Over the past few years, investors, policy-makers and researchers have increasingly stressed the importance of considering frontier markets and frontier economies as part of the investment opportunity set as well as a source of diversified growth. In standard macroeconomics and development economics1, the theories of economic growth and growth convergence suggest that the potential for growth and the rate of convergence to advanced countries is higher amongst countries with very low GDP per capita levels that are undergoing transformations of institutions and the human capital base.
The traditional emerging markets (e.g., Brazil, China, India and Mexico) have shone in the past as countries which have experienced high growth rates over the last 15 years, but their growth too has slowed down as part of the overall global slowdown. This reflects the fact that, in a globalized world, emerging markets have not decoupled from the advanced developed markets post the global financial crisis which started in 2008. This has led to a search for newer sources of growth. The economies of frontier markets are expected to provide compensating growth for the growth slowdown in developed countries and the traditional emerging market countries as well as diversification potential.
We use the definition of frontier markets adopted by the Standard & Poor’s Dow Jones Indices since they have provided the longest history of EM indices and the IFC (whose indices are now part of S&P and which originally coined the term ‘frontier economies’). Their classification criteria of frontier markets include economies which have at least two of the following criteria a market capitalization greater than $2.5 bn., domestic annual turnover of over $1 bn. and an exchange development ratio (market capitalization over GDP) of over 5 percent. There is no explicit GDP criterion that governs the classification. Other frontier market indices also do not use economic criteria in their classification of frontier markets. The set of 34 countries whose equity markets are included in the S&P Dow Jones Frontier Market index exhibit wide divergences in economic size and development.
Our main report focuses on 12 main frontier economies in four regions—Nigeria, Kenya, Morocco (Africa), Pakistan, Bangladesh and Vietnam (Asia), Lithuania, Bulgaria and Croatia (Europe and CIS), and Kuwait, Oman and Lebanon (Middle East).
- Economic and financial indicators
Sizes of frontier market economies measured by GDP vary widely. Of our 12 selected economies, the European ones are on average smaller than the Asian frontier economies. Nigeria has the largest economy within the group with a GDP of USD574 billion in 2014, equivalent to 28 percent of India’s GDP or 5.5 percent of China’s GDP.
In terms of GDP per capita, countries in Africa and Asia are much poorer than the frontier economies in Europe and the Middle East. As countries in Africa and Asia are further away from the technological frontier, they have larger potential for catch-up growth, provided good infrastructure and institutions are in place.
Population size is important in computing standard of living measures such as GDP per capita, which varies widely.
Explicit GDP criteria are not used in defining frontier markets, explaining the large disparities within the group in both of the measures, especially in terms of GDP per capita. Kuwait, the richest among this group, has a GDP per capita level similar to that of France, while Bangladesh is 40 times poorer.
The state of financial market development is the main criteria in the S&P DJI determination of which markets it classifies as frontier markets. Frontier markets are mainly ones with relatively smaller and illiquid stock markets than large advanced countries or the larger emerging market countries (China, Brazil etc).
Kuwait, Vietnam and Pakistan have the largest capital market size with market capitalizations of more than $60 billion. However, adding these three countries together accounts for less than 0.4 percent of the total world market capitalisation. China (excl. Hong Kong) accounts for 9.84 percent of the total world market capitalisation while India accounts for 2.27 percent.
Kuwait, Morocco, and Kenya have market capitalisation to GDP ratios of around 50 percent, similar to the levels in China (52.3 percent) and Germany (49.3 percent), lower than India (84 percent), but higher than Brazil (33.8 percent) and Russia (17.3 percent). Appendices 3 and 4 present demographic and economic indicators for all the 34 countries.
- Comparative demographics
Population sizes across the 12 selected countries vary widely. When we compare the most populated and least populated countries out of these we note that Pakistan’s population is 65 times the size of Lithuania’s, at 188.92 million vs 2.88 million.
