Unemployment in Emerging Markets should not spook investors

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13 mins. to read
Unemployment in Emerging Markets should not spook investors

Developing countries like Kenya tend to have shockingly high rates of unemployment. But that should not deter investors – rather it is a sign of potential.

Worrying numbers

When I wrote last week that Kenya has an unemployment rate of 38 percent, a number of colleagues questioned that figure. How could it possibly be so high? Surely that denoted an economy in crisis. Who would invest in an economy where between one third and one half of the workforce is jobless?

In fact it turns out that Kenya is not alone in that respect. It is relatively “normal” for developing countries to sustain high but hopefully gradually declining levels of unemployment over time.


If we were to observe a developed economy with sky-high unemployment (that would be anything over 25 percent of the workforce) we would conclude that the economy in question was in crisis – either due to a severe depression or to a natural disaster of to some deep-seated structural problem in that economy. But for developing countries, which are moving in a generation or two from a pre-industrial to a post-industrial one, high levels of unemployment give us some notion of the economic potential yet to be unlocked. I am therefore much more worried by Greece’s 28 percent unemployment than by Kenya’s 38 percent.

Writing this article I have extensively researched the statistics available on unemployment in developing countries and I have to tell you that the IMF-World Bank and OECD statistics are highly questionable. The only reliable sources come from local media on the ground. Just check out one investigation in Kenya which puts Kenyan unemployment at 39.1 percent[i] and one in South Africa which estimates unemployment there conservatively at 26 percent[ii].

An economic conundrum

In a society of hunter-gatherers where people subsist by killing game and foraging in the forest, the GDP is zero – even if people create artefacts and make wondrous cave paintings. That is because no cash (or other form of money) changes hands – the activity of the people, though productive (in the sense that they are able to survive), is not monetised.

In exactly the same way, those goat hands in Kenya that I mentioned last week who shepherd their flocks on behalf of their extended families contribute nothing to the economy of monetary value – even though they perform an essential service for their communities. Similarly, most of Kenya’s 38 percent of unemployed people, while not receiving wages and salaries, are busy making and repairing things for their families even though they remain outside the formal economy.

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Actually, this phenomenon is not unique to developing countries. In the UK, for example, if the local authority employs a carer to look after an elderly person with dementia, that counts towards GDP. But the hidden army of carers who tend to the needs of elderly relatives for love do not show up in the economic statistics. I recently speculated on the economic value of charity shops in the UK which make a huge contribution to the recycling of goods for beneficial causes but officially count for little because their staff members are overwhelmingly unpaid volunteers.

Some of the problem arises as a result of national accounting. The great British economist Alfred Marshall (1842-1924) observed in the late 19th century that when a gentleman marries his housekeeper then GDP declines by the amount of her wages. (Wages paid to housekeepers show up in GDP statistics but housekeeping monies paid by one spouse to another are transfers outside of GDP.) Non-economists often find it puzzling that GDP statistics can be skewed by such national accounting conventions.

So the large numbers of people who are officially unemployed in countries like Kenya are not necessarily idle but remain outside the official workforce. They remain available for employment as and when sufficient capital is invested into business enterprises which need to employ labour. To that extent, they may be seen as a future resource that the country can draw upon as it accumulates capital – so long as they acquire the requisite skills needed by potential employers.


Of course, that is no consolation for people who are in hardship. There is no unemployment pay for people who are out of work in Kenya though I understand that they have access to the state healthcare system (which is rudimentary). One can assume that these high levels of unemployment are correlated with poverty – although one could argue that rural poverty in a traditional society is qualitatively different from urban poverty in a developed one.

In terms of developmental economics, as the economies of developing countries grow over time, so a larger percentage of the total adult population will be drawn into the labour market and unemployment will decline. However, there is a tendency for the gains of economic growth to accrue to those already in work, so the rate of unemployment does not decline as rapidly as policy-makers might hope. In rural Kenya people are poor but relatively few are hungry – as is the case in under-developed and war-torn countries like South Sudan.

Types of unemployment

Economists identify three distinct types of unemployment: frictional, structural and cyclical.

Frictional unemployment arises where workers quit their jobs in order to seek another preferred one. It also arises because new workers entering the labour market (for example students leaving university) may take time to find a job. Given good quality information about job vacancies and assuming benign economic conditions such job-seekers should be able to find jobs relatively speedily. In developing economies the quality of information regarding job vacancies is often inadequate. For that reason there is less opportunistic job-hunting than in developed economies.

