Democracies Tend To Bankrupt Themselves

From The Dismal Outlook for 2012:

A Note on Race, Caste and Fiscal Prudence

It is a core view that I have elaborated on in prior letters that democracies with universal suffrage have a long run tendency to spend their way into fiscal bankruptcy and degrade their currencies along the way. Investors have to recognize this phenomenon. The so called advanced West has reached that point of bankruptcy now. Politicians pass measures to please the majority that elected them, regardless of whether the country can afford it or not.

This phenomenon becomes more politically complicated if there is some difference – be it race, religion or caste – that differentiates the recipients of the government largess from those who produce the wealth, pay most of the taxes and dominate the professional and entrepreneurial classes. Normally in these situations the recipients, who are of a different race, religion or caste, believe they cannot compete with the professional/entrepreneurial groups and regard the government largess as an equalizer and redress for current and past wrongs.

Indian democracy provides an interesting case study regarding this point. The so-called Indian masses tend to be from “lower” castes (India has a complicated definitional scheme to formally identify these groups) than the professional and entrepreneurial groups running the businesses and generating the wealth. The democratic process in India has become a mechanism whereby the lower castes, who constitute significant “votebanks” and regard themselves as having been oppressed for centuries, appropriate wealth to themselves through the (unfortunately corrupt) political system. This may be why Indian politicians, who presumably really do know better, cannot say “no” to fiscally irresponsible welfare schemes.

The same phenomenon is observable in other countries, including South Africa and Brazil and even in the US where the word “race” can be substituted for caste and to some extent welfare and subsidy schemes carry racial overtones. In the US, when the real brawling over cutting back government spending starts after the 2012 elections, the subject of race will come up. Things could get ugly. Economists and Wall Street analysts don’t like to talk about these things for fear of being labeled politically incorrect. But they have investment significance.

China on the other hand does not have this problem, partly of course because it is not a democracy in which politicians have to appeal to voters but also because ninety percent of its people define themselves as Han and its minority groups are on the geographic and political periphery of the country. The lower income Han do not perceive themselves as different from the professional and entrepreneurial groups which are also Han. In this case China’s relative homogeneity – which is sometimes criticized as an impediment to creativity –can be viewed as an investment plus.