Monday, 17 April 2017

When markets love the bad boys

First it was Trump; now it's Erdogan. Something "bad" happens in terms of future governance, in a democracy -- either the election of an egomaniac with autocratic tendencies or a constitutional powergrab by someone of that description. And a lot of economists believe that good institutions are good for growth and governance, me included (in some way). Now, in both cases, stock markets have reacted positively -- by a lot in the case of Trump, by a bit in the case of Turkey today. (BTW, the same thing happened in Turkey in 2010). There is also another case that I explored with Tom Ferguson a while ago, of a powergrab being associated with stock market increases (not that spectacular overall, but large for connected firms) -- valuation changes after Jan 1933. While this is just a bunch of cases and not a systematic analysis, there are at least some (pretty important) cases when markets seem to love the bad boys and bad news in terms of institutional quality.

How to put these two things together is not entirely clear to me -- constraints on the executive have NOT gone up this morning, in Turkey; and while the verdict is not out on Trump's presidency, there is no sense in which the man has shown excessive deference for checks and balances, etc. In Jan 1933, it became pretty clear pretty quickly that things were not headed in the "inclusive institutions" direction.

So what are the logical possibilities? First, it could be that it's just about stock market listed firms -- maybe everyone including markets understand that authoritarianism is not going to be good in the medium or long run, but listed, big firms with more connections could be doing better. So this would be about a worsening of governance, with established firms benefitting and others suffering. Second, it could be that authoritarianism isn't really that bad for growth and profits overall. This would go against the grain of empirical papers by Daron Acemoglu and co-authors, like this latest installment (with Suresh Naidu, Pasqual Restrepo, and Jim Robinson). Third, it could be that markets are just getting it wrong; short-term optimism is not the same as a fair and balanced judgement of actual future growth. If that was true, then there should be significant money to be made from shorting these "authoritarian pops" in the stock market...

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