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Human capital in emerging markets

November 2019

Unlocking human capital in emerging economies

All developing countries have a seriously under-tapped resource: their people.  That's important for emerging debt investors to bear in mind.

Unlocking human capital is key to opening up  emerging economies’ potential.

Our analysis shows that improving human capital – which is the economic value of people's skills and capabilities – boosts a country's productivity and growth, leading to an improvement in its credit rating. This has important implications for investors in emerging market bonds.

The majority of developing countries tend to show improvement on the United Nations Human Development Index (HDI). But while the top 50 per cent are rewarded, on average, with a 2.13 notch upgrade on their credit rating (where, say A to AA, is one notch)  those in the bottom half only benefit from a 0.24 notch upgrade. (See Fig.1)

Fig 1. top hdi perfomers also achieved significant rating upgrades
Rating notch upgrade(+)/downgrade(-)
Human development index impact on credit ratings

The change in the HDI index vs the change in rating over the 2001-2017 period. Sample includes EM countries where data is available. Source: OECD productivity data, UN HDI data.

Despite this, investors have tended to ignore human capital when assessing developing countries’ prospects, not least because it’s been hard to measure and analyse. That’s changing, though. Recently, the World Bank’s Human Capital Project, the UN’s Human Development Index and Sustainable Development Goals have all pushed human capital into the limelight, offering new ways of measuring it. At Pictet Asset Management, our emerging market debt team is using these tools as part of its country analysis, particularly where it relates to environmental, social and governance (ESG) issues.

Key to EM prospects

Having a firm grasp of human capital is particularly important right now – it serves to dispel some of the current gloom about emerging market economies’ prospects. Rising trade protectionism, stumbling progress on structural reforms and the end of the commodities super cycle are considered drags on traditional manufacturing and export-driven development. But in a world where flows of information rather than goods are becoming increasingly important sources of growth, latent human capital gives emerging markets enormous potential. Which is why it’s crucial that emerging countries are investing in their people. (Fig.2)

Fig. 2 top hdi perfomers are also productivity champions
% change in productivity (2001-2017)
Human development index impact on productivity

% change in productivity vs percentile rank of HDI change over the 2001-2017 period for countries where data is available (43 countries EM and DM). Source: UN's HDI data, S&P Ratings transformed in numerical format such that +/-1 point translates to one rating notch upgrade/downgrade. Source: S&P Ratings.

It’s also why we make sure human capital is on the agenda for our discussions with policymakers. Indeed, we’ve gone beyond the traditional EM investor approach to due diligence by looking for new sources of insight.

From understanding human capital to developing it

As a concept, human capital is as old as modern economics. The 18th century economist and philosopher Adam Smith described it as “the acquired and useful abilities of all the inhabitants or members of the society.” More recently, Paul Romer was awarded the 2018 Nobel Prize in economics for work that puts both human capital and innovation at the centre of economic growth theory.

The debate has moved beyond the importance of human capital for economic growth to how it affects the kind of growth a country experiences – whether it finds itself on a more inclusive, and thus sustainable, development path.

But to get the full picture about how human capital is developing in emerging economies means looking beyond interactions with the sorts of institutions traditional EM investors are most familiar, and comfortable with. It’s not enough to stick to the usual repertoire of meetings with government officials and senior business people, of being bussed from smart hotel to air-conditioned office and back again.

To get the full picture about how human capital is developing in emerging economies means looking beyond interactions with government officials and senior business people.

One way we’re developing a ground’s eye view of social and economic developments in the countries we cover is to build a partnership with EMpower, a well-respected and innovative charity focused on youth in emerging economies. Contact with its programme managers in key regions and countries gives us an on the ground perspective and puts us in touch with people we would otherwise never have access to.

One such programme is South Africa’s Mamelani Projects.2 Mamelani was founded by young community development workers to help Cape Town townships’ many homeless young people who’d grown up in institutional care, often orphans or victims of South Africa’s AIDS epidemic. Thanks to EMpower, Pictet AM investment manager Robert Simpson recently had the opportunity to spend time with Mamelani’s director, Gerald Jacob. He saw for himself Mamelani’s comprehensive approach to building the human capital of local youth by combining personalised emotional support, education and life skills training – including helping them to develop their own support networks.

“It informed my discussions with the South African government about how best to balance immediate fiscal considerations against protecting the sources of long-term growth,” Simpson said.

During other recent trips, other members of Pictet AM's emerging markets debt team have spent time with EMpower sponsored charities in Brazil and Argentina. Each meeting has added a wealth of insight to our country analysis.

These insights help us, in turn, to hold more informed and sharply focused discussions with the policymakers and business leaders who have the power to influence policies that affect human capital development. Getting the right message across will ultimately be good for the country’s people. It will also help ensure we become better stewards of our investors’ capital and, we hope, improve their long-term returns.