Investors have consistently underestimated populism. Now, with the election of Donald Trump in the United States, there is a sudden reappraisal of what wider populism might mean. It seems likely that populism will play a significant and potentially destabilising role in global markets in the coming years.
Populism prioritises the views of a majority of the population. That is not the same as democracy, which gives rights to the minority and creates institutions that protect these rights. With populism the will of the majority is the only legitimising factor. Populism appeals to the group in society “left behind” by the economic developments of the past quarter century. Rural, older and lower-skilled workers have seen their relative incomes decline. By claiming to give this group “a voice”, populist politicians can win support.
Populism is also helped by social media, which encourages the idea of direct democracy – everyone’s opinion should be heard. If you can vote directly on something as important as Pop Idol, then why should you not have a direct vote on negotiations for free trade? However, most constitutions rely on some form of representative democracy and people vote for someone they think is best qualified to make decisions on their behalf. When direct democracy and representative democracy collide, the result is populist politicians – representatives who claim they will speak for the voice of the people.
Financial markets do not tend to price the risk of populism very accurately. Investors, fund managers and traders are almost by definition not the people who have been left behind over the course of the past quarter century. Their views, and the views of the social circles that surround them, are unlikely to match the views of those supporting populists.
There is also a desire to believe in the status quo. Investors cling to the belief that populists cannot really mean what they say, that markets will force a change of policy, or that the status quo will endure. Any event that suggests the status quo is being reasserted can yield disproportionate market reactions.
When the UK high court ruled that Parliament would have to vote on the UK’s exit from the European Union, there was a revival of investor interest in the idea that the referendum result might be reversed. When Mr Trump’s scripted victory speech followed the conciliatory norms of more conventional presidential candidates, markets took it as a signal of mainstream politics. Both reactions may tell us more about market desires than political reality.
Populism, therefore, creates more market uncertainty, with investors likely to overreact to any signal of the re-emergence of a more conventional politics.
Populism also adds uncertainty as the direction of international economics of the past quarter century is upended, creating uncertainty about the new direction of international policy and the consequences of that change in direction. Finally, populism will remain hard to predict, further fuelling uncertainty. With opinion polls derided for their repeated underestimation of political populism, investors are likely to approach the coming votes in Europe with a heightened degree of uncertainty about the balance of risks.
It is also worth reflecting that populist policies may not solve the problems of the group left behind. Mr Trump’s tax cuts and infrastructure spending may not offer much direct benefit to lower income, lower-skilled groups (most construction workers are skilled or semi-skilled, and any increase in housing costs arising from the stimulus would disproportionately hurt lower-income families). The risk is that this simply spurs ever more aggressive populist policies, further fuelling the uncertainty.
Populism is not a temporary phenomenon. Structurally, populism is likely to persist in the near term at least. This suggests more unstable financial markets. The world has become a less certain place.
Paul Donovan is global chief economist at UBS Wealth Management
business@thenational.ae
Follow The National's Business section on Twitter