When someone puts us down because of our weaknesses, the best way to respond is to prove that we can be just as good, if not better. To do that, however, we must first be prepared to take a hard look at where we have gone wrong. And that is the intention of this week’s article, which, in fact, is a reinforcement of what we have previously published on the state and direction of our economy.

Chart 1 compares Malaysia’s growth in gross national income (GNI) per capita with selected countries in the region over the past 50 years. We have written extensively on why the Malaysian economy and stock market have relatively underperformed, and especially so after the Asian Financial Crisis (AFC). The same is true of the value of the ringgit (see Chart 2).

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Wide-ranging protectionist measures undertaken to boost domestic industries and select businesses have been largely ineffective — leading to rampant rent-seeking activities that benefited a small elite group at the expense of the people, inefficiencies and wasteful use of scarce resources. As we have written before, enduring comparative advantage can be gained only from exposure to — not by being shielded from — domestic and global competitive pressures.

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See also: <a class='gtm_see_also_1_inread' style='text-decoration: underline;' href='/capital/tongs-portfolio/right-leave-domestic-interest-rates-unchanged-ringgit-will-weaken?utm_source=website&utm_medium=article&utm_campaign=ONPAGESEO'>Right to leave domestic interest rates unchanged, but ringgit will weaken</a>

There is also no doubt that Malaysia’s unorthodox response to the AFC, with capital controls, has serious, lingering long-term consequences. Capital controls hurt investor confidence and deterred investments that resulted in premature deindustrialisation, stagnating productivity gains and failure to move up the value chain.

The loss of investments as the primary growth driver then led to the misguided policy of transitioning to a services-based economy — promoting consumption to drive the domestic economy while the people’s income levels were still too low. This debt-driven consumption binge was ultimately unsustainable. High indebtedness — and forced deleveraging — further weighed on households’ spending and business investments for years thereafter. Corporate earnings and returns declined, making Malaysian stocks less and less attractive to investors, particularly as competition (for investor money) from other regional markets grew.

The combination of falling foreign direct investments and portfolio fund inflows, the collapse in oil prices and rising imports (including consumer goods) that resulted in declining trade surplus and foreign exchange reserves, as well as deteriorating confidence over the 1Malaysia Development Bhd (1MDB) scandal, all exerted downward pressure on the ringgit post-AFC. Because Malaysia failed to move up the manufacturing value chain, we could not capitalise on the weaker ringgit to boost exports and margins, unlike South Korea, which saw GNI per capita rise by more than 124 times between 1970 and 2021. By comparison, Malaysia’s GNI per capita increased by just 27 times over the same period. The continuation of populist government policies, of subsidies and handouts, has raised government debts to unsustainable levels, further weakening the ringgit.

See also: <a class='gtm_see_also_2_inread' style='text-decoration: underline;' href='/capital/tongs-portfolio/chasing-small-caps-now-will-likely-end-tears?utm_source=website&utm_medium=article&utm_campaign=ONPAGESEO'>Chasing the small caps now will likely end in tears</a>

But these are all the consequences, the reaction and responses to a more fundamental reason for why Malaysia’s economy is underperforming. Indeed, why do some countries prosper and continue to grow from strength to strength while the development and growth in some others stagnate or, worse, falter and decline? To answer this question, we will revisit two of my past articles: (i) one titled “Is democracy good for business?” (first published on Sept 4, 2006, and reprinted here below) and (ii) a review of the book Why Nations Fail: The Origins of Power, Prosperity, and Poverty by Daron Acemoglu and James A Robinson (published on Oct 14, 2013).

Is democracy good for business?

Businessmen would generally agree that there are four broad conditions that are good for business. They are:

● The rights of individuals to security, liberty and private ownership;

● The rule of law and equal rights. The law and its institutions should allow individuals the freedom to pursue their lives, and run their businesses, so long as they respect the equal rights of others;

● The right to exchange property by mutual agreement, that is, a free market. When governments start handing out rewards on the basis of political pressure or factors, we will have group conflict that will act against the free market and the well-being of the economy; and

● The right of people to retain the fruits of their labour.

For more stories about where money flows, <a class='gtm_see_also_3_inread' style='text-decoration: underline;' href='/section/capital?utm_source=website&utm_medium=article&utm_campaign=ONPAGESEO'>click here for Capital Section</a>

The question is whether these four conditions are necessarily consistent with the term “democracy”.

What is democracy? Literally, it means rule by the people as derived from the Greek word demos, which means “people”, and kratos, which means “rule”. Generally, the principle of democracy is majority rule.

The question as to whether democracy is good for business is perhaps a reflection of Francis Fukuyama’s proclamation of the “end of history”, where he argued that the great Cold War battle over ideology had ended, with the triumph of the mixed-economy democracy. Fukuyama pointed to the gradual adoption of Western-style liberal democracy in more and more countries as evidence to support his argument.

