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As widespread unrest spreads across Egypt after the ousting of President Morsi, investors need to be wary of a growing trend affecting broader emerging markets.
Much of the unrest around the world is caused by one thing: Uprisings against governments and their inabilities to provide basic services to citizens with rising income levels.
For decades, government intervention in the marketplace has been fueled by growing expectations for politicians to provide opportunities to the lower and middle classes.
But as more money flows into these economies, citizens are quickly learning that government intervention is depressing economic freedom, and failing to ensure the upward mobility expected by younger citizens of the world.
Simply put, economic freedom is the driver of growth, not government.
Egypt is uniquely important to global investors, as its control of global shipping lanes is having an impact on crude oil prices. CNBC and other news outlets are blazing headlines about how oil prices are expected to increase and a premium for Middle East unrest will continue to grow.
But investors are actually focused on the wrong commodity.
Instead, we should focus on an entirely different commodity class, as it highlights one key metric that few investors understand when examining the potential of certain markets.
Look at Food Costs in Emerging Economies
Egypt’s economy has struggled over the past two years since the overthrow of President Hosni Mubarak. The increased instability and political uncertainty have significantly depressed tourism revenues and deterred foreign investment.
And though the country has attempted to shift toward a freer marketplace, the nation is still bogged down by socialist policies. The government also heavily subsidizes food and energy for the poor, in a nation where 25% of the population now lives in poverty.
But these subsidies haven’t done much to affect one of the key drivers of political unrest in the North African nation. That issue is food on the table. For many there isn’t a lack of food, there is a lack of money to pay for it.
Food inflation has crippled the middle class and lower classes, as this food prices are up more than 9.5% on the year. What’s worse, Egyptians spend a disproportionate amount of their income on food, approximately 38.3% of their earnings, according to the United States Department of Agriculture.
But the poorest in the nation pay more than half of their income on their daily diets.
This figure is extremely high in comparison to more stable economies like the United States (6.8%), Canada (9.1%), Denmark (11.4%), or Hong Kong (12.3%).
Looking forward, investors should look at the percent of income that citizens of emerging markets pay for food, as rising costs increase the opportunity for unrest. Even in the reliable BRIC nations, food costs are significantly higher than more stable economies. Brazilians pay 24.6%, Russians pay 29.1%, Indian citizens pay 35.8%, and the Chinese pay 33.9%.
Investors should recognize that as this figure falls over time, citizens of these countries will have more money to spend on products and services of companies looking to expand into these markets.
Use the Liberty Investment Principle
In addition to the food share of certain economies, it’s critical to understand the economic freedoms in a nation in order to understand the nation’s potential. Simply put, more economic freedom has meant more money for food and greater food security.
But as we noted last week, investing in emerging markets requires a true understanding of the country’s economic potential. The easiest way to invest is to use what Martin Hutchinson calls the “Liberty Investment principle.” There are two tools that you can use in order to determine the best emerging economies to invest in.
Use the Heritage Foundation Index of Economic Freedom to understand each country’s investment opportunity. This index provides a scaled raw score to rank 185 nations on their economic freedoms, including property rights, investing rights, and business rights.
Investors should also evaluate the Transparency International’s Corruption Perceptions Index to determine how free of corruption each country has been.
And like Brazil, Egypt fails both tests.
Egypt ranks 118th in transparency and 125th in economic freedom.
Both of these figures should be extremely troubling to an investor looking at a market like Egypt.
Economic freedom is a significant driver of growth, one that has a strong link to reduced food costs. Investors should look to Switzerland, Singapore, Australia, and Canada when looking for reliable growth.
Not only do these nations have significantly lower food costs, but each is economically free and less susceptible to the powers of corruption.