July 13, 2020
The Perils of Economic Populism, by Beatrice Magistro & Victor Menaldo
Argentina has cycled between populist democracies and military dictatorships over its modern history. This has catalyzed countless economic crises and catastrophes. The same is true of other Latin American countries. By contrast, Europe’s liberal democracies and the US have largely avoided this predicament, at least since World War II. That is, until now: Their political-economic equilibrium seems to have unraveled since the 2008 Global Financial Crisis; with citizens increasingly questioning the legitimacy of incumbent institutions, including the media and higher education, researchers fear liberal democracy itself is under threat (e.g., Albertus and Menaldo 2018; Levitsky and Ziblatt 2018).
What is the relationship between crises and populism? What explains why some countries have avoided the economic perils associated with populism that have visited Spain, Argentina, Chile, Greece, and Italy? Why have contemporary politicians and publics flirted with populism in Great Britain, India, Poland, Hungary, and the United States despite its poor economic track record? Given the economic collapse engendered by the Covid-19 pandemic, what might be in store for populism and liberal democracy?
In a working paper entitled “The Perlis of Populism,” Beatrice Magistro and Victor Menaldo address these questions. They define populism as the idea that the time-honored institutions that undergird liberal democracy and welfare state capitalism, and the experts who help them function, should be ignored in favor of the so-called will of the people, usually represented by a charismatic leader. The opposite is pluralism, which sees the opposing interests and opinions of the people as a strength, favors diversity, and espouses the view that politics is about compromise.
While the institutions that populists rail against vary from place to place, populism almost always threatens both liberal democracy and welfare state capitalism. It also threatens the legitimacy and independence of the professional bureaucrats, scientists, economists, and diplomats who run and regulate the modern state and regulatory apparatus that make this system work. The protectionism and mercantilism that accompanies populism also weakens the fabric of liberal democracy and welfare state capitalism in more subtle ways.
This has important normative and policy implications. The marriage of these two institutions explains why millions upon millions of people are more prosperous and secure than ever before (McCloskey 2016). Liberal democracies are more likely to foster industrial capitalism: to provide public goods that reduce transaction costs and promote arm’s length exchange, deep and sophisticated capital markets, and Schumpeterian creative destruction: the churn of ideas, firms, and industries that drive economic dynamism (North, Wallis and Weingast 2009). They also adopt policies that reduce risks associated with market exchange (Albertus and Menaldo 2018).
The checkered development history of populism should therefore give us pause. Whether they are governed by politicians on the left or the right, these political experiments share one thing in common: they usher in economic collapse. Populists spend too much too quickly, expropriate property from the wealthy, corporations and banks, and engage in trade protectionism and mercantilism. The upshot is economic volatility and stagnation induced by chronic balance of payments problems, sovereign debt defaults, financial crises, and hyperinflation. The ultimate result is a reactionary countermovement expressed in either a coup or internecine violence and rampant political instability. Today, Turkey and Venezuela tell a similar story.
Conversely, liberal democracy and welfare state capitalism have worked together, at least since the end of World War II, to promote political stability. Indeed, in Latin America populism has unfailingly led to economic and political crises. What is particularly troubling about today’s populist reincarnation is that demagogues have exploited preexisting crises and rode waves of uncertainty, fear, and dissatisfaction with the status quo to office. They have then fomented further chaos once in power. Hungary’s Viktor Orbán is a prime example, but there are others.
In their working paper, Magistro and Menaldo explain the troubled economic and political history of populism. They account for the logic of economic populism and the fact that populists representing either the left or the right tend to converge on a similar political economic model based on protectionism, crony capitalism, and inveterate rent seeking. They provide a framework to make sense of this pattern and explain the systematic association between economic crises and populism. They proffer both historical and contemporary examples to adduce support for our view that include not only Argentina but also Chile, Spain, Greece, and Italy. They also play Cassandras, and forecast what the future might look like if populism continues its current ascendance.
