Emerging Markets: Millions Returning To The Natural Economy
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Emerging Markets: Millions Returning to the Natural Economy

Director, Risk Pricing

In China, nearly 20 million migrant workers are expected to return to their villages and small towns within this quarter. At home, these workers will join the ranks of 750 million Chinese who live in the countryside, look for casual work, try to live off the land and wait for employment in one of the large infrastructure projects which Communist Party officials in Beijing has been announcing for the better part of the decade. In brief, until those dams, roads, bridges and hydroelectric plants get “shovel ready”, the reverse migration will force those leaving China’s once-booming industrial zones to enter the “natural” economy.

In India, 300 million casual labourers were living on the fringes of the natural economy, despite government-issued national growth statistics, just prior to the credit crunch. Now, as construction jobs disappear and thousands of small-scale factories shut down throughout the country, the casual workforce is being driven right back into a socio-economic framework where money plays a limited role, where the barter of goods and services is commonplace and where the only credit available is from the local loan-shark.

The distinction between a natural economy and a commodity (price-based) economy has been the subject of extensive scholarly debate since the late 19th century, when the primary object of colonization was to access cheap raw materials and labour, and to find new markets for industrial products. While the country-to-town transition was perfected during the industrial revolutions in the UK and the western European mainland, the colonial ideology left the economies of the third-world hovering between limited western-style urban development and widespread pre-capitalist-era rural structures.

For many decades, GDP data from the emerging markets appeared to suggest that pre-capitalist modes of production and exchange had been condemned to the past. However, the global recession has exposed core transition- and growth-related weaknesses. Today, as the emerging markets are in a broad and deep contraction phase, it is important to realize that sizable proportions of their populations are exiting the traditional consumer demand equation altogether.

Those American corporations who are relying on the supposedly dire need for hospitals, health-care facilities, electricity, schools and consumer essentials in the developing world for their earnings forecasts are failing to grasp the fact that natural economies survived for centuries, and even thrived in certain historical periods, without the need for capital inputs from external sources. Clean water, for example, is not a concept which is recognized in agrarian and semi-agrarian areas where residents have suffered no identifiable or visible harm by drinking from wells, streams, rivers and storage containers (for rain).

This regeneration of the natural economy has direct and immediate implications on emerging market asset valuations. On the one hand, corporate business models predicated on an ever-expanding middle class are no longer able to promise shareholder value enhancements in the foreseeable future. On the other hand, countless infrastructure projects have been rendered irrelevant since many of them will not create any credible economic activity, post-completion.

Those trading shares with a significant international profile, like General Electric (GE), Procter & Gamble (PG), Colgate Palmolive (CL) and even Wal-Mart (WMT), should review how the reverse migration process in the emerging markets will influence earnings for this year and beyond. This writer is more focused on staying short on the emerging markets (ADRE, BIK, BKF, EEM, EPI, FXI, GXC, INP, PXH, PXR, VWO) despite the steep declines of 2008. Profits of 20%-plus, from this week’s highs, will become a reality as the hard numbers begin to show that a billion-odd people have simply vanished from the global demand matrix. There is need, however, to track the price graph of the various emerging-market ETFs to ensure best timing and liquidity.

For those in the value-investing camp, here’s a helpful hint: buy undervalued defense counters. Third-world governments will continue to maintain huge military budgets to keep the restless in check; in many respects, defense spending by the poor nations since the Second World War has acted like a permanent stimulus package for the American economy. Today, rising poverty and unemployment levels are already causing street protests throughout the developing world. More food riots mean more defense orders, as unsavoury as that proposition may sound to some. Interestingly, when asked about government plans, announced with great fanfare, to build a new highway, a village headman in the Indian state of Bihar said that “all this road will do is to allow paramilitary and army units to move around efficiently, to punish people protesting against higher food prices and upper-caste abuses, and to allow corrupt politicians to organize better election campaigns.”

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