It's just getting started
You can subscribe to receive these notes by email here
Five years on from the political earthquakes of 2016 in the UK (Brexit) and the US (Trump), the longer-term impacts are becoming clearer.
The UK trade data for January (the first formal month of Brexit) were out last week, with some awful numbers. Relative to January 2020, UK exports of goods to the EU were down by 38% compared to an 8% contraction in UK exports to the rest of the world.
This is not just a function of dampened demand due to Covid-19 but suggests a rotation away from the EU market – most likely due to the impact of Brexit. Imports from the EU into the UK were also down more sharply (-16%) than non-EU imports (-9%).
Some of this relates to short-term problems, but there are structural forces at work. And ongoing tensions between the EU and the UK suggest that things will stay bad for some time.
In the US, things are different in the post-Trump era. There is a marked change in tone under the Biden Administration; a massive stimulus package has been legislated; and offshore, ‘the US is back’ (re-joining the Paris Agreement, the WTO, and the WHO).
But the US is not returning to its pre-2016 days; there is little appetite for broad trade agreements, for example. And we shouldn’t underestimate the structural damage that Mr Trump has done to the political system in the US (see Anarchy in the USA).
Rules v discretion
However, the political significance of 2016 extends beyond Brexit and Trump, and signals an underlying change in the political zeitgeist.
One way of understanding 2016 was as a reflection of frustration with rules-based approaches to economic policy. A small majority of the UK voted to ‘take back control’, and Mr Trump was elected on a ‘Make America Great Again’ platform. The common underlying idea was that institutional constraints (the EU, trade agreements, multilateral institutions) needed to be removed in order to deliver national prosperity.
Regime change from policy rules to discretion (and back) is a recurring theme in political economy, as I discussed in a 2017 note.
The post-war (Keynesian) consensus was heavy on government policy discretion. But after the outcomes of the 1970s, a shift towards policy decision-making constrained by (Hayekian) rules was implemented – from macro policy to increasingly far-reaching international trade and investment agreements. Small economies, from Sweden to New Zealand, led the charge on this policy innovation.
This bargain – a transfer of decision-making from politicians to central banks, finance ministries, trade ministries, as well as international institutions like the WTO – was politically sustainable while it delivered good outcomes.
But several of these rules no longer seems to represent a stable political consensus. Among other things, there have been political concerns that fiscal policy was too tight after the global financial crisis; that migration flows were a technocratic rather than a political decision; and that international trade agreements were not serving the national interest. The Brexit and Trump votes reflected a desire to take back direct political control over big economic policy decisions.
Ideas matter
Five years on from 2016, these ideas remain - and are underpinning a broader regime change in economic policy.
In fiscal policy, there is an active debate about fiscal sustainability in a low interest rate world. There is broader comfort with much higher levels of debt than a decade or two ago. Fiscal rules are being relaxed, being converted into policy guidelines or norms. Discretion is taking over.
In monetary policy, central bank independence is being weakened – and the lines between monetary and fiscal policy are being blurred. Central banks are large purchasers of government debt issuance.
And the centrality of inflation targeting is being weakened; real economy targets (including employment) are being used more widely. In New Zealand, which led on inflation-busting central bank independence, the Reserve Bank has been given a broader mandate (including most recently a house price criterion) and is working more closely with the Treasury.
Part of the market volatility over the past few weeks reflects uncertainty as to whether inflation is returning – and how large economy central banks will respond. As rules are weakened, the extent of political influence is likely to loom larger.
Economic policy regimes tend to shift every several decades; and we are in another regime change process now. From trade wars and macro policy to the new interest in industrial policy (strategic innovation priorities, supply chain resilience, investment in green and digital), the 2020s will be a period of disruptive policy and institutional change.
Although some of these policy shifts make sense, it is likely to increase economic and political turbulence. And a more discretionary policy-making environment increases the importance of the quality of decision-making, for better or worse (see Brexit). The strength of policy-making institutions will become more consequential for national outcomes.
Singapore is an example of a high quality, high discretion policy environment. And many other small advanced economies have institutional strengths. But not all governments will perform well in this environment: rules were introduced for a reason.
Overall, January’s UK trade data is a reminder that political ideas can have major consequences. And more broadly, the changing of the intellectual scaffolding to economic policy that is underway will have major impacts on the global economy over the next several years and beyond. Fasten your seatbelts!
Get in touch if you would like to discuss this analysis and its implications. I am also available for presentations and discussions on other global economic and political dynamics, and the implications for policymakers, firms, and investors. Do let me know if your organisation is interested in arranging a discussion.
Chart of the week
Commodity prices have risen strongly over the past 12 months, from iron ore and oil to copper and dairy. This reflects a strong global economic recovery, including strong demand from China. This has supported the economic performance of commodity exporters such as New Zealand and Australia. Over time, rising commodity prices will add to overall price pressures in the global economy.
Other writing
I prepared an essay for the Institute of Emerging Market Studies at the Hong Kong University of Science & Technology on lessons from the increasingly different economic models in Singapore and Hong Kong for post-Covid economic policy in Asian emerging markets. The essay is available here.
Around the world in small economies
New Zealand’s Q4 GDP data was released on Thursday. It showed GDP growth of -1.0% for the quarter, weaker than expected, for growth of -0.9% relative to Q4 2019. For full year 2020, GDP was down by 3%. Although the domestic economy is largely open for business (with only occasional lockdowns), borders remain closed which restricts tourism and migration. For Q4 GDP charts on New Zealand and other advanced economies, see here.
The UAE announced the establishment of a $10 billion investment fund aimed at strategic sectors in Israel; the UAE ‘will invest in and alongside Israel, across sectors including energy manufacturing, water, space, healthcare and agri-tech’.
There has been an ongoing debate about establishing a sovereign wealth fund in Switzerland. Philipp Hildebrand, former head of the SNB, is the latest to weigh in, arguing that a Swiss fund would generate substantial financial and political benefits.
Team New Zealand beat Italy’s Luna Rossa in yachting’s Americas Cup in Auckland to retain the Cup. For those unfamiliar, this is as much Formula One racing as sailing, with the yachts able to reach speeds of close to 100km/hour: Team New Zealand used advanced AI technology to design its yacht.
The Netherlands has been an early winner from Brexit, with the relocation of economic activity from the UK. Financial services, fintech, technology, and logistics firms are setting up in the Netherlands to better access the EU.
And Dutch elections were held during the week. As expected, the largest party led by PM Mark Rutte won the largest vote share (he will become the longest-serving PM). The big winner on the night was the pro-European party D66, which came in second. Populist right wing parties slightly increased their share. But all up, the new coalition will likely look similar to the previous one.
Tech firms with small economy roots have been in the headlines. Stripe, a payments firm founded by two Irish brothers, concluded another capital raising – led by an Irish government fund – which valued it at $95b. And Rocket Lab, a company founded by a New Zealander that sends satellites into space from a launch base in New Zealand, is listing on the Nasdaq via a SPAC – with an expected valuation of $4.1 billion.
Dr David Skilling
Director, Landfall Strategy Group
www.landfallstrategy.com
www.twitter.com/dskilling