Besides exploring several historical and contemporary examples of populism and establishing a systematic link between economic populism and crises, Magistro and Menaldo make a few additional contributions. First, they submit that, rather than seeing most economic interactions as “win-win” situations, which is the traditional economic perspective (namely, that there are always mutual gains from voluntary exchange), populists are obsessed with the idea that market exchanges are invariably characterized by “win-lose” situations. Moreover, populists are wont to stigmatize an outgroup: a convenient scapegoat blamed by them for the losses. Populists also eschew some of the other key tenets of economic thinking, such as weighing tradeoffs and future consequences. Finally, and ironically, the economic policies that populists pursue, whether they emanate from the left or the right, are equally tragic and invariably end up harming the groups they claim to champion. For example, in Latin America these movements have claimed to help the poor and ended up doing the exact opposite. Argentina and Venezuela are archetypical examples.
Magistro and Menaldo also speak to current events in light of the Covid-19 pandemic. As economic activity has plummeted everywhere in the wake of the spread—and attempted containment by governments—of the Covid-19 pandemic, unemployment has skyrocketed. The length and depth of the current economic decline remains a source of great uncertainty; it may ultimately depend on whether Covid-19 will continue to represent a public health threat (OECD 2020). According to the IMF World Economic Outlook 2020, the EU’s economy is expected to shrink by 7.5 percent in 2020, with Greece and Italy expected to be the worst affected countries (seeing respective declines in GDP of 10 and 9.1 percent). That source also projects that the US economy will shrink by 5.9 percent.
In the most optimistic scenario, in which the pandemic’s threat to public health recedes in the second half of 2020 and governments gradually lift restrictions, the US and EU economies are projected to grow by 4.7 percent in 2021, in a V-shaped fashion. However, there is great uncertainty over whether the most optimistic scenario will indeed materialize and during July of 2020 Covid-19 outbreaks significantly worsened in many US states, including in California, Texas, and Florida (Partlow and Miroff 2020).
If these current trends continue and the virus crests as a “second wave” in the fall, the likely economic fallout is projected to be much worse: the recovery will look more like a U or an L (Derby 2020). The upshot could be another huge increase in joblessness as lockdowns and quarantines follow new Covid-19 surges (OECD 2020). Indeed, early signs are that a nascent economic recovery in the US is under threat in the wake of an economic pullback induced by increasing Covid-19 infections (Tankersley and Casselman 2020).
The biggest sources of future damage are likely to be human made, however. In the wake of the pandemic, populism and its attendant crises may become self-reinforcing: the ongoing economic crisis associated with Covid-19 might fuel more populism and populism, in turn, may make the economic situation worse, as well as stoke political crises.
When Covid-19 hit, the EU had just emerged from the worst economic crisis in the bloc’s history, as well as a refugee crisis of epic proportions, and the United Kingdom’s secession. Unexpectedly, 400 million people were forced into lockdowns and almost 180,000 people died. The result? European politicians began to attack each other with ferocity and turned inward, rather than cooperating (the Economist 2020). To speed up the EU recovery, a group of countries led by Spain suggested a grant of about euros 1.5trn, which would be funded by debt backed collectively by the EU as a whole. However, this plan was opposed by small northern countries from the get go since this recovery fund would mostly help collapsing southern European economies (the Economist 2020). On May 27th 2020, the European Commission issued its proposal for a recovery fund of about 750 billion Euros, mostly made up of grants, rather than loans, and a revised long-term EU budget of €1.100 billion for 2021-2027.
The recovery fund (“Next Generation EU”) involves raising funds through bonds guaranteed by the EU budget and distributing them as grants and loans, conditional on whether expenditures are aligned with EU priorities (Leigh 2020). The EU and its member states have been debating over how to allocate the recovery package, which currently includes both an insurance feature, where countries hit harder get more EU funds, and a redistributive feature, where countries with lower per capita incomes receive more EU funds (Darvas 2020). The current plan is supported by Europe’s four biggest economies, Germany, France, Italy and Spain, but not by the “frugal four”: The Netherlands, Austria, Sweden and Denmark (Leigh 2020).
This raises the question of whether the EU will survive Covid-19 or if, instead, more exits like Britain’s will be triggered by the pandemic’s continuing economic and political fallout. The burden of this latest crisis will, as it did in the wake of the Eurozone crisis of 2009, once again fall heaviest on the peripheral countries. While this may provide more impetus for a fiscal union and deeper integration, it may also fuel the ongoing backlash against the distributional consequences of a stronger political and fiscal union. The jury is still out on this question. However, recent history suggests that Europe will continue to be ripped asunder by the basic economic and political imbalances between northern and southern countries; these divides may, in turn, be magnified by populists and used to fuel campaigns of resentment, revanchism, and scapegoating in both blocs.
