September 12, 2016
“All happy families are alike; each unhappy family is unhappy in its own way.” – Leo Tolstoy, Anna Karenina
Around the world, people are unhappy with politics. In the United States, only 18 percent of Gallup respondents approve of how Congress is doing its job. Across Europe, only 33 percent of Eurobarometer respondents say they trust the European Union. Over the past year, violent labor protests have erupted in South Korea and France. In Latin America, prominent politicians are harassed in restaurants, malls, and airports, and their humiliations are posted on YouTube.
This intense public unrest is driving global politics and policymaking in powerful ways, and the consequences for multinational companies are significant. And, like Tolstoy’s unhappy families, each unhappy polity is different. Understanding the whys and hows of each national family’s unhappiness is essential if corporate executives are to navigate the risks and opportunities of this new era.
Underneath this worldwide frustration, there are some common elements: slow economic growth and rising inequality, structural unemployment, political incompetence, and venality. The financial crisis of 2008 – 2009 was not the beginning of this new era of discontent, but it did catalyze some of the responses. That crisis began in the developed markets of the United States and Europe. But as these economies slowed, the fall in demand for commodities and manufactured exports quickly spread the pain to emerging markets. And while global economic downturns have occurred before, this time disruptive technologies and digital communications intensified and magnified popular angst.
But while the underlying conditions may be similar, political and policy responses to it have been strikingly different, particularly between developed and developing countries. In developed countries, popular frustration is leading to increasingly unpredictable populist politics and policies that are often anti-trade and challenging for businesses. In developing countries, popular discontent is driving a more business-friendly set of responses.
The most compelling explanation for the difference in policy responses in developed and developing countries is their differing experiences with globalization – the movement of goods, money, people, and ideas across borders. While globalization has lifted millions out of poverty in developing countries, the Western middle class has suffered as manufacturing and blue collar jobs moved abroad. And while globalization has led to new opportunities for large numbers of newly mobile immigrants from the developing world, their arrival has stirred up fear, anger, and prejudice in many parts of the West.
Globalization has opened a rift between the developed and developing world.
In the developed world, anxiety over the economy has translated into the view among some citizens that the political establishment does not care about their welfare. The financial crisis and the threat of terrorism have convinced them that their leaders have failed to provide either effective economic management or public safety. The result has been a populist and nationalist surge across the United States and Europe. As a result, ideas that were previously out of bounds have now entered the marketplace of ideas.
In Western countries where politics is dominated by two parties, anti-establishment sentiment has propelled the rise of fringe candidates within the main parties, including Bernie Sanders and Donald Trump in the United States and Jeremy Corbyn of the UK’s Labour party. This has hollowed out the political center, increased partisanship, and widened the array of possible policy outcomes.
Trump is the personification of the new policy volatility. He has promised to reject the Trans-Pacific Partnership (TPP) trade agreement, threatened to abrogate NAFTA if he cannot renegotiate its terms, questioned the worth of the 67-year-old NATO alliance, and vowed to deport 11 million undocumented immigrants. This radical reconsideration of U.S. policy – and the uncertainty that comes with it – will outlast his campaign, win or lose. His protectionist and isolationist views are now part of the discussion, particularly in conservative circles. Meanwhile, Sanders’ calls for free college tuition, the return of Glass-Steagall-type bank regulation (repealed in 1999), nationalized healthcare, and trade protectionism are now embedded in the conversation on the left.
Meanwhile, the more fragmented political landscape of continental Europe has witnessed the rise of new (or previously marginal) right-wing parties, such as Alternative for Germany and the National Front in France. These parties’ agendas typically focus on immigration, domestic industry, and cultural protections. But in Europe, national governments have ceded their sovereignty over many of these issues to the European Union, and Brussels does not share their agenda. So naturally these parties are reliably anti-EU (and anti-Eurozone).
This will be the focal point of policy uncertainty in Europe. Brexit was the ultimate manifestation of anti-EU sentiment, and other European countries may now flirt with leaving the EU. More likely, national capitals will come into increasing conflict with Brussels on a range of issues. Already this year, Poland is in dispute with the EU over its treatment of the judiciary and media; Italy is fighting for more control over its spending agenda; and Germany is opposed to Eurozone plans for the establishment of a bank-deposit insurance program. In April, Dutch voters rejected a European Association agreement with Ukraine in a referendum that was widely understood as a proxy vote against the EU. In August, the European Commission’s dunning of Apple for $14.5 billion in back taxes owed Ireland was condemned by the Irish government as interference in its economic management. Refugee policy is also likely to be a flashpoint between Brussels and many EU governments, with Hungary set to hold a referendum October 2 on whether to accept any future EU-dictated quota system for resettling migrants.
Even though anti-establishment leaders and parties have not yet taken power in any European country, their ideas are entering the mainstream political discourse and influencing policy. In fact, the Brexit referendum was put on the agenda by former UK Prime Minister David Cameron as an attempt to outflank the UK Independence Party and put an end to agitation from Eurosceptic Tory backbenchers. Obviously, Cameron’s gamble failed. And while Hillary Clinton was a strong supporter of the TPP trade agreement during her tenure as Secretary of State, pressure from Sanders supporters in the Democratic Party led her to oppose the TPP in her presidential campaign. And in France, in order to outflank the National Front, the Republicans, led by former French President Nicolas Sarkozy, are adopting a more anti-Islamic and anti-immigration message.
Among many developing countries, the story is different. The developing world benefited from the commodities supercycle, in which natural resource extraction supported economic growth that swelled government coffers. It also allowed governments to avoid hard policy choices and structural reforms, creating an environment in which corruption could flourish. Today, with exports and commodity prices in the doldrums, those economies are suffering, and the reckoning has arrived.
To be sure, there is plenty of anger directed at politicians in the developing world for sins ranging from indifference to corruption to incompetence. In Brazil, the president was impeached and removed from office; in Mexico, South Africa, and South Korea, incumbent presidents are suffering dismally low approval ratings; and in Taiwan, Nigeria, Indonesia, and India, voters rejected establishment parties in favor of new leadership. But in all these cases, the response by policymakers has been to pursue market-friendly reforms. Why has there been such a relatively orthodox set of policy initiatives across such a diverse set of countries even as the developed world is rushing pell-mell in the opposite direction?
First, globalization is not the target of popular complaint in these nations. In fact, the developing world has disproportionately benefited from increasing trade and investment, while immigration is not usually perceived as a threat to their national identity. So the popular and political response has been a renewed effort to fix domestic structural problems rather than to blame larger external forces.
Second, many developing countries are resilient and democratic enough to make their political institutions capable of responding effectively to popular preferences. Indonesia is a good example. There was growing popular frustration during the 10 years of the Yudhoyono administration. Manufacturing was stagnating, infrastructure was neglected, and the country appeared to be losing ground to its peers. The election of President Joko Widodo in 2014 represented a powerful rejection of the status quo. But Widodo came to power at a time of declining commodity prices, which make up over half of Indonesia’s total exports. Widodo struggled in his first two years to rally political support, but now his efforts are starting to pay off. He has appointed former World Bank managing director Sri Mulyani Indrawati as finance minister to push business-friendly reforms. And the recently published 2017 draft fiscal budget looks more credible than those of past years. Widodo’s government also recently won passage of a tax amnesty bill and will push to reduce Indonesia’s corporate tax rate from 25 percent to 17 percent.
Taiwan also faced a reckoning as stagnating global trade, bleak domestic growth prospects, and widening economic inequality drove down the approval ratings of former President Ma Ying-jeou and his KMT party. The result was a major victory for the opposition DPP and President Tsai Ing-wen in general elections in January 2016. Tsai and the DPP, on the backs of their first-ever legislative majority, are pushing a robust agenda of economic reforms featuring fiscal consolidation (mainly by controlling the costs of the bloated state pension system), trade diversification (including joining the TPP), and industrial policies including visa and immigration reforms meant to bring in more foreign workers. Her administration also is open to inbound investment from foreign multinationals in high-tech industries.
The story is similar in Latin America, where an aspiring middle class has grown increasingly frustrated with government inefficiency, a lack of transparency, and corruption. The headlines from Brazil focus on the political chaos but, meanwhile, the country is pursuing business-friendly economic policies. New President Michel Temer is promising to roll back a fiscal deficit that reached 10 percent of GDP, freeze government spending in real terms for years, reform the pension system, privatize infrastructure, and adopt pro-market regulations in areas like oil and transportation. Yet it is not widely appreciated that this shift did not start when former President Dilma Rousseff was suspended from office in April. Immediately after winning reelection in late 2014, Rousseff surprised her supporters by reneging on promises of more social spending and began embracing austerity. She failed to implement this new agenda successfully due to some misbegotten economic policies in her first term, an overly centralizing leadership style, and because the havoc created by the Petrobras-centered investigation into her administration consumed her political capital – and, on August 31, 2016, cost her the presidency.
In Mexico, polls show President Enrique Peña Nieto is the most hated president in two decades. Popular anger at his government has been driven by allegations of corruption, as well as its apparent failure to address the murder of 43 students in Guerrero State in 2014. His party was badly beaten in recent local elections and is rapidly losing support, while unprecedented citizen initiatives are pushing politicians to increase government transparency and accountability. But amidst this environment of popular discontent, the president’s groundbreaking reforms to open the energy and telecom sectors are moving forward and will continue to reshape the Mexican economy.
In Argentina, there is widespread popular cynicism about the political class, and for good reason. Former President Cristina Fernández de Kirchner is accused of holding millions of dollars in secret foreign accounts, and a member of her government was caught burying bags of money and a rifle in a convent. New President Mauricio Macri has also come under fire after his name appeared in the Panama Papers. Yet within just six months of taking office, Macri has reconnected Argentina to the global credit market, removed capital and currency controls, slashed taxes on exports and imports, and cut transportation and energy subsidies (although the Argentine Supreme Court reversed the latter). He is also promising to implement an ambitious “Plan for the Modernization of the State,” expanding access to information about the government and giving authorities better tools to fight corruption.
Investors and businesses have long understood that developing markets present a challenging array of policy risks. And there are important developing markets that have not responded constructively to the downward turn in their economic fortunes and the frustrations of their people: Russia, South Africa, and Venezuela are three examples. But there is also good reason for optimism about the political and policy trajectories of a number of important developing countries. The real test for developing countries will come as the Federal Reserve normalizes U.S. interest rates and yield-hunting hot money begins moving away from them. At that time, market reactions will highlight the difference between those developing countries that have improved their economic and institutional frameworks, and those that have not.
At the same time, we must be prepared for a wider range of policy outcomes in developed markets. Just as the financial crisis of 2008 exposed the underappreciated economic risks in developed markets, so now political developments are highlighting the potential for erratic and business-unfriendly policy outcomes in countries that could previously be counted on as champions of global economic integration.
The period of benign globalization may be ending, and concerns over stagnation, inequality, and terrorism are coming to the fore. This new political environment allows for a wider range of possible policy responses, and it behooves business leaders to make sure they have access to reliable on-the-ground intelligence as to what is happening (and about to happen) in those markets. And while the Wall Street Journal, the Financial Times, and similar publications may be excellent, they report on what has happened, not on what will. Savvy executives know that strategic planning requires more insight and depth than that.