Democratic Capitalism Requires Effective Governance – This Is Equally True For Countries As Far Apart As America And India

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By Paolo von Schirach

November 3, 2012

WASHINGTON – If you ever doubted that successful democratic capitalism is premised on effective pro-growth governance, just consider America for a moment. It may be a bit of an exaggeration, but business leaders today ascribe corporate reluctance to invest more to political and public policy uncertainty than to objective market circumstances.

US: policy uncertainty discourages investments

Managers state that, beyond the basic economic environment, the broader scenario is too confusing. They have no idea if and how the federal “fiscal cliff” issue will be avoided. At the moment, America is set on a insane course of automatic severe budget cuts and tax increases beginning in January 2013, unless a political compromise on spending cuts and new revenue will be hatched before the end of 2012.

This of course depends in large part on the outcome of the presidential elections. But even when we know who the winner is in just a few days, depending on which party will control the House and the Senate, there may be more political gridlock and thus more uncertainty. And business does not like uncertainty, especially when some outcomes may have devastating consequences.

What are the rules of the game?

Likewise, corporations and small businesses do not like the current and quite burdensome regulatory environment that tends to stifle their operations. They would also like to have lower taxes, hopefully in the context of a broad based tax reform plan that would bring about simplification. Finally, nobody really knows the real economic impact of health care reform, (Obamacare), if and when it will come into full force. Will it discourage hiring more people? And so on, and so forth.

Is it fair to say that corporate timidity regarding new investments and additional hiring is due entirely to messy Washington? Probably not. But let’s say that perennial confusion and gridlock at the federal level has undermined business confidence.

India stuck because of its impossible politics

Well, if America is not in great shape, think about India for a moment. A recent long and detailed survey in The Economist news magazine, (India: in search of a dream, Sept. 29 – Oct. 5), provides a really depressing picture of a once promising emerging country now stifled by a horrible combination of acrimonious politics, widespread corruption and almost grotesque bureaucratic incompetence.

The result of all this is that “nothing gets done” at the central government level. Forget about needed pro-growth reforms. The situation is somewhat better at the state level where home grown political leaders have more latitude. But the overall picture is most uninspiring. So much so that foreign direct investment this year is about 70% lower than last year. India is stuck, largely because of its impossible politics and primitive public administration.

Democratic capitalism is delicate

The basic point here is that democratic capitalism is a piece of delicate machinery. To produce results it needs all moving parts in good order and working well with one another. Once upon a time, when governments were small and public policy played only a minor role, capitalism was all about capital, credit, technology, and labor.

Today, entirely different picture. Whatever the other variables, nowadays an unfavorable policy environment created by constant political and policy confusion coupled with inefficient administration leads to paralysis and is by itself enough to impede new activities, investments and badly needed growth.

Governance is vastly more important

Indeed, today the eco-system necessary for the flourishing of capitalism is vastly more complicated than even a few decades ago. Governments can overspend. They can regulate sectors out of existence. They can create non tariff barriers that will effectively block imports. They can enforce or not enforce intellectual property rights. They can promote or discourage labor markets flexibility. They can over tax or under tax. More broadly, they can invest or under invest in education, R%D and infrastructure –all critical components of the connective tissue that makes capitalism operate more or less efficiently.

Lawyers make poor stewards

Getting all this right is admittedly very difficult. But ruling classes, composed mostly of lawyers and bureaucrats who love procedures but who in general have little or no understanding of what it takes to keep an enterprise going, make mediocre or really poor stewards. We could do a lot better, as both America and India can attest.

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