For many investors, time horizons are better measured in decades rather than years. In some cases the aim is to preserve and grow wealth not for a single lifetime, but for future generations. As a result, we think it is important to step back from the short-term noise of markets and reflect on the issues which could have an impact on investment returns over the very long term.
One such theme is the resurgence of populism, and the relationship this has to increased inequality or perceptions of increased inequality. Modern day populism is far reaching, and playing an important role in the politics of the UK, the USA and a number of countries across Europe. It is also versatile enough to encompass the whole political spectrum. It has contributed to the success of Donald Trump’s agenda, as well as to the success of Democrat presidential candidate Bernie Sanders, for example.
At first glance inequality and populism may appear to be a predominantly social and political phenomenon. However, we think they have a number of implications that could have meaningful impacts on economics, markets and investment portfolios.
Globalisation’s winners and losers
Globalisation has had many benefits. It has increased global GDP, boosted investment in poor countries and, most importantly, helped reduce global poverty.
So how has it led to a rise in inequality and populism?
The problem has been that the decline in global inequality has been accompanied by a marked increase in domestic inequality.
In many developed countries, low-skilled labour has been driven out of work by the availability of low cost international labour and goods. Meanwhile, middle class incomes have stagnated while wealth ownership has become more concentrated.
In the US, it appears that a smaller proportion of the population benefits from a growing economy. In the boom years between 1961 and 1969, according to French economist Thomas Piketty, the least wealthy 90% of the American population took home 67% of the income gains. During the expansion from 2001 to 2007, they took just 2% of additional national income generated, while the wealthiest 10% took the rest.
Two key agreements in the history of globalisation illustrate how disruptive a force it has been for certain groups.
Firstly, there is the North American Free Trade Agreement (NAFTA), long a target of Donald Trump’s ire. From the signing of the agreement at the start of 1994 to the end of 2015, trade between the US and Mexico increased from $85.2 billion to $481.5 billion, a real increase of 255%. Whilst the impact on most US workers was modest, there were meaningful consequences for “blue collar” manufacturing workers. Wage growth for this group fell by 17% between 1993 and 2000 relative to industries which were not as exposed to the impacts of NAFTA.
US Manufacturing Jobs (1993-2016)
Source: Bureau of Labour Statistics
The second key milestone was the entry of China into the World Trade Organisation (WTO) in 2001. US imports from China have since grown to over $500 billion. These imports adversely affected the employment and wages of many American workers in the early 2000s. For instance, work by MIT economist David Autor attributes the loss of close to 1 million manufacturing jobs in the US from 1999 to 2011 to the Chinese “trade shock”.
Against this backdrop, support for Donald Trump and his protectionist stance makes more sense. It also explains the success of populist movements in European countries where workers have suffered due to rising exports from China and other emerging economies.
Domestic economic policies designed to increase competition – such as deregulation and privatisation – have allowed consumers to benefit from lower cost and greater choice. However, they may also have contributed to the rise in inequality. Companies have generated enormous wealth for shareholders while employment in many industries has become more precarious. Some commentators argue that shareholders have taken an unfair share of the rewards of globalisation and economic reform.
More recently, this debate has focused on the huge volume of share buybacks, especially in the US. This has raised concern that companies are prioritising shareholders at the expense of growing production and hiring new workers. As Bernie Sanders has noted, “between 2008 and 2017, 466 of the S&P500 companies spent around $4 trillion on stock buybacks, equal to 53% of profits. Another 30% of corporate profits went to dividends. When more than 80% of corporate profits go to buybacks and dividends, there is reason to be concerned.” Leaving aside the politics, these numbers give a clear indication of the extent to which companies have focused on keeping their shareholders happy.
Wealth inequality and the rise of populism could have potential impacts on economics and financial markets, most notably productivity growth, labour costs and government debt levels.
One area where inequality is already having a worrying impact is on access to education, especially in the US. This could have long-term implications for productivity growth. Since 1979, the cost of higher education in the US has increased by over 1000%, according to research undertaken by the Bank of England, far outstripping income growth. As a result, higher education is less accessible than it once was.
This has created constraints to educational attainment, with the average years of education for the US population starting to plateau.
The National Bureau of Economic Research in the US estimates that 20% of the growth in output per worker between 1950 and 1993 was driven by a more skilled workforce. If educational attainment stagnates due to rising costs, the contribution of human capital to future productivity growth may diminish. A more fundamental question regarding longer-term productivity growth is whether the pace of technological innovation can offset the impact of declining human productivity as described above.
Populist movements may have the unintended result of accelerating technological innovation and reducing the future need for traditional labour. If, for example, a populist rejection of globalisation and international movement of goods and labour led to an increase in domestic labour costs, corporate margins would suffer. This could incentivise greater automation.
Costs of education have soared
Source: Bank of England
Political activism arising from wealth inequality – or perceptions of wealth inequality – may also have far-reaching implications for government finances. A 2017 report by the European Economic Advisory Group defines the populist economic agenda as “characterised by short termism, the denial of budget constraints, the failure to evaluate the pros and cons of different policy options as well as trade-offs between them”.
Populist economics often focus on increased public spending or lower taxes. The current situation in Venezuela is perhaps the starkest example of this. Following the election of Hugo Chavez in 1998 and his succession by Nicolas Maduro in 2013, Venezuela has lived under populist rule for over two decades. A series of failed populist economic policies over this period has seen an increase in national debt, a significant devaluation of the currency and hyperinflation. Whilst Venezuela does not publish official inflation statistics, the price of a cup of coffee with milk rose 100-fold in local currency from the start of December 2018 to the end of February 2019. As a result, around 90% of the population is now classified as living in poverty.
Whilst it would be a stretch to suggest that western nations might follow a similar path, in the context of already exceptionally high government debt levels populist economic measures could further exacerbate the difficulties many developed economies face.
 Hakobyan & McLaren, ‘Looking for local labor market effects of NAFTA’ Review of Economics and Statistics 98, 2016
 Gabe Lipton, ‘The Elusive ‘Better Deal’ With China’, The Atlantic, August 2018
 NBER Working Paper No. 19830, ‘The Future of US economic Growth’, G. Fernald and C Jones, 2014.
 Bloomberg data