How much do political leaders matter?

After the political turbulence of 2016, political risk now rivals central bank watching as the focus of commentary and analysis.  The Brexit and Trump votes were significant shocks to the system, raising concerns about the emergence of protectionism and populism.  But the consensus narrative has changed over the past few months, with a reassessment of the political risk environment. There has been a collective sense of relief after the electoral results in France, the Netherlands, and elsewhere. These elections were anxiously followed as barometers of the strength of populist sentiment.  But the centre has held in many parts of Continental Europe.  Indeed, in some commentary, Mr Macron has stopped populism in its tracks.

However, some of these political events are being over-interpreted; many of the structural risk factors remain intact. Indeed, I noted last week that the prospect of systemic, market-moving change is increasingly likely – from protectionism to big power politics.  To understand the outlook, it is important to distinguish between structural policy risk and event-driven political risk.  My assessment is that the next decade will be a period of significant policy and institutional change – in a similar way as the challenges of the 1970s led to fundamentally new policy approaches in the 1980s and 1990s. But the public narrative – and market pricing – seems more focused on specific political events.

Indeed, the focus of these narratives reminds me of the ‘great man theory of history’. In this theory, initially popularised by Thomas Carlyle in the 1840s, history is powerfully shaped by visionary leaders – from Alexander the Great to Napoleon; and more recently perhaps to FDR, Stalin and Churchill.  In economic policy, leaders from Margaret Thatcher to Deng Xiaoping and Lee Kuan Yew were instrumental in setting the strategic economic policy direction of their countries.

Contemporary equivalents would be President Trump – with his America First policy – or President Macron’s new reform agenda for France and Europe.  In very different ways, both were remarkable candidates and look set to remake many aspects of economic policy in their countries and beyond.  But neither would have been possible without deep underlying dissatisfaction with the status quo.  And in China, President Xi is a very different leader from his immediate predecessors, changing domestic and foreign policy in marked ways.  But this reflects China’s state of development and its changing position in the world.

Indeed, historical accounts that emphasise longer-term dynamics are widely seen as more persuasive than this ‘great man theory’.  Political leaders crystallise – and to an extent galvanise – political support, but they reflect underlying preferences, pressures and incentives. Human agency still matters, and some electoral choices are clearly consequential – victories for Marine Le Pen or Hillary Clinton would have altered the short-term trajectory, for example.  But the ability of leaders to shape events is conditioned by the context in which they operate; the available policy choices are constrained by the environment.

The shock election results of 2016, and the surge in populism, reflect long-standing pressures that had been building in the system.  The distributional impact of globalisation, the nature of domestic policy choices, and the increasingly rules-based approach to decision-making, eroded the legitimacy of elites and policy approaches.  These forces would have manifested in some way, even without David Cameron’s reckless decision to hold the Brexit referendum or the emergence of Mr Trump.  For example, Mrs Clinton committed to oppose the TPP because of its political unpopularity in the US.  It is clear that there are changes in the public mood on many aspects of the policy orthodoxy, and politicians are reflecting the changing location of the median voter.  Over time, changing voter preferences will lead to a different type of economic policy approach.

Elections are useful as a Bayesian updating tool, providing a sense of the underlying demand for change.  Our priors needed to be updated post-2016, in which the strong demand for a marked policy break became clear.  But neither should we move from one end of the pendulum to the other. For example, although Mr Macron’s victory shows that there are limits to the appeal of populism, the underlying economic and social challenges remain and there is strong political pressure for new approaches to deliver better outcomes (and the National Front won 34% of the Presidential vote).

Rather than a simple focus on assessing event-based political risk based around specific people, it is important to understand policy risk – the likelihood and nature of a shift in the economic policy regime.  These underlying dynamics matter more than the outcomes of specific elections.

It may be that there is less immediate risk of a series of populist victories, but the likelihood of significant policy change remains.  Many large country governments have not managed globalisation as well as they should have.  And they need to respond to emerging challenges, such as the impact of automation.  My expectation is that there is a regime change underway in many aspects of economic policy.  As I have noted before, I expect a greater weighting on national political autonomy and an increased emphasis on policy discretion rather than rules and institutions.

It is these structural policy changes rather than event-based political risk that will have a more consequential impact on economies and markets – and perhaps relatively soon.  Bill Gates once remarked that we consistently over-estimate the pace of innovation over the next two years, and under-estimate it over the next decade. This is true for economic policy as well: I expect significant, disruptive change over the period ahead to respond to emerging challenges and opportunities.

Political events contain informational content, but they need to be interpreted properly.  Rather than simply being a binary struggle between liberal and populist candidates, elections allow for a Bayesian process of updating our assessment of the nature and pace of policy change.  And from Trump and Brexit to Macron, there is clearly an ongoing demand for significant policy change.