Democracy vs Economic Growth: Institutional Foundations | INSEAD Economist Ilian Mihov on Democracy, Middle-Income Trap, and Sustainable Leadership | Stewardship Asia Podcast

[00:00:03][Music] Hello and welcome to another episode of sustainable sustainability where we talk to steward leaders who are either creating profitable solutions to today's environmental or social problems or shedding light on how we can do so.

[00:00:25]Today I have a very special guest on the show with me, Ilen Mihov, noted economist and former dean of INSEAD. In fact, he has been the longest serving dean of INSEAD over 10 years uh in total and uh spent about 28 years uh at INSEAD so far. Welcome to the show. Thank you.

[00:00:44]Pleasure to be here. Ian, to begin with, tell us what have you been doing since you stepped down from uh from the deenship? Yes. So I stepped down on 31st of August last year and since then I have been on sbatical uh this academic year that just passed I spent my sobatical at Stanford University in California. Um because I served 10 years so for every five years you get one year soatical. So I have a second one now coming which uh I will spend between MIT and Stanford. Very good. Very good. So as you know in this podcast we explore the idea of doing well by doing good uh and feature anybody that is uh actually profitably solving today's existential challenges. Um I wanted to talk to you particularly about the S of ESG today given your research. Um and I want to particularly dive into two pieces of your research. one is on the economic development of countries on which you've uh talked about quite a bit and written quite a bit and the other is about the decline of democracy worldwide that you talk about. So maybe we start with the first one first. Give us in very simple terms the gist of your research on the economic growth of countries.

[00:01:58]So I'm focusing on a very specific issue and that is how some countries grow initially and then stop growing around the middle income around the levels that are not now known as middle income trap.

[00:02:12]Um we uh with one of my quarters we're trying to understand how actually they manage this growth and why you know at some point they stop around 20 $25,000 in terms of income per capita and international dollars and um I think that the interesting thing from the data is to see that the key variable that plays a role is institutions the institutional environment in the country, rule of law, cadral corruption and so on. And we realize that there is not a single country that has more than let's say $40,000 income per capita while the US is at 80,000. The rich countries are between let's say 60 and 100,000. So there is not a single country that is more than 40,000 income per capita and has poor quality institutions. M so once you reach that level if you have not reformed your institutions already you have to do something like that. So the uh you call it the great wall which is the uh middle income trap that they get stuck in. So why do they hit that wall? So I call it the wall because uh one of my students in 2005 actually asked me a question after like two hours of three hours of uh lecturing. Yes. He said, "Okay, you talk a lot about institutions and you know, democracy, political stability, and if institutions are so important, why is China growing?" So, you know, to me that was an interesting question and I did not know the answer at the time.

[00:03:48]So, I started looking at this um and uh I realized that then there is this this area where countries stop growing unless they reform their institutions. I call it the wall because initially it was triggered by a discussion of China. So what is interesting is that before that level before $25,000 let's just say $25,000 in the 2021 dollars. U before that level countries can grow simply by accumulation of factories of production which are capital and labor. In other words, in plain words, just build factories and mobilize people to work and perhaps uh perhaps emulate the innovation that has happened in the high- inome countries and used cheaper labor uh to deliver it. Yes, exactly. So that would explain the hockey stick curve that these countries face uh experience in your research. Yeah. So, but not all countries actually have this. So, you still have to do several things, right? But you don't have to reform your institutions. Gotcha.

[00:04:56]because you just accumulate factors of production. But if you if if you reach this level, then the way that you combine capital and labor, what we call productivity, the way that this productivity matters a lot. So innovation starts becoming more and more important. And if you don't have the right environment, it's very difficult to realize this. It's very difficult to create complex value chains with a lot of different suppliers and so on and then you start stagnating. So at the same in other words at some point the cost advantage and the efficiencies other than institutions sort of level off and then you get stuck in that in that trap.

[00:05:39]So we've talked about institutions quite a bit and I believe there are six institutions. Uh talk to us a little bit more about those. So there are a lot of measures of institutions out there. Uh I I just stick with the original original data that I got in 2006 from the world uh the world bank called the world governance indicators and there are six uh there they're actually drawn from a lot of other sources. So the first one is voice and accountability which is a measure of democracy. So uh so freedom of speech.

