Autocracy’s risky; but so is buying freedom too dear

 
Philip Salter
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IT IS risky to invest in unstable countries, and autocracies are on average more unstable than democracies, despite some commentators’ views to the contrary. But surprisingly the data suggests that whether or not a country is democratic shouldn’t be a key factor for investors’ decisions.

IMMORTAL DEMOCRACIES
Stability and growth matter for investors. Happily, promoting economic growth also turns out to be the best guarantee of stability in a democracy. Although Singapore and the oil producing countries show that economic growth isn’t always and everywhere a corollary of democratic rule, democracies require wealth to survive, a useful incentive for their voters and politicians. Charles Robertson, global chief economist at Renaissance Capital, points out: “The most stable democracies in emerging markets are the immortal democracies – which is what all democracies are if their per capita GDP is above $10,000 (£6,300).”

Some commentators – such as author and New York Times columnist Thomas Friedman – claim that “enlightened” autocracies like China have great economic advantages. However, New York University’s William Easterly demonstrates in Benevolent Autocrats that this ignores available evidence and is often based on a policy bias towards bigger government in the analyst’s own country. Easterly “cautions scholars about jumping too quickly to benevolent autocrat explanations of growth successes.” In Africa: The Bottom Billion becomes the Fastest Billion, Robertson notes that democracy “tends to reduce corruption.” For Bestinvest’s Adrian Lowcock, “with a centrally controlled government and economy, no-one knows if the data coming out of China is accurate.”

REFORM AGENDAS
However, that isn’t the whole story. “We all started as non-democracies”, says Robertson, “and investors have made money in countries without full democracy, from the UK in the eighteenth and nineteenth centuries to investors in China in the twenty-first century.” For Robertson, the key is to buy into countries with reformist governments, which have a strong, growth-minded leadership. He cites the case of Chile’s Augusto Pinochet. “The most strongly reformist country in Europe, the Middle East and Africa (EMEA) may be Rwanda,” says Robertson, “which is generally not labelled as democratic, but which is advancing a reform agenda that Chile or Singapore followed in the twentieth century.”

FOOLED BY FACTORS
Yet a growth agenda is not an infallible investment cue either. Despite what appears to be the obvious and irrefutable correlation between the Pinochet coup, his radical economic reforms and the country’s growth, economic growth spurts occur without reforms. Growth Accelerations, a paper by Ricardo Hausmann, Lant Pritchett and Dani Rodrik, concludes: “While economic reform is a statistically significant predictor of growth accelerations that are sustained... most instances of economic reform do not produce growth accelerations.” Hausmann et al. find “increases in investment and trade” to be of greater importance. These could be driven by technology and other factors outside of governmental control.

Today, countries starting from a low base can reliably outstrip the growth of developed countries simply by copying technological innovations and best practice. Investors should seek to be exposed to this trend, although David Miller of Cheviot cautions that the absence of contract law and proper company titles can still be a concern. He also thinks investors shouldn’t get trapped into the simplistic belief that emerging markets are good and developed markets are bad. Miller says investors can also invest in companies in developed markets with business models predicated on emerging market growth. That may offer the best of both worlds.