Populism is in the ascendancy in today’s political environment. Loosely defined as any ideology that separates ‘the people’ from a ‘corrupt elite’, populism has existed in various forms over the last century. While it’s often believed to be the preserve of the right, parties on both sides of the political aisle espouse populist platforms under the guise of being ‘anti-establishment’. On the left, one might find policies advocating for a diminished role of the private sector; on the right, more libertarian moves to reduce government regulation. Regardless, a common theme across the political spectrum is the invocation of an existential crisis (either real or imagined) to justify the need for political unity. Typical policies include income redistribution, public spending increases, a rise in trade barriers and tariffs, tax cuts, restrictions on immigration, and an anti-global rhetoric.
But what about the economic impact? The populist agenda can spur short term growth. Few would argue against an increase in spending on outdated public infrastructure, for example. However, over the long term, populism has the potential to hinder growth, fuel inflation and result in a loss of competitiveness and productivity. An increase in government spending – especially in the form of rising transfers and benefits, combined with tax cuts – can increase budget deficits, the financing of which can crowd out private investment and potentially lead to higher inflation.
Restrictions on migration can hamper worker mobility and have a similarly inflationary impact on wages from a mismatching of labour, skills and demand. Limiting the independence of external agencies, such as a country’s central bank, can also cause inflation as politicians run expansionary policies at the expense of fiscal discipline in order to fuel short-term growth. Excessive taxation on incomes and capital can discourage labour and productivity-enhancing investment. Trade barriers can lead to the suboptimal use of resources under the show of protecting national security interests, when those same resources could be used in more productive capacities.
A primary channel by which populism can affect financial assets is through protectionist policies. Countries that impose restrictions on foreign investment may end up limiting the investor base for global assets, resulting in inefficient price discovery and potentially lower valuations. By deterring foreign investment, protectionism can necessitate a decline in the currency or an increase in yields in order to overcome the increased risk associated with the investment– particularly if foreign investors are uncertain about their ability to dispose of assets at their discretion.
As trade continues to grow, countries such as the US and the UK, which have run trade deficits for decades, should be mindful of their partial dependence on foreign capital for financing consumption. Trade deficits don’t imply a lack of economic health, but rather a dearth of savings versus investment, which must be imported from abroad. Overseas investment – which includes net purchases by foreigners of equities, corporate and government debt, and real estate – plays a significant role in making up for the US and UK’s relative lack of national saving. As the IMF points out in its Finance & Development magazine, “Protectionist policies are unlikely to be of much use in improving the current-account balance because there is no obvious connection between protectionism and savings or investment”.
Foreign direct investment (FDI) is particularly important in supporting a country’s current-account deficit. FDI includes the impact of mergers and acquisitions activity, flows from investment in the form of equity and loans, as well as reinvested income, and is an important source of financing capital. As with trade, FDI also stimulates competition and investment in new, more productive technologies. A UK study by the Office for National Statistics showed that firms with inward FDI were 74% more productive than non-FDI firms, although they acknowledge the relationship is not necessarily causal.
According to a study by the UK’s Centre for Economic Performance that used bilateral flow data to assess how FDI was impacted when countries joined the European Union (EU), membership was found to increase FDI by between 14% to 38% depending on the statistical method used. In contrast, no gains were found for membership in groups such as the European Free Trade Association. With 43% of the UK’s estimated £1.3 trillion stock of FDI having come from other EU members in 2017, a reduction in FDI from the EU could prove problematic.
Similarly, the current protectionist trade war between the US and China could imperil FDI flows between the two countries. China’s stock of FDI in the US is low (1% at the end of 2017) but it has been growing: it totalled $5.1 billion in 2015, rose to $25.5 billion in 2016 before becoming negative (a net disinvestment) to the tune of $500 million in 2017.
The US and UK already have some of the more restrictive policies towards FDI among Organisation for Economic Co-operation and Development (OECD) members. While the absolute level of restrictiveness is still low in both countries, the OECD has found evidence that in Brazil, Korea, Vietnam and the Philippines – countries with previously high levels – there’s been a clear correlation between improved regulatory reforms and greater FDI inflows. One cannot ignore the possibility that an even greater level of restrictiveness under the guise of protecting national interest could lead to a reduction in FDI.
While much of inward FDI in the US and UK is focused in financial services, commercial real estate assets have been a growing area of investment. Even so, after peaking in 2015, net acquisitions of UK commercial real estate by cross-border investors have declined for the past three years, even as cross-border activity rose in the US in 2018 (led by the sizeable acquisition of Westfield by Unibail-Rodamco). Slowing global growth (particularly in less open economies) could cause cross-border investment to reduce; already, China’s government has restricted outbound flows through capital controls amid a decline in economic activity, resulting in a year-on-year decline in cross-border capital from Greater China of 60% in 2018.
It’s too soon to tell what long-term consequences a rise in populism will have. Protectionism may raise the return premium demanded by investors as compensation for increased country risk, particularly for less liquid assets such as commercial real estate. To paraphrase a comment from a European Central Bank panel member, there will be no winners under protectionist policies – just different degrees of losers.