[00:06:16]Yes, the voice of the public in electing the government and the accountability of the politicians. Okay. The second one is control of corruption which obviously it means um people understand what it means. Uh quality of regulation is also very important. Then the fourth one is government effectiveness. Then we have political stability basically absence of political violence and unrest and so on.

[00:06:42]And the final one which actually turns out to be very important is the rule of law. So basically contract enforcement, how courts are working and so on. So uh again it's these six institutions that you have to strengthen continuously if you want to go past the wall and and and that explains why many countries while they came within striking distance of the US or the richest countries haven't crossed it. Yeah. Okay. Okay. So and China. So that's the the big question. I don't know how many trillion dollars maybe $18 trillion question today and it is um the question is China when I started looking at it and I had a talk in Beijing in 2007 China was pretty far from the wall from that level at the time. Today China has just entered the zone that is sometimes called the middle income trap.

[00:07:36]So it's 20,000 plus and um it is the the biggest question is will China reform in order to start improving its institutions and therefore facilitating further growth or will they stagnate and get stuck at the wall of course sometimes people say well you know China is different and you know they don't need these institutions they have figured out what to do how to do things we don't know what They're still in the middle income trap. But I but but you know still some people argue don't worry about this middle income trap.

[00:08:13]They will be able to go through this trap and and grow and become a rich country with this quality of institutions. Um just for the uh for the viewers um the institutions are usually you know they they're ranked they're measured from minus2 to plus two. So they're you know basically standardized.

[00:08:34]So zero is kind of like the average. Um so China today is probably about minus0.5. So it is below the the average and um it's uh at that level. So everybody anybody below zero it's difficult to move.

[00:08:50][Music] So my my view is that China still has some probably room to grow within that gray area, the middle income trap reaching 30 maybe even 32 33,000 but as we can see already there are issues there are um that that there are signs that that may not continue uh easily. Now my personal view for many years was that once China reaches the wall and if it starts you know shaking then things will start changing.

[00:09:26]Sometimes when I say this people think but are you talking about democracy and the communist party rule and all these things. To be honest the most important thing is not that. The most important in my view of these institutions is the rule of law. Because the rule of law is about contract enforcement and contract enforcement is important because to create value to be rich, it means that you produce in a short period of time a lot of value. But in the rich countries, it's not like people produce the whole thing. Usually they specialize in something very small. they become very efficient and then they combine these individual tasks into a final product between different companies and if you have contract enforcement you know that you'll be able to create this long value chain and still deliver but if you don't have contract enforcement and your um suppliers do not deliver you basically then you start thinking maybe I should start producing it myself and that creates because you can't rely on the ecosystem anymore Yeah. Yeah. Exactly.

[00:10:31]So, like you said, some people think that China is different, but what about other Asian countries? Your views on country other big countries like Indonesia, India. Well, they're very far still from the from the wall. Uh and China Chinese is moving quite rapidly.

[00:10:46]Um I think that India has a little bit better readings in democracy, but on political stability, on some other of these issues, they're a little bit behind. Um I think that for all of them the thing is the same. It's the same the institutions institutions institutions got it. It's actually very interesting you know over the last year I've been looking at this a lot. So I decided to to look at the trajectory of Korea of South Korea how it was growing like China initially at without changing institutions with lowquality institutions. I have not looked exactly at what changed and then at some point you can see institutions changing and going through the wall reforming and going through the wall and becoming well a rich country today a high income country. So it is possible to give examples in the region. I mean Singapore of course is Singapore of course yeah is a is a great example as well but it's it's possible to give examples where you can see countries um reforming and growing. Got got it. Very good. Okay, let's turn now to the other uh interesting research uh which is about uh uh democracies are on the decline worldwide. Give us a quick sound on that. Well, there are there was so many books published on this in recent years.

