Democracy and investing in 2024

This year will reportedly see more people than ever before vote in national elections. Yet democracy is widely said to be in 'crisis'.

You certainly don't have to look far for evidence of political ill-temper and dysfunction. But is this a crisis? And would it affect portfolios if it is?

The collapse of European collectivism after 1989 removed the defining axis of modern political debate. Setting aside the existential conflicts in Ukraine and the Middle East, which have specific regional origins, much of today's furious Western political discourse arguably reflects instead the narcissism of small differences.

The dysfunction – most visible in the United States, perhaps, which can barely agree on a national budget – is arguably a perverse by-product of tacit agreement on the thing which matters most since 1989, namely: the units of political account are individuals, and not classes, creeds or races.

The election of an idiosyncratic US president is not in itself a crisis of democracy, though many establishment voices seemed to think it was in 2016. A president trying to stay in office after losing an election, as seemingly almost happened in 2020, certainly could be. But populism has always been part of democracy, which is why so many writers – from Plato on – have looked for other ways of choosing leaders. The proposed alternatives have always been unconvincing – and worse.

Why might this matter to us as investors? Because there is a big overlap between the democratic politics which have fostered peace and stability, and the liberal markets which have fostered prosperity. The shared ground is that of freedom – the freedom to choose our government; and the freedom to choose how we spend our time, and what we make and buy. It is no accident that the most prosperous economies to date have been democratic (the jury is still out on rapidly-growing China, which is not yet prosperous or democratic).

Neither system is perfect, or optimal. But each can be – and has been – described as the least bad of those tried. Representative democracy and the market-led economy, in practice, are arguably not about optimising, choosing the very best outcome, but are instead examples of 'satisficing' – they deliver acceptable outcomes which allow us to get on with our lives. The search for utopias led to the inhumanities of the twentieth century.

The imperfections of electoral democracy are (or should be) well-known, and reflected in the public choice literature (including Arrow's famous 'impossibility theorem'). These flaws are why we have a small number of political parties, rather than a parliament comprised of the entire electorate, and why we vote only occasionally, not on each of the many issues at stake, but for the party we think may come closest to representing our views on them. And we further devolve some key technical matters to independent bodies. Such bodies are not infallible, but make for more efficient and objective decision-making.

A topical example of such devolved power is that vested in today's mostly independent central banks. They are far from infallible, as the recent surge in inflation testifies, but they have allowed us to de-politicise monetary policy. They are not completely unaccountable: their mandate comes from elected governments, who retain the power ultimately to take back control. But tellingly, despite recent mistakes, few politicians have yet felt able to claim that they could do a better job than our chastened central banks – and few of us might believe them if they did. Investors inclined to blame the lack of more direct monetary democracy for today's bond prices are surely mistaken.

The imperfections of product markets are also well-known. They can deliver things which are objectively bad for us, when they fail to price-in pollution, for example. In other areas, if left to themselves they would end up not producing things which are objectively good for us – such as infrastructure. And they are prone to excess. For these reasons and others, we expect governments to step in. As Germany's SPD put it in 1959 : 'competition where possible, planning where necessary'. The modern mixed economy, like representative democracy, is a work-around that delivers.

Of course, we shouldn't push the parallels between political and economic freedom too far. One-person-one-vote is transparently fair, but ignores the intensity of voter feeling, which is why safeguards are needed to prevent majorities voting 'fairly' to do great harm to minorities. Conversely, markets can express intensities of feeling, but only at the expense of fairness: some people have more votes (spending power) than others, which is why in practice we intervene to make outcomes less unfair.

But the link between political and economic freedom, and the correlation of both with prosperity, is perhaps the nearest thing to a natural law in the subjective realm of political economy. In each case, the key is that individuals matter, and that allowing their views to drive the efficiency of collective decision-making may deliver an acceptable society – and, along the way, an acceptable investment portfolio.

As yet, then, we do not see today's geopolitical worries as evidence of a wider crisis in democracy, a backlash against that mixed-economy status quo. If we did, the investment implications would be the least of our worries.

Instead, we think the global business cycle will likely remain the day-to-day driver of portfolios – not because today's geopolitical concerns aren't important, but because they may not affect the key investing fundamentals, namely: discount rates and corporate profitability. We suspect that the strength of the US economy, and what it means for the Federal Reserve and S&P earnings, will remain the biggest influence on global investment returns in 2024.

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