Does an expanded Government role impact investment returns?

• Currently there is no compelling evidence to suggest that higher levels of Government involvement in the economy may stifle investment returns.  However, inevitably returns will be affected.

The severity of the Global Financial Crisis necessitated Government intervention around the world to help restore confidence in the financial system.  Unwinding this expanded government role in the global economy may take many years.  Does this mean that the business environment will be less favourable in coming years?

This question is not a new one.  The cover of Time magazine in July 1975 asked ‘Can Capitalism Survive’ in the face of the severe recession.  In the 1930s US President Roosevelt financed the construction of power plants around the country that drew an outcry from the large privately owned energy producers.  In 1984, the Continental Illinois Bank failed, which was the largest banking failure ever at the time.  The US Government became the majority owner of the bank for the next 10 years.

It is difficult to determine whether widespread Government involvement in the economy hampers economic growth, as it is only one of many factors that affect stock returns.  Even if we can predict Government policy, we cannot use this knowledge to predict stock returns.  

The graph below illustrates the annualised sharemarket returns for several major economies for the 39 year period ending 31 December 2008.

Source: ‘Government Intervention & Stock Returns’, Westin Wellington, MSCI data, July 2009

The graph tells us several things:

• Countries with typically high levels of Government involvement in the economy, such as Sweden, Denmark and Canada, do not appear to have experienced stifled economic growth relative to countries where Government involvement is more limited, like the US.
• Australia ranks 17^th out of the 18 countries listed.  Although Australia’s sharemarket performance has been amongst the strongest performers over the past 10 years, this graph shows the importance of global diversification over the longer term.
• The power of compound interest and diversification.  One might be happy with the US return of 9.12% pa over 39 years – after all, $100 invested in 1970 would now be worth $3,008.  But $100 invested in Sweden would now be worth $11,119 – or 270% more. 

Whilst 39 years seems like a reasonable sample period, it is still short.  For every $1 spent by Government, it is $1 less spent by private enterprise.  In the long term, we believe in Adam Smith’s statement that, in general, markets should be free of Government influence.

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