Democracy, demography and deglobalization: the geopolitical situation

Democracies are on the decline. At least that is the opinion of Xi Jinping and Vladimir Putin and gives them the opportunity to be increasingly aggressive. Are they right?

At first glance, a look at the historical development of each of the 10 economically largest countries, measured in terms of purchasing power, proves them right. The lines of Germany, the UK, France, Japan and the USA have been gradually declining for decades, while Turkey and Russia, the only moderately democratic India and, of course, the seemingly all-powerful China have been on the rise since 2003 (chart 1).

At the beginning of the 1990s, the world looked different after the collapse of the Eastern Bloc and the economic liberalization of China. The American political scientist Francis Fukuyama, the son of Japanese immigrants, became famous at the time with his book "The End of History". In it, he expressed the conviction that the world was becoming increasingly democratic and liberal. However, with the financial crisis of 2008 and the rapid rise of China, doubts about the fundamental superiority and attractiveness of the Western form of government and economy grew soon afterwards. Since then, democracies have increasingly been seen as at risk of decline. This shows that geopolitics is subject to strong and rapid changes and that, contrary to Fukuyama's assessment, history is by no means over. As recently as 2006, when the respected British business newspaper "The Economist" launched a democracy index, democracies were clearly in the majority (chart 2, light green, yellow and orange are mixed forms between democracy and dictatorship).

There was only one dictatorship (Saudi Arabia) and various semi-autocratic countries (orange circles) among the larger economies included in charts 2 and 3 (national income in 2021 greater than USD 100 billion), but even China, whose national income had not yet reached the level of Japan or the major European countries, did not appear very threatening. In 2022, however, the orange and red circles have become more numerous and significantly larger (chart 3); dark green is no longer dominant.

This is bad news for billions of people. The fact that Putin and Erdogan do not govern their countries particularly well can only be disputed by convinced dictator fans. In other countries, however, autocrats are not very successful either. Chart 4 shows that per capita income in democratically governed countries is far higher than in more (red) or less (yellow, orange) autocratically governed states.

One of the reasons for this lies in history. Most of today's democracies were already industrialized countries with partially democratic forms of government before the First World War (Western and Northern Europe, USA, Japan); in many other countries, industrialization only began after the Second World War. The dictators of today are innocent of this. However, in contrast to democracies, nepotism is widespread in many autocratically governed states (Figure 5). In 1995, the German economics professor Johann Graf Lambsdorff developed a "Corruption Perception Index" (hereinafter Corruption Index) at the University of Passau, which is published annually by Transparency International (see: Country comparison: global corruption (laenderdaten.info)). If this corruption index is set in relation to the democracy level of 116 of the 119 countries assessed, for which a democracy index value is also available from The Economist, a clear correlation emerges (Figure 6).

No country with a form of government classified by "The Economist" as a full democracy (index values 8 to 10 on the x-axis of chart 6) has a corruption index of over 40 (average value: 23). In contrast, with the exception of Hong Kong, none of the countries with a democracy index of less than 6 (form of government: semi-autocratic to dictatorship) has a corruption index of less than 55 (average value: 71). Unfortunately, this is not a statistical exercise, but has tangible consequences for the people who have to live in these countries. With the exception of Uruguay, no country with a corruption index of less than 40 has a per capita income of less than €20,000 (Figure 7). In countries with a corruption index of over 60, on the other hand, per capita income never exceeds €10,000. Despite their only moderate democracy index, countries such as Hong Kong and Singapore have very good corruption scores and, with per capita incomes of over €40,000, are in the top group, which is otherwise reserved for complete democracies (unfortunately, no corruption index values are calculated for the rich oil countries in the Middle East).

The unpleasant conclusion is that undemocratic governments tolerate or encourage corruption and that corruption goes hand in hand with low prosperity.

Since 2006, the year in which the Economist's Democracy Index was compiled until 2022, the economic importance of democracies has declined (charts 2 and 3). By contrast, China's economic power has risen dramatically over the past 50 years (chart 1, this chart is not based solely on national income, but also on purchasing power parity, which is often higher in poorer countries than the nominal national income figures indicate). We are now investigating whether these trends will continue.

Figure 8 shows some long-term forecasts for the development of the Chinese economy compared to the US economy (Figure 8). In 2011, the major US investment bank Goldman Sachs was still convinced that China would catch up with the US in 2026 and then continue to widen the gap (green line in chart 8). In 2021, the OECD (International Organization for Economic Cooperation and Development) expected China's relative development to be similar, but somewhat weaker (yellow line).

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In 2022, Goldman Sachs did not see China catching up with the US until 2035 and only a further slight increase thereafter, followed by a parallel development of national income in both countries (orange line). The latest forecast was published by the independent London-based economic research company Capital Economics. According to this forecast, China will no longer match the US economy and will gradually fall behind the USA again from the mid-30s of the 21st century.  

This perhaps somewhat surprisingly cautious forecast is in line with the economic policy uncertainty index (chart 9), which has risen sharply in China since Xi Jinping took office in 2012 compared to other countries. Apparently, Chinese and international investors are increasingly concerned about the country's future. Figure 10 shows that private equity funds have increasingly withdrawn from China since 2017.