Large population sizes do not necessarily translate into better demographic prospects due to reasons of governance as well as lack of homogeneity (more likely to be observed in smaller countries). As past experience has shown, the capture of the demographic dividend (higher GDP per capita growth with lower birth rates and better human capital) due to youth abundance is not automatically guaranteed.
Population growth rates reveal that all the countries have experienced decreasing population growth rates, but recent population growth rates in Kuwait, Nigeria, Kenya and Pakistan have been more than 2 percent p.a. (double the world average population growth rates).
Some countries like Bulgaria, Lithuania and Croatia have even experienced shrinking populations (negative population growth rates). These eastern European countries have been through a political, social and economic transition since the fall of the Iron Curtain.
Population growth rates vary dramatically similar to population sizes across these economies, from nearly -1 percent (Bulgaria) to nearly 2 percent p.a. (Nigeria and Kenya). High population growth rates typically relate to high working age population growth rates, which are important inputs for GDP growth as discussed later. Decreasing population growth rates appear to have been a universal trend over 1980-2015, and these are projected to continue.
A very important gauge of future population sizes is fertility rates. We highlight the differences in fertility rates across these countries, from a minimum of 1.48 children per woman (close to the EU28 average) in Croatia to a high of 5.48 children per woman in Nigeria.
People tend to popularly associate increasing life expectancy with demographics. The life expectancy at birth ranges from a low of 53.7 years in Nigeria to a maximum of 80.3 years in Lebanon across the countries. This is equivalent to a gap of a generation or nearly two in terms of average life expectancies.
One of the largest increases in life expectancy over 1980-2015 was observed in the case of Bangladesh, which may possibly be attributed to advances in micro-finance and female literacy rates.
Fewer children and more old people, due to lower fertility rates and higher life expectancies, is a global trend captured in old-age dependency ratios.
We note an increasing trend, but also a wide divergence, from Kuwait with a ratio of 2.6 to Bulgaria with a ratio of 30.42 (similar to many ageing advanced countries).
While old-age dependencies are a major concern for older advanced countries (such as Japan, Germany, Italy, Sweden, and Norway) as they lead to higher fiscal burdens, the prime focus in less developed frontier economies is on youth dependency ratios.
Dealing with the youth and garnering their future potential are what the leaders and policy-makers in frontier economies need to focus on.
Youth dependency ratios are falling across all the countries, but future progress depends on nurturing the human capital of future work force through education and training.
- GDP growth and its drivers, GDP structure
GDP growth has increased in most of the countries. Growth rates higher than 6 percent p.a. (Nigeria, Bangladesh and Vietnam) contrast with lower ones of 2 percent or less (Croatia and Bulgaria).
GDP growth decomposes into working age population growth, labour productivity growth and labour utilization growth.
In developing economies, labour productivity growth contributes significantly to GDP growth. The contribution of working age population growth has decreased for all countries due to their declining working age population growth. This needs to be compensated for by an increase in labour productivity growth, which requires better education and training frameworks, or else GDP growth will decrease.
The share of household consumption varies dramatically, from Kuwait (28.2 percent) and Oman (30.8 percent) to Pakistan (80.7 percent) and Kenya (82.1 percent). The openness of economies, the sum of exports and imports, also differs widely across the selected countries, from Lithuania (160.5 percent) and Vietnam (169.5 percent) to Pakistan (31 percent) and Bangladesh (44.5 percent).
An alternative way to evaluate the structure of the economy is to look at gross value added by sector to GDP. Gross value added is the value of gross output less the cost of materials and other intermediate inputs. Except for Kuwait and Oman, the service sector is the highest value added sector for all the selected countries. Although agriculture has the lowest share in value added, it still contributes to a fair share of GDP in both Asia and Africa.
Economic structure differences imply different responsiveness to policies and external shocks of economies. We believe that “Structure of Economy” matters importantly.
Working age population growth has declined in every selected country. European countries display negative rates, in contrast to the rest of the countries which exhibit declining but positive growth in working age population. Forecasts suggest that most of the countries in Europe, the Middle East and Asia will see negative working age population growth by 2045-2050.
