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Capital Acumen Issue 30

Governance And Economies

On a global scale, it’s clear that when people are free to pursue their goals, the economy benefits.

Ceiling of the capital building

Fred Hatton/Getty Images

Over the past several years, research institutes from several countries have collaborated on a global method to measure the qualities that capture the essence of “good” governance, particularly as it relates to economic success. Individual country measures of these characteristics have been aggregated into an index for more than 150 countries called the Human Freedom Index.1

Countries in the top quartile of the index have a much higher average per capita income (approx. $30,000) than those in the lowest quartile, where it averages less than a tenth of that (approx. $2,600). Most of the countries that rank in the top quartile are concentrated in Europe, North America and developed Asia. The countries in the lowest ranks are concentrated in the emerging markets, with heavy representation in Africa, Asia, Latin America and the Middle East. Despite these sharp income differences, all countries have one thing in common: The ability of governance to keep pace with change seems to be increasingly challenged in rich and poor countries alike.

What Exactly Is “Good” Governance?

With so many dimensions, it’s hard to define simply, yet there are many features common to good governance.

One fundamental requirement is the ability to maintain order and security, so people can focus on their personal success rather than self-defense. Another is offering the freedoms necessary for individuals to create and pursue their ideas unfettered. Third, there needs to be a mechanism to change the rules as needed.

A system that protects people from abuse from other parties, including the state, along with the sanctity of contracts and property rights, is what helps balance the tension between order and freedom.

When viewed alongside some of today’s biggest issues, we can see how better governance can benefit a country’s or a region’s economy and future.

Russia

Russia has built a freer economic system in the wake of the Soviet Union’s collapse, but its progress has slipped under President Vladimir V. Putin’s leadership.  

In the Human Freedom Index data published in 2015, which reports findings from 2012, Russia ranked 111 out of the 152 countries, which is close to the bottom quartile. Since 2008, it has fallen 10 notches in the rankings. It is definitely moving in the wrong direction, and its slide into recession suggests that its people will continue to experience the economic consequences of poor governance. In addition, its aggressive military moves into other countries threaten good governance beyond its borders.

What is Good Governance?

The Human Freedom Index looks at 76 indicators in the following areas to measure personal and economic freedom of individuals.

  • Rule of law
  • Security and Safety
  • Movement
  • Religion
  • Association, assembly and civil society
  • Expression
  • Relationships
  • Size of Government
  • Legal system and property rights
  • Access to sound money
  • Freedom to trade internationally
  • Regulation of credit, labor and business    

China

Since 2008, China has dropped from 125 to 132 in the rankings, and it is the only major economy in the bottom quartile.

As the country sailed through the 2008 financial crisis relatively unscathed, its stability caused some people to doubt the effectiveness of freer markets. However, over the past summer it has become clear that a lack of transparency is masking deeper problems. We now think it is unlikely that Chinese living standards will ever rival those countries in the top quartile unless state coercion is reduced and individuals’ rights are better recognized. Like Russia, China aspires to the world stage. This raises the risk that its poor governance standards will spread beyond its borders.

India

On a more positive note, India jumped from 99 to 75 in its ranking between 2008 and 2012. As China’s growth has slowed, India has emerged as the world’s fastest-growing developing economy, and Prime Minister Narendra Modi has raised hopes for more progress with reforms that have already lifted the country’s gross domestic product (GDP). India was also one of the few countries to see its equity market rise in the third quarter of 2015, suggesting the country has become a darling of international investors.

Africa and the Middle East

An obvious example of failing governance is the chaos in the Middle East and sub-Saharan Africa. Of the countries in the bottom 20 rankings, four are in the Middle East, including Iran, which ranked last at 152, and 13 are in Africa, including the Democratic Republic of Congo, which tied for second-to-last with Myanmar. This poor governance and the resulting economic instability are key factors in the current flood of migrants — the greatest since World War II — from those regions. Unfortunately, faced with mounting demands on their resources and lacking the mandate of the governed, governments in destination countries are struggling to provide them refuge.

Europe

Europe ranks high on the freedom index, particularly Northern Europe, whose principal countries — Denmark, Finland, Iceland, Norway and Sweden — all ranked in the top 15.

Europe is working to make more coherent governance possible, but it is proving difficult. The lack of centralized power is a chronic issue that has threatened Europe’s stability on and off since the 2008 financial crisis. And, though many of its countries have positive governance compared with elsewhere, they are struggling with big issues, such as the Greek government’s debt crisis and this year’s refugee crisis.

Governance is Falling Behind

Technology is changing the world and the economy at an accelerating rate. This means the issues crying out for government action in the areas of national, personal and cyber security, the environment, human rights, economic regulation and immigration, just to name a few, are proliferating.

Headshot of Robert McGee

Photograph by Andy Ryan

 

We can see how better governance can benefit a country's or a region’s economy and future.

Yet governance moves slowly, and its pace is hard to change. When the gap in these time scales widens to the breaking point, revolutions and radical change are often the result.

Geopolitical risk rises when governance is faltering. People in poor countries who have seen how “the other half” lives are demanding change that their governments are not able to deliver, as the post–Arab Spring results illustrate. Even the richest, best-governed countries in the world are showing rising governance strains. Investors need to prepare for a future of more volatile and disappointing global governance.

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