Evaluating Governments in Emerging Markets

Governments in emerging markets care about financial markets because the markets can be sources of power — or threats to it. As you do research on a country, you’ll get a sense of whether the government is promoting trade or hindering it. Entering into trade agreements is a good sign; talking about putting restrictions on profiteers is not so good.

A government needs to provide the stable ground rules that make commerce work, including fair regulation with consistent enforcement. The greatest responsibility of a government is to manage the nation’s economy. Governments have many tools to intervene in the economy:

  • Planning priorities: Governments use budgets and plans to make decisions about national spending priorities. The citizens and the businesses within a country have their own budgets and plans, too. Ideally, all the plans come together to form a clear blueprint for growth. Planning agencies may include:

    • Central planning: The government sets the national economic priorities and allocates funds accordingly. This method is often associated with authoritarian governments.

      Everyone knows what the plan is and what’s expected and central planning is a good way to get big infrastructure projects up and running, which many emerging markets need. However, decisions have to go through a bureaucracy, which can be downright slow and rigid. And central planning itself lacks flexibility.

    • Market planning: When a government is weak or disinterested, planning gets pushed to the market. On the upside, the market can respond to changes in needs quickly and efficiently. On the downside, businesses usually balk at infrastructure and development projects because they’re not likely to be profitable. The other problem is that some efforts overlap, wasting money and effort.

    • A mix of central and market planning: Most governments mix. For example, the government may plan infrastructure projects to encourage development in certain parts of the nation and then leave it to entrepreneurs to decide to set up businesses there.

  • Tax collection: Some services can be provided only by a central authority, such as a national defense and an effective court system. Other services, such as schools, roads, and parks, can be provided by the private sector in theory but probably won’t be. Taxes on corporate profits and employee earnings can give a government the money it needs to take on projects that it wants to accomplish. As long as businesses generate the funds that the government needs, the government will have an interest in helping businesses grow.

  • Regulation: Governments have a vested interested in protecting the health and welfare of the people. Regulations that protect workers, customers, and the environment can make a nation more stable and increase people’s trust in business. Effective regulation protects businesses, too by protecting intellectual property rights and enforcing contracts.

    Emerging markets don’t necessarily have a long history of successful and responsible businesses, and both the people and the politicians of an emerging-market nation may be less willing to have a light hand with regulation than people and politicians in developed markets.

    The key to regulation is ensuring that it’s reasonable and is enforced consistently. If regulations are too strict, ethical businesses play by the rules and suffer because the rules are too onerous, while their unethical competitors start paying bribes to circumvent the rules. Likewise, if regulations are enforced capriciously or not at all, businesses learn to ignore them.

  • The job market: Politicians like to create jobs for voters, and many politicians appreciate the private sector and its ability to create jobs because they know that employed people tend to be happy people who reelect politicians.

    But the private sector can also compete for workers with government agencies, and many government officials would prefer that the country’s top college graduates take government jobs in order to make a difference in the country instead of serving a private-sector, profit-maximizing company.

    A nation’s economic success depends on the talent and commitment of the people in it. If the people have no interest in working for companies in the private sector, then development will be very slow. And slow development can affect the growth of businesses and of investment opportunities for emerging markets investors.

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