Four Certainties About Populist Economics

Michael Spence

Michael Spence, a Nobel laureate in economics, is Professor of Economics at NYU’s Stern School of Business, Distinguished Visiting Fellow at the Council on Foreign Relations, Senior Fellow at the Hoover Institution at Stanford University, Academic Board Chairman of the Asia Global Institute in Hong … read more

MILAN – Successful economic globalization requires reasonably successful growth patterns in individual countries. That dynamic characterized the 30 years or so after World War II: growth rates were relatively high across a wide range of countries; their benefits were broadly shared within countries; and the rise of developing countries reduced global inequality. This period was arguably the heyday of globalization.

Of course, globalization continued through the 1970s and beyond. But the underlying growth patterns changed. Driven by the labor arbitrage embedded in economic globalization and the rise of disruptive digital technologies, advanced economies’ middle-class manufacturing jobs disappeared, their median incomes stagnated, and job and income polarization grew, even as GDP growth remained strong. This new pattern – which persisted through the 1980s and 1990s, and accelerated after 2000 – caused inequality to rise sharply, weakening the foundations of globalization.

Countries’ responses have varied widely. Some have taken steps to reduce inequality, such as redistribution through the tax system, social security and education systems, various kinds of social protection, and support for effective retraining. The potency of such efforts tends to be shaped by cultural norms, the institutional bargaining power of labor, the level of trust between labor and business, and the influence of individual and corporate wealth on politics.

In countries with weaker mitigating forces – particularly the United States and the United Kingdom – disparities of income, wealth, and opportunity became the most extreme. The lack of any substantial policy response, together with the apparent lack of concern from those whose economic bargaining power had increased, incited deep anger among those most affected.

Beyond the distributional issues that many countries face, Japan, parts of Europe, and some developing countries are confronting weak growth and persistently high unemployment. In Europe’s case, these problems are rooted in a system with few escape valves and adjustment mechanisms.

But the fact remains that persistent non-inclusive growth has lately been transforming economies. In such situations, the circuit breaker is political, and often dramatic. Outside of developed democracies, persistent lapses in inclusiveness are nearly always devastating for long-term growth and development, and often lead to violence and civil strife – a tendency that the Growth Report of the Commission on Growth and Development highlighted several years ago.

In functioning democracies, the political drama usually remains confined to elections and referenda – such as the British vote to leave the European Union and the US presidential election, won by the populist outsider Donald Trump. Disaffected voters reject the systems that produced the deficiencies. This is a normal and healthy response. And, absent a tectonic shift in growth dynamics and policies, we may well see more of it in the next few years in Europe – specifically, in France, Italy, and Germany.

It may be too late to persuade voters not to reject the existing systems, but there is still time to build effective alternatives. The potential upside to the tremendous uncertainty that many around the world feel is that we essentially are confronted with a clean slate. With previous presumptions, biases, and taboos having been erased, it may be possible to create something better.

Consider the US. New growth patterns and policies could take many directions, including the rejection of multilateralism, in favor of bilateralism or protectionism; immigration-policy shifts; expanded public investment and fiscal stimulus; regulatory changes; tax reform; or supply-side measures in education, training, and health care. There are risks and potential benefits in all of these areas, and the results will depend on the entire policy package.

While the potential combinations remain bewildering at this stage, a few things are clear. First, when it comes to investment, consumer spending, and employment growth, expectations and confidence matter. Hints that more robust and balanced policy responses are coming have had a noticeably positive effect, though it may be transitory, depending on implementation. The uptick in expectations is reflected in financial markets, though many, including me, believe that current asset valuations are too optimistic.

Second, it seems likely that nominal growth in the US will rise, though the underlying mix of inflation and real growth is yet to be determined. This matters, because it will shape the US Federal Reserve’s response, affecting asset prices in America and beyond.

One possibility is that expanded public and private investment begins to reverse the downward productivity trend, thereby generating real growth. But the return of gridlock in Congress could short-circuit this trend and put a damper on expectations, while growth-constraining secular trends like demographics are not just going to disappear.

A third feature of America’s new growth pattern is likely to be added pressure on large companies to maintain their reputations within the US. Even before his inauguration, Trump was trying to influence companies’ choices about manufacturing locations, including by threatening import tariffs on products manufactured in, say, Mexico. While Trump has made deals to keep some jobs in the US, such as the agreement with Carrier, his more powerful tactic has been to threaten companies’ brand image, including via Twitter.

Some characterize Trump’s efforts – and his Twitter forays, in particular – as more style than substance, unlikely to have any longer-term quantitative impact. They may be right. But, in my view, Trump seems to be sending a deeper message about corporate decision-making. Despite Trump’s own business record – which, his opponents will point out, includes multiple bankruptcies and non-payment of contractors and their workers – it’s possible that he is now trying to change a business and investment culture that elevates the interests of capital, corporations, and shareholders, and treats labor as expendable.

The fourth trend we can count on is the continued march of digital technology. That, however, is where the certainty ends: the Trump administration has so far offered few, if any, signals about how it will approach the issue of supporting adaptation by the workforce.

In the next few months, we will learn more about whether the recent uptick in economic optimism is robust; whether Trump’s efforts to fight offshoring and boost growth and employment have a long-term impact; and whether protectionism prevails. Only then can we determine whether Trump really was the right economic choice for America’s disaffected workers.