Bridge over ocean
1 October 2015 CFA Institute Journal Review

Have Your Cake and Eat It (Digest Summary)

  1. Biharilal Deora, CFA, CIPM

The transition from a nondemocratic political system to a stable democratic system has resulted in substantial per capita GDP growth for various countries. In terms of economic growth, democratic systems show better results than nondemocratic political systems. Some researchers, however, have contrarian views on this subject.

What’s Inside?

The fact that China’s GDP growth rate is better than that of its democratic emerging market rivals—for example, India and Brazil—puts a question mark on the effectiveness of a democratic political system in terms of economic growth. But according to various researchers, broadening the spectrum to include more countries for analysis demonstrates that the democratic political system is the clear winner.

How Is This Article Useful to Practitioners?

The author compiles the viewpoints of various researchers by studying their published papers on the subject. Some researchers report that in a democracy, politicians cannot lay the foundations for long-term growth because voters want instant gratification. Politicians are guilty of diverting resources away from people who could use them more efficiently and, instead, spending lavishly on unemployment benefits and pensions for political gain. But when people have no political power, the risk of conflict rises, driving away investors. It is complicated to compare the economic impacts of different political systems because the average per capita GDP of a “free” country is, on average, four times that of an “unfree/partly free” country, which means that poorer countries can always grow faster than richer countries.

When a country goes from being an autocracy to a democracy (or vice versa), GDP growth stumbles because such transitions often involve mass protests or violent coups (e.g., in Tunisia and Egypt). Data of 175 countries from 1960 to 2010 show that permanent democratization leads to a 25% increase in per capita GDP in subsequent years. The reasons could be higher investment in education and health care and less social unrest.

Abstractor’s Viewpoint

All political systems are guilty of inefficient allocation of resources. So, it is important to see the impact of investment in education, health care, and infrastructure on economic growth across all political systems to have an unbiased view of the effect of a country’s political system on economic growth. But there is no doubt that freedom combined with economic growth is unbeatable.

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