The Russian war of aggression against Ukraine from February 24, 2022 may have contributed to the growing uncertainty among Chinese consumers, as the consumer confidence index in China fell extremely sharply from March to April 2022 (chart 11), although China has officially taken a neutral position in this conflict to date. Even in Europe, which is directly affected by the war, political uncertainty has barely risen since the outbreak of the war (chart 9). The easing of the rigid coronavirus restrictions in China in January 2023 had been expected to provide a strong boost to the economy, but consumer confidence remains at a very low level. There must be underlying reasons why the outlook for China is increasingly negative.  

The fact that before Xi Jinping came to power, the top politicians in China were trained in the natural sciences and mathematics (Figure 12, for the terms "hard" and "soft" sciences, see Wikipedia: "hard sciences") is likely to have contributed to China's outstanding economic rise (see Figure 1). Now, increasing the prosperity of the population is no longer the main goal of politics, but maintaining the power of the Communist Party (chart 13). This obviously requires politicians with other qualifications.

After the 2008 financial crisis, Chinese politicians relied on a form of economic stimulus that had already caused great damage in Japan from 1990, in Germany from 1995 (keyword: East German real estate) and in the USA (subprime crisis) (see Capital Market Outlook from October 2020, which you can find here). Chart 14 shows that in the USA, real estate investments amounting to less than 6% of national income in just a few years were enough to trigger the subprime crisis, which in turn led to the financial crisis and thus the worst recession in the USA and many other countries since the Second World War. China has channeled as much as 15% of national income into real estate over a much longer period of time. There are now 65 million vacant apartments in the residential sector alone, which are not generating enough rental income to service the mortgage debt (source: Morgan Stanley, September 2022). Due to these gigantic bad investments, China is already more indebted than many rich industrialized countries (chart 15), which means a particularly heavy burden on future growth with a much lower level of prosperity (chart 16).  

China's growth and financial strength will be significantly impaired in future by the very unfavorable demographic development, even by international standards (chart 17), so that it may not succeed in overtaking the USA, not only in terms of economic output but also in terms of military spending (chart 18). The other aggressive dictatorship, Russia, will not be able to even come close to keeping up with China, let alone the USA. Even before the war in Ukraine, it was clear that Putin had not developed Russia geographically, but economically back in the direction of the Soviet Union. With state revenues accounting for 56% of national income, Russia had already far surpassed the Europeans in 2021 (peak in 2016: 48.7%) (Figure 19). Just as the admission of more and more private companies, which operate more efficiently than state-owned enterprises all over the world, was the most important step towards the Chinese boom from the end of the 1970s, the lack of an efficient private sector was the cause of the Soviet Union's decline. Russia had already left the circle of relevant superpowers before the war.  

The incorporation of Taiwan, a declared goal of Xi Jinping due to the considerable trade deficit in the important chip industry (chart 20), is unlikely to be achieved through military conquest for the time being. In Beijing, the efficiency of Western weapons systems in the Ukraine war will be observed closely and with unease, as will the quick willingness to impose sanctions on Russia. In addition to the major problems of the domestic economy in the real estate sector, China cannot afford harsh sanctions from the West, which would hit Chinese industry.

In addition to the lowest possible level of corruption, a high level of technology is also required for the performance of the economy and therefore also the military. If we consider artificial intelligence (AI) as the spearhead of modern technology, the superiority of democracies is not yet in jeopardy. The AI Index Report 2023 from the top US university Stanford (HAI_AI-Index-Report_2023.pdf (stanford.edu)) provides interesting information on this.

Figure 21 shows the number of newly developed AI systems in China, the USA and the EU including the UK. Even the Europeans can keep up with China; the USA has a clear lead over China. This is confirmed by the expenditure on AI systems in the USA, which at USD 47 billion is far ahead of the other 14 countries shown in chart 22 (together just under USD 40 billion). The expenditure per capita also shows that China is not investing or cannot invest very much in AI, and little money is spent on AI in the large Asian countries of India and Japan either. Only the small countries of Israel and Singapore invest a lot of money in this sector. Apart from China, only democratic countries are represented in chart 20. Russia does not appear.

China is also the only non-democratic country with a very small share in the composition of global currency reserves (chart 23) and the dominance of the US dollar remains unbroken. The only notable competitor is the euro.

To summarize, we can say that the thesis of the decline of Western democracies is an exaggeration. Autocratic governments, as in China, can indeed generate strong growth, but only as long as the government ensures that economic policy is geared towards increasing prosperity. This has not been the case in China for some years now. Democracies generate significantly greater prosperity for their people than non-democratic governments because they do not allow corruption to get out of hand. China has achieved a lot technologically, but has not yet surpassed the USA and Europe. Other autocracies such as Russia are neither technologically nor economically significant.

The decline of the West (title of a book by Oswald Spengler from 1918 (Part 1) and 1922 (Part 2)) is still a long time coming.

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Finally, our key statements from the June 2020 Capital Market Outlook, which you can find here:

• Deflationary risks predominate in the short term
• As soon as the economy picks up again (after the coronavirus restrictions), strong inflationary factors will take effect:

1. the corona-related conversion of supply chains

2. demographics

3. the hesitant and belated fight against inflation

• Equities will continue to perform well

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You can also download the capital market outlook here.

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