Stocks are affected by the nations they call home. Even companies that span the globe and gather revenue from all over the world can be hurt by a recession or a change in regulations in the nations they were founded in. This means that the politics of a nation have a direct impact on stocks. In this article, we'll take a look at some major political systems and how they impact the capital markets within their border.

SEE: Government Regulations: Do They Help Businesses?

Democracy is a system of government where the citizens of a nation vote representatives to govern. In general, a democracy is good for investors, as it means that property rights – even those of foreign investors – are likely to be respected. Democracies also seem to encourage an entrepreneurial spirit, because people are free to choose their work and gain large rewards when they are successful.

The trade-off is that democracy can be a messy process and business is not always the top priority. Democracies may also waver a fair bit, politically and economically, but they are surprisingly resilient and can produce some of the most fertile grounds for economic growth. Milton Friedman was fond of pointing out that you can have capitalism without democracy, but you can't have democracy without capitalism. That said, there is no pure democracy in the world - in fact there are few, if any, pure political systems. Often, they end up being mixed as in social democracy (socialism + democracy). However, even an element of democracy is seen in a positive light by many investors.

Autocracy is when one person rules the government and the nation. This kind of absolute power can provide stability – something investors like in emerging market economies - but it also means that stability comes at a price and with a time limit.

Autocracies can last for decades, as with Ghaddafi in Lybia (1977-2011). In a political science course, distinctions are made between autocracies, military dictatorship, authoritarian regimes and totalitarian governments, but to investors these all act in similar ways. Autocracies can quickly turn on foreign investors, changing the rules of the game in a way that best serves the dictator.

Although these regimes can be stable for long periods, the implicit threat of overthrow or death makes it difficult for investors to think long-term in these regions. For example in 2011, Middle Eastern countries such as Egypt and Tunisia endured the Arab Spring, a systematic protest of their countries despotic leaders and advocacy of pro-freedom regimes, which resulted in many of them stepping down. Civil unrest in this area has spurned pessimism among oil investors in the region, as prices remained relatively stable previously under these autocratic regimes.

Socialism is a bit of a sticky one for investors because, in the purest form, the nation and its citizens own all assets collectively. In practice, however, there are self-managed companies in socialist nations and they tend to enjoy advantages such as a highly educated workforce in nations with free or highly subsidized universities, and have less need to provide medical coverage or pensions to these employees.

The tradeoff, of course, is high taxes on individuals and companies. Some have observed that these taxes help the state pay for programs that provide a social safety net. This safety net may encourage new ventures and new businesses that otherwise may not have existed. Simply put, instead of being encouraged by rewards, the entrepreneurs of socialist nations are spurred on by smaller risks. All this means that the companies within socialist nations can be attractive to investors, even if the taxes are not. Business owners in nations such as Norway, where many facets of the economy are state-owned, enjoy the fruits of their company's labor with reduced entrepreneurial risk as a result of the country's social net.

Monarchies, the apparent rule of a nation by a particular family, are usually judged on a case by case basis when it comes to investing. Many that exist today are a shadow of their former medieval selves (with remnants of this bygone era still existing today with castles, artifacts and even in the vocabulary of modern investors.) By and large, most modern monarchies retain a traditional or ceremonial role; if anything, the benefit they can provide is adding an intrinsic sense of stability to a nation. Essentially, these select public figures are a good way to unify a nation with disparate views. On the other end, a monarchy that actually controls a nation, such as Saudi Arabia, comes with the same issues and advantages as an autocracy. Investors don't mind monarchies as long as they promote stability in a way that is not likely to end with blood in the streets.

Communism and Other Unique Situations
Communist nations wouldn't even be mentioned on a list of investment destinations if it wasn't for China's wedding overtly communist doctrine with capitalism. China is not communist. China is most definitely not a democracy and it doesn't fit well under the socialist label, either. What it seems to be is a unique meshing of elements - an authoritarian regime with capitalist leanings. This political stability and potential growth does, and has, attracted investors. A true communist nation, however, would send those same investors running.

The same is true for nations that are heavily influenced by religion - theocracies. These can be difficult to peg, as religious influence on the political system can be stabilizing or damaging.

The Bottom Line
In the end, it all comes down to stability. When you invest in a foreign market, you can't just look at the company, its earnings and its prospects – or the broader exchange-traded fund for that matter. You have to look beyond to see if the political system of the nation is going to be a complicating factor.

Most of the world's economies are not one system or the other, however. They tend to be a mixture – democracies with socialist elements, democratic nations with monarchies, etc. – and these mixtures may enhance or decrease the overall stability. When it comes to emerging markets, these systems can change rapidly, going from autocracy to democracy, to socialism to communism and then back to autocracy, for example. As an investor in these nations, you need to keep up with the political changes and know what affect they can potentially have on your portfolio.

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