Investment Views Hero

Populist revolution or protest vote?

03 Nov 2016

Chris Darbyshire, Chief Investment Officer

Conventional politics is dead. Brexit and Donald Trump are not the only examples of the growing desire among voters to try something radically different. Their actions are thought to express economic and political disadvantage arising from under-representation in national governments and the delegation of sovereignty to supranational organisations. How deep does this undercurrent run, and how concerned should investors be?

Conventional politics is dead. Brexit, Donald Trump, ‘Feel the Bern’ Sanders, Italy’s Five Star Movement (founded by a stand-up comedian), Alternative für Deutschland, Austria’s Freedom Party – all are examples of the growing desire among voters to try something radically different. Their actions are thought to express economic and political disadvantage arising from under-representation in national governments and the delegation of sovereignty to supranational organisations. How deep does this undercurrent run, and how concerned should investors be?

As one such supranational organisation, the European Union (EU) is commonly agreed to lack democratic legitimacy. Upon joining the EU, many legislative powers are transferred from national governments to the European Parliament and the Council of Ministers. Meanwhile, voter turnout for European Parliament elections is low and falling. European institutions lack the ability to engage the people on whose behalf they function.

But it’s not just the EU that suffers a democratic deficit. In our own general election, UKIP received 3.9mn votes and won one seat in Parliament. The Scottish National Party, by comparison, received 1.5mn votes, yet won 56 seats. Despite living in a democracy, in spite of our ‘one-man, one-vote’ system, a party that won less than half the votes of its rival was able to win 56 times as much representation.

This anomaly was corrected, with a vengeance, in the subsequent EU referendum. That there is a gulf between the outcomes of ‘direct’ democracy and ‘representative’ democracy should not surprise us. Most developed societies consciously avoid the former in favour of the latter. The significance of the EU referendum is in its indication of the direction of travel. Not surprisingly, voters are keen to preserve their own culture and restrict immigration - if you had offered the British electorate the chance to curtail immigration any time over the last 50 years, they would probably have taken it. More worrying for investors is the implied protest against globalisation.

This protest is explicit in the US presidential election where Trump attacks China for "cheating" on trade, promises to rejuvenate rust-belt industries in America and to secure more jobs for American workers at the expense of Chinese workers. Despite winning the Republican nomination, Trump is not a conventional Republican. Neither was the second-placed candidate in the Republican nominations – Senator Ted Cruz, having been instrumental in closing down the government in 2013. If elected, Cruz planned to shut down whole swathes of government infrastructure, including the Department of Energy, the Department of Education and the Internal Revenue Service. Nor was Bernie Sanders a conventional Democrat: he was a long-serving Independent Senator who only joined the Democratic Party in order to contest the primaries. He has since resigned to become an Independent again! Three of the semi-finalists running for the Presidency, therefore, were expressions of populist discontent. Despite living in a democracy, in spite of our ‘one-man, one-vote’ system, a party that won less than half the votes of its rival was able to win 56 times as much representation.

In threatening to reject conventional politics, the US electorate has merely emulated some of its politicians. The electorate sees a government that is almost unfit to govern: Democrats and Republicans, driven by ideology rather than the national good, unable to agree policies; Tea Party Republicans undermining other Republicans; incumbents in gerrymandered districts lobbing grenades from the sidelines; legislators now too scared to vote for anything that might encourage a challenge from the extremes of their own party.

Obama promised change, but could not deliver due to a divided and increasingly fractious government. Trump, Cruz and Sanders promised ‘revolution’. Do they represent protest votes that can be absorbed by existing political systems, or are we on the verge of a revolution in the way US politics operates? Will we ever see another Presidential candidate from the political establishment, or will there now be a stream of would-be Presidents from television, Hollywood, YouTube or the music industry that are crowd-financed and supported by election campaigns on Twitter?

