Opinion

If You Think Dictatorships Are a Good Investment, You Are Dead Wrong. Here's Why

Sure, strongmen can muscle through reforms where democrats would not dare tread. They can also change their minds in a blink

Protest against judicial reforms in Wroclaw, Poland, July 26, 2017
Agencja Gazeta, via Reuters

It’s a crying shame that among the plethora of specialized investment funds, no one has had the audacity to set up one that puts money into authoritarian regimes.

There are lots of funds that create ethical portfolios, eschewing investment in tobacco, gambling or fossil fuel stocks, for instance. So why isn’t there a fund that targets immoral investments? It’s not like Wall Street is dedicated to making the world a better place.

As it turns out, this year has been a good one for investors who put their money into authoritarian regimes, as a Reuters report found this week. Among the top eight performers of the MSCI Emerging Markets index – a widely used benchmark of stocks – five were in countries where democratic institutions and civil liberties are under threat.

At the top of the Strongman Index

At the top of the list is Poland, whose government is trying to eliminate an independent judiciary, where investors enjoyed a 41% return. Turkey, where tens of thousands have been arrested in a post-coup crackdown, was No. 2 at 35%, followed by China, where Xi Jingping has been removing whatever small freedoms the Chinese have had until now.

eople walk by an electronic board displaying stock trading index at a brokerage house in Beijing
Andy Wong, AP

India, where civil society is under attack by Hindu nationalists, generated a 29% return and Hungary, the birthplace of so-called illiberal democracy, a 28% profit.

Alas, our Strongman Index has a few losers, like Egypt and Russia, which disappointed investors with stock market returns of 8.3% and 3.9%, respectively  (although investors who put money in Egyptian-dollar debt have gotten back more than 10% this year). Anyone who bet on Venezuelan debt or risked their money in the Zimbabwe sinkhole has learned to regret it. 

Also, a few democracies have done well, too – Greece is up 34% and South Korea 33% – so it’s not like repression and the rate of return are inseparable partners.

As Reuters found, investors aren’t so bothered by financial exposure to creeping dictatorships as long as the man in charge keeps doesn’t run big budget deficits and gets economic policy right. "Providing governments are responsible fiscally, they can get away with a lot of undemocratic measures," explained Renaissance Capital global chief economist Charles Robertson.

Count'em: One...

Some analysts even take the view that democracy is a burden when it comes to good policy. Look how Egyptian leader Abdel Fattah al-Sissi undertook unpopular measures like floating the currency and reducing subsidies for basic goods, which has caused surging inflation. "In my opinion, a democratic government would not have been able to deliver [those changes]," concluded Shahzad Hasan, a portfolio manager at Allianz Global Investors.

We’ll ignore the ethical factor in all of this, and not just because in the financial world, greed is regarded as good. None of the countries at the top of the MSCI index are real baddies. Hungary and Poland are members of the European Union, Turkey is in NATO and China is a place everyone is happy to business with, including consumers who should be appalled the country’s lack of freedoms, but have homes chock-a-block with Made in China products. There’s no reason to hold investors to a higher standard of ethics than everyone else.

But investing in non-democracies is almost always a bad bet. The number of that have a long and consistent record of economic growth is so small you can count them on your fingers, and leave one hand in your pocket. It’s one, and it’s called Singapore.

Others have had good runs of economic growth under dictatorships, such as South Korea and Taiwan, but when they reached a certain stage of development they became democracies. China, which despite two decades a breakneck growth is still a poor country, has a few more years of autocracy ahead of it before it become an advanced economy and faces the choice of democracy or bust.

Messy, but motivated

As messy as they are, free and democratic societies are more creative and innovative, their people are more motivated to work and contribute and (contrary to conventional wisdom) their governments can and do make courageous decisions because their leaders know the consequences won’t be a bullet in the head.

Strongmen typically portray themselves as great patriots, fathers of their countries and friends of the ordinary citizen.  This is nonsense. They are in power because they like power and to keep it they shower money, contracts and titles on a cadre of close supporters. Out of strongman rule comes corruption and cronyism, and that leads to economic malaise and mismanagement. People grow rich, not because of their abilities or talents but because of who they know.

The investors Reuters interviews more or less admit that and say they’re in places like Hungary and Turkey for the short term. But there’s a catch, which is strongman economies are much more prone to a Black Swan event.

That is a sudden, unexpected and catastrophic deviation from the norm that wreaks havoc on investment models, like the 2008 financial crisis. Democratic societies can have them, but undemocratic ones are likely to have more, since power is vested in a single person and political change when it happens is more likely to be violent and predictable.  Investors who think that can enjoy the fruits of illiberal government and get out before trouble emerges, are fooling themselves.