Populist anti-globalization: A rising global symptom
April 10, 2017
“We are for local, against global!” These were the words of Marine Le Pen, a populist and leading candidate for the presidency in France, speaking to her supporters at a February rally1. It’s a common theme among today’s populists. As the drumbeat of populism continues around the developed world, investors are debating the potential economic fallout from this political upheaval. Is the future of the European Union (EU) at risk? Are trade wars looming, driven by the very countries that modeled and advocated for free trade only months ago? Do we face limited volatility, or a more serious upending of political and economic structures?
These questions point to a theme. In a number of ways, a backlash against globalization — in areas like trade, labor, and views on immigration — seems to be helping to fuel a rise in populism. Despite the alarming aspects, our view is that the worst-case scenarios for capital markets remain unlikely, in large part because the current populist trends are more of a symptom than a cause — a symptom of structural imbalances aggravated by globalization and steamed in a pressure cooker of low growth and high debt. Without structural reform, however, these problems could persist far longer than any populist politician.
Here, we take a closer look at these underlying imbalances and potential solutions, and offer our take on possible outcomes and implications for investors.
Anti-globalization trends threatening the status quo
When we consider the political upsets across the developed world — Brexit in the United Kingdom, the election of Donald Trump as US president, and the rise of Marine Le Pen and other nationalist European politicians — the patterns seem clear. All are categorically populist, building followings around the worries of “everyman.” All modeled underdog polls that surprised many, and they tend to display nationalist tendencies, such as President Trump’s message of “America first.”
But of these three commonalities, it’s really only the nationalist — that is, anti-globalization — tendencies that threaten the status quo. In the United States, it’s the anti-trade, anti-outsourcing, and anti-immigrant rhetoric. In the UK, while anti-immigration sentiment contributed to Brexit, particularly in the views about immigrant EU workers, there has been a definite anti-EU element. Across continental Europe, where strains from war refugees layer on top of other issues, there tends to be anti-immigrant feeling.
A convergence of trends
We argue that the current populism is symptomatic of two long-standing trends that seem to be converging with more recent forces, such as low gross domestic product (GDP) growth globally and high debt, which have developed since the global financial crisis.
One of the two more established tracks is globalization, an ever-deepening, cross-border exchange of capital, labor, goods, and services. For much of the postwar era, the world generally has viewed globalization as a given — and as a good thing because of the more efficient economies, cross-border financings, and other benefits facilitated by globalization. Arguably, globalization has further developed from an increased reliance on central banks and monetary policy to help stimulate fragile growth, an effort largely coordinated across borders over the past decade.
Structural imbalances — inefficiencies in economies that don’t work themselves out in market activity — are the other long-running development, deeply connected to globalization. In a world where capital, labor, goods, and services can move easily to the most attractive opportunities, structural gaps become more pronounced. Anti-globalization can be viewed as one reaction to these structural imbalances. In part, this is because globalization is seen as not helping (and perhaps hindering) efforts to resolve the imbalances.
From rhetoric to resentment, an anti-globalization sentiment is simmering
Anti-globalization thought can be seen, for instance, in the anti-trade, anti-outsourcing rhetoric in the US. As low-skilled jobs have moved to better cost regions, it’s created a rift because of the large number of unskilled laborers without sufficient opportunity. This has become a structural imbalance. Shutting the borders to trade, offshore jobs, or immigrants, however, is unlikely to correct either the uncompetitive cost to produce goods, train idle workers in new skills, or attract the employers to hire them. The effects of this kind of protectionist tilt, which could also eventually affect the US economy and markets, range from increasing inflation risk to potentially slowing further growth.
A similar storyline underlies all of the anti-global trends. In the UK, citizens aren’t particularly anti-trade. But they don’t like EU immigrant workers using state-sponsored benefits, a part of their economic structure that the immigrants’ home countries don’t necessarily offer. In France and Spain, anti-competitive labor laws prevent the employment market from shifting as quickly as EU neighbors, leading to persistent unemployment.
The euro, another globalization tool, creates its own magic to exacerbate structural imbalances by pegging different economies to the same currency. In Germany, the finance minister has complained in recent years that ultralow interest rates set by the European Central Bank (ECB) are a threat to German savers as their country’s inflation heats up. Perhaps this is a justified complaint given the weakness of some other EU economies. And so we see an assortment of home-based structural problems that appear linked in some fashion by globalization.
Fiscal tensions bring issues to breaking point
These two long-term issues — a world moving toward globalization and the related pileup of structural imbalances within borders — face even more stress in an environment of low growth. Indeed, since the global financial crisis, all developed nations have been facing lower long-term growth rates than in previous expansion cycles (see charts below). During the recovery period between 2000 and 2007, global GDP growth posted an average annual gain of 4.38%. The global economy cooled in the subsequent expansionary period — between 2008 and 2016 — achieving an average annual expansion of only 3.08% (data: Organization for Economic Cooperation and Development (OECD)).
