My heart tells me that the best possible thing that could happen in this world over the next decade would be for all the emerging markets to emerge successfully. That would pull hundreds of millions of people out of poverty and into something approaching middleclass-hood. But my brain tells me that even if that happened, overweighting EM might not be a good trade. (See Part 1.) Worse, my hunch tells me that most of them won’t even emerge.

In my last post I argued that investing in EM because of their projected rapid GDP growth wouldn’t necessarily lead to good investment returns. In other words, even if the EM growth story is real and continues, investors might not want to over-allocate to EM.

In this post, I want to take issue with the growth story itself, to suggest the possibility that many – perhaps most – of the emerging economies of today will still be emerging economies long into the future.(1) In other words, their growth will slow, become episodic, and that will lead in turn to the sort of social upheaval that produces more slowing and chaos.

The problem has to do with the historical economic development model followed by virtually all emerging countries, from the US to Japan, Germany, Taiwan, South Korea, China, Brazil, India, etc. That model relies on the fact that capital is vastly more mobile than labor.

Thus, if labor is cheaper in, say, India,(2) then capital will tend to flow to India from the developed West and that capital will be used to make things, which will then be exported back to the source of the capital. The people employed in making those things will want to buy houses and toilet paper and gradually a consumer economy will arise and the first thing you know India will look like the US. That’s how it’s supposed to work and that’s how it has always worked since the dawn of the Industrial Revolution.

But what happens if the model’s broken? What happens if the labor component of virtually everything dwindles to the point that it’s mostly irrelevant? It may still be true that labor in India is cheaper than labor in the US, but since labor is such a small component of the overall cost of production, who cares?

If we close our eyes we can almost imagine the entire steelmaking process,(3) from mining the ore to wet-charging the coke ovens to firing the blast furnace to driving the rolling mill, all handled by one guy sitting in front of a computer in Woodstock, Vermont.(4) Why send capital to India to make steel when you can make steel in the US (or nearby Mexico) for roughly the same overall cost and then you don’t have to ship it halfway around the world?

India (and China) might still make steel – and other products – for domestic consumption, but that’s a vastly smaller market and the growth rates of such emerging economies will plummet.

A world in which the cost of labor matters less and less is a world that no longer favors undeveloped societies whose main advantage is lots of cheap labor. And if that’s the case, how will these countries emerge? What is the developmental model for emerging economies in such a world?(5)

Some might argue that even if my thesis is correct, the labor component of production will decline so slowly that most emerging societies will have time to emerge. I disagree. In the first place, emergence is itself a very long process: China has been growing at north of 10%/year (until recently) for three decades, but its 1.4 billion people still produce well under half the GDP of America’s 300 million. How long will it be before India’s 1.2 billion people reach anything like a middle class life?(6)

In the second place, even the most successful emerging economies face a double bind: as the labor component of production declines, wage rates are actually rising. Thus the problem for (e.g.) China is that as automation and artificial intelligence replace more and more working humans, the humans that are working are simultaneously demanding higher wages, better benefits, and improved working conditions.

Hence the investment strategy question: Do we really want to tilt our portfolios in the direction of an EM overweight if the development model is broken? What if past isn’t prologue?


(1) We tend to imagine the economic development process as unidirectional, moving from undeveloped to developed in an immutable process. But that’s not always the way it works. In 1900 the per capita GDP of Canada and Argentina were roughly the same. Today, Canada is a wealthy, developed country, while Argentina is still “emerging.” Hence the remark: “Argentina is the country of the future – and always will be!”

(2) The important role played by cheap labor was first brought home to me in an amusing way about twenty years ago. I had a friend, now deceased, who had built a very successful oil and gas business. Late in life, my friend and his wife decided to fulfill a long-held dream by taking the Orient Express from Paris to Istanbul, then the Trans-Siberian Express from Moscow to Vladivostok, arriving eventually in China. When the President of China Gas Co. learned my friend was in-country, he invited him in for a chat. Following the usual pleasantries, the conversation proceeded roughly as follows:

China Gas: How much gas you make?

My Friend: [Tells him.]

China Gas: I make ten times as much.

My Friend: Very impressive.

China Gas: How many employees you got?

My Friend: 1,600. You?

China Gas: Three million.

(3) By 1920 America was far and away the world’s dominant steel producer. But beginning in 1970, thanks to lower labor costs elsewhere, steelmaking almost disappeared in the US. Between 1970 and 2001 Bethlehem Steel, Republic Steel and Jones and Laughlin Steel all went bankrupt, and US Steel had to merge with an oil company (Marathon) to survive.

(4) Where I’ll be in a few weeks.

(5) Emerging countries with vast raw materials reserves can expect to sell those commodities to the West and China, but that’s not a developmental model, its an extractive, exploitive model.

(6) I would point out that many people who scoff at the labor-component thesis because it works out only over a long period of time are themselves strong proponents of taking demographics into account when investing. But demographics are (a) extremely long-term projections, and (b) almost always wrong.

Next up: Submerging Markets? (Part 3)


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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.