Democracy and Investing Culture 24. October 2011 Rahul value investing (0) The title of this post deals with two disaparate subjects. One is the development of a democratic form of government and the second is the development of a culture of investing. They share common ground, however, in that they are very hard to create in a country and in its population. Democracy: The last two decades (since the fall of the Soviet Union) have been a period when the desirability of a democratic form of government has become the popular preference of the world's population. I will not dwell on the merits or demerits of one form of government over the other. However, let us look at the record. With the exception of some eastern and central European countries, democracy has failed miserably in almost all of the former soviet nations. The torch bearers of failure are Russia, Ukraine and all the central asian republics. The US bungled up in Somalia and in the former Yugoslavia in the late nineties. The twenty first century opened with George Bush Jr.'s desire to bring democracy to middle eastern nations with his quest in Afghanistan and Iraq. While Bush managed to depose the dictatorial regimes in these two countries, nobody in their right mind will call either of these countries democratic. In the process, Bush managed to destablize and destroy the limited democracy that existed in Pakistan. The Arab Spring has had a poor record so far. While Egyptian's deposed Mubarak, and the rebels in Libya killed Gaddafi, neither of these countries look like they will have democratically elected functioning governments for a long time to come. The script in Yemen and Syria is yet to be written. The above failures make one shudder at the thought of what will unfold in China if a revolution leads to the fall of Communist Party and the world supports a democratic form of government there. Democracy is a bottom up process driven by the people of a country. It is a state of mind. Democracy is a form of government which emerges when people desire individual freedom but are willing to exercise it within the binding constraints of natural justice and rule of law. Unfettered individual freedom is called the law of the jungle (martial law) and not democracry. When the rule of law is suspended even for brief periods, episodes like the mob riots in the UK tend to occur. What is truly great about the US is that the founding fathers built the country on the ideals of individual freedom and natural justice. The country over its two hundred and some years of existence has embraced these ideals (with ups and downs albeit) and today every social contract in the US is embodied with these ideals. Some may argue that the US is on a path of self destruction especially with its current heated political theatre. I will wager that just like the internalization of democratic ideals takes decades if not centuries, the ideals of freedom and democracy run so deep in the American psyche that it will take decades if not centuries of consistent damage to destroy them. India is a young nation compared to the US with only six decades since it became independent. However, the manner in which India became independent (a bloodless national revolution), and the strong foundation on which the country was created planted the seeds of the democratic social contract in the country. It does not mean that democracy in India functions as well as it could or that it is free from risk of destruction. It means that democracy exists in India because the people of India truly want a democracy and that they make the sacrifices that a democratic form of government entails. Investing Culture: I compare the democratic mindset among people to the development of an investment culture among the population of a country. Investing is the process of laying out capital today on a venture or activity in order to get one's capital back at a future date with a return on that capital. The sophistication of an economy increases when the interaction between those with excess capital but insufficient opportunity and those with opportunity but insufficient capital increases. This, however, depends on the rule of law and the existence and enforcement of contracts. Just like the creditworthiness of a borrower does not depend merely on the current solvency of the borrower but also depends a great deal on the credit history of the borrower, the process of investing depends not only on the current rule of law and contracts but also on its history and on the perception of its sanctity in the future. Added to the mix is an investor's fear of expropriation of his or her capital by criminals or by the state itself. How long does it take for an investment culture to develop in the population. No one knows. However, I have been amazed by the complete absence of invesment culture in many parts of the world. I have spent a considerable amount of time interacting with people who trade in the markets in the middle east including Dubai. The common lament is that there is absolutely no long term investor base. Participants in the market are almost exlcusively hyper traders and believe that only the bird in the hand is theirs. This is very deep rooted in their psyche. While oil wealth has brought prosperity to the region. It has been observed that the pre-oil history of the middle east was one of nomadic life fraught with plunder. The only people who did well in this environment were traders and strong-men and those with a nexus between the two. I was in Italy recently and I met a fund manager who lives in Switzerland and invests in the South Korean markets. He stated that the entire market is trading oriented. He shared an anecdote with me, where a company bought back its own stock from the market because it was undervalued only to sell it back in the market 10% higher. The CEO of the company was apparently thrilled that he had made a profit for the company. The US has one of the strongest and most well developed investment cultures of any country in the world. It also has one of the deepest, most liquid and most open financial markets in the world. It has been at the forefront of almost all financial innovation over the last two centuries. Similarly, India is a 5,000 year old civilization that was built on agriculture and trade. India has had an entrepreneurial class and homegrown financing systems for millenia. Individual property has been always respected and protected even though India has been ruled by different kings and regimes over the centuries. Private property transitioned from pre-Independence India to post Independence India without any expropriation (with the exception of the feudal or zamindari contracts bestowed by the British on select individuals). It has a very well developed investing culture. The whole world has witnessed the success of the US model and is trying to replicate it. The verdict is not yet out on whether many parts of the world will be able to develop the democratic and investing cultures that the US possesses. India, however, despite its many challenges, will hopefully tread (waveringly perhaps) in the general direction and on the path created by the US.