Decoding the success of the best-performing emerging economies
Emerging economies are in the news again because of market jitters about Argentina and Turkey. While volatility has long been a feature of some developing economies, a subset of countries has withstood periods of turbulence to grow GDP per capita in a rapid and sustained fashion over long periods — of 50 and 20 years. In the process, they have lifted about one billion people out of extreme poverty since 1990 and played a major role in driving global consumption growth.
In other words, it is important not to allow short-term volatility in some emerging markets to hide the longer-term and very positive story about emerging economies being the engines powering global economy over the past couple of decades — and likely long into the future.
Who are these “outperformers” and what lessons can we learn from their success? New research from the McKinsey Global Institute looked at 71 emerging economies and identified 18 that achieved rapid and consistent GDP growth. Seven of them, including China, South Korea, and Singapore, grew per capita GDP by 3.5 percent annually on average over half a century, starting in 1965, while a further 11, including less-heralded economies including Azerbaijan, Cambodia, Ethiopia, India, and Vietnam, grew by at least 5 percent on average over the past 20 years.
Three essential ingredients
What was the “secret sauce” that explains this successful track record? We found two essential ingredients. First, in terms of policy, the outperformers pursued pro-growth policies that encouraged a virtuous cycle of rising productivity, income, and demand. Those agendas included, for example, steps to increase capital accumulation, such as by forcing retirement saving; efforts to boost government effectiveness; and measures to encourage more competitive dynamics in the domestic market. When we decomposed total productivity growth across 35 sectors in these countries, including 15 manufacturing sectors and 20 service sectors, in most cases we found that long-term growth was overwhelmingly driven by productivity growth within individual sectors rather than from the mix across sectors. In other words, success depends less on finding the right mix of sectors than on identifying sources of competitive advantage — and continuously driving productivity improvements within those sectors.
The second essential ingredient was the presence of strong competitive dynamics within many of the outperforming economies, which enabled the rise of a generation of large companies that have driven productivity and GDP growth. These large companies have been less studied in emerging economies, but our analysis highlighted their standout and often underappreciated role: the 18 outperformers have twice as many publicly listed companies with annual revenues of $500 million or more as other developing countries, adjusted for economy size. In these countries, the revenue-to-GDP ratio almost tripled in just 20 years, from 22% in 1995 to 64% in 2016 — far higher than the ratio in other emerging economies, and approaching high-income country levels. Over the same period, the contribution of value-added to GDP also rose sharply, from 11% to 27%.
Third, outperformers participate to a substantial degree in the global economy, both at the level of national economies and through their highly competitive firms, via inflows and outflows of goods, services, finance, people and data. For example, in 2016, outperformer economies captured almost 30 percent of the global goods trade, compared with 1 percent in 1980.
Battle hardened by competitive dynamics
When we examined the track of the top companies in the outperforming economies more closely, we found that they are often battle hardened by domestic competition: more than half that reached the top quintile in terms of economic profit generation between 2001 and 2005 had been knocked off their perch a decade later, in 2010–15. By comparison, 62% of incumbents in high-income economies on average remained in the top quintile for the same decade. In the United States, 68% stayed put, and in the United Kingdom it was as many as 76%.
A survey we conducted of companies in seven countries also brought its share of surprises. The top-performing emerging-market firms innovate more aggressively than their advanced economy rivals: 56% of their revenue comes from new products and services, compared with 48% for firms in advanced economies. These firms also invest almost twice as much as their advanced economy peers, measured as a ratio of capital spending to depreciation. And they are nimbler as they do so: on average, they make important investment decisions six to eight weeks faster, or in about 30–40% less time.
They can also be a good investment: between 2014 and 2016, the top quartile of companies in the best-performing economies generated total return to shareholders of 23% on average, compared with 15% for top-quartile firms in high-income countries.
Lessons for us all
There are several lessons in these findings for all of us — in advanced as well as emerging economies. First, the pro-growth policy agenda focusing on productivity growth and capital accumulation is a powerful formula that has enabled the outperformers to withstand previous bursts of emerging-market turbulence or to bounce back from it quickly. That was the case with the 1997 Asian crisis, and the 2008 global financial crisis.
Second, the outperformers tended to improve government effectiveness, including the rule of law, which helped them bolster their relative stability.
Third, allowing and indeed encouraging domestic competition brings results not just for the firms that survive it, but also for the economy as a whole. Successful large firms in the outperforming economies act as catalysts for change, through investment and building capability among their suppliers. Many of these suppliers are small- and medium-sized companies that tend to be less productive than the larger firms, but are nonetheless critical for employment. By bringing them into their ecosystems, the larger firms help instill management and operational best practices, and can accelerate and encourage technology adoption.
Finally, outperforming economies have benefited from increasing their participation in the global economy, especially by tapping into global demand growth through export markets and by attracting FDI to fuel investment and growth domestically. In other words, greater participation in the global economy has been an essential driver of their growth.
While congratulations are in order, complacency is not. The global context is changing, with the rise of automation, changing demographics, and shifting trade patterns. The 18 outperformers will need to continue with their pro-growth agendas, and others hoping to join their ranks will need to ensure they, too, have the fundamentals in place. The global economy has a strong interest in more emerging economies joining the ranks of the outperformers: if all 71 countries we studied could achieve the productivity growth record of the 18, the world economy would grow by 10% by 2030 — the equivalent of adding another China.
James Manyika is a senior partner of McKinsey & Co. and a director of the McKinsey Global Institute. This piece originally appeared on LinkedIn Pulse.
