Uncle Sam’s Governance Is Ugly: But Still a Sideshow

The dysfunctional federal government in the United States has been on the global stage in recent months to the dismay of most Americans, including the business and investor communities. The legislative and administrative branches of government in Washington clearly are not delivering the desired level of performance. The system could be improved by reforms. My personal list of needed changes includes reforms of the laws regarding political contributions and the way legislative districts are determined. However, such changes would not alter the fact that there are sharp philosophical divisions in the U.S., particularly about the desired role of government. Geographically, the current political divisions appear in a broad sense to be between the Atlantic and Pacific coastal regions versus the middle and south regions.

The U.S. has experienced and survived periods in the past when the political situation was at least as challenging, but Americans are surely justified in calling for better performance from those we elect. That said, democracy in any large country with a heterogeneous population is unlikely to function smoothly. And it is noteworthy that U.S. citizens are not alone in their dissatisfaction with government. A 2012 Gallup World Poll indicated that 60 per cent of the populations of the 34 member countries of the OECD, all democracies, did not trust their governments. That is a disturbing statistic.

Despite the unresolved budget brawl in Washington, the U.S. stock market has continued to trend upward, with the S&P 500 having gained over 24 per cent year-to-date by mid-November. Investors are looking beyond the political sideshow to an economy that is recovering with firms and banks earning substantial profits. Global investors have not deserted the U.S. dollar, quite the contrary, with a stronger greenback the prospect in the coming year. Having one of the best central banks in the world deserves a sizable share of the credit for this positive outlook.

As global investors we give careful consideration to the quality of governance in the locations in which we invest. For our most important asset class, U.S. municipal bonds, we do our own proprietary credit analysis for every state or city government and economy under consideration. For our international equity investing, where we use only exchange-trades funds, we have developed a global governance ranking of the 44 countries in our investment universe, including the U.S. This ranking is based on several well-established comparative studies by international organizations. The reports cited below can be found at the organizations’ respective web sites.

The first is the annual “Doing Business” ranking of the World Bank and International Finance Corporation (IFC) which compares business regulations in 189 countries. The comparisons cover such areas as starting a business, getting credit, paying taxes, enforcing contracts and protecting investors. The United States is ranked 4thin the recently released 2014 report. Above the U.S. are Singapore (1), Hong Kong (2) and New Zealand (3). Canada is ranked 19th, with low grades for dealing with getting electricity, construction permits, enforcing contracts and registering property. We pay particular attention to the ranking for protecting investors. Here the United States ranks 6th (Canada sits higher in 4th place).

We also consider the Global Competitiveness Index developed annually by the World Economic Forum. This index draws together information on institutions, infrastructure, the macroeconomic environment, health, education, goods and labor market efficiency, financial market development, technology, market size, business sophistication and innovation. In their 2013-14 report, the United States is ranked 5th, an improvement over last year’s 7thposition. Above the U.S. are Switzerland (1), Singapore (2), Finland (3) and Germany (4).  Canada’s position is unchanged at 14th. 

Finally, we consider the Corruption Perceptions Index produced by Transparency International. This index measures the perceived levels of public sector corruption at all levels in 176 countries. It is based on surveys covering expert assessments and views of business people. In the Index for 2012, Canada gets a higher grade than the U.S. with a 9thplace ranking compared to a disturbing score of 17thfor the States. Above Canada are Denmark, Finland, New Zealand, Sweden, Singapore, Switzerland, Australia and Norway.

We combine these indices into an overall Governance Ranking for the 44 countries in our investment universe. We think it presents an overall view of how well these countries are governed, with an emphasis on matters of interest to investors. The United States is ranked 7th, behind Singapore (1), Finland (2), Denmark (3), Hong Kong (4), New Zealand (5) and Sweden (6). It is first among major economies. China, the second largest, gets a rank of 32, while Japan comes in 15th, Germany places 10th, France sits at 22 and the UK is number 11.  Canada’s rank is 14th.

Small differences between rankings are probably not statistically significant, but large differences do command our attention. In our investment evaluation process, we become particularly concerned about the quality of governance for countries falling into the bottom 10 of our ranking, including Peru (35), Mexico (36), Columbia (37), Brazil (38), Indonesia (39), Greece (40), Philippines (41), India (42), Russia (43) and Vietnam (44). 

Overstated as they may be, current fears that America is becoming ungovernable are somewhat justified. Widespread distrust and indeed disgust with government officials, if continued, can have a lasting negative effect on the ability of a government to implement policies effectively and on investment decisions and the economic health of the nation. Responsible political leadership from both sides of Congress and the White House is needed to correct this situation. But when viewed from a broad governance perspective, the United States still looks relatively attractive as a market in which to invest.