Economic growth is one of the most powerful tools for reducing poverty, and a key driver of economic growth is investment. Argentina and Saudi Arabia, two countries that have committed to political and economic reforms in recent years, are hoping to spur investment from abroad. The announcement by MSCI, an equity index provider, to classify them as emerging markets has attracted sizable foreign investments to the two countries. But whether the capital flows support economic growth is still up for debate.
MSCI
MSCI created its Emerging Markets Index in 1998 and since then it has become a benchmark for investment in emerging markets. Many investment funds track the index by buying a similar composition of stocks. Therefore, when stocks are added to the index it inevitably prompts investment flows to increase in certain countries.
In late June, MSCI decided to add Argentina and Saudi Arabia to its emerging markets index. The decision is a result of the reform efforts in both countries. The Crown Prince of Saudi Arabia, Mohammad bin Salman, is trying to shift the country from its oil dependency and increase social liberalization, including allowing women to drive while President Mauricio Macri of Argentina has sought to end disputes with international investors and remove barriers to capital entering and leaving the country.
The effects of their addition to the index may be profound. Some estimates predict approximately $3.5 billion and $40 billion of capital inflows into Argentina and Saudi Arabia respectively in the coming year. The inflows could lead to businesses in these two countries giving them cheaper access to credit that will further lead to more investments; thus boosting economic growth and productivity.
Poverty in Saudi Arabia and Argentina
The two countries are seeking to boost economic growth and stability by any means possible. Saudi Arabia’s economy contracted 0.7 percent in 2017, driven by lower oil prices. Argentina also had to turn to the International Monetary Fund for a $50 million line of credit after capital flight weakened its currency.
Given these countries’ extensive poverty, economic growth is needed for their governments to maintain its credibility. Argentina’s poverty rate is over 25 percent, and while there are no exact figures for poverty in Saudi Arabia, it is believed that almost four million people or approximately 12 percent of the population, live on less than $17 a day.
Do Capital Flows Support Economic Growth?
Do capital flows support economic growth in emerging markets? The answer to that is vague. Take Africa for instance. An economic study concerning private capital inflows found that capital flows had a detrimental effect on Africa’s economic growth in the absence of well-developed financial markets. Conversely, a research paper by the World Bank in 2015 found that capital inflows into Sub-Saharan Africa would have a positive effect on its economic growth. This study found, however, that the most effective type of capital inflow in boosting growth wasn’t private capital flows but aid.
The economic literature debating whether capital flows support economic growth is expansive and divisive. Therefore, increasing private capital flows to Argentina and Saudi Arabia may or may not be the answer to the economic instability plaguing the two countries. But both aid and private capital will continue to play an important role in the economic growth and futures of emerging markets.
– Mark Fitzpatrick
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