Structural unemployment refers to the mismatch between unemployed people and the demand for specific types of workers. This occurs when demand for one kind of labour is expanding while demand for another kind of labour is declining either due to the changes in the structure of demand for industrial products or due to changes in technology. Famously, with the rise of the motor car in the early 20th century, demand for the services of blacksmiths went into sharp decline while automobile manufacturers faced an acute shortage of skilled mechanics.

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The distinguishing feature of structural unemployment is that unemployed workers lack skills required by expanding industries. Structural unemployment also occurs because of the mismatch between the location of job vacancies in expanding industries and the location of unemployed workers. In Lord Tebbit’s notorious phrase, workers may need to get on their bikes and relocate to where the work is. In developmental economics this normally translates as migration from the countryside to the towns.

Structural unemployment tends to last much longer than frictional unemployment because more time is required for people to get new training or acquire new skills or to move to new locations where the expanding industries are.

Frictional unemployment plus structural unemployment are together often termed the natural rate of unemployment, which will fluctuate depending on the rate of change in technology and so forth.

Cyclical unemployment arises because of a downturn in demand caused by a recession or a depression (which is a sustained recession). Since economies tend to operate according to a business cycle – upturn, boom, recession, depression – cyclical unemployment is considered to fluctuate over time. During the Great Depression of 1929-35 unemployment in the United States reached over 25 percent. In boom periods when the economy is running at full capacity (as is the case now in the United States) cyclical unemployment will effectively be zero and all unemployment will be frictional and structural. Full employment does not mean that everyone is in employment since there will always be people in any society, regardless of its level of development, who remain outside of the workforce because of age, sickness or infirmity.


There is a fourth category of unemployment associated with a predominantly agricultural economy: seasonal unemployment. In farming, more hands are needed in planting and then in picking and harvesting while in the intervening months few hands are required at all.

In developing economies that are growing there will be no lack of aggregate demand and therefore no cyclical unemployment. There will only be frictional unemployment to the extent that wages are growing fast and workers perceive that they can earn better pay elsewhere. The basic cause of unemployment in developing countries is a shortage of capital inhibiting the growth of employment. This was first identified by Karl Marx in the 19th century, so is by no means a new idea.

One potential problem for developing countries, like numerous African ones today, is that the stock of capital may grow more slowly, even given economic growth, than the population. I mentioned in my piece last week that, thanks to improved infant mortality and nutrition, the population of Kenya has been growing by one million a year over the last decade. If more workers are entering the labour market than there is capital to employ them, then unemployment will increase.

The Harrod-Domar Model (1950s)

Capital as the major bottleneck to growth of employment was popularised by the Harrod-Domar model of economic growth named after economists Sir Roy Harrod (1900-78) and Evsey Domar (1914-97). In this model capital accumulation plays a pivotal role and the rate of growth of output depends upon the proportion of national income saved, divided by the capital-output ratio. The key equation is g = s/v, where g stands for the growth rate, s for the proportion of income saved and v for the capital-output ratio.

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This model assumes that the capital-output ratio and capital-labour ratio remain constant – which is now contested. With constant capital-output and capital-labour ratios, the more the capital there is and the higher both output and employment will be. When adapted to less developed countries, the model suggests that the rate of growth of output and therefore of employment is determined by the growth of capital stock.

Professor Sen’s theory

According to the Nobel prize-winning Indian economist, Professor Amartya Sen (born 1933) who is a leading light in the field of welfare economics the quantum of wage employment in the economy depends on the total supply of wage goods on the one hand and the real wage rate on the other[iii]. Wage goods are basic comestibles essential for the survival of families in conditions of near-poverty (grains, eggs, basic meat, sugar, fruit and vegetables, spices, tea and fuel e.g. gas).

If E represents the quantum of employment, M the supply of wage-goods and W the real wage-rate, then according to Professor Sen potential employment will be given by the following equation:

E = M/W

It is evident from this equation that if the supply of wage-goods (M) is less than that required to supply the labour force then some workers will not be able to find employment. In order to stimulate employment, wage-goods industries, especially agriculture, must be accorded a high priority in a country’s economic development strategy.

