Why These 3 Countries Could Be Too Risky To Invest In

By Tim Begany | September 14, 2011 AAA
Why These 3 Countries Could Be Too Risky To Invest In

Although robust imports and exports are important for a vital economy, some countries are actually dangerously overdependent on foreign trade. The U.S. isn't one of them and hasn't been for a long time, but South Korea and a couple of other foreign countries popular with many investors right now, are much too trade-dependent. This makes them potentially risky places to invest in.

TUTORIAL: Economic Basics: What Is Economics?

In the case of South Korea, economists say the country's "dependence ratio" is way too high. Although it may sound complicated, the dependence ratio is simply the ratio of imports and exports. In other words, trade to gross domestic product (GDP). GDP is a broad measure of the health of a country's economy that is defined as the monetary value of all finished goods and services produced within that country during a specific time period. (For related reading, see What Is GDP and why is it important?)

Dependence Ratio Rising
Although usually on the higher side, the dependence ratio for South Korea has soared in the first quarter of 2011 to about 110%, reflecting the increasingly disproportionate role of foreign trade in that country's economy. The dependence ratio for China is about 49%, while Japan and the U.S. each have a dependence ratio of only about 25%, suggesting that these three countries are much more self sufficient economically.

The big problem with being too trade-dependent is it vastly increases a country's vulnerability to economic shocks originating outside its borders. For instance, if the U.S. fell back into recession or Europe's debt problems worsened and further hindered that region's economy, South Korea's economy might slow down even more severely since most of its trade is with the U.S. and Europe. For South Korea, the damage would probably be the worst in the automobile and electronic products industries, according to the LG Economic Research Institute, a private South Korean business and economic think tank.

A country is more prone to being trade-dependent if it's relatively small like South Korea, which only has a population of about 49 million (compared with about 128 million, 312 million and 1.3 billion, respectively, for Japan, the U.S. and China). A small population means a small domestic market, which forces a country to rely a lot more on foreign trade for economic growth and prosperity.

Germany and Mexico
Along with South Korea, Germany and Mexico are also known for being trade-dependent, though to a lesser extent. Germany, with a population of only about 82 million, has a dependence ratio of 87% stemming mainly from its reliance on the European Union for trade. It wouldn't be much of a surprise to see a sharp slowdown in Germany's fast-growing economy soon, since the rest of Europe is instituting austerity measures that are apt to greatly reduce demand for German exports.

Mexico has a substantially larger population than Germany (nearly 113 million.), so as you might expect, its dependence ratio is lower at 55%. This is still fairly trade-dependent. Because Mexico relies so heavily on the U.S. for trade, its economy suffered worse than other Latin American economies during the 2009 recession.

The Bottom Line
If you're thinking of investing in a foreign country, as part of your overall research, find out its dependence ratio to get an idea of how closely the country's fortunes are tied to those of other countries. Reasonably current dependence ratios are pretty to easy find on the Internet by doing a Google search on the name of a particular country and the words, trade dependence ratio.

You shouldn't necessarily avoid investing in a country just because its dependence ratio is high. The ratio is only one indicator of the riskiness of the investment, and it's up to you to decide how much risk you're willing to take. When you consider the dependence ratio along with all the other facts you dig up, you may end up deciding to make a large investment in a particular country, a small one or none at all. (For related reading, see 5 Economic Effects Of Country Liberalization.)

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