Stock markets are usually considered to be the nervous system of an economy. Whenever something out of the ordinary occurs, the markets react. If there is something happening, or is likely to happen, that might have adverse consequences for the economy, such as political disturbances, stock prices fall. Investors switch to holding cash as a precautionary strategy. These reactions are different from sectoral price corrections that occur from time to time in markets. A recent piece of research conducted by a Harvard Business School faculty, Max Miller, found that not all kinds of political disturbance have the same effect on stock prices. Interestingly, his research, which considered data for 90 countries over 200 years, reveals that when political disturbances led to increasing democratisation, stock prices fell quite sharply. Dividend yields — the percentage paid as dividends divided by the stock price — would rise even up to 19%. On the other hand, when political changes seemed to be moving towards greater authoritarian rule, stock prices would fall only marginally, with dividend yields rising by only 2.4%. In other words, markets panic much more when democratic influences are expanding, while authoritarianism comes with less severe stock market effects.

The author suggests a number of reasons for this. There is evidence that investors constitute a relatively small but economically wealthy elite in society. The spread of democracy is perceived by this elite as a condition that would increase the possibility of an income redistribution through tax hikes for the rich. Rising democracy is also taken by this constituency to be indicative of future labour market reforms, leading to wage increases. There is a conjecture, too, that greater democracy leads to greater vigilance on corruption and bribes, thereby restricting the chances of opportunistic behaviour by wealthy investors. Moreover, democracy leads to more open markets with greater competition. Consequently, the new forces could challenge the monopoly power that big investors often enjoy. The spread of democracy is considered to be a threat by the wealthy elite on account of all these reasons.

There is a basic assumption that democracy and free market capitalism are made for each other. That perception, however, is increasingly coming into question. This is because democracy and the market operate on the basis of distinctly different principles — morally and otherwise. There is bound to be tension between the two. Another issue is that market capitalism, left to its own devices, tends to create concentration of wealth and incomes. That gets reflected in the stock market through ownership patterns. Finally, the joint stock corporation had once been hailed as a form of people’s capitalism with stocks likely to be held by many small holders. That anticipation has not turned out to be true. In today’s world, where there is widespread pushback against democracy and a rise in authoritarianism, many had expected a sharp stock market reaction. But Mr Miller’s study indicates that no major stock market disruption is likely due to these prevailing political trends. That may be a reason why, to cite one example, Donald Trump’s economic policies — even though some of them are having adversarial effects on the domestic economy of the United States of America — have had no significant impact on stock prices.