Democratic political systems are becoming more prevalent among Asian countries, supporting the region’s economic rise and potential for even greater investment windows
The percentage of Asia’s population living under democracy has risen steadily over the last three decades but in many ways this has been overshadowed by the region’s dramatic economic growth. However, Asia’s political evolution has paralleled the region’s economic rise. With over half the population now living under democracy, Asian countries are gradually becoming more mature and representative.
A true democracy arguably encompasses both an inclusive economic system and an inclusive political system. As investors, we welcome the development of such inclusive systems as they create a more dynamic marketplace, sustain long-term economic growth and may even generate greater respect for the rights of minority shareholders and drive improved corporate governance norms.
In democracies that are economically and politically inclusive, improvements become dispersed through society as individuals and businesses innovate. Paradoxically, in societies that foster open competition, firms must constantly strive to stay ahead. For instance, the launch of Apple’s iPad understandably has led to alternate tablet products being created by its competitors; thereby helping to limit Apple’s pricing power in the space. In inclusive societies, such as the US, companies such as Apple cannot forbid competition. Hence, competition and pricing pressure thereby raise real labour costs and real wages, and ultimately increase the incentive for further innovation.
Improvements in efficiencies are typically driven by those incentivised to take risks. An automobile factory, for example, can produce a certain number of cars per day given certain equipment and labor force capabilities. More advanced machinery and more skilled labour could boost productivity. However, even if those changes were to be put into place, continued productivity would be dependent on the ongoing innovation of its managers and workers. Typically, for that to occur, a firm needs to establish the incentives and culture to foster that innovation among its employees. Management, likewise, needs to believe that it is worthwhile to innovate and that its profits will not be eroded by government policies such as high taxes, price controls or lax intellectual property protection.
In economic terms, these innovations or improvements in efficiencies are referred to as multifactor productivity (MFP), a country’s most important sustainable growth driver. From 1948 to 2002, MFP for the US accounted for 55 per cent of the country’s average annual labour productivity growth. Asian countries have been following similar productivity trends. India’s MFP from 1990 to 2011 was at about 29 per cent of overall GDP growth and MFP in Taiwan was approximately 47 per cent of GDP growth.
Where does Asia stand now?
“Creative destruction” is a process whereby new business models and technologies replace old business models, which are inherently cyclical. Either this “destruction” in the marketplace, or new entrepreneurial activity, may be represented by the percentage of firms that do not retain their leading market capitalisation positions over time. Countries with less inclusive institutions typically have more inertia among its top companies. Not surprisingly, in comparison to the US, India, South Korea and Taiwan have shown less turnover in their top market cap firms.
Given the diversity in Asia, different countries have followed different paths. India has been a democracy since independence in 1947 (notwithstanding a brief state of emergency declared by Indira Gandhi in the mid-1970s). But for decades, a Soviet-inspired planning model fostered an autocratic economic system. Despite its political freedoms, this lack of economic freedom meant that almost all major business decisions required permission from the government. India’s economy was on the brink of collapse by the early 1990s. But the crisis spurred a wave of reform and economic liberalisation that put the country on a path toward a more entrepreneurial economy.
South Korea followed a different route. In the years following the Korean War, US influence and the leadership of Park Chung Hee led to a more capitalist economy, albeit one under an authoritarian regime. The clannish chaebol—conglomerates that dominated Korean industry—were dependent on government cooperation. Given the lack of political freedom, political payoffs were viewed as simply another form of tax on industry. Only since the 1980s has Korea moved toward political liberalisation.
Why are these changes happening? Inclusive policies are typically sustainable when aligned with the interests of a country’s leaders. This is the case when the government is beholden to a large percentage of the population to be in power. In these situations, it becomes too expensive to try to win supporters with financial favours and more cost-effective to launch initiatives that benefit the broader populace. Parliamentary elections over the last 30 years have indicated that in countries such as South Korea and India, those in power are dependent upon support from a higher percentage of voters and, hence, forced to diversify their support base.
The plethora of mechanisms for social media and news sharing has also benefited political and corporate oversight. The trend toward greater public scrutiny that we witness in India and South Korea should eventually lead to less pervasive corruption.
Perhaps for the first time, many countries in Asia are close to having both a free-market economic system and a democratic political system. As these newer forms of economic and political systems get entrenched, the old ways of doing business should fade away. As long-term investors in Asia, we look forward to the strengthening of these trends.
Sudarshan Murthy is a research analyst at Matthews Asia