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The economic consequences of populist politics
Populist leaders can deliver short-term economic benefits via fiscal largesse, but research finds economic growth suffers in the long term.
The below is an extract from our Q4 Asset Allocation Outlook.
Plato worried about the dangers of democracy over 2,000 years ago. He foresaw the rise of demagogues: charismatic leaders who manipulate public opinion with false promises, prioritising personal power over the common good. Today, there are concerns that far-right parties in France and Germany could replicate the rise of extreme parties in the Netherlands, Austria, Italy and across Eastern Europe. If populist leaders continue to gain ground, what economic impacts should investors anticipate?
What’s the cost?
On the one hand, the impact of government policy on the economy is the most important short-term driver for markets. To the extent to which extremism leads to expansive fiscal policy, it will impact growth, inflation and central banks’ reaction function. That could easily become the dominant driver for markets. In a weaker economy, that might be great for the stock market.
Against the current backdrop, with limited slack in the economy, fiscal expansion could drive inflation and interest rates up and equity markets down if markets convince themselves central banks are committed to offsetting the fiscal effect on inflation.
An article in the American Economic Review in 2023 shows that the long-term economic cost of populism is high. Based on a sample of 51 populist presidents and prime ministers from 1900 to 2020, after 15 years GDP per capita is 10% lower than it would have been in a plausible non-populist scenario. The study found the end result of populist rule has tended to be a budget deficit and restrictions on trade with lower-than-expected trend growth.
The medium is the message
One way of understanding the rise of populist politics is through the lens of the mass media, with its constant evolution shaping voting behaviour.
There was a convergence in US politics from the 1930s to the 1960s. This has been linked to the rise of network radio and television by academics who analysed the data at a local level given the gradual roll out of these technologies.[1] Unlike newspapers, which often had clear political affiliations, network radio and TV provided more uniform and less partisan news coverage, and politicians moderated their voices before joining shows.
However, the advent of cable TV in the early 1980s and the subsequent rise of the internet and social media have been linked with a reversal of this trend. These platforms can create ‘echo chambers’ where individuals are exposed primarily to information that reinforces their existing beliefs.
Arguably, this has led to a rise in political extremism, distrust, and a ‘them vs. us’ mentality, with less appreciation for opposing viewpoints and a decline in consensus. Leaders can today use social media and cable TV to shape public opinion, leading to increasingly polarised environments where ‘experts’ are dismissed. Social media also has more potential for foreign interference, using automated or human-operated accounts to spread misinformation and exacerbate divisions.
This is likely a secular trend. Older generations who still use and trust newspapers and TV are passing away, replaced by younger generations who are more trusting of social media.
The new political landscape
What does this trend towards extremism mean in practice? Elections and referendums pose bigger risks than before as political views become more extreme. This is particularly the case in ‘first-past-the-post’ systems where a minority of votes can take a majority of seats. Proportional representation systems are more nuanced, particularly because the ‘extreme left’ is countering the ‘extreme right’.
But centrists become squeezed and previously taboo topics become acceptable (as per the ‘music market’ experiments,[2] people associate quantity with quality, and so the more ‘likes’ something has, the more people will think it’s good).
This suggests today’s mainstream views on balanced budgets, free trade, independent central banks, tackling climate change and immigration will be challenged.
The above is an extract from our Q4 Asset Allocation Outlook.
[1] rcampante_media_polarization.pdf (harvard.edu)
[2] Experimental Study of Inequality and Unpredictability in an Artificial Cultural Market, 2006