Tuesday 18 June 2019

The economy doesn't pay dividends in global politics

Even as the great and good debated world affairs at Davos, the conventional wisdom does not always apply, writes Dan O'Brien

President Donald Trump with British Prime Minister Theresa May at the World Economic Forum in Davos. In
different ways, both have experienced the volatility of voters and the unpredictability of financial markets. Photo: AP/Vucci
President Donald Trump with British Prime Minister Theresa May at the World Economic Forum in Davos. In different ways, both have experienced the volatility of voters and the unpredictability of financial markets. Photo: AP/Vucci
Dan O'Brien

Dan O'Brien

Bad economic times cause politics to sour and people to give their votes to parties offering simplistic or illiberal solutions to society's ills. This is a commonly held view now.

As common is the view that bad political outcomes can lead to bad economic outcomes. There is a global industry of "political risk" analysis which advises companies on how uncertainty and instability in politics can negatively affect their businesses.

Last week political and business leaders from around the world gathered at the annual Davos meeting. How politics and economics interact was much discussed, as it always is at the Swiss event.

But the conventional wisdom on the relationship, in both directions - from politics to economics and economics to politics - is only partly right, at best.

Start with fears about political uncertainty derailing economies. Two years ago, Ireland had its longest ever time lapse between a general election and the formation of a government. The minority administration cobbled together is one of the weakest in the State's history.

Around the same time, Spain experienced an even longer period of post-election political uncertainty. As in Ireland's case, the best Spanish politicians could agree to was a minority government.

At the time, both countries were emerging from very deep and protracted recessions. There were fears aplenty that uncertainty and weak government could cause consumers and businesses to pull in their horns. These fears proved unfounded and both economies continued to enjoy strong economic growth. Even hyper-sensitive financial markets shrugged off the uncertainty. Neither country was penalised with higher interest rates on their respective public debts by the "bond market vigilantes".

Since then, more evidence has accumulated that uncertainty caused by inconclusive elections is overstated as a risk to economies. Last year, the Netherlands broke its previous record for coalition formation, with six months passing after the March election before politicians formed a government. It is hard to find as much as a blip in the Dutch economic and financial data during that period of political uncertainty

In Germany it has been more than four months since inconclusive elections were held and Europe's biggest economy is still weeks away from a coalition deal. Its caretaker government is led by a much diminished Angela Merkel and the finance ministry is presided over by a mere stand-in following the departure before Christmas of Wolfgang Schauble, up to then the longest-serving finance minister in Europe.

What effect has all this had on Europe's powerhouse? Very little, according to economic data. The German economy not only continues to power ahead, but business confidence hit a record high in January while consumer confidence is at its highest since early in the last decade.

What about the two biggest political shocks in recent times: Britain's vote for Brexit and the election of Donald Trump?

Despite the result amounting to one of the biggest upsets in the history of democracy and despite, let's just say Trump's unusualness, his victory did not cause economic agents to stop spending and investing. Nor has all that has happened since inauguration day a year ago negatively affected the US economy.

An incoherent policy agenda, the constant change of personnel within the administration, megaphone diplomacy and the undermining of international trade relations could in the past have been expected to cause a recession. But the combination of these things in the Trump administration has done nothing to dent strong growth in the US economy. Despite the worst happening politically, the US economy has gone from strength to strength.

Brexit has turned British politics upside down and raised enormous uncertainty about the UK's relations with Europe and the rest of the world. Unlike all the other instances discussed above, it has had an economic impact. But it has been less serious than most economists anticipated, and that has been the case despite the scarcely believable breakdown in government cohesion and effectiveness since the vote.

The first thing that should be said about the economic impact is that it has been small and could already be waning, at least until Brexit actually happens. Last Friday, new figures showed that British GDP strengthened in the second half of last year, expanding by 0.5pc in the final quarter. That is in line with the long run rate of growth. It was also revealed last week that the numbers employed in the UK have just reached their highest level ever recorded.

Perhaps most notable about the mild slowdown Britain has experienced since the Brexit vote is that it has come via financial markets, rather than as a result of corporate and consumer behaviour (the Brexit-related fall in sterling caused inflation, which in turn eroded real incomes. That led to a weakening in aggregate demand).

Despite Brexit bringing huge uncertainty for many businesses, in particular for those trading with the EU, levels of corporate spending on new capacity have risen since the vote. This goes against all conventional wisdom. It is a mantra among economic forecasters that uncertainty is the enemy of investment. That has not been the case in Britain since the referendum. This is the starkest case anywhere of the breakdown in the link between political uncertainty and economic outcomes.

So, if politics in the developed world is having less impact on economics than feared, what about the role of economics on politics? The conventional wisdom is that "it's the economy, stupid". It is, frankly, stupid to persist with this claim given the weight of evidence.

Here in Ireland there was a widely held view among those in politics and commentary that voters would return to the Fine Gael-Labour coalition in 2016, as they would not want to put the recovery at risk (the slogan "keep the recovery going" was not derided when it was first rolled out, only after it had failed). This is also exactly what happened in elections in Portugal and Spain, two other crisis countries that were in recovery around the same time.

While governments usually do get punished when they preside over bad economic times, they often do not get rewarded in boom times. Politics is no longer just about getting economic management right, if it ever was.

Nor does the evidence support the view that economics is the main explanation for the rise of populist parties, as is so frequently claimed. Both the Brexit vote, the election of Trump and other elections in which the extremes have gained ground are often attributed to economic weakness in general and, more specifically, to swathes of people being "left behind" by economic change. There are lots of problems with this argument.

First, while there is evidence to support the "left behind" thesis in the US, there is much less in Europe. And even where there is evidence that more people are losing out economically, the numbers involved are much smaller than the numbers that have given their support to the political extremes.

Second, there are examples of populists gaining ground even in the best performing economies.

Australia is the star performer of the developed world. It has not had a recession in more than a quarter of century and has recorded only a very modest increase in income inequality. Yet it has seen a rise in populism.

Poland is another example. It has been the best performing economy in Europe over the past decade, yet its arch-conservative governing party is one of the continent's best supported.

Yet another weakness in the argument that politics is driven by economics and inequality is that those who are less well off are actually moving away from pro-redistribution parties. Most of the hard right parties in the western world don't advocate a more generous welfare state. Despite this, they have made much bigger gains than the hard left, and they have mostly made those gains at the expense of the centre left.

There is no doubt that economics has a considerable impact on political outcomes. It could be that there is too much complacency about big political changes and that it is only a matter of time before Trump, Brexit and weak governments bring about slower economic growth. But perhaps not. The world is a messy place. As the interaction between politics and economics becomes more complicated, it appears to be getting messier.

Sunday Independent

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