[00:12:10]Of course, the first book that I should site is Francis Fukuyama's book, The End of History. uh and the last man that's the the whole title which was published I think in 1992 with basically uh Fukuyama was arguing that history is not about events history is about the clash of ideas about ideology and you know there was communism fascism there were all kinds of you know different regimes but the western liberal societies the western liberalism won at the end in 1990 when in the Soviet Union collapsed and therefore from now on it just basically one of these regimes will be dominant.

[00:12:53]Unfortunately in the last few years we have seen that that's not true. So there is still a clash of ideologies and especially in more recent years you can see aristocracies like the Russia and uh you know the non-democratic states like um uh China and so on moving uh becoming richer and richer. So people started talking about the demise of democracy also in the western societies but also the the increase in um the rest of the world. Now last year in one of the seminars uh at Stanford I listened to uh to a paper by Daniel Traceman who is a professor of political science at University of California Los Angeles and he present a paper that shows exactly the opposite that basically shows that the number of democracies from 1900 of the last 120 years has been increasing steadily reaching a peak at some point in 2000 and then there is a small decline but we're still above the what he called the heyday of democracies which was the 1990s and then I looked at this and you know a lot of people in the audience were a little bit in disagreement with this I looked at this and interestingly two weeks before that without knowing about the paper I had created my own index of democracy for the world. So imagine that every country has uh an indicator from zero to one on how democratic it is whether it's electoral democracy or liberal democracy. So they're two different indicators and then I decided that in order to know to understand where the world is heading I don't need the number of democracies because the fact that Aruba is a democracy and you know Russia is not does not help him very much because you know the the size and the impact is very different. So my indicator is putting a weight on every single reading. Then the weight is basically the share in world GDP. So small countries have small weight, big countries like China have big. What about share of population? So that's that's another indicator. Somebody actually in the audience was suggesting that uh but I think that economic power is determining where the world is heading. So the indicator I constructed from 1960 until 2023 and it's very very interesting. 60s and the 70s basically have a flat reading. Then in the 70s the indicator starts increasing not because there are more democracies but because it turns out at that time that the west is growing very rapidly while the Soviet Union was stagnating collapsing. Yeah.

[00:15:43]Yeah. referring to the previous conversations that we had actually the Soviet Union collapsed exactly at the wall at the middle income uh trap. So it was already hitting the wall at the times leaving staying behind while the western world was growing and the indicator my indicator was increasing and I would say that this increase actually led to the changes in Eastern Europe and the collapse of the Soviet block because the west was becoming so powerful and uh and then of course there's further increase in the indicator because East European countries became democratic and the peak is in 1999. Since then the indicator is going down globally. Globally the global indicator of democracy. So again this is just one indicator for the world is going down and today we are at the same level as we were in the 1970s during the cold war. I think that this is important because it will create dynamics that are very different from what we have observed in the years since 1990.

[00:16:50]um the non-democratic and autocratic states are becoming much more powerful.

[00:16:57]Um I think that the growth in China which was engineered very well by the government gave confidence to a lot of other rulers and countries around the world to say look at China we can grow without necessarily having the same kind of like democratic societies like the western I was just going to say so if uh China pulled out so many millions of people out of poverty a lot of people might say what's wrong with that kind of autocracy u and I think it's a good question But again it's not uh first let's see in the next five 10 years whether China manages to continue growing but you know we value democracy not just because it gives you higher income per capita higher wealth which you know basically does but uh there are a lot of freedom it's about freedom it's about um you know freedom of speech freedom of expression it's about you know being yourself and not trying to humanity Yeah. Yeah. Yeah. No, I get that. But a lot of people make that argument though that it's a trade-off, right? In some countries.

[00:18:05]Um, coming back to the uh the decline in the indicator, the democracy indicator, the global uh indicator does the increase. So you comparing from 1970, you said 60 and until now, but global population has doubled since then. Yeah.

[00:18:23]So does that have something to do with it? Do you think um it could in general because population is you know more population should be creating more GDP. Mhm. But fundamentally I think that it was uh it was coming from especially after the n of the 2000s it's not so much the population growth but it Chinese population is even shrinking. I mean not growing at the but global population is increasing.

