In recent years, populism has been on the rise in many different countries. While “populism” may have different meanings to different people, we use the term to describe policies that promise quick solutions to problems, often of an economic nature, without the hardship usually associated with more orthodox processes.
According to traditional policy recipes, macroeconomic imbalances should be managed using a range of macroeconomic tools including, but not limited to, prudent fiscal and monetary policies, openness to trade, deregulation and a move towards greater global economic integration.
In the wake of the various global crises of the last decade, these traditional measures have dangerously begun to be considered outdated, especially in some advanced economies. They contributed to the Brexit vote, where a majority of British voters took the country out of the European Union (EU) to limit immigration and re-establish a higher degree of national control over policy and regulation. Populist and nationalist parties have gained popularity in several other EU countries, adding to the uncertainty for upcoming elections in 2017.
In the recent US presidential elections, strong and clear-cut populist elements emerged on both the Republican and Democratic sides, supporting a more interventionist and attentive economic attitude to the domestic situation of the country, combined with a more isolationist approach to global trade, proposing to impose high tariffs on imports, abrogate or renegotiate trade treaties and block immigration.
Strong criticism of the North American Free Trade Agreement (NAFTA) and immigration from Mexico signaled the US temptation to turn its back on Latin America. This would be detrimental to the US economy and especially ironic at a time when Latin American economies are moving in the opposite direction, abandoning populist economic policies in favor of pro-economic and free-market reforms.
We analyzed the experiences of Latin American countries in recent years, focusing mainly on three countries that had adopted populist economic policies: Argentina, Brazil and Venezuela. The first two have recently reversed course, unlike the third. We believe that comparing their experiences teaches some valuable lessons to policy makers currently at risk of succumbing to the siren song of populism.
Advanced economies are naturally in a much stronger position than the countries featured in this article, both in terms of economic fundamentals and institutions. However, we believe that the economic consequences of poorly designed policies would be qualitatively similar. In a situation where the temptation to adopt protectionist policies is particularly strong, we are convinced that this analysis can offer some useful indications. We also underline the potential attractiveness of investment opportunities in Argentina and Brazil and, more generally, in countries with sound orthodox macroeconomic policies.
THE SIRENS OF POPULISM
Figure 1 summarizes the experiences of four Latin American countries, three of which (Argentina, Brazil and Venezuela) fell into the trap of populist policies, while the fourth (Colombia) did not. The end of the commodity supercycle affected all these countries to varying degrees and their ability to sustain their respective political environments was tested: those that veered towards populism ended up in an inadequate situation. Figure 1 on the right gives an overview of the type of measures adopted by the more interventionist governments.
THE DAMAGES
All three countries that have adopted populist policies have faced extremely negative consequences: inflation has risen to high levels, the economic system has undergone severe distortions, productivity growth has suffered, exchange manipulation combined with the high inflation has caused a significant appreciation of the real exchange rate (which has weakened competition) and, in some cases, public debt has rapidly increased.
Argentina and Brazil are committed to reversing the trend and healing the damage inflicted on these economies by the abandonment of prudent macroeconomic policies; the experience of Venezuela, which has refused to follow a similar path, speaks for itself. Figure 2 gives an overview of the damages suffered by different countries, but not by Colombia, which has stood out by maintaining prudent policies.
REVERSE OF COURSE
In Argentina, the prolonged deterioration in economic conditions eventually led to the defeat of Cristina Kirchner by Mauricio Macri in November 2015. President Macri was elected on the basis of a robust platform of economic liberalization. The new government quickly launched a wide range of reforms, such as institution building, monetary policy tightening, fiscal consolidation, exchange rate policy normalization and international relations regularization. These far-reaching and robust reform measures represent a clean break with the past and send a strong signal to international investors that the government is seriously committed to implementing the new economic policy course; we believe that a willingness to tackle the most difficult problems immediately is the most compelling way to establish credibility.
In Brazil, the policy fix has been forced upon former President Dilma Rousseff, who has been increasingly denied the funding needed by the market to continue her unsustainable policies; Rousseff's popularity plummeted. The new Brazilian government, led by President Michel Temer, has undertaken the first measures aimed at fiscal consolidation, the reduction of the ceiling on public spending and the elaboration of a possible reform of the social security system. The government has also begun to reverse its previous micro-management of the economy in order to reduce political distortions. One of the most significant measures was represented by the start, in 2015, of the deregulation of administered prices. Faced with rising inflation and the economy still in recession, the central bank had to find a difficult compromise in 2015; after keeping the real interest rate stable until mid-2015, it let it rise (while starting to reduce nominal rates) with a view to ensuring a drop in inflation in 2016. The adoption of a more cautious was also confirmed by the reversal of the previous credit expansion.
In ColombiaDespite the absence of a major policy deterioration, the government has indeed taken steps to manage inflation resulting from exchange rate depreciation. Monetary policy has been tightened, steps have been taken to further consolidate the fiscal balance to manage the potential impact of reduced revenues caused by falling oil prices; finally, negotiations were conducted at the same time with the Revolutionary Armed Forces of Colombia - People's Army to put an end to the long conflict with the guerrilla group, strengthening and protecting the country's democratic institutions.
At the time of writing this article, the protectionist policies of the Venezuela they are still fully in place. The population is now facing extremely difficult conditions, with high unemployment and severe shortages of food and other basic necessities. This has sparked protests and increased risks to social stability, but has not yet translated into policy changes, much less policy adjustment. Figure 3 illustrates a summary of the corrections (or failure to correct) policies in each country.
TOWARDS THE NEXT DECADE
The political framework of Colombia contrasts with that of the Venezuela: resolute in rejecting populism. It is significant that Colombia, thanks to the maintenance of prudent macroeconomic policies, has suffered only from the increase in inflation caused by the depreciation of the exchange. A sharper contrast is hard to imagine.
In Argentina e Brazil, there are reasons for optimism, even though the policy correction has only just begun. While maintaining momentum will be essential over the next few years, the most important factor seems to exist in both countries and that is political commitment and if the new policies are maintained, we believe there will be substantial benefits.
Conversely, it's hard for us not to be pessimistic about the outlook for the Venezuela. The country boasts oil reserves greater than those of Saudi Arabia as well as the world's fastest-shrinking economy, inflation estimated to reach 1.000 percent, and food and medicine shortages that are plunging the country in a humanitarian crisis. It is hard to imagine a more disastrous set of circumstances for a country.
These examples from Latin America teach important lessons to the developed world. We are not suggesting that the United States or the various European countries that yearn for populism risk taking some of the extreme paths we explore in the full article, yet these examples offer a cautionary tale at a time when orthodox economic policies risk becoming increasingly unwelcome.