That is also significant because countries such as Kenya with a climate and geography that is favourable to agriculture can and do generate hard currency income by exporting agricultural products. I have been arguing in these pages for more than one year now that agriculture should be regarded for what it is – the biggest and most vibrant industry in the world.

Why education is key

If you want hope that these extraordinary levels of unemployment in developing countries can be driven down to more “normal” levels, you need only to look at the education system. Further to my recent journey across Kenya I can report that efforts to create a modern educational system there are bearing fruit.

In 2003 the government of President Mwai Kibaki made it compulsory for children to attend primary school for a minimum of eight years from the age of six to 14. There is a non-compulsory secondary education system available to youngsters of 14 to 18. Some of those will move into tertiary education from the age of 18 to 22 though this is not yet state-funded.

Primary education in Kenya is free, though parents must pay for school uniforms (which cost about $8-10) and, endearingly, a desk (costing $20-25). The most striking thing is the sheer number of primary schools extant even in the most remote corners of the country. In the vibrant early African morning one sees immaculately turned out children trekking through the countryside on their way to school – often covering 10 miles or more on foot. What’s more, Kenyan children are, I am assured, overwhelmingly polite and respectful of their teachers. This is socially disciplined and conservative Africa! These youngsters have lessons in both Swahili and English – the two official languages of the country. Some schools even teach Latin.


The school curriculum in Kenya has a very old-fashioned British flavour – and without the stifling supervision of contemporary health and safety culture obtaining in Britain (where teachers have to file risk assessments for every class or woe betide the OFSTED inspectors). Kenyan children are allowed to bring knives to school: there might be a poisonous snake lurking under their desk – and Dad almost certainly carries a machete, so what’s the problem? And they hold communal hymn-singing sessions, one favourite being I vow to thee my country!

I admit that one does observe quite a few ten-year olds herding goats in the deep countryside (and I still haven’t mastered the Swahili for Why aren’t you at school?). But the country’s commitment to education at every social level is undoubted. Illiteracy has been slashed – evidence for which is that Kenyan children are keen users of social media. It is not entirely surprising then that on the Nairobi-Mombasa highway just past Jomo Kenyatta International Airport a huge space has been cleared for a new Tech City where supposedly Apple (NASDAQ:AAPL) and Google (NASDAQ:GOGL) will soon establish the HQs of their entire African operations.

Kenya is just one African nation which is slowly creating a workforce fit for a modern technological economy.

Conclusion: lessons for investors

Unemployment in developing countries is not caused by a lack of demand as it is in developed economies but rather by a shortage of capital. Therefore, investors who wish to invest in emerging markets should not be deterred by high levels of unemployment but should look at the rate of accumulation of capital – which is not the same as the long-term growth rate for reasons that I shall explain soon.

Of course, potential investors should also look at the overall direction of economic policy and political stability is obviously also paramount. In a series of up-coming articles I shall try to identify how to pick winners in the heterogeneous world of emerging markets. The fact is that there is no direct correlation between economic growth and stock market returns in emerging markets. Investors therefore need to combine top-down country analysis with bottom-up company analysis.

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I shall also explain this year why, if you are a British taxpayer, the tax that you pay on your hard-earned income dedicated by the politicians to “international aid” is almost entirely poured down the proverbial drain. In the meantime, if you want to help dynamic upcoming open economies like Kenya, you should invest there in agricultural land, property, or the equities and bonds of dynamic companies. That will bring in capital which, over time, will reduce unemployment and thus poverty. And will very likely yield you rewards. Win-win.

I’ll have much more to say about specific targets for your money in emerging markets over 2018. As you will know if you have read my lead article in this month’s MI magazine, I am feeling optimistic about the prospects for stock markets this year. And certain selected emerging markets look more encouraging than others. I shall reveal the identities of three of these shortly.


[i] See: https://www.standardmedia.co.ke/article/2001253818/unemployment-in-kenya-what-you-should-know

[ii] See: http://www.ilo.org/wcmsp5/groups/public/—dgreports/—dcomm/—publ/documents/publication/wcms_541211.pdf

[iii] See, in particular On Economic Inequality (1997). I had the immense privilege to attend Professor Sen’s lectures while an undergraduate. He has written extensively on philosophical topics as well as economics including theories of justice and is widely regarded as a modern genius.

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