Some mainstream politicians have been quick to shift their positions to accommodate the populist movement. Their response has several themes: less immigration to please the populist right, less globalisation to appease the populist left and, given neither of these policy shifts has any economic credibility, more government spending to offset any slowdown in economic growth. Thus Theresa May’s conference speech contained some novel ideas for a Tory Prime Minister: actions to undermine the employment of foreign workers, reform of corporate governance in favour of workers over management, an expansion of government spending, plus some meddling in markets. Trump goes one step further in actively discouraging free trade.

There is a distinct left-leaning bias to these policies. The populist monster might have been unleashed by the Republicans in the US and UKIP in the UK, but its final destination will be a shift to the left in government policy. How so? Because the swing voter in each case is both against immigration and globalisation. Brexit revealed this discontent, with the real surprise on the day of the referendum coming not from Tory voters in the shires wanting less immigration, but from the blue-collar Labour heartlands. In the same way, Trump attracts blue-collar workers from the traditionally left-leaning ‘Rustbelt’ states, where the explicit promise of protection from free trade sells.

Blue-collar workers, in essence, feel threatened by economic and cultural change. And so they should. The Polish immigrant is just one very visible sign of their competition. The Chinese worker is less visible, but has done more to change our society over the last two decades. The real competition, however, is technology, and this is a battle that blue-collar workers cannot win. Curtailing cheap immigrant workers will simply accelerate the move to even cheaper technologies. One of the main defences against the ravages of competition is to accept it: harness the benefits of cheaper goods for the population as a whole while retraining and re-educating manual workers for roles in service industries that are less exposed to competition. This is a slow process, however, measured in generations rather than years. Meanwhile, the ultimate benefits are lost on those whose livelihoods are threatened or damaged.

Moreover, as technological change gathers pace, imperilling white-collar as well as blue-collar workers, it has become clear that an increasing share of the population will simply be unable to compete for jobs. The state will have to provide for them, increasing the tax burden on those more fortunate. By shifting leftwards in anticipation, our democratic societies are acting out of self-preservation – turning a potential populist revolution into a protest vote. This is normal: when democracies are threatened (via the political process), the economic pie is eventually redistributed to stave off that threat.

All of this will take time to develop. However, a more immediate impact will be felt in government bond markets. Unlike companies, bonds cannot adapt to a radically different environment except through their prices. Central bankers have been able to preserve an eerie calm, devaluing the currency by printing trillions of it, but using that cash to ramp up bond prices and repress interest rates. Not being beholden to anyone, government can devalue this asset class far more effectively. Moreover, the timing of populism is almost perfectly awful, coming just as central banks are beginning to reconsider the benefits of ultra-low interest rates. Without central banks keeping interest rates and bond yields low, increased government spending is likely to hurt government bond prices. Given bond prices are at all-time highs, I doubt capital markets will wait around for governments to act. Bonds will sell off on the mere whiff of populist policies. Bonds still have some value in portfolios as risk-mitigants, but the day is drawing closer when they will become the main source of portfolio risk. We continue to avoid them.
When democracies are threatened, the economic pie is eventually redistributed to stave off that threat.

Unfortunately, a side-effect of less globalisation is lower growth. This occurs via the protection of uncompetitive industries and a reduction in global trade, leading to slower improvements in living standards at an aggregate level. The relatively sudden rise of populism has stranded two of the world’s largest ever trade deals: the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership. Despite negotiations being at advanced stages, neither now has sufficient political support in key countries. This will please the anti-globalists, of course, who see free trade agreements as being more for the benefit of multinational corporations than the average citizen. Professional investors will not agree. They will mark down their growth expectations for the countries and industries most affected.

Stockmarkets are not immune, therefore. But the impact on companies is relatively hard to define, being mixed with many other factors affecting company profits. Some companies would benefit from increased government spending. Stockmarket investors will be nervous, but are unlikely to panic. They will wait and see how this latest threat plays out.

Chris Darbyshire
Chief Investment Officer

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