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Global macro & geopolitics from a small economy perspective

History doesn’t repeat, but it rhymes

David Skilling
23 April 2017

France goes to the polls today in what is seen as another test of populist sentiment after the Brexit and Trump votes. Although there are deeply idiosyncratic factors in each country, my sense is that there are also structural political dynamics at work across many developed countries. These are not simply a series of rogue election results.

The historical record provides a useful perspective. I am struck by the periodic regime changes in economic policy approaches in developed countries every four decades or so over the past century: in the 1930s/40s and the 1970s/80s (and at a stretch the 1890s). There is nothing particularly scientific about this regularity, but it speaks to the contingency of policy. Policy responds to the specific challenges of the time, but as the context changes these policies become less able to generate satisfactory outcomes. Indeed, policies that solve one set of problems often create new pressures that eventually need to be addressed.

From the 1930s, most notably in the Great Depression, aspects of the prevailing policy orthodoxy became increasingly problematic: for example, the gold standard and the attachment to balanced budgets. Over time, with the assistance of the Keynesian intellectual revolution, the world moved to a new policy consensus that emphasised macroeconomic management to tame the business cycle – the notion that the economy was a self-equilibrating machine was rejected.

The subsequent Keynesian consensus that governed global economic policy thinking from the 1940s supported a process of strong global growth. However, demand management through fiscal and monetary policy combined with domestic political incentives led to imbalances in several large developed countries. And these domestic decisions placed pressure on the supporting international system of fixed exchange rates. As the Keynesian system was converted into an increasingly technical exercise of economic planning, the economic system was pushed beyond its limits. This was evident from the 1960s and into the 1970s, leading to stagflation, high levels of unemployment and macro imbalances, particularly when coupled with external shocks like the Oil Crisis.

Again a process of intellectual activity led to a new approach to economic policy from the 1980s, personified by President Reagan and PM Thatcher. There was a focus on reducing inflation and budget deficits, as well as deregulation, privatisation, and so on. This was a response to the limits of government intervention and a desire to reduce the role of politics in the economy.

This was happening at the same time as a period of intense globalisation was commencing, supercharged by the integration of large emerging markets. The zeitgeist of the time – with the fall of the Berlin Wall, and the apparent triumph of capitalism – supported a market-based view (the Washington Consensus). This generated many benefits: it was the period of the Great Moderation, with stronger growth and lower inflation and budget deficits.

But as previously, the success of a new approach led to over-confidence and to pushing the new model beyond its limits. For example, constraints on finance were removed, there was a shift over time towards ‘hyper-globalisation’, and too little attention was paid to issues of income distribution. And the (reasonable) views on the risks of government intervention in the economy were over-interpreted, leading to policy passivity. Over the course of a couple of decades, these pressures and challenges have contributed to the current political moment.

Indeed, many of the current policy debates are reminiscent of the writing that appeared from the late 1990s on the risks associated with globalisation and technological change. As just a few examples, Anthony Giddens, academic and Blair advisor, on the ‘runaway world’; Dani Rodrik on the stresses associated with hyper-globalisation, and the need to manage the globalisation trilemma; and Raghuram Rajan, who warned of a looming financial crisis at the Jackson Hole meetings in 2005 and the surge in household debt to compensate for stagnant wage growth.

So these pressures have been well understood for some time. Although some countries have taken these warnings seriously, notably in small economies, there has not been a concerted policy response. Even after the global financial crisis – when there was a burst of writing on new models of inclusive capitalism and a ‘New New Deal’ – there was little change. Instead there was a doubling down on the traditional playbook of (some) fiscal stimulus and very accommodating monetary policy. This provided some support to the recovery process, but did not address the structural challenges – such as income inequality.

The past 12 months has seen a marked change in the political mood (Brexit, Trump, the rise of populist candidates in Europe, and so on). Several of these results has come as a shock, but this longer term perspective suggests that perhaps we should not be surprised. The political events of the past 12 months were a response to the accumulation of stress in the system over the past few decades. It is better to see this as reflecting a paradigm shift in the Thomas Kuhn sense, where the prevailing policy ideas are no longer adequate to the challenges.

Over the next several years, meaningful change in key aspects of the global economic policy consensus is likely. New policy solutions will need to be found to address current challenges. The priorities are less high inflation and distorted domestic economies, as in the 1980s, as much as income inequality, employment and productivity. This may be a messy process. There is significant uncertainty as to what a new policy consensus will look like, and it is likely that there will be some poorly calibrated policy responses (such as protectionism).

The exposure of countries and markets is not simply to ‘populism’ or to specific election results, but to structural changes in a wide range of economic policy areas. After a period of relative policy stability, at least outside of central banks, the potential for policy regime change has increased sharply. As in previous periods of transition, the economic policy orthodoxy may turn out to be quite fluid.

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