Youth unemployment rates are high for all countries. The high youth unemployment represents a societal challenge. The health, education and employment prospects of the youth should be central in terms of public policy attention.
Youth unemployment requires attention across all countries in order to increase GDP growth and maintain social stability. The general unemployment rates are much lower than youth unemployment rates across all the countries, but particularly lower in the poorest Asian countries.
Across all countries, female labour force participation rates are much lower than male labour force participation rates, although increasingly more women are getting better educated and better skilled.
The labour force participation rate gender gap varies dramatically across the selected countries. Lebanon, Oman, Pakistan and Morocco have gender gaps close to 50 percent, whereas Vietnam, Kenya, Croatia, Bulgaria and Lithuania have gaps lower than 15 percent. Note the contrast between Bangladesh and Pakistan, Morocco, Lebanon and Oman on female labour force participation rates, showing the catch-up potential for those with low rates.
Gender income ratios reflect differing levels of gender inequality when comparing incomes, ranging from high levels in Pakistan, Morocco and Lebanon to much lower levels in Vietnam, Bulgaria, Lithuania, and Croatia.
Gender parity by income and labour force participation are areas of great potential catch-up for countries due to positive gains in growth, equity and consumer power.
- Health expenditures, life expectancy measures
Health is critical to the well-being of all consumers and workers. The physical and mental well-being of workers precedes their educational background and skills training.
We note that the concept of healthy life expectancy is different from that of “life expectancy at birth”. The differences are material in terms of quality of life, ability to work part-time and, most importantly, being less likely to draw on public funding due to poor health.
Conditional life expectancy (life expectancy at age 60 or 80) is a very different measure than life expectancy at birth, but is more relevant for public funding of old-age expenditures. This affects the old-age dependency ratio that we discussed earlier.
The health status and quality of life of citizens are related to health expenditures (both public and private). Some countries (Vietnam, Lebanon, Croatia, Bulgaria, Lithuania and Morocco) spend 5-10 percent of GDP on health (similar to several advanced countries), while others spend less than 5 percent of GDP on health, like Oman, Kuwait, Pakistan and Bangladesh.
A more meaningful comparative indicator of health expenditures is one normalized by population size, i.e., health expenditure per capita, which shows very large differences. The level of health expenditure per capita in Kuwait is nearly 50 times that in Bangladesh. That extent of difference in health expenditures explains at least partially the differences in life expectancy at birth and median age that we discussed previously.
It is important to note that factors beyond health expenditures, such as health education, sanitation and hygiene as well as food and water provision, matter for life expectancy and median age. We discuss some of these factors later in the report. Health efficiency is also an important feature that many poor countries need to address in the future, drawing on experiences of the richer advanced countries.
What also vary across countries are the causes of death or morbidity some of which are avoidable through better health and social policies, whereas others are not.
Education is important in building a country’s human capital and achieving its potential growth. Most of the frontier economies have achieved high primary school enrolment ratios, with the exception of Nigeria which has only 85 percent of primary school-age population enrolled (all other countries exceed 90 percent). The performance record for secondary and tertiary education is much more varied, with frontier economies in the Middle East and Europe performing better in terms of secondary and tertiary education enrolment than their Asian and African counterparts.
A literate and well-educated population is crucial to a country’s manufacturing and service sectors. European countries score the best with nearly universal literacy rates, and around 90 percent of the population has at least some secondary education. Africa and Asia lag behind in literacy terms. In order to bridge the gap, governments in Kenya, Morocco and Vietnam are spending more than 6 percent of their GDP on education.
Urbanisation rates have increased in all 12 selected countries. The fastest urbanisation across frontier economies has occurred in Asia and Africa. As of today the most urbanised countries are in the Middle East. Increased urbanisation is a global trend which requires significant complementary investments.
Across most of the countries the majority of the urban population live in cities with fewer than 300,000 inhabitants. Asia has the largest share of its population living in ‘mega cities’ (>10 million population). In Bangladesh and Pakistan, more than 30 percent and 20 percent respectively of their populations live in mega cities.
