Buckle in: Populism could be here for the long haul

Investors need to watch out for the rise of populism, a trend ushering in political leaders who favour damaging economic policies that are unlikely to deliver long-term rewards

Viewpoint

Markets may be quick to respond to populist-driven events, but they have not grasped the potential long-term global economic impact and challenge to investors’ portfolios populism may have. The uprising against mainstream parties will not disappear any time soon. Consequently, any strategy based out-waiting populist movement is likely to be a long-drawn-out affair: not a positive omen for the ongoing US-China trade discussions.

Despite their differences, economic redistribution is a common thread between populists of left and right. Both stemming from a sense of inequality, those on the Left seek to redistribute resources to the people through aggressive taxation and cheaper, more widely available, public services; while those on the Right propose restricting the definition of “the people” primarily to the middle class, excluding immigrants, ethnic minorities and the very poor.

On the economy, the Left tend to be anti-business, while the Right want to make business more competitive through tax cuts and deregulation to prevent jobs from being outsourced overseas. Both are hostile to free trade, regarding it as damaging to the employment and earnings prospects of “the people” as they regard them.

Lessons from History

History shows that loose fiscal policies adopted by populist regimes have historically been combined with policies that directly challenge central bank independence, corporate governance, and property rights. Typically, these policies have resulted in negative economic outcomes, such as unsustainable fiscal deficits, high inflation, steeper yield curves, lower real yields, and currency depreciation.

This is not too dissimilar to what happened in the US in the 1970s, when a combination of price controls to limit inflation and expansionary fiscal policies to support real income growth amid shocks from rising oil prices led to the S&P 500 failing to keep up with inflation, a fall real yields on US 10-year Treasuries and a depreciation of the US dollar against other major currencies.

These return profiles provide an insight into what one might expect from populist governments that seek to deliver on overzealous election promises and pressure central banks to maintain accommodative monetary policies. The effects dent business confidence, as well as reduce capital formation and job creation, which ironically makes income redistribution and social mobility harder, not easier, to deliver. While growth might initially be supported by some of these policies, it is likely to suffer over the longer term as their effects mature.

The foundations of these conditions can be seen in President Trump’s deficit‑financed tax cuts and the ruling Italian populist coalition’s battles with the EU to push through an expansionary budget. The fiscal accounts of Hungary and Poland have structurally deteriorated after the election of right‑wing populist governments, and the markets price in a fiscal deterioration in Mexico under the newly elected left-wing president Andrés Manuel López Obrador.

Failure Won’t Be the Death of Populism

While it seems unlikely the current generation of populists will deliver the income redistribution and social mobility that their base demands, it is also unlikely their failure will lead to the demise of populist politics generally. The median voter’s demand for greater equality and social

mobility will not be silenced until those demands have been met – and if the first populist government that is voted into power fails to deliver, voters are more likely to elect another populist candidate than to vote for mainstream candidates.

Moreover, it is not only populist, “alternative” candidates who promise greater equality and mobility: incumbent politicians are likely to shift their stances to address the populist threat. In this way, populist movements can exert considerable influence over policy without actually gaining power.

In respect to rising geopolitical tensions, like the breakdown of the trade talks between China and the US, a succession of populist leaders in the US spells bad news: all populists, regardless of colour, take a hostile stance towards free trade.

The path forward is fraught with uncertainty. However, it is important for investors to at least embrace the possibility that the populist movement is a long‑term, structural phenomenon.

If it is, we will likely contend with the profound implications of populism on economies and financial markets for many years to come.

Nikolaj Schmidt is the chief international economist in the fixed income division of T. Rowe Price.

Prior to joining the firm in 2015, he worked as a director of economic research at Pharo Management, and also held positions at Goldman Sachs and the Danish Ministry of Finance.

He earned a master's degree and a PhD in finance and economics at the London School of Economics and Political Science.

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