[00:18:51]Um it's true and I think that again the GDP of the countries where population is increasing very fast is not necessarily increasing as fast. So there are a lot of countries in Africa that have even negative population sorry positive population growth and negative GDP growth. So my indicator is really measuring economic power. But I completely agree that um it will be good to create also this indicator by using population share rather than just economic share. I mean each one of these indicators give you different perspective on the world. So if you ask the question tomorrow we have a vote in the United Nations and every country has one one country one vote then the number of democracies matters you know. Yeah that's true. No, I was just wondering whether uh you know uh the fact that the that the democracy indicator is going south um has anything to do with increasing population that we are now 8.1 billion people? Does that have anything to do with democracy going down because it is that much harder to manage a a population of 8 billion versus 4 billion and in countries which are highly populist anyway. Yeah. I mean I think it's actually a very interesting hypothesis to see whether So yeah but it is very easy to to check this uh because uh you know we we can see what is happening in the countries with a higher population growth is it is their weight increasing in the GDP or not it's a um so in in the indicator in the population indicator if you construct it with population shared weight it basically will ask the question on average how many people live in a democratic society what is the average reading of the let's say 50% or 30% and so on which is different question yes it is and then I wonder whether whether you know the fact that in many countries populations are getting very polarized ideologically polarized like in the US you're either left or right or India for example very very polarized yeah does that have anything to do with it would be another interesting one to uh look at I guess it is actually true and I looked at some of these things so I tried to to decompose the decline line and of course the first hypothesis is the rise of China. China has become so powerful economically and China we know that they they practice geoeconomic power. So geoeconomics now has become one of the big topics in research. So ge geoeconomics is about using your economic relationships or economic power in order to achieve political or even economic goals as well. But it is it is using this power.

[00:21:38]It's not geopolitical power. And we know that China has a lot of relationships with a lot of countries that are uh going beyond just the economic uh agreements. So that's uh it's interesting where this will end. But as I was saying, I was looking at the the decline of the indicator. If you remove China and the United States, so because you know the two big countries, the indicator still goes down. going south and it goes down not to let's say right now the reading is between zero and one so it's 0.3 it will be something like 0.5 or so but it has gone down quite significantly um interesting interesting so you know in our own research at stewardship Asia where we look at uh business organizations and we find that there are two types um given the current climate uh those that are profiting from today's ex existential challenges like climate change and social inequity quality and those who are finding profitable solutions to these challenges. Uh from your research, it seems like it's true for countries and governments too. Would you agree or disagree? Yeah, I think that I think that there are definitely governments that try to figure out how to solve the problem and how to solve the problem in a sustainable way.

[00:22:54]Meaning that through market forces and creating environments for profitable organ enterprises.

[00:23:02]My you know when I think around the world you know which are these countries where do you see this most clearly I would say that probably the Nordics like Denmark, Sweden these countries are so passionate about uh finding solutions to the um to climate change. I think it's Singapore in the last I don't know how many years also has been focusing more and more into uh in sustainability and and climate change addressing it and trying to figure out how can we make it here to be a profitable enterprise because if it is just government regulation or if if it's taxation and so on and companies do not believe in this or they're not profitable they're losing money eventually they'll figure out how to circumvent this and there'll be No innovation. Yeah. And that's what we need, right? Yeah. Exactly. So, uh in today's context where humanity is literally sort of fighting for survival against the environment, against social forces, inequality is at its highest. Um what advice do you have for political leaders particularly in developing countries?