The topic of democracy and business can also be related to the “Asian values” argument that was promoted so strongly in the few years preceding the 1997/98 financial crisis. Expounded by certain Asian political leaders, it was used to justify authoritarian capitalism. This model has since been tarnished by economic events of recent times.

It is true that many democratic countries are liberal democracies. These countries are noted not only for free and fair elections, but also for strong adherence to the rule of law, the separation of powers and the protection of freedom of speech, assembly, religion and property.

In a pure sense, in a democratic country we, the people, are the government. Therefore, the government would never violate the people’s rights or do anything against their interests.

Unfortunately, the reality is that we cannot all be in the government so we elect representatives to establish the government. The role of the government is to be the enabler, our enabler, so that we can be secure to go about our business.

But does democracy actually guarantee the rights of individuals and freedom?

Not necessarily, because we can live in a democracy and yet not have much liberty, which is the right to make individual choices and to pursue projects of one’s own choosing. To me, the most important political value is therefore liberty and not democracy per se.

As an example, let us compare India with Hong Kong.

India is the world’s largest democracy, yet its commitment to the free market and pluralism is far from strong. Its citizens are subject to a web of protectionist regulations that limit their freedom of choice. On the other hand, Hong Kong is not a democracy as we know it but it allows so much space for individual choice.

To be sure, there is a connection between freedom and democracy but that relationship is not mechanistic. Indeed, democracy or rule by majority needs to be mitigated with protection for individual rights and liberty.

I would therefore argue that democracy is neither a necessary nor by itself a sufficient condition for business to thrive. Instead, I would say that the concept of freedom would better secure choice and, ultimately, prosperity.

So, why do people talk more about democracy than freedom? I believe it is because democracy affords the option of state intervention. There are many people who say we need to limit personal liberty in the best interests of society as a whole whether for economic or national security reasons. And it is the job of the government to undertake that task.

My view on this can be illustrated with the following analogy.

To avoid accidents at airports, air traffic controllers manage or intervene by directing every aircraft for safe and timely landings and takeoffs. It is a highly intensive effort, and those who favour a strong government hand in the economy will find meaning in this example.

Now, imagine the millions of people who spontaneously drive their cars in and out of a big city every day. It would be impossible for a centralised traffic controller to try and coordinate and direct each and every car and driver on the road. Instead, the cars and drivers are left on their own to move around, except that they have traffic rules to follow. Occasionally, the authorities may re-time traffic lights or build new roads to ensure smooth traffic flow. This is the lighter hand of the state at work. This way, the state becomes an enabler and not a director.

While less complex systems can be planned and directed by governments, the more complex systems must be more rule-based and allowed to develop more spontaneously.

In a free market, price is determined by millions of producers and consumers who may not even have to meet. Yet, it is precisely this spontaneous demand/supply pricing mechanism that helps us work together to produce more of what everyone wants. State intervention often distorts this pricing mechanism.

Back to the question: Is democracy good for business?

My view is democracy alone is not good enough for business. Going through a process of voting in a government every five years alone is inadequate. Rule by majority alone is also not good enough.

What is more crucial is for a government or society to also respect and protect the rights of individuals; to practise the rule of law and equal rights; to allow a free market to operate; and to guarantee the rights of people to retain the fruits of their labour.

Only these four conditions can protect the individual from the tyranny of the majority, something that can happen in a democracy.

- "Is democracy good for business?" article ends -

The following is an excerpt of the book review (please scan the QR code to read the full article):

Traditional development economics theory ignore politics. Therein lies their failure, for it is politics, argue the authors, that drive everything. Get the politics right and all else will follow.

And what is right are “inclusive” institutions that incentivise citizens and create virtuous circles of innovation, expansion and widely held wealth. Elements vital to keeping the virtuous circle going are pluralism, where many varied groups exist to check each other’s power, laws applied equally, universal education, a free media to inform and empower, secure property and patent rights that encourage investment and open markets free of monopolies and progressive taxes.

However, where “extractive” institutions prevail, allowing the small elite to monopolise economic gains, technological advances are blocked, productivity deteriorates and a vicious circle of enduring backwardness sets in. There is great and easy profit to be made merely by controlling power, expropriating the assets of others and setting up monopolies. Hence the hostility to new technologies, the impact of which is both creative and destructive. Favouring new skills and economic groupings, innovation invariably undermines the power and privileges of the old, vested elite.

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Acemoglu and Robinson (professors at the Massachusetts Institute of Technology and Harvard University respectively) provided an expansive analysis of economies around the world, both extinct and modern, the development paths and factors driving their success or failure. Their thesis is that economic prosperity depends above all on the inclusiveness of economic and political institutions, rather than on their geography, climate, natural resources, culture or genetic makeup of the population.

