Frontier market investments: Can the African lions really replace Asian tigers?

Demographic advantages were once considered a major advantage for fast growing Asian economies, the so called Asian Tigers. But many of these economies have matured. They have now been replaced by African Lions, majority of which are commodity dependent

It is fashionable in New York these days to mention investments in obscure African countries at dinner parties. Not only does the speaker look international and sophisticated, but the investment appears to be very smart. After all the so-called Frontier markets in general and the African markets in particular look particularly profitable. Since January while the Emerging Markets index fell, the MSCI Frontier Market index has is up slightly. (Although to be fair, it did tank from January 2011 to July 2012).


This seems to support the basic ‘story’ of Frontier Markets. The idea is that the Frontier Markets will become the BRICS of the future. Their favourable demographics and large populations will ensure steady economic growth. They will surpass developed nations and even the now maturing emerging markets. This thesis seems especially true in Africa.

Half of the top 20 of the fastest growing economies in the world are in Africa.  Presently these include South Sudan, Libya, Sierra Leone, Gambia, Mozambique, Democratic Republic of the Congo, Chad, Cote d’Ivoire, Zambia, Rwanda, and Liberia. Although Nigeria’s rank comes in at 21, it is still a good example of why forecasters have such faith in these countries. Nigeria and many other African countries have had very rapid growth rates. Today it has 170 million people, but it is projected to have 440 million, more than the present population of the US, by 2050. These countries also have youthful populations. In Nigeria 44% of the population is under the age of 15.


These demographic advantages were once considered a major advantage for fast growing Asian economies, the so called Asian Tigers. But many of these economies have matured. They have now been replaced by African Lions, a true marketing winner.


But look a little deeper and there are definite flaws to the theory. With the possible exception of Rwanda, all of the fastest growing countries are commodity dependent. Whether it is the newly discovered oil in Chad or South Sudan or the mineral wealth of Zambia, Mozambique and the Democratic Republic of Congo, these economies are still based primarily on commodities extraction. Demand from the developing world and the more advanced emerging markets have increased the number of commodities dependent countries by 30%. Between 1996 and 2010, the number rose from 46 to 61.


Whether you believe that the commodities boom of the past ten years was driven by the fourth commodities supercycle or demand from China, either way it resulted in many discoveries in Africa. These projects are now coming on stream. There is copper in the Democratic Republic of Congo and Zambia, oil in South Sudan, Uganda, and Ghana, gas in Mozambique and Tanzania, and iron ore in Guinea and Sierra Leone.


This commodities boom had nothing to do with demographics. Worse the so-called “curse of oil” often causes more problems than it solves. The ‘curse’ occurs in regions with an abundance of natural resources, like minerals and fuels. They tend to have less economic growth and worse development outcomes than countries with fewer natural resources.

The main reasons for this problem, especially in Africa are the weak, ineffectual, unstable and corrupt institutions. The real necessity for sustainable economic growth is an economically efficient legal infrastructure. This encourages the governing elite to extract more resources from a growing economy than from the ground.


They have an incentive to build a system that adequately educates a young population to be productive. They also have an incentive to build a physical infrastructure to insure that the country’s growth is sustainable. If the natural resources are sufficient to provide them with enough or more goods than they can ever possibly use, there is no reason to help the rest of the population.


As you might expect with all the mineral wealth promoting growth, the fastest growing African countries end up at the bottom of international tables for doing business and corruption. Most of these countries are in the bottom quartile for Doing Business and in the bottom third for Corruption Perceptions Index. For investors this is especially important. Without protections, there is no relationship between economic growth and the success of any investment.


Nigeria stands out as a prime example. Nigeria was once the world’s biggest exporter of palm oil. Since oil pumped from the ground was easier to get and more profitable the business shrank. Nigeria is no longer a player in the business. In addition its physical infrastructure is falling apart. Its roads are dilapidated. Its ports congested. Its electrical grid barely exists. Despite its oil wealth and rapid economic growth, without institutions it will continue to fall behind.


There are some investors who think that they don’t really need legal protections. The Chinese believe that by making the right connections their investments will be safe. They are not squeamish about paying off corrupt leaders. There is one flaw to this method. Without law there is nothing to guarantee that once an official is bought, he stays bought. He can always ask for more. There is also no way to know you are buying the right person at the right price. Leaders in all countries change. The Chinese invested in Sudan mainly by making deals with northerners in Khartoum. This became a problem, because the southerners eventually were in possession of the oil.


But the real problem with China is that its growth model has problems too. Years of inefficient allocation of capital by the government instead of markets has created massive problems. Solving those problems will require either slower growth or potentially a meltdown. Either way the demand for African commodities will slow and along with it the hope of an African economic rebirth.


But all is not hopeless. One positive outcome of the commodities boom is a rising middle class. As De Tocqueville pointed out property owners have something to lose, so they are more interested in laws that protect wealth. There are also a few leaders who have figured out that it can be more profitable to tax growing economies rather than depleting natural resources. These trends will likely produce results, but not any time soon.


(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)

1 decade ago
A well thought out view point. For India, there is an opportunity, to fuel it's industrial growth using African natural resources and also to invest in industrial growth in African countries that encourage it. Both are tracks which out private & public sectors must aggressively pursue with long term contracts and on ground set ups, as these will also help fuel Indian industry and correct balance of forex flows.
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