[00:24:11]Well, it's a it's a very difficult question because you know we in many of the developing countries particularly in Asia and Africa we have this habit of saying oh the problem was created by the west and now they're lecturing us uh and those solutions for ESG don't actually apply to us because when we try to solve a e problem the way the west is trying to address it we create s problems so don't lecture us etc. Uh but so what what would you I mean these things are are true. Sure, I mean these arguments are not necessarily wrong that uh first of all if you look at the carbon emissions, carbon dioxide emissions over the last 200 years, it is true that still most of the buildup is due to the United States and Europe whether it is EU or the whole of Europe it doesn't matter but this these three regions uh EU Europe outside of EU and the US have contributed the most. China probably will overtake them in the next I mean it depends how fast they continue increasing emissions but in the next 20 years uh for sure if they just continue at the same level that they are today they don't increase as we know they've been increasing it so it is true that the west has a lot to do in order to remove this carbon but also I think that they are doing it so if you look at the emissions in Europe you know they have been going down since the 1990s and it's uh now what can um government in a developing country do? Well, it depends a lot on the country there is no one single solution. It's not yes there's no prescription if if we try to give a pres so you have to look at the country where are the bottlenecks what are the issues what are how can you resolve them but I think that to me the most the most important thing which relates to our stewardship compass the most important thing is to realize that we cannot ignore the long run that's right and you know we see that the west is also failing in this.

[00:26:24]Many times we see that many many countries, many governments but you know I I I have to be elected to do this. No, to be elected you do things that are not necessarily interest more very short-term focused and so it boils down to values then yeah it it's values it's ability to be to be convincing because you have to have the people with you and I think that it is um it is patience because uh you know at the end of the day growth development success whether it's environmental or any other success is a result of a sacrifice That's right. Today you have to give up today something to be able to build for the long term long run. So my last question in so the the the the importance of institutions for economic growth for at the country level is clear from your research. What parallels can CEOs of businesses draw from that research? It's it's interesting. you know I' I've talked you know over 15 years now about this um these uh institutions and growth and and um several companies where I had talks after that said you know what we have adopted this in uh your framework uh in in in our company and I think that at the end of the day you can think about it in the following way when I think about countries you know some countries with the same amount of capital and the same amount of labor produce much more output than other countries with the same levels. So they have the same inputs but they have more output because the productivity is higher. And when you ask the question why is productivity higher?

[00:28:07]It is because the environment in which people operate the institutions as we say are different. The same is true for companies. Some companies with the same capital and the same labor produce much more output. Why? It's because the the culture, the organization that you have inside, what we call the institutions, the the way that you structure everything and the exchange is is just so much better. And I think that this is um this is an interesting way to think about this because when you think about the inputs capital and labor you can buy the same machines you know you look at Apple you know you can find the same machines that Apple has in order to produce actually Apple is not even producing they're outsourcing this you can find if the people are so good you can poach some of them and and get them but if you don't have the culture if you don't have the organization ation and the the flows of ideas and the realization that's not going to happen.

[00:29:12]So I think it's again it's it's similar the institutions at a different level at the corporate level. Yeah. Exactly. And this corabolis very uh clearly with the research behind our book as well that you mentioned the compass that companies that are successful at doing well by doing good uh actually believe in interdependence that the more I do for society the more we will succeed. They do think long term. they think in generations not in in quarters and years. uh they take ownership that we're going to do business in a way that we are going to live 100 years and uh responsibly and and I think that they are they will be even bigger beneficiaries in the times to come because looking at the temperatures rises in the last year which has been had several months with the highest temperature in the history since uh you know we have records uh we are well above 1.5 5 degrees already and it's just a matter of time before governments start actually imposing regulation because you know they they they have to do it you know otherwise and or or unions like the European Union imposing restrictions on imports unless you prove that you produce this in a sustainable way I don't want to hear I put tariffs that are penalizing you know so companies that today are focusing on this that are adjusting the moment this thing comes they'll be in a better position and those who are just milking the current cash cow business model and not investing enough in innovation are going to perish. Yeah. Exactly. Very good. Very good. Well, thank you very much. This has been a fascinating conversation and to our viewers I hope uh uh it sheds some light on the environment in which uh businesses are operating because the key question today is in the 21st century which is headlined by climate change inequality and the both the opportunities and perils of technology how do you seek profitable growth and it seems from this conversation the answer is uh definitely focus on today but absolutely focus on tomorrow because today's cash cow will run out or regulators will will will clamp on it. Alen, thank you very much and thanks once again for being on the show. It was uh lovely to have you.

[00:31:26]Thank you, Rajie. It's a pleasure to be here. Thank you.