Culture plays a very important role in an economy, and there is a reason for it. Humans beings are designed to be cultural. Since the evolution of human modern human society, culture has continued to be a strong part of average people’s lives. Culture tends to influence people views, values, money, aspirations, hopes, their priorities along with loyalties as well as worries and to a large extent their fears.
And since culture occupies a very big place in people’s lives ,it influences not just the politics, but also the larger economy. How people invest and why. What sort importance they put on long term relationships as well as the idea of value and money. People do tend to rely on their cultural brain more often than we would probably prefer. And therefore, developing a better understanding of people’s cultural inclination is quite important, whether talking about the society at large or the nature of the economy of a specific society as well as the global economy.
Traditionally some societies tend to be quite risk averse than others, and that gets reflected in the make up of the overall economy. As a way of comparison, Europeans as well as Asian societies tend to be more risk averse than their counter parts in the United States. There is ample evidence to conclude that Investor’s behaviour does tend to differ across the world, which in turn has a significant impact and influence on investment strategies, return expectations as well as priorities, when considering an investment opportunity. And it is widely accepted fact that, Anglo-Saxon society is probably culturally more adept towards tolerating losses than others.
In many societies failure still isn’t an accepted norm. And this fear of failure can have serious side effects. While humans have evolved and the continued technological progress has stated changing the cultural make up of societies, the pace of transformation has also created conflicts and confusion. People’s expectations have changed, and so has the idea of value or value creation. Culturally, many societies still favour traditional investment tools as a way to preserve or create wealth.
For example, a lot of capital in a country like India is stuck in hard assets, because that’s the traditional and cultural mindset of the society. And yes, I could probably rightfully argue that, you can’t have so much money locked in Gold and other hard assets, because that type of investment won’t translate into value and wealth creation as well as growth. You will most likely make more money by investing part of your investment in an idea that can potentially grow into a $ 100 billion business, not only making you significantly richer, but in the process also your country and the society much richer. Yes, the inefficient distribution of wealth remains a thorny issue. But a prosperous society will always need more wealth creator.
A case can be made, as to why the stimulus along with the negative interest rate environment in the Eurozone countries didn’t translate into a sustainable growth, because culturally European investors prefer safe investments. And that’s understandable, but without taking risks, you won’t have creation new wealth. And one easily burn through old wealth, if that wealth is not busy creating more wealth. Maybe, this is where the policy makers in the EU failed to push forward a change in the overall cultural mindset of people at large. So going forward governments, central banks along with the regulators may need to conceive smarter regulations, to balance things out a bit.
A lack of deep, diversified and vibrant domestic investors base is never a good thing. By a way of example, for the year 2017-18 India’s Gross Fixed Capital Formation was estimated to be around US$ 561.44 billion, of this, the overall investments made by Domestic Institutional Investors (DIIs) as they are known was only US$ 14.00 billion in the year ending 2018. Also the PE and VCs related investments estimated to be over $ 20 + billion in the year 2018 was largely driven by foreign investors. So quite clearly the Indian markets have become heavily dependent on Foreign Institutional Investors ( FIIs ) for domestic capital formation.
Capital has no nationality, but some investors do tend to have home bias for obvious reasons. And when deploying capital institutional investors do tend to be mindful of the larger global picture. In Europe post financial crisis of 07/08, it’s been mostly Chinese and US investors that are buying up companies including of tech and tech related businesses, because raising money for European companies continues to be somewhat difficult. But there are exceptions, which sort of also serves as an evidence of cultural predisposition. For example, Fin-tech related business housed in London have managed to raise significant amount of capital, and that trend has helped other European FinTech companies to raise capital also. So in a way, the accepted consensus view is that, the city of London is culturally more predisposed towards taking risk.
Culturally European and Asian investors aren’t comfortable investing in ideas that could be classified as risky ventures. But US based investors tend to be culturally more ok with the idea of risky ventures. That’s probably one of the reasons why US still continues to lead the world in terms of companies with highest market capitalisation. Now in case of India for example, people will rather invest in Gold, and keep that capital locked in. So how will that create economic activity? Also the corruption money has mostly ended up in real estate or media. Because it’s considered safer. Without bringing about a change in cultural mindset, as an economy, India will remain quite dependent on foreign investors to fuel its growth especially when hundreds of billions of dollars worth of domestic investments is stuck in hard assets.
Innovation in the US, China and also UK to some extent works because the domestic investors tend to be more active, and a deeper domestic investor base makes the financial markets more attractive to foreign investors, as is the case for US. And it’s probably one of the main reasons why the US economy continues to be the largest recipient of Foreign Direct Investment in the world, and US based investors are still the largest investors base globally . For the year ending 2018, the sum of total inward FDI flow into the US economy stood at around $ 4.3 trillion, where as the overall outward investments as FDI from the US to the world was around $ 5.9 trillion. In a way, the world invests in the United States, and the US continues to invest in the world. And a sizeable portion of the foreign capital deployed in the US economy ends up being invested outside the US also, again because culturally US investors tend to be more open to exploring opportunities outside their home base.
There is no deeper capital market in the world than the US. And the capital formation therefore, in the United tends to be at a faster pace than anywhere else. The EU will have to make changes. And it looks like the policy makers in Brussels are now looking to create their own € 100 billion sovereign fund, to combat the expansion of US and Chinese companies in Europe, but we will have to wait and see what comes out of it. One could argue that culturally speaking the EU isn’t predisposed to taking risks.
Also when taking about risks, the bottom line is, there is no risk free investments. No new company is ever born with a balance sheet, and it is the non financial metrics that eventually creates the financial metrics of a company. And when you are running a business then, the only guarantee you have is losses. So while chasing profits you could in fact open the flood gate for losses to seep in. The right business model along with the strategy and a strong team is in fact more important than simply analysing the financial metrics to understand risks associated with investing in a business. The success of a business as an idea is, pinned on the potential future value of that idea, and the ability of a team to successfully execute it. The higher the level of execution, the grander the success. And non financial metrics play a key role in making a business successful.
Regulators and govt agencies can certainly help change the existing dynamics, but the problem of funding will continue especially if there is no real cultural change in how average people view the risk and reward equation. No market is perfect, and there are issues within any economic system, whether a capitalistic or socialistic model. But that’s a different discussion. And yes, there is a visible cultural shift also in the US towards a more state lead economy especially post 07/08 financial crisis, as the income inequality has grown wider. So the existing architecture of the US economy and the current model of capitalism will have to change to reflect the cultural shift and priorities, but culturally the US society will most likely continue to be more risk taking than others, and therefore, it will lead the world on wealth creation and the overall pace of capital formation. But whatever maybe the case, the influence of culture on investment behaviour at large is undeniable.
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