Which Countries are Frontier Economies?

According to MSCI, the custodian of the widely-used MSCI Frontier Markets Index, a country's stock market qualifies as a "frontier market" if its liquidity and size, as well as its accessibility and institutional strength, meet certain minimum standards. For example, there must be at least two companies with a market cap of $635 million that see trading volumes of at least 2.5 percent of market value each year, and there must be some openness to foreign investors. Countries with financial markets larger and more liquid than this classify as emerging markets, those with financial markets smaller than these thresholds do not count at all.

We have a different take. In our experience, there is no country or even subnational jurisdiction in the world in which markets do not thrive, and many markets with frontier opportunities do not have liquid stock markets, if they have stock markets at all.

To us, frontier economies are not defined by their relative liquidity and size but rather the political and economic risk that the investor assumes.

Frontier economies, we argue, have one of three characteristics:

1. They have not yet been able to establish dependable prosperity for their citizens. An economy like Tanzania's, though it has exhibited slow and steady growth, has not been able to produce real prosperity for most of its citizens. Venezuela, on the other hand, has been rich but through mismanagement and swings in the oil price sees its income per capita fluctuate dramatically. We classify any country with annual per capita incomes of less than $1,500 as a frontier economy; Tanzania's $630 compared to China's $6,560, for example. To capture the volatility of income, we classify any country that has experienced a fall in GDP per capita of 20% or more in a six-year period over the last two decades as a frontier economy. Venezuela's GDP fell by nearly 25% between 1998 and 2003, for instance, making it a frontier economy. In contrast, even during its headline-grabbing financial collapse, income per capita in Iceland only fell by 11%.

2. In a frontier economy, the largest companies succeed because of politically engineered market distortions or state-given concessions rather than innovation or differentiation. We use as a proxy for the access to these politically-determined advantages Transparency International's Corruptions Perceptions Index, and label any country with a score below 34 as a frontier economy. Nigeria's score on the Index was 25 compared to Brazil's 42. In Nigeria, many of the largest firms are in the extractive sector, where their profit turns on the share they owe the state. For large manufacturers, the strategy is to consolidate market share then lobby the government for protective tariffs.

3. There's unequal enforcement of rules and regulations in a frontier economy. Our measure of unequal enforcement, the indicator of executive constraints from the Polity IV dataset, is widely used by economists and political scientists. It is defined as "the extent of institutionalized constraints on the decision-making power of chief executives, whether individuals or collectives" and is on a 7-point scale. Countries scoring lower than 3, which is defined as "slight to moderate limitation on executive authority," are instantly classified as frontier economies. Uzbekistan scores a 1 on this metric compared with 5 for Malaysia and 7 for Chile. What the rules are on paper usually doesn't correspond to what there is in reality. In Uzbekistan, the World Bank's "doing business" report indicates that it is supposed to take around 280 days to get a construction permit, yet the Bank's own enterprise surveys revealed the average firm obtained one in 70 days.

As of 2016, here are the countries we classify as frontier economies.