The authors concluded that, at critical junctures in time or moments of significant changes in a nation’s history, the decisions made by its political institutions — most often wilfully, rather than out of ignorance — determined whether they set off on a path of rising prosperity or trapped in poverty. Success or failure is primarily down to the economic institutions put in place, whether the systems are “inclusive” or “extractive”. Historical evidence showed that even small initial differences became significant over time.

Inclusive economic institutions encourage and incentivise ALL citizens to participate in economic activities, to be creative and work hard. They are assured to reap what they sow. There is strong economic freedom and protection of equal rights and equal opportunities for individuals to succeed. Inclusive institutions ensure the people’s rights to retain the fruits of their labour, through the rule of law in a free market environment.

Extractive institutions, on the other hand, typically lack pluralism. With power and wealth in the hands of the elite few, they seek to expropriate-redistribute income from one group to another, instead of promoting growth for the whole. Thus, there is little incentive for the exploited group to invest and innovate — if they cannot keep their rewards — and, more often than not, leads to brain drain and capital outflows.

The US, South Korea and Singapore are prime examples where inclusive political and economic institutions foster innovation, productivity, economic growth and prosperity. Extractive institutions are most prevalent in countries in Africa, Latin America and the Middle East, as well as large swathes across Asia (see “Is democracy good for business?”, to understand the difference between freedom and democracy).

Inclusive political and economic institutions, we think, will ensure that the US remains the leading economic powerhouse in the world, as it has been since the 1870s. The country continues to be a magnet for human capital and investments, the key ingredients driving innovation and productivity. The three CEOs at the centre of the current artificial intelligence (AI) evolution are all immigrant Chinese from Asia — Jensen Huang (Nvidia Corp), Lisa Su (Advanced Micro Devices, or AMD) and Hock Tan (Broadcom). As we acknowledged last week, our big bet on China was overoptimistic and we were too pessimistic on US stocks. Like many, we were distracted by short-termism rather than focusing on the long-term structural drivers.

A key lesson highlighted by Acemoglu and Robinson is that one event can mean a country takes an entirely different institutional path, thereby changing the course of its future. As we have said, politics drive everything. Political institutions and policies play a significant role in shaping a nation’s trajectory. Thus, getting the politics right is essential for future success.

Case in point: Malaysia’s decision to implement capital controls was political. At its roots, the objective was to bail out select, highly leveraged corporates and individuals, thus preventing the restructuring that would have happened under market forces. By contrast, South Korea was one of the worst-affected countries during the AFC. Its political institution opted to accept financial assistance from the International Monetary Fund and, as a condition, the country undertook structural reforms to address weaknesses in its financial and corporate sectors. Yes, the measures were painful — but the results are clear for all to see. South Korea has transformed into a hugely successful and advanced industrial economy. Its GNI per capita is now more than three times that of Malaysia — despite coming from a lower base back in 1970.

Malaysians are fond of complaining about everything that is wrong in their lives. Yet, few would actually act on changing their situation. Instead, most will turn a blind eye when a wrong is committed, or simply pack up and leave. The thing is, unless we are prepared to fight for what is right, it will not miraculously happen.

The new politics of Malaysia, one that is void of an overwhelmingly strong single party, has resulted in many challenges to political stability. But perhaps it could also be a blessing in disguise — our “one event”, and opportunity, for a Great Reset.

To restore confidence for businesses and the people, government and society must respect and protect the rights of individuals to economic freedom and private ownership, to practise the rule of law and equal rights, to eliminate rent-seeking and allow a free market to operate, and to guarantee the rights of people to retain the fruits of their labour. These are the broad conditions.

Democracy is not synonymous with individual liberty or freedom, nor does it automatically set the nation on the path to economic prosperity. Democracy alone is not good enough for business. Rule by majority alone is also not good enough as there can exist tyranny of the majority, where the rights and interests of minorities are not protected or, worse, oppressed.

We take to heart what Prime Minister Anwar Ibrahim said recently, “Due to the changes of times and political climate, this government has decided that the media in this country should get freedom without censorship … I firmly believe a journalist’s job is not just to report but to initiate ideas for the country.”

So, Mr Prime Minister, get the politics right and all else will follow.

The Malaysian Portfolio fell 2% last week, paring total portfolio returns to 164.7% since inception. Star Media Group was the only loser last week, falling 7% while Insas (+1.8%) and KUB Malaysia (+1%) were the notable gainers. This portfolio continues to outperform the benchmark FBM KLCI, which is down 24.3%, by a long, long way.

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Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

Get the politics right, and all else will follow

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