What Is a Developing Country?

Developing Country Classifications

Getty Images / Oliver Burston.

International investors often classify countries around the world based on their level of 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 based 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 these terms have been the subject of criticism, they remain commonly used in many circles, including among international investors and international organizations.

How to Measure Development

Institutions measure a country's level of development in many different ways. 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, although other analytical tools may 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 titled ​"Classification of Countries Based on Their Level of Development" that outlines its methodologies for classifying a country's level of development.

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 gray areas for international investors to consider.

Typically Recognized Developing Countries

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

Some other countries that appear on most lists of developing countries include the following:

  • Argentina.
  • Chile.
  • Malaysia.
  • Mexico.
  • Pakistan.
  • Philippines.
  • Thailand.
  • Turkey.
  • Ukraine.

Investing in Developing Countries

You can invest in developing countries easily with exchange-traded funds (ETFs) focused on emerging markets. While these investments aren't as safe as those in developed countries, since they are more volatile, they tend to have higher rates of return over a long time horizon, simply because developing economies tend to grow at a faster rate than developed ones. This makes them an important component for an investor's portfolio - particularly if they have a long time horizon.

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) trading on U.S. exchanges to easily gain exposure to specific companies within these developing countries. Keeping a diverse portfolio across multiple 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 taxation and regulatory 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 factors. Examples include the United States and Western Europe.

Less economically developed countries (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. As a result, these tend to be riskier investments since there is a much higher level of uncertainty, but they may be suitable for a well-diversified portfolio.

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.