A Risk Argument: Democracies versus Dictatorships

A few days ago, Tom Friedman, the columnist for the New York Times, and best-selling author of books on globalization, evoked controversy when he opined that "one party autocracy" is not too bad if it is led by a "reasonably enlightened group of people, as China today". To be honest, I have never found Friedman's work to be particularly thought provoking, nor do I much care for his characterizations of globalization: flat earth, fat earth, round earth, whatever.... . However, his article did start me thinking about whether businesses face less risk or more risk in a democracy than in a dictatorship.

As a generalization, there is more day-to-day uncertainty when dealing with a democracy than with a dicatorship. A democratically elected government can offer policies that are favorable to business, but may either not be able to deliver them legislatively or have to modify them to meet public consent. A dictatorship operates under no such constraints and can deliver on its promises, albeit at substantial cost to some segments of its population. Furthemore, the nature of democracy is that governments change and policies change with them. The flip side is that dictatorships do not last forever, and a benign dictator today can become malignant one in the future. Policies can then be turned on their head and today's favored businesses may fall out of favor tomorrow.

The choice between democracies and dictatorships, in my view, boils down to whether you prefer to deal with the continuous, ongoing risk of operating in a democracy or the discontinuous risk of operating in a dictatorship. The former will manifest itself in a chaotic environment of changing rules, fiscal and monetary policies and exchange rate regimes. The latter may show up in periodic upheavals in policy, nationalizations (real or quasi) and a requirement that you pay due respects (or more) to policy makers.

I have argued in my book on strategic risk taking that it is far easier to deal with continuous risk than discontinuous risk for two reasons.

1. The first is that market traded instruments work better at dealing with continuous risk, whereas insurance, often imperfect, is the tool you need for discontinuous risk. To illustrate, compare floating exchange rates to fixed exchange rates. The former create more day-to-day uncertainty for businesses but is eminently hedgeable using options or futures contracts. The latter allows for long periods of stability, interspersed with sudden revaluations and devaluations of currencies, much more difficult to hedge.

2. Managers of firms in the (artificially) stable environments created by dictatorships are lulled into a false sense of complacency and are completely unprepared for the risks that inevitably follow. Managers of firms in chaotic environments learn to cope with change, one reason why I think these companies may have a competitive edge in the more uncertain global economies of the future.

Friedman's arguments are not new. Mussolini's supporters initially thought of him as benign and argued that he made the trains run on time, an incredible accomplishment in Italy. In later years, they discovered his dark side. I do not trust any group of people, no matter how well trained and intentioned, to make decisions for me for the rest of eternity. So, I come down on the side of democracy, chaotic and frustrating though it may be, because I can manage its risks better (both as an individual and a business) than I can in a dictatorship. We will have a ring side view of this tussle, and the strengths and weaknesses of both systems, as we watch the Indian and Chinese economies struggle for dominance over the next few decades.