What is a Developing Country?

Developing Country Classifications

Getty Images / Oliver Burston.

Investors rely on classification systems in order to simplify the process of finding investment opportunities. For example, small-cap stocks are those trading with market capitalizations of less than $300 million and income stocks are equities that offer attractive dividend yields.

International investors often classify countries around the world based on their economic development. These classifications are based on a number of economic and social criteria, ranging from per capita income to life expectancy to literacy rates.

Developing countries, less developed countries (LDCs), or emerging markets are those with lower ratings on these statistical criteria.

Countries that are deemed more developed than LDCs are known as "developed countries", while those less developed are known as less economically developed countries (LEDCs) or frontier markets. While criticism has emerged of these terms, they remain commonly used in many circles, including among international investors and international organizations.

In this article, we will take a closer look at how developing countries are measured, some examples that meet the criteria, and important considerations for international investors.

How to Measure Development

There are many different measures of development used by a wide variety of institutions. For instance, the United Nations has few conventions for distinguishing between "developed" and "developing" countries, while the World Bank makes specific distinctions using gross national income (GNI) per capita - though other analytical tools may also be used in the process.

The International Monetary Fund's (IMF) definition is often considered to be the most comprehensive measure since it takes into account per capita income, export diversification, and the degree of integration into the global financial system. In 2011, the organization published a research report on the topic of classification called Classification of Countries Based on Their Level of Development that outlines its methodologies.

The World Bank has a much more concrete methodology as it considers countries with per capita income of less than US$12,275 as "developing" countries. But the organization also divides these developing countries into numerous income classes, ranging from low income to upper middle-income countries, meaning there are other grey areas for international investors to consider.

Popular Developing Countries

Different organizations use different measures to determine how companies are classified, but there are a few common denominators in the mix. For instance, the so-called BRICs are generally considered developing countries and include Brazil, Russia, India and China. But, examples of common developing countries go far beyond these popular emerging markets.

Here are some other countries that appear on most lists of developing countries:

  • Argentina
  • Chile
  • Malaysia
  • Mexico
  • Pakistan
  • Philippines
  • South Africa
  • Thailand
  • Turkey
  • Ukraine

Investing in Developing Countries

Investing in developing countries can be easily accomplished using exchange-traded funds (ETFs) focused on so-called emerging markets. While these investments aren't as safe as developed countries, they tend to have higher rates of return over a long time horizon.

The reason for this is simply because developing economies tend to grow at a faster rate than developed ones.

A secondary benefit of these emerging markets is diversification, which spreads out investment risk so that exposure to any single asset is limited. Emerging markets provide investors with diversification from both domestic and developed market equities that tend to account for most of a portfolio. For example, the iShares MSCI Emerging Markets ETF (EEM) has a correlation coefficient of just 0.5619 compared to the SPDR S&P 500 ETF (SPY) between January 2004 and July 2017.

Some popular emerging market ETFs include:

  • iShares MSCI Emerging Market Index ETF (EEM)
  • Vanguard MSCI Emerging Markets ETF (VWO)
  • BLDRS Emerging Markets 50 ADR Index ETF (ADRE)
  • SPDR S&P Emerging Markets ETF (GMM)

Alternatively, investors can purchase American Depository Receipts (ADRs) in these developing countries.

Keeping a diverse portfolio across multiples developing countries can provide a great, diversified portfolio of international opportunities. Those seeking even more specific returns can also consider purchasing stock on foreign stock exchanges, although this entails some unique risks.

Alternative Classifications

Developing countries sit just below "developed countries" and above "less economically developed countries". Developed countries are countries with economies that have high growth and security when looking at gross domestic product, per capita income and general standard of living, among other things. Examples include the U.S. and Germany, as well as many parts of Europe.

Less economically developed countries, or LEDCs, are countries that exhibit the lowest indicators of socioeconomic development. According to United Nations standards, these countries have low incomes, human resource weakness and economic vulnerabilities that include weak natural resources or population displacement.

The Bottom Line

Investors like to use classification systems in order to simplify the investment process. When it comes to regions of the world, developing countries are those countries that haven't quite reached maturity, although there's a wide array of different definitions. International investors may want to be cognizant of these different criteria when evaluating the risk and return potential of their portfolio.