Italy is in perhaps the most precarious position. It was not only the European country that was hardest hit by the pandemic in terms of deaths from the virus, but its economy suffered a devastating blow. Although growth had just started to pick up slightly when Covid-19 hit, Italy’s GDP is slated to experience a 9.5 percent contraction in 2020 according to EU forecasts. This may put further strain on Italian government debt as budget balances will likely deteriorate further in light of the pandemic induced downturn, leading to lower tax revenues and higher unemployment benefit payments. In order to afford its generous safety net and produce enough jobs for Italy’s youth the country needs growth, a difficult task in light of the fact that its productivity effectively flatlined twenty years ago. Where this growth will come from is unclear.
What is not in doubt, however, is that the EU, rooted in the tenets of liberal democracy and welfare state capitalism, has delivered more than half a century of peace, stability and prosperity, raising living standards for over 300 million people. The Eurozone and refugee crises, and the economic and cultural struggles that ensued, fueled a populist upsurge in Europe; the ultimate scope of the Covid-19 crisis, and the individual response of member states, whether cooperative or unilateral, will determine the future of the EU, with consequences for prosperity, liberty, and stability.
The situation in the United States is unlikely to be much different. In a context where deglobalization, inequality, and populism were already on the rise, the ongoing economic crisis and spike in unemployment that has accompanied it may make the situation much worse. Anti-globalization feelings may increase further as restrictions on travel and cross-border investment continue apace. Populists are likely to take advantage of rising fears over legitimate national security concerns. They make seek to renationalize and on-shore industries that produce “essential goods” such as antibiotics, masks, and ventilators—and are unlikely to stop just there.
Whether Donald Trump wins or loses the US Presidential Election in November 2020 is also likely to affect the direction that the US will take. It is unclear if, were he to lose, the GOP will suffer an existential crisis and decide to change direction, away from its current nationalist, nativist, and populist drift. Maybe there is no going back to liberal internationalism, globalization, and free markets; the American electorate has changed, both demographically and ideologically, perhaps circumscribing its ability to maneuver politically. The road the Republicans take will likely also depend on what Joe Biden does if he is elected president; specifically, whether his policies will be centrist or more left-leaning (Brownstein 2020).
Furthermore, in addition to all the uncertainty surrounding the pandemic and its political consequences, another financial crash might be around the corner. The reforms passed in the aftermath of the 2008 financial crisis, although well intentioned, have not kept banks from falling back into old habits: while cheap mortgages fueled economic growth in the 2000s, easy and risky corporate debt issued at high levels of leverage has been juicing the US economy over the past ten years. Loan defaults are already on the rise in the wake of the Covid-19 crisis — and it may only get worse in the next few months.
But if banks were to find themselves on the edge of the precipice once again, facing the possibility of going insolvent and taking the global economy down with them, this time around the political response may be much different than in 2008. Both populists on the left and right have been highly critical of handouts to big banks and bailouts in general. It is also unclear if the US Federal Reserve can continue to keep its foot on the liquidity and stimulus gas pedal, which it has done since March of this year in response to Covid-19, without triggering an adverse reaction in the sovereign bond markets and stoking high levels of inflation. This would in turn fuel higher interest rates, making it more difficult for an economic recovery to take hold.
Finally, there is the effect of potential future populism in Europe and the US on the world. If deglobalization accelerates beyond essential medical supplies to include ordinary industries and the nationalization and vertical integration of supply chains, this is likely to have devastating consequences on the standard of living in developing countries. It basically risks putting hundreds of millions of people back into poverty (Rogoff 2020).
Are Europe and the United States dangerously close to the path taken by Argentina under populist governments in the post-World War II era? Is rampant crony capitalism and protectionism masquerading as industrial policy around the corner? What about serial balance of payments crises, sovereign debt defaults, and stagflation?
Populism preceded the Covid-19 nightmare and polarization; inequality, and a breakdown in the norms of liberal democracy in the context of an economic depression and unemployment crisis may accelerate the march to dysfunctional and less accountable governments across the west. Plus, the payoffs to demagoguery are higher when the tradeoffs are costly and the solutions to problems complicated. It goes without saying that Covid-19 has increased those costs and complications to the nth degree.
For works cited click here
