5 Economic impact of country liberalization

The liberalization of emerging market countries provides new opportunities for investors to increase diversification and profits. Economic liberalization refers to the “opening up” of a country to the rest of the world in trade, regulations, taxation, and other areas that generally affect the country’s business.

As a general rule, you can determine the degree of economic liberalization in a country/region by how easy it is to invest and do business in that country/region. All developed countries (first world) countries have gone through this process of liberalization, while emerging countries need to undergo a series of changes. The following are the five effects of national liberalization.

Key points

  • Economic liberalization is generally regarded as a beneficial and desirable process for developing countries.
  • The fundamental goal of economic liberalization is to allow capital to enter and exit the country without restrictions, and to promote economic growth and efficiency.
  • After liberalization, a country will benefit politically from the stability of foreign investment, which is almost like a board of directors in an emerging country.
  • These countries are considered high-risk at the beginning, but this does not prevent large investments by institutional investors who wish to enter first.

1. Eliminate international investment barriers

If there are multiple barriers to entry in the country/region where you invest, investing in emerging market countries/regions may sometimes be an impossible task. These obstacles may include tax laws, foreign investment restrictions, legal issues, and accounting regulations, all of which make entering the country difficult or impossible.

The process of economic liberalization must first relax these obstacles and transfer control of the direction of economic development to the private sector. This usually involves some form of deregulation and privatization of the company.

2. Unrestricted flow of funds

The main goal of economic liberalization is the free flow of capital between countries and the effective allocation of resources and competitive advantages. This is usually achieved by reducing protectionist policies such as tariffs, trade laws and other trade barriers.

One of the main effects of the increase in capital flowing into the country is that it reduces the cost of obtaining capital from investors for the company. The lower cost of capital enables companies to undertake profitable projects that they may not be able to carry out at a higher cost of capital before liberalization, leading to higher growth rates.

3. Stock market appreciation

Generally speaking, when a country becomes liberalized, the stock market value also rises.Fund managers and investors are always looking for new profit opportunities. This situation is similar in nature to the anticipation and flow of capital inflows into an initial public offering (IPO).

When the entire country can invest, it often reaps windfalls from foreign investment.

The sudden availability of a private company that was previously unavailable to investors usually leads to similar valuation and cash flow patterns. However, just like an IPO, the initial enthusiasm will eventually fade, and the returns will become more normal and more in line with the fundamentals.

4. Reduce political risks

Liberalization reduces the political risk for investors. If the government wants to continue to attract more foreign investment, it must also strengthen areas other than the aforementioned areas. These areas support and cultivate the willingness to do business in the country, such as a strong legal basis for resolving disputes, fair and enforceable contract law, property law, and other areas that allow companies and investors to operate with confidence.

Therefore, government bureaucracy is a common goal that needs to be streamlined and improved in the process of liberalization. All these changes collectively reduced the political risk for investors, and this lower level of risk is part of the reason why the stock markets of liberalized countries rose after the barriers disappeared.

5. Investor Diversification

Investors can benefit by investing part of their portfolio in a diversified asset class. In general, the correlation between developed countries such as the United States and underdeveloped or emerging countries is relatively low. Although the overall risk of emerging countries itself may be higher than average, adding low-correlation assets to your investment portfolio can reduce the overall risk profile of your investment portfolio.

However, what should be distinguished is that although the relevance of a country may be low after opening up, the relevance may actually increase over time. A high degree of integration will also increase the risk of contagion, that is, the risk of domestic crises caused by crises in different countries.

This is exactly what happened during the financial crisis that began in 2007-2008. The weaker countries in the EU (such as Greece) began to experience serious financial problems, which quickly spread to other EU member states.In this case, investing in several different EU member states will not bring too many diversified benefits, because the high degree of economic integration among EU member states increases the relevance of investors and the risk of contagion.

Bottom line

Economic liberalization is generally regarded as a favorable and desirable process for emerging and developing countries. The basic goal is to allow capital to flow in and out of the country without restrictions to promote the country’s growth and efficiency. The effects of liberalization should arouse investor interest because they can provide new opportunities for diversification and profitability.

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