The Economics

of Populism
October 2017

In a clear signal from voters who feel left behind by globalization,

populist political parties have been gaining ground around the world.
This could create serious long-term headwinds for economies and
markets, including lower growth and higher inflation.
Stefan Hofrichter, CFA
Chief Economist

Key takeaways
Support for populist parties globally has recently skyrocketed to the highest
level since the early 1930s
The global rise in income inequality since the 1980s is boosting populist support
Populism is not a fad; it is a challenge to the current order and a headwind for
economic growth and markets
Valuations and structural growth trends are still of utmost importance for
long-term investors
In an age of populism, opportunities exist for active managers who understand
the economic dimensions of politics

The populist phenomenon has been making
headlines since last year the Brexit vote and
the election of President Donald Trump were
two of the more notable examples. But unlike
some other political trends, this one has the
potential to create significant challenges for
economic growth and markets. For investors,
understanding populism as a political force is
critical to positioning portfolios actively in a
changing landscape.
Page 2
Populism isnt new,
but its enjoying a resurgence
Before we analyse populisms effects on the markets, it
may be helpful to define what it is, where it comes from
and where we are seeing it today.
Political scientist Cas Mudde has an insightful defini-
tion: Populism is best defined as a thin-centred ideolo-
gy that considers society to be ultimately separated
into two groups, the pure people and the corrupt
elite, which argues that politics should be an expres-
sion of the general will of the people (but) it says
little about the ideal economic or political system.
The support for populist parties globally has recently
skyrocketed reaching the highest levels since the early
1930s, according to the hedge-fund management
group Bridgewater. More importantly, this wave has
recently swept several populists to power, including
President Trump in the US, Victor Orban in Hungary,
Jaroslaw Kaczinsky in Poland and the Finns Party in Fin-
land. In the UK, the populist-fuelled Brexit vote led to a
major change in the countrys political landscape and
future direction.
Figure 1: Support for Populist Parties
Has Grown in Europe
Percentage of votes for populists,1980-2016
20
17
Share of Votes (%)
14
11
8 0.25
1980 1990 2000 2010
Source: Timbro, Allianz Global Investors. Data as at 2016.
The Economics of Populism | October 2017
Not all populist movements have been successful, of
course. Several high-profile movements in Europe
experienced pushback in the first half of 2016, when
the majority of Dutch and French voters chose
established parties and candidates at their respective
national and presidential elections. And in Germany,
voters once again chose an establishment government
led by pro-European Chancellor Angela Merkel even
though the populist and anti-establishment Alternative
for Germany (AfD) party has become the third-biggest
party in the German Bundestag.
Not all populist movements have been winning:
Dutch, French and German voters recently voted
for the establishment
However, this pushback does not imply that populist
parties are in retreat overall. In Austria, the populist
Freedom Party of Austria (FP) has been garnering a
surprising amount of support with its far-right views.
And in Italys spring 2018 elections, Beppe Grillos Five
Star Movement may attract more votes than any other
party.
Figure 2: The US Congress Has
Become Increasingly Polarized
Average of Senate and