Is Democracy good for economic growth? Part III

Source: Wall Street Daily

So, economic development precipitates the growth of a middle class, which, in turn, ferments political reform, best manifested through democratisation.

But does this transition promote further growth?

The answer is yes, it does; however, this renewed economic growth is not the same as before. To understand this, it is worth considering the finite nature of economic expansion. Figures of GDP growth such as the annual 8% that china has been regularly posting are only sustainable for a limited amount of time.

As has been stated previously in this series, the driving force of national economic growth is competitive advantage. This is achieved, quite simply, by undercutting international competition, and selling goods or services to foreign markets at a lower price. This can only be achieved for so long, because the increasing export sales of national goods bring more money into the country, which leads to a subsequent increase in the value of domestic currency, which accounts for this financial increase.

However when the value of currency rises, domestic wages and costs associated with the construction or delivery of exports rise. This eats into the profits of exporters, who are consequently required to increase the price of the products that they are selling. Thus, the exports lose their original competitive edge, and both sales and profits decrease. Nonetheless, there are ways to avoid this. The most common means of countering this cycle is to outsource various elements of the business to countries that can provide cheaper labour, or provide some other form of discounted production cost. In order to continue projected growth, these businesses must be replaced by those delivering higher value products. For example, the Korean electronics giant Samsung expanded its initial shipbuilding industry to incorporate robotics and mobile phones into its portfolio, thus continuing its export-oriented strategy. In addition, the aforementioned increase in domestic wages opens up domestic sales opportunities, which we are currently seeing in the Chinese market, with the vast increase in automotive sales. Nonetheless, competitiveness has been largely reduced, and as china shifts its economic strategy, we can expect to see growth slow.

More significantly however, this growth is lopsided, and conceals vast inequalities within the Chinese economy. China’s Gini coefficient has consistently risen since the economic transition of 1978, indicating a rise in inequality. More worryingly, figures illustrate that there is a vast chasm between urban and rural Chinese, with the income of the former, on average, nearly three times higher. Moreover, whilst total government revenue has accelerated 5.7% from 1995 to 2007, urban income has increased merely 1.6% in the same period. This means that there are vast income inequalities with average household income lagging behind national growth figures. This is creating resentment from the population, and an increase in what the Chinese government calls ‘mass incidents’, meaning demonstrations, many of which are turning violent; though figures regarding mass incidents are sketchy, reliable statistics show that the government is certainly increasing its spending on internal security, which is actually higher than the national defence budget. In order to retain legitimacy amongst the population with an economic slowdown impending, wealth redistribution is mandatory for the Chinese government. The consequences of shirking structural reform are inevitable domestic insecurity and political turmoil. If history teaches us anything, then it is that the ultimate cost of ignoring the need for reform is paid for in blood.

Whilst this does not necessarily indicate the need for democracy, a lack of economic restructuring and less equitable wealth distribution almost always results in political change. In countries, such as China, that are party to a large or expanding middle class, political change often results in democratisation. This occurs because, according to theorists such as Lipset, the middle classes aim to secure their collective economic power and compete for their interests through political representation, as they see this as the best means to secure their new status. This is particularly significant with regards to the judicial system, which is a salient feature of democratic transitions, and emphasises the interrelation of democratic procedures, liberal conceptions of ‘rights’ and capitalist economics discussed in the first article of this series.

At the macroeconomic level, the significance of a country’s legal system is clear when we begin to assess the importance of the service sector in developed economies. Besides China, Russia, and Saudi Arabia, the other 17 countries in the top 20, all possess highly developed third sector economies, based around services. Indeed, the hallmark of developed economies is the services sector, which, for example, accounts for 69.4% of GDP within the European Union. However, services rely heavily upon intellectual property rights in order to function effectively, and therefore, an effective rule of law and judicial system. In states governed by authoritarian regimes, the rule of law is inevitably weaker and exercised far more arbitrarily. Students of Russian political affairs will be acutely aware of this, particularly with regards to the recent trial of Pussy Riot, and the high profile arrest of Mikhail Khodorkovsky a few of years ago. The Russian energy industry, more broadly speaking, is a good illustration of the role of politically motivated legal manoeuvres; for example, the domestic politics of the sector were the primary factor in BP’s recent decision to withdraw from its Russian operations.

The broad consequences of this are detrimental to overall economic stability. After all, if corrupt officials are empowered with the ability to influence business law, why should a private citizen, or even a multinational corporation, patent or develop a new innovation? This is damaging for grassroots economic activity, and potentially inhibitory for diversification. Economic diversification means that the key drivers of a domestic economy are not concentrated as they would be under a planned economy; that they are spread out means that they are less vulnerable to industry-specific crises, and more flexible in dealing with various issues that may negatively impact on sales figures. For example, the primary challenge facing Vladimir Putin’s government is the need to balance out the Russian economy, which is utterly dependent upon oil and natural gas exports. For the Russian government to balance its budget, it is essential that the price of oil stays above $120 a barrel. It has currently dipped below this price, and Russia is set to suffer the consequences of its oil and gas dependency over the coming months. Such is the costs of the failure to diversify the economy.

This series has not argued that democracy is infallible. Indeed, Winston Churchill claimed it was ‘the worst form of government except all the others that have been tried’, certainly a backhanded complement. Does democracy promote economic growth? There is no statistical evidence of a direct link between democratic politics and economic growth, though the same could be said for authoritarianism. However, democratic transition does open up areas for renewed growth in developed economies; particularly growth in services and other industries focused around intangibles, creativity and innovation. If the ingredients are in place for a successful transition (namely, a politically entrenched middle class, and a developed economy), then it is likely that success, and renewed growth will follow. This does not happen immediately, and fledgling democracies often have to survive a period of hardship in order to consolidate. But more often than not, they bounce back. Of course there are exceptions, Russia regressed under Putin, Weimar Germany fell to Hitler and Nazism. Both of these cases were caused by economic disaster. Chile, too, could be reasoned to have fallen under the control of Pinochet as a result of economic factors. However, what is clear is that since World War Two, global economic crisis has preceded what Samuel Huntington terms ‘waves of democratisation’. Periods where authoritarian regimes collapse, and are replaced with democracies.

Global economic crises are cyclical, inevitable features of a capitalist world economy, and occur regardless of political systems. Nonetheless, they seem to precipitate political change, with democratisation a key consequence. It is even arguable that we are already witnessing the latest ‘wave’ of democratisation with the advent of the Arab Spring, which was initiated by a transition in Tunisia fundamentally underpinned by an unemployment crisis; a crisis caused by the global recession that began in 2008. It remains to see whether the transitions of Egypt and Tunisia will be successful, but what is inconceivable is that any consolidated democracy will fall to authoritarian rule as a result of the global recession. Greece, Spain, Portugal, and many other democracies are also currently suffering economic crisis, which is ruining the lives of millions. But no one expects the political systems of these countries to crumble.

This longevity, this political stability that is maintained by channelling dissent through political representation (as discussed in the previous article); this is good for the economy. When Europe and North America recover, and they will, they will see renewed and consistent growth at stable levels until the next global recession (barring local and regional crises); at which point the cycle will continue again. Returning to the contrast I began with at the start of this series (a long time ago!) it is likely that the Greek economy will suffer for years to come, whilst the Chinese economy grows. But consider the fate of these countries’ respective governments if the situation was reversed. Would China’s communist Party survive an economic recession? History suggests that it would not.

This series was also published in International Policy Digest