Investing in democracy

Are democracies up to the challenge?

Last week’s US midterm elections were a powerful reminder of how swiftly democracies can deliver change. Many in the West, including committed democrats, lament that autocracies are better at making swift decisions, particularly on long-run, consequential problems. Yet democracies’ indecision often reflects due caution and best-ideas sorting in the face of Uncertainty; decisive action comes when and as needed. I have written a lot over the years about the challenge state capitalism poses to liberal capitalist democracy as a paradigm and how China, specifically, has leveraged state capitalism to challenge US hegemony over the last three decades. But perhaps surprisingly, the West’s political volatility and seeming disorder over the last decade — including last Tuesday — reaffirms my faith that democracies can meet the challenge. That’s important for more than just geopolitics; it likely matters far more for your investment portfolio than you may realize.

Lessons from nature

Nature’s crucible of evolutionary competition didn’t freeze when Homo sapiens sapiens first set foot upon the earth. The heat just shifted to competition between humans’ organizational systems: tribes, feudal orders, nations, and competitive political systems. Nature’s lessons still apply. While evolution is often taught as a battle for ruthless efficiency — the first tree to fill an opening in the forest canopy, the fastest gazelle or cheetah — exclusive focus on efficiency almost always is a genetic dead end. A moth that perfectly blends into its landscape becomes a visual archetype for birds; a rabbit taking the fastest path to its borrow gives a fox a predictable intercept path; or the strongest male lizard may be cuckolded by a sneaky rival while fighting.¹[1] The solutions to all of these problems were solved by nature through genetic trial and error that often settled on inefficient solutions — randomized patterns and escape paths, mixed mating and survival strategies — that give both a leg up on the competition and boost survivability when the unexpected happens, like a comet hitting the earth. Competition between rival political systems is no different.

Where the mandarins’ genius ends

With impeccable timing, Francis Fukuyama called liberal capitalist democracy’s victory over all other political systems the “End of History” just in time for state capitalism to arise as a formidable new challenger.²[2] Within three decades, China rose from an impoverished, technologically backward land of bicycles to the world’s largest manufacturer, technological leader and the only real strategic competitor to the US. Yet, China’s rise was only possible due to the certainty Pax Americana provided. Without US guarantees for freedom of navigation, flow of capital and rules for trade, China’s miracle could never have happened. China’s leadership should be applauded for plotting a steady course when few others did, but their top-down design could only succeed amid the environmental certainty afforded by US hegemony. Set against the collapse of the post-War liberal order with a “Clash of Civilizations”³[3] impeding a new world order, accelerating technological progress upending social, political, economic, and military hierarchies, space emerging as the new frontier, and an unprecedented collapse in global birthrates, top-down planning is far less likely to succeed in the decades ahead.

And democratic chaos excels

As Mother Nature knows, chaotic, bottom-up adaptations excel in confronting the Uncertainty that challenges efficient, top-down planning. That has been democracies’ secret weapon on the battlefield from Salamis to Hiroshima, in trade from the Venetian and Dutch Republics to the US, and in technological leadership from Roman engineering to Silicon Valley.⁴[4] Democracies have repeatedly delivered innovative solutions to complex problems in large part because they are inefficient: America’s Congress dismissed General Horatio Gates in favor of Nathanael Greene midway through the Revolutionary War; Abraham Lincoln shuffled through several generals before settling on Ulysses S. Grant; the UK changed prime ministers in both world wars. And even democracies’ saviors like Themistocles and Winston Churchill will be cast aside once danger passes. To paraphrase a famous Churchill quote: democracies can be counted on to get it right, after they have tried everything else.

The ignorant voter myth

I know that some readers are rolling their eyes and retorting, “Voters in my country are too stupid to be trusted.” I have two responses to that, one moral and one factual. My moral response is “Fine, but please never again lecture anyone about democracy.” Few things irk me more than supposed defenders of democracy who don’t trust their fellow citizens to vote. If you don’t have faith in your compatriots to inform themselves and vote their interests without intervention, then you really don’t believe in democracy, so stop pretending otherwise. If you genuinely prefer autocracy or oligarchy, good for you for being honest.

Joe Six Pack has a strategy

My factual answer is that there’s a vast political science literature showing that voters are far better at informing themselves and voting their interests than is generally accepted. All Swiss cantons and 24 of 50 US states combine republican and direct democracy, i.e. elected representative government with the ability to enact laws through popular referenda. Researchers poring over thousands of referenda across decades, two countries, and dozens of jurisdictions with varying degrees of direct democracy consistently find that even on extraordinarily complex issues like insurance rules that even confuse industry lawyers, voters, on average, inform themselves sufficiently to vote their own interests.⁵[5] Through a “wisdom-of-crowds” aggregation of information across employers and coworkers, civic and religious organizations, friends and neighbors, they triangulate their own interests by judging supporters and opponents.⁶[6] Voters don’t need to become experts to make informed, self-interested decisions and that on average their errors cancel out. Remember that the next time your favorite news media interviews an ignoramus with a view they want you oppose but not the equal-and-opposite idiot from the next village.