Lower growth essentially creates a smaller pie to split among the same number of constituents. When resources are scarce, conflict can emerge.
Data: OECD. Annual observations.
The global debt supercycle only amplifies the smaller-pie problem. The cycle, which we can see in the aggregate level of global debt versus GDP, has been trending up since the early 2000s and only accelerated after the financial crisis in the era of bailouts and extreme monetary easing (the charts below show two country-level examples of the growing appetite for debt). Ultralow rates have posed little barrier to borrowing. When fiscal resources are strained and also leveraged, the pressure tends to increase. (For more on this topic, read about the debt supercycle.)
Whether private or public, credit has been expanding and is rising fast
Data: Bank for International Settlements, via Federal Reserve Bank of St. Louis. Quarterly observations.
Data: US Office of Management and Budget, via Federal Reserve Bank of St. Louis. Quarterly observations, seasonally adjusted.
The way out, ultimately, is reform
If the developed world were experiencing high growth levels, these problems would downshift in urgency, probably deflating the urge to vote in the outsiders who are promoting change. Higher growth should mean better job opportunities (happier citizens), flush tax revenues (happier politicians), and little danger of insolvency (happier investors).
There is a bright spot in that growth has stabilized and accelerated a bit in the US and even shows promise across the EU (see chart), where it has stagnated significantly in recent years. Economic growth is not only welcome but critical to head off possibilities like a bear equity market and the effect on fixed income yields.
Data: International Monetary Fund.
Yet even GDP improvement may not be enough. While growth can soften the issues, the ultimate way out of the conundrum, in our view, is structural reform. There are examples of countries that have successfully tackled major reforms, such as Iceland and Ireland after the global financial crisis, with both recovering quickly. Germany also successfully reformed its labor laws, but France and Spain, as noted, have much work to do in this realm.
Steps toward anti-globalization may seem to voters like a simple fix, but are unlikely to solve these deep structural imbalances. And as discussed, some anti-globalization moves, like trade tariffs and other forms of protectionism, may only worsen the problems.
Amid such complex problems, our investment track back to how policy changes could affect fundamentals. The following are some global observations:
The current risks to the EU are likely to play out in currency volatility and, if Le Pen continues to gain support, in a widening spread between EU-denominated sovereign yields. While we shouldn’t forget that the EU requires reform, nonetheless the extremely easy monetary policy and weak currency there has resulted in an economic growth turnaround in recent quarters, as discussed above. The ECB has begun the process of reducing its stimulus efforts (with plans to taper bond purchases from 80 billion to 60 billion euros in the second quarter of 2017). As a result, we see the spread between EU and US debt holding some promise for the EU currently.
Amid trade-related protectionism, the greatest risk is home-country inflation — a possibility for the US and already under way in the UK, as import costs rise. We see the greatest effect as an upside risk to US interest rates. Anti-trade, follow-on effects could also slow growth rates, putting the brakes on an optimistic global stock market. An equity bear market is a real possibility, in our view. In this respect, it’s crucial to balance investor portfolios with sufficiently conservative bond positions to buffer against equity downside, as they are intended to do.
Above all, these issues are likely to be reflected in bond market volatility. Even if the EU’s future becomes more stable over the course of 2017, these structural imbalances should remain, and the debt supercycle continues to loom. In such an environment, investors are likely to be rewarded for embracing volatility.
Key populist events, and where they may lead
While these events present challenges, we see the EU ultimately surviving the current climate. Recent elections in the Netherlands offered investors some assurance that the far-right nationalist positions may be losing some support, as Geert Wilders and his nationalist Freedom Party performed more poorly than expected in parliamentary elections. A strong anti-Brexit contingent continues to prevail in the UK, particularly among the younger generation concerned about losing the benefits of an interconnected Europe.
The exception to these trends could be the rise of Le Pen in France. Polls suggest that she will lose in the May 7 election runoff. But in a country facing economic challenges similar to those in the American Midwest, her supporters seem as devoted as those who helped put President Trump into office. Brexit and the US presidential election have taught investors not to rely on polls alone.
In terms of other protectionist trends, like Brexit and the specter of trade wars, we again see a middle ground winning out. Brexit was not an explicitly anti-trade movement, and new trade agreement negotiations are likely to be as open as the UK’s trading partners will allow (and take many years to negotiate). In the US, it remains to be seen how successful President Trump will be with his more populist, anti-globalization initiatives, especially those involving trade.
The Trump administration has already withdrawn from negotiations for the Trans-Pacific Partnership (TPP) trade agreement and continues to push for renegotiations of the North American Free Trade Agreement (NAFTA) with Mexico and Canada. However, trade wars are deeply opposed by many in Congress. As such, we anticipate that American trade relationships are likely to manage to steer clear of all-out trade wars.
1Time magazine. "The Power of LePen," March 16, 2017.
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