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's 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 can include strong economic growth, high per capita income, liquid equity and debt markets, accessibility by foreign investors, and a dependable regulatory system.

It typically becomes more integrated with the global economy as an emerging market economy develops. 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. Some notable emerging market economies include India, Mexico, Russia, Iran, Saudi Arabia, China, and Brazil.

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

Understanding an Emerging Market Economy

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

Risks of Emerging Markets

Risks can include political instability, domestic infrastructure problems, currency volatility, and illiquid equity because many large companies may still be state-run or private. Local stock exchanges might not offer liquid markets to outside investors.

Emerging markets generally don't have highly developed market and regulatory institutions like 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

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 they adopt reforms and institutions like those of modern developed countries over time. This promotes economic growth.

Emerging market economies tend to move away from activities that are focused on agricultural and resource extraction toward industrial and manufacturing activities instead. 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.

Export-led growth is more typical of economies that are considered emerging because 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 various ways. 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.

The International Monetary Fund (IMF) classifies 20 countries as emerging markets. 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.

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

The Bottom Line

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

Emerging market economies can be attractive to investors due to their rapid growth and greater returns but they also involve greater exposure and risk due to political instability or currency fluctuation.