Greece has become a byword for financial dysfunction, the example par excellence of what happens to a globally uncompetitive country when its inflated asset markets experience a destructive "correction."
South Korea and Taiwan, by contrast, are formidable players in the world economy, a result of their leadership in value-added technology. With combined foreign currency reserves of $700 billion between them and debt-to-GDP at a comfortable 40% in Korea and 34% in Taiwan, their national balance sheets are in very sound shape.
So it was striking to read last week that indexer MSCI had only now put Greece on review to possibly remove it from its "developed" country equity indexes and had decided against elevating South Korea and Taiwan from "emerging market" status.
In MSCI's defense, a country's economic development is only one criterion for its index rankings; also important are the size and liquidity of a country's stock market and the degree of accessibility to foreign investors. It is on those issues that South Korea and Taiwan have repeatedly failed to get the upgrade, even as they remain on review for it. And according to MSCI, the Greece review wasn't so much prompted by concerns about its debt crisis and potential departure from the euro zone, but by the repeated failure of Greek authorities to bring their country's equity-market regulations in line with other developed countries.
Nonetheless, such incongruous contrasts in country classifications, which are replicated throughout Wall Street and by all types of asset managers, have real-world implications. Although fewer institutions rigidly follow the weightings of international indexes such as MSCI's, they continue to have a significant influence on fund flows and on the internal structure of the investment industry. They also have a profound effect on currencies.
In essence, the nomenclature of international investment has a long way to go before it catches up to the realities of our rapidly changing global economy. The classifications around which portfolios are arranged and trading desks organized have never seemed more arbitrary than they do now, when the biggest threats investors face lie in "developed" European economies while the best hope for healthy, long-term growth resides in the "emerging" economies in Asia and Latin America.
Changes are under way. Bond investors started catching onto the idea of GDP-weighted indexes, for example, rather than the more common ones based on market capitalization, when they realized that the latter had the perverse effect of recommending higher asset allocations to countries with dangerously outsized debt loads, such as Greece or Argentina. But in investing, as with life itself, old habits die hard. There is still an awful amount of money invested according to outdated categorizations.
The integration--and now the potential disintegration--of the euro zone has made the task of classifying countries more complicated. Euro-zone member nations have the backing of a modern first-world central bank with extensive resources. If you assume that will always be the case--and until recently, it was a rare investor who imagined that a country might leave the zone--it becomes conceptually difficult to grant different classifications to different member nations.
But it is also likely that classifications such as "emerging market" or "developed economy" depend on criteria that are simply outdated or biased. Should securities regulations carry as much weight in these determinations as a country's productivity, technological advance and fiscal security?
There is also an insidious self-fulfilling element to all this. Once classified as an "emerging market," a country attracts different kinds of fund flows than those dedicated to "developed" nations. Emerging markets inherently draw risk-seeking, speculative investors who are prone to moving in rapidly when times are good but also more likely to flee at the first sign of danger. In a classic case of circularity, this reinforces the potential for capital flight and for market volatility, which are in turn defining features of emerging markets and their currencies.
Yet, as behind the curve as it is, a sea change is under way in how investors conceive of the risks across countries. Eventually, that will lead to more reclassifications into and out of the "emerging markets" and "developed country" categories and thus to shifts in capital flows in and out of certain currencies.
At some point, the South Korea won and Taiwan dollar will get a much-deserved boost from their countries' graduation to the developed country club.—Michael Casey is managing editor for the Americas at DJ FX Trader, a foreign-exchange news service from Dow Jones Newswires and The Wall Street Journal. His new book on the global financial system, "The Unfair Trade," was published this month. Write to Michael Casey at Michael.J.Casey@dowjones.com.