THE INSIDERS: The politics of economics

By bne IntelliNews August 24, 2011

Marcus Svedberg of East Capital -

The catalyst to the renewed turmoil in the global financial and economic system was the inadequate policy response from the US and the Eurozone. The market was dismayed to see how the infighting between American politicians almost shut down the government and yet failed to reach any significant agreement on the underlying budget and debt problems. Meanwhile in Europe, the leaders of the Eurozone call emergency session after emergency session without coming up with much of substance other than promising more summits, benchmarks and coordination.

It is, therefore, tempting to think that the economic and financial crisis is also a crisis for the Western liberal democratic model of economic governance. This is an especially appealing line of thought since the Chinese economy, which is the least democratic country in the G20, has outperformed throughout the crisis. Even if one has reservations about the long-term appeal and sustainability of non-democratic governments, is it possible to think that representative governments are great when things are going well but awful in times of crisis, and vice versa for authoritarian regimes? A friend posed that question recently and as appealing as it may be to answer affirmatively, I believe it would be a mistake to rush to that conclusion.

It is about economics...

First of all, not all undemocratic economies outperformed and not all democracies underperformed during and immediately after the crisis. Looking at the 2009-2011 period, India, which is considered a free economy by Freedom House, was the second fastest growing G20 economy, while Russia, which isn't reckoned to be free, was one of the worst economies. The level of economic development seems to have a stronger relevance, as the three fastest growing economies - China, India and Indonesia - also happen to be the three poorest in GDP/capita terms. Similarly, the three worst economies from a growth perspective - Japan, UK and Italy - are among the richest.

Second, growth is about economics, not politics. Although politicians often think that they can create or administer growth, they can merely create an environment conducive to growth. They can also, as has been crucial during this period, stimulate the economy through extraordinary packages and bail out struggling enterprises (often banks) that are deemed crucial for maintaining the stability of the system. The Chinese received a lot of praise for the speed, size and implementation of the stimulus, while the Europeans and the Americans were criticised for being too late and moderate with their initiatives.

But at the end of the day, it is companies that create growth by increasing the capital or labour base, or their productivity. It is obviously easier to achieve this when moving from a low base, which has little to do with form of government, and implementation may be quicker in an authoritarian regime, but it is not necessarily better.

... and transparency

Third, and perhaps most importantly, having a multitude of actors with a high degree of independence is sometimes messy, but should be able to create a more favourable outcome over time.

Take the role of central banks. The European Central Bank, Bank of Japan and the US Federal Reserve have - through quantitative easing, dramatic rate cuts, bond purchases and provision of liquidity to the banks - played an enormously important role during the crisis. These institutions act independently from their governments and in a transparent way (although the minutes of the meetings are released with some delay). Central banks in non-democratic economies, on the other hand, tend to be less independent and less transparent, thus making it difficult to distinguish it from the regime and to analyse the reasoning behind the policies.

The rating agencies are another example. The downgrade of the US credit rating by Standard & Poor's in early August sent shockwaves through the global financial system. But just as it was possible (although heavily criticised) for an American firm to downgrade its own government, it was equally possible for the market to ignore the change and pile into US debt. Meanwhile, neither governments nor the market cared that Dagong, the Chinese rating institute, downgraded the US credit rating days earlier. The biggest effect of the S&P downgrade may very well be that it puts pressure on the policymakers. Presidents, prime ministers and ministers of finance may decide the right things, but they may also make the wrong calls and they need independent and influential actors like the media, central banks and rating agencies to tell them so.

Fourth, the state of affairs may not be as good as they seem in non-transparent economies. That debt tends to be lower and growth higher in some of the authoritarian regimes has more to do with the level of economic development than with the form of government. It is emerging markets - democratic or not - that tend to have plenty of leverage and growth potential. Moreover, debt can be hidden and growth rates manipulated. Chinese growth is by any estimate very strong, but many economists suspect there is an element of manipulation, especially as some local governments have incentives to inflate the numbers. And while the official public debt in China is below 20% of GDP, some analysts argue that the correct ratio is closer to 80% if local government debt and non-performing loans of state banks and other pockets where some of the stimulus money ended up are included.

Lessons learned

All of this doesn't mean that we should give Western politicians a break or suspect that all politicians in non-democratic economies cheat and lie by default. I am still convinced that representative governments with their network of independent institutions produce better results than authoritarian regimes even during times of stress. But it is of vital importance that we continue to scrutinise their work very thoroughly, especially during challenging times.

I am also convinced that the prospects for emerging economies are brighter than for their developed peers and that they ultimately will democratise. The fact that there are so few non-democratic countries (that are not commodity exporters) among the richest countries in the world, suggests that emerging economies either become democratic or get stuck in the middle-income trap.

And, finally, the government likely to produce the best response to a crisis is a government that has been in a crisis before. Many of the economies that are growing fast and have sound public finances went through a crisis where growth contracted and the economy deleveraged. Think about Latin American economies in the 1980s, Asia in the late 1990s, or Eastern Europe in 2008-2009. The Swedish experience in the early 1990s is good example from the developed world, as it is one of the most prudent and fastest growing economies in the EU today.

So, the lesson here is that it is lessons that matter the most when it comes to crisis response and economics that matters most when it comes to economics. Combining liberal economics with authoritarian politics may seem like an increasingly attractive way forward for emerging markets that have not yet become fully-fledged democracies, but it would be a huge mistake to go down that road.

Marcus Svedberg is Chief Economist of East Capital

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