Mega cities have economies of scale, agglomeration and consolidation, but also have their associated problems of crime, congestion and pollution.
Frontier economies in Asia have the highest population densities, which are still increasing due to increasing populations, whereas the frontier economies in Europe have the lowest densities which are expected to decrease further due to decreasing populations.
The frontier economies display large differences in access to sanitation facilities and water sources. The countries in Africa lag behind, with only 29 percent and 30 percent of the populations in Nigeria and Kenya respectively having access to sanitation. Also, a much smaller proportion of the rural population in the African frontier economies has access to water. These are big challenges that the governments need to address in order to improve living conditions.
Higher population density and higher urbanisation rates can lead to health hazards too. It is crucial to invest significantly in infrastructure to create proper sanitation facilities and water access, especially in mega cities where diseases can spread more easily. Clean air, clean water, and affordable housing and transport are fundamental to basic living conditions.
- Human security: food and criminality
Human security is fundamental to good human development. This encompasses not only the physical security of individuals and their property but also the personal, community, health and political aspects.
Asia has the highest rate of food inadequacy, followed by Africa, with Kenya being the least food secure country out of all the 12 selected countries. Food inadequacy leads to malnutrition, many diseases, and high infant mortality rates.
In terms of personal physical security, there exist wide divergences across frontier countries; those within Europe have the highest numbers of people in prison and the lowest homicide rates. In contrast, frontier countries in Africa and Asia have fewer people in prison and more homicides. Nigeria has the lowest number of people in prison and the highest homicide rate. Violence against women is high, but is not well recorded.
Having a strong and robust institutional structure (economic, social and political) is vital for a country’s sustained and balanced economic growth.
A quality of life index called the Human Development Index is a multi-dimensional index created by the United Nations Development Programme (UNDP) to measure the level of a country’s overall human development. It combines health, education and GDP per capita to construct this overall standard of living measure. Frontier economies in Asia and Africa rank very low in the world rankings (below 100), and the best ranked countries are Lithuania and Croatia. The relative rankings and the value differences are consistent with the findings noted above.
The Global Gender Gap index created by the World Economic Forum depicts a similar trend, with Asian and African frontier economies ranking relatively towards the bottom.
The Corruption Perception Index created by Transparency International also tells the same story, indicating that there is lot of room for improvement on the ethical and governance front.
The Democracy Indicator constructed and maintained by the Economist Intelligence Unit (EIU) ranks the frontier economies in the Middle East relatively low compared to their stronger economics and demographics, and at par with the frontier economies in Asia and Africa.
The “ease of doing business index” shows a similar pattern. Frontier markets in the Middle East such as Lebanon and Kuwait rank lower compared to their performance in other indicators. Asian and African countries ranked low on this indicator primarily due to their inefficient bureaucracies and their poor physical and legal infrastructure.
Frontier markets, as defined by various index providers such as S&P DJI, MSCI and FTSE, are fashionable and gaining popularity amongst investors. The classification criteria for including countries do not rely on economics or demographics. In this report, we study the demographics of the 34 countries in the S&PDJI Frontier BMI index, with a detailed examination of 12 of these economies. Our findings suggest that while frontier economies have very strong growth and investment catch-up potential, they are very diverse and extremely different in terms of their economic and demographic profiles. We caution against treating frontier markets as a homogeneous group, just as we would caution with regard to regional groupings based on geography, trade regions or growth rates, such as ASEAN, Mercosur, NAFTA, or the BRICs. All these aggregates mask wide divergences between their individual country constituents. Frontier markets display very wide divergences across the whole spectrum, and considering them as a homogeneous grouping without acknowledging their extreme diversity could lead to grave mischaracterisations, particularly during weak parts of the business cycle.
We highlight health, education, infrastructure, social conditions, GDP growth and core demographic indicators for each of the 12 countries, which demonstrate that the degree of commonality lies more in the ‘investment potential’ or the ‘growth catch-up potential’ rather than in the existing economic, demographic and qualitative indicators that we analyse.