And makes better choices than his leaders

What is even more astounding is that this literature shows that voters tend to make better laws than their elected leaders and that merely having the ability to do so improves their representatives’ lawmaking.⁷[7] The greater the degree of direct democracy across mixed jurisdictions, the lower are taxes and fiscal debts,⁸[8] the better are state services delivered,⁹[9] the higher are productivity, per capita income and economic growth,¹⁰[10] the happier are citizens with their governments, and the more trusting are they of their institutions.¹¹[11] Indeed, because citizens are better at representing their own interest than elected representatives, researchers even find that laws passed by referenda are more stable and less subject to future change.¹²[12] Perhaps most fascinating — and counter to conventional wisdom — is that greater direct democracy leads to less redistribution of income than representative democracy.¹³[13] As if to emphasize that point, last week California voters rejected a ballot initiative imposing a billionaire tax with higher “no” proportions in rural and poorer counties.¹⁴[14]

Roots of Rage

A key finding from The Politics of Rage, the 22-country study of populism I wrote a decade ago,¹⁵[15] that people have the hardest time accepting is that income inequality is not an important driver of it. Across countries and political parties reviewed, I found instead that the primary source of popular rebellion was average voters’ sense that they had been disenfranchised by their governments and had lost sovereignty. The literature on mixed democracies reinforces my findings: given the opportunity, voters do not try to redress income inequality through redistribution nor do they undertake irresponsible spending. They are happy to let the richest among them be as long as everyone is equal in the voting booth. It is telling that the only OECD nation with a fully mixed democracy, Switzerland, is among the most fiscally sound, highest per capita income, highest productivity, happiest with their government, and has not experienced a significant populist backlash. Even more telling is that Swiss citizens report higher government and institutional satisfaction than expats living among them in the same circumstances because they are active participants in its creation.¹⁶[16]

Restless voters

Most Westerners live in pure republican democracies, however. My point above is that voters are not as stupid (in aggregate) as many seem to believe, and can achieve similar results to mixed democracies in a sufficiently competitive pure representative democracy. That’s why I was encouraged by the US midterms. Figure 1 is reprinted from my election post mortem at Thematic Markets and shows the dramatic, back-to-back swings in voter preferences from 2020 to 2024 and from 2024 to 2026. Nearly all major demographics swung by double-digit percentages to Republicans in 2024 and away in 2026. As I discussed in the post mortem, it appears that many of the same disaffected voters who supported President Obama’s “Hope and Change” swung to and from President Trump over multiple elections.¹⁷[17] One of the things I got most wrong about this year’s election is that unlike 2012, when those voters sat out after losing their “hope” for “change,” many actively sought change. That’s a great sign for their increasing sense of power and the vibrancy of the US democracy.¹⁸[18]

Drive better representation

Research also shows that greater voter fluidity creates more responsive representative government,¹⁹[19] while party loyalties weaken responsiveness and enable corruption.²⁰[20] This makes sense in the context of George Savile’s 17th century observation that “The best Party is but a kind of Conspiracy against the rest of the Nation.” The extent to which voters enable such conspiracies undermines both their own representation and national dynamism. Indeed, corrupt politics is a telltale sign of voter dissatisfaction: experimental research shows that voters’ tolerance for corruption increases with their sense that no alternatives exist.²¹[21] That government corruption was a top-two issue for voters according to exit polls last week is an extremely positive sign that US voters are beginning to feel that they have more agency.²²[22]

Competing for votes

Both the Democratic and Republican Parties appear to be getting the message. Despite boiling partisan anger among the Democratic base, prospective Speaker of the House, Hakeem Jeffries, said after the election,“The American people don’t want us to get even. They want us to get things done on their behalf.”²³[23] His sentiment was echoed by numerous newly elected and incumbent Democratic politicians.²⁴[24] Republicans, too, began to frankly assess their failures and recalibrate their positions to better appeal to voters in 2028.²⁵[25] Even President Trump suggested he was willing to work with Democrats to get legislation passed.²⁶[26] I’m not naïve enough to think everyone will bury the hatchet and move on. Social media responses from both sides’ respective bases suggest that will be difficult. But the tone of Democrats, in particular, was distinctly different from their midterm election wins in 2006 and 2018 facing an unpopular Republican president.

Bullish on democracy

Given my small-c conservative preferences, it is unlikely that I will share many, if any positions with Representative Jeffries. But that’s not the point. His prospective Speakership testifies to a vibrant and competitive US democracy that likely will better respond to the heightened Uncertainty of our age. If he and his Democratic colleagues do not, in 2028 they will find themselves on the receiving end of the vote-switching that helped bring them to power in this election. Redistricting that backfired on Republicans this year makes Democrats just as vulnerable to swings in voter sentiment in two years.²⁷[27] I am sometimes accused of being pro-populist but in reality I’m pro-democracy. All of my research into populism shows that its foundational issue is a demand for greater democratic accountability. A vibrant democracy bubbles up new ideas and lets the best win, solving complex problems better than any panel of experts.

Investable conclusions

While competition with China is a critical issue, this is about far more than just geopolitics. Societies are grappling with numerous unprecedented challenges from how to master AI rather than be mastered by it, to rapid aging amid collapsing births, to rising cultural tensions within and between nations; along with ancient challenges like debt sustainability and growing standards of living. These are exactly the problems that democracies solve better than alternative forms of government. But there also are investable conclusions. As I noted above, more competitive democracies produce better economic outcomes, higher productivity, better infrastructure, and more sustainable finances. Looking through last week’s rout of AI stocks and what are likely to be noisy and chaotic US politics for the foreseeable future, US political and economic dynamism is hard to deny. That is particularly true in relative terms. Not all democracies are equal in their dynamism as Europe demonstrates only too well. This will almost certainly reveal itself in sustained US outperformance until Europe and others begin to show the same electoral volatility the US is demonstrating.