More than just a referendum

From CityWire

The impact of Brexit from a UK and global perspective is still far from clear. Here, Brendan Mulhern, global strategist at Newton, breaks down what an increasingly fragmented global political landscape might now mean for investors.

The United Kingdom’s historic vote to leave the European Union (EU) will have profound implications for the future of the country. It is the latest and most conspicuous example of the political fragmentation that is playing out in democratic countries across the globe.

This fragmentation is the result of a growing discontent among electorates that are ever more hostile towards authorities who they regard increasingly as a ruling elite that does not serve their interests. Given the global nature of these developments, an examination of what has underpinned the seismic shift in the UK political landscape may offer valuable insight into what the underlying drivers are.

A very British revolution

In voting on whether or not to remain part of the EU, the UK electorate was split down socioeconomic lines, as opposed to those of party politics. Members of the working class overwhelmingly voted to leave the EU, while more affluent, better educated parts of the country voted to remain. In simple terms, this was a vote split between the ‘haves’ and the ‘have-nots’ – a modern day class war.

The world has evolved rapidly in recent decades, perhaps more so than at any time in history, with the pace of change often proving discomforting for societies. In particular, the decline of the UK’s manufacturing industries over recent decades has seen once-thriving parts of the country lose out in the age of free markets and globalisation. Real incomes for much of the country have remained stagnant, or even fallen.

Meanwhile, waves of immigration and global culture have washed across the world, changing communities beyond recognition at a rapid pace, and accentuating the feeling of helplessness and abandonment felt by those who have lost out economically. The evidence indicates that the spoils of free trade and immigration are not shared equally. The wages of the relatively unskilled working class in developed economies have been suppressed as companies have been able to access cheap alternatives in a globalised labour market.

At the same time, the winners in this world – a self-confident, well-educated urban class – have seen their wealth grow amid rising house prices, high employment and rising wages.

Policies pursued in the wake of the financial crisis by western authorities have only served to exacerbate levels of wealth inequality that were already at the upper end of the historical range. Further propping up asset prices with borrowed cash has made the owners of overpriced assets even richer. Perhaps what is most striking is how peaceful this rebellion has been, and how long it has taken to come to pass.

Political fragmentation

Across the world, national politics is becoming increasingly complex as voters reject traditional parties in favour of new organisations – typically further from the political centre ground. This fragmentation of politics is making the formation of stable and effective governments more difficult.

The emergence of Podemos and Ciudadanos in Spain, the AfD in Germany, the Five Star Movement in Italy, the UK Independence Party in the UK, and Donald Trump’s nomination as the Republican Party’s presidential candidate in the US all also embody this trend.

This time it’s different?

History shows us that financial crises are typically followed by periods of political fragmentation. However, the political consequences of financial crises typically start to fade around five years after the beginning of a crisis. As economic fortunes begin to improve, voter grievances are assuaged, with the political upheaval largely resolved ten years after the onset of a crisis.

What does this say about the current episode of political fragmentation, one that shows no sign of abating – eight years on from the start of the financial crisis?

Because a sustained acceleration of economic activity remains conspicuous by its absence even after this period, there has been no palliative for the numerous and diffuse grievances of voters, the bulk of which are economic in origin. Across much of the developed world, unemployment remains stubbornly high, while wages remain stagnant. Anaemic economic growth has been, and remains, the ultimate cause of ongoing political fragmentation.

Economic fortunes are structurally impaired

In the years following the financial crisis, lacklustre economic growth was attributed to cyclical factors. There is now a growing recognition that structural factors are blocking a sustained acceleration in global economic activity. If we are correct in our view that the economic outlook is structurally challenged, those hoping for an improvement in economic fortunes as the remedy to mounting political discontent are likely to be disappointed. Without a return to the sort of economic growth that enables a majority of individuals to be content with their perceived economic opportunities, the fragmentation of political systems and rise of nationalism are likely to continue.

Unfortunately, the economic policies that have been implemented by governments and backed by institutions only serve to entrench and exacerbate the structural headwinds to economic growth, with no sign that a change of tack is on the horizon.

Against this backdrop, political risk looks set to be an increasingly important consideration when evaluating investment opportunities and risks.


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