-driven initiative” about attracting skilled workers and intellectual property.
“You want to ultimately become an economy that’s not driven by resources, but one driven by ideas,” Davies said.
Davies sees barriers to human capital flow, like stringent visa requirements, as impediments to diversification in emerging markets. The model for growth going forward needs to mirror the development of Asian economies after the 1997 financial crisis. Asian economies had to cut rent-seeking, attract talent and capital, and improve institutions to become more efficient. Once-promising countries like Brazil, Russia, and South Africa must follow a similar path to enter the next phase of economic development.
“The emerging market story, I would argue, is ultimately a governance story,” Davies said.
Davies attributes the recent downturn in emerging markets to two exogenous factors. First, in the aftermath of the financial crisis, quantitative easing (QE) policies in the United States increased capital flows into emerging markets, by $85 billion a month according to Davies. By the end of 2015, those capital flows stopped.
Second, China’s growth model began to shift from resource-intensive industries to services. Davies believes that African economies have been too dependent on China for the last 15 years, especially in relying on China’s demand for resources. In earlier periods, growth in China increased demand for resources from emerging markets, putting inflationary pressure on commodities prices. With those pressures subsiding, economies that depend on exporting a single resource are experiencing poor growth. Davies says that this, the demand side of African dependence on China, is more important than the headline-grabbing supply side, the flow of sovereign Chinese capital into Africa through the Export-Import Bank of China and China Development Bank.
On the other hand, low commodity prices, especially low oil prices, are a “tailwind” for some emerging economies. The commodities slump will likely shift growth east, away from petro states like Brazil, Russia, Angola, Nigeria, and those in the Middle East to China, India, Indonesia, and East African countries, where economies are positioned to exploit low commodity prices.
The takeaway for investors is to look for emerging markets with strong institutions for growth and avoid markets enjoying a temporary boost from high commodity prices. The latter are likely to suffer from Dutch disease, as resource development will render other sectors uncompetitive. Service sectors, including health care and education, are more promising candidates for long-term growth than resource extraction. Indian Ocean Rim countries, in particular, are poised to grow and diversify as the slump in commodities prices continues.
“In many emerging market cases, high, overinflated commodity prices, especially oil . . . result in what’s a fear-of-missing-out effect among investors, in which people have to get in no matter what the price in any sector,” Davies said. “That’s not sustainable and it was not very smart long-term.”
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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