Strong-Arm Governments Are Taking Over the Global Economy

(Bloomberg Markets) -- Surveying the end of the Cold War in 1989, political scientist Francis Fukuyama famously argued in an essay titled The End of History? that Western liberal democracy was the culminating form of government. That’s not quite how things have played out. History, you might say, has returned.

Consider the Group of 20. Establishment political parties in those countries, the avatars of Western democracy, have seen their share of the G-20’s total economic output shrink in recent years. The most striking countertrend has been the rise of populism. Populist parties—claiming to defend the common man against corrupt elites, valuing national unity above cosmopolitan inclusion, and offering simplistic solutions against complex policy debate—have been gaining strength since the global financial crisis a decade ago. President Donald Trump in the U.S. is one prominent example. Italy is another. The Northern League and Five Star Movement swept into power there this year. Populists, according to our classification, now manage the largest bloc of the G-20 economies. (For additional Bloomberg Economics research on the topic, run {BI ECON } on the Bloomberg terminal and search for “populism.”)

Here’s how we broke it down: Each year from 1980, we sorted the governments of the G-20 countries plus Spain into four categories—establishment democracy, populist democracy, weak democracy, and authoritarian—and tracked what portion of the G-20’s total gross domestic product they oversaw.

A couple of things emerge from this analysis. First, the populist category jumped in 2016. That reflects our decision to characterize the U.S. as “populist” after Trump’s election and to shift the world’s largest economy into the category.

Second, the rise of China means that authoritarian regimes, with strong central power and limited political freedom, play an expanded role. That’s a significant shift in how the world economy is run. So far it hasn’t had a major negative impact on growth and financial stability. Is it only a matter of time? A deeper look at the relationship of governance to growth reveals some nuance about what’s likely to be important in that regard.

To put some numbers to it: When you add up the nominal output of the G-20 states plus Spain, their combined GDP is about $64 trillion. Populist governments now control 41 percent of that. By contrast, in 2007, before the crisis roiled the world, the figure was only 4 percent.

Mainstream democratic parties, which typically occupy the center of the political spectrum, have gone from dominance to minority. They preside over only 32 percent of the G-20 output. In 2007 they accounted for 83 percent.

Authoritarian regimes—China, Russia, Saudi Arabia, and Turkey are all classified as “not free,” according to Freedom House, a Washington-based think tank whose founders included Eleanor Roosevelt—manage 24 percent of G-20 GDP. China accounts for almost 19 percent, up from 8 percent a decade ago.

There are, of course, issues of judgment. Should the U.S. under Trump fall in the populist or mainstream democratic category? Probably somewhere in between.

So is there another way to tease out a populist trend? One is to examine the share of popular vote garnered by the top two parties, which typically represent mainstream political sentiment. Among major democracies, that share has fallen to 63 percent from 74 percent in 2007. What that misses is the way mainstream parties—particularly the U.S. Republican Party and U.K. politicians after the Brexit vote—have adopted populist agendas to hold on to votes. Even so, the same pattern stands out: The mainstream is losing influence.

What consequences will economies face from the lurch toward populism and authoritarianism? Mainstream parties, and indeed economists, should be humble about how much they know about good policy. Failure to manage the forces that globalization unleashed created the conditions for the rise of populism in the first place.

Even so, as traditional economic logic plays a diminished role in big policy decisions, it seems reasonable to ask if a slide toward populism and authoritarianism will erect barriers to growth. The shift is, after all, producing plenty of violations of the good-policy playbook.

Leaving aside self-interested mismanagement of the economic cycle—goosing growth for short-term political gain, for example, a practice common to both mainstream and populist governments—we’d break the missteps into two categories: First are policies that damage growth potential. Brexit, taking the U.K. out of the world’s biggest free-trade bloc and shrinking markets for the country’s goods and services, is one example.

Second are policies that undermine institutions. That includes everything from the head-spinning reversals of U.S. policy under President Trump, such as his refusal to sign the G-7 communiqué in June (adding to uncertainty), to Turkish President Recep Tayyip Erdogan’s appointment of his son-in-law to a key economic post in July (reducing accountability).

Is it time to get out the placards saying, “The end is nigh”? Not yet. To be sure, Turkey and Italy are flirting with crisis, and the U.K. is underperforming. But looking at the G-20 as a whole, GDP growth rose to 3.8 percent in 2017, the fastest pace since 2011. In part, that’s because populists got lucky. They fed on economic discontent but ultimately inherited an upswing. Pro-cyclical policies, notably the U.S. tax cuts, are giving growth an additional boost. A pro-business stance, with a bonfire of regulations in the U.S., China, and India, is also helping.

Those factors are important. But the persistence of growth reflects something more than just luck and stimulus. Some aspects of governance, it seems, are more important for growth than others.

The World Bank’s Worldwide Governance Indicators project has gathered data in more than 200 countries on six dimensions of governance: voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law, and control of corruption. An analysis using that data shows that high-quality regulation and government effectiveness correlate more closely with growth than democratic values such as voice and accountability, which track views about citizens’ ability to participate in their government. In those terms, the trajectory on governance in the G-20 looks less alarming. Democratic standards may be deteriorating, but quality of regulation and government effectiveness remain comparatively stable, even edging up in recent years.

Will the new rulers of the world’s major economies really be able to decouple long-term growth from the institutions that underpin good governance? Count us skeptical. Cycles turn. Confidence fades. Government effectiveness and high-quality regulation are tough to maintain in the absence of policy debate and accountability for leaders. The return of history has not, so far, meant the end of growth. But we’re keeping our placards on hand … just in case.

Orlik is chief economist at Bloomberg Economics in Washington. Jimenez is an associate economist in Hong Kong.

To contact the editor responsible for this story: Jon Asmundsson at jasmundsson@bloomberg.net

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