The Political Roots of Prosperity

Why do some economies grow faster than others?

Photo: Paul Anderson. Source: Morguefile

In his recent book, “The Origins of Political Order,” Francis Fukuyama argues that democracy is a stool that stands on three legs: a stable society, political accountability, and the rule of law. Without any one of these elements, democracy is not possible. A stable society means it is safe to come and go. Political accountability provides a way to discipline leaders. And the rule of law means that the law is supreme—that everyone plays by the same rules.

These three factors correspond to the three branches of US Government—executive, legislative, and judicial. The Executive branch establishes order, Congress is the most politically accountable branch, and the judiciary adjudicates property rights. Contrary to anarchistic utopian dreams, a truly weak state doesn’t safeguard liberty. It encourages the rise of gang warfare and the rule of tribal warlords.

Economic growth depends of three items that roughly correspond to Fukuyama’s three political factors. A stable currency is like a strong government. It’s necessary for economic exchange, and for people to be able to make long-term plans. Part of the problem with inflation and deflation is that you can’t make long-term economic plans.

Market accountability is like political accountability. Companies geet feedback via a free marketplace for goods and services. If their products don’t sell, they’re not going to stick around. Also, they get feedback through the daily price mechanism of securities markets. Sometimes this can lead to short-term thinking, but over time, the market delivers good information, and more data is better than less data.

Apple stock price with date of iPhone launch. Source: Bloomberg

Respect for property rights—especially economic property—is analogous to the rule of law. People need to know that their assets can’t just be confiscated. In 1952, when President Truman nationalized the steel industry in to avert a strike, the Supreme Court ruled that he didn’t have the authority to do this, in spite of our need for more steel during the Korean War. The court said that if the federal government wants steel, they can buy it just like everyone else. The rule of law protected property even in wartime. Thirty years later most of these strategic assets went bankrupt, as steel production shifted overseas.

A stable currency, market accountability, and robust property rights are essential infrastructure for economic prosperity. They send deep roots into the political soil that allows the economy to grow. Countries that establish and maintain these institutions will prosper.

Douglas R. Tengdin, CFA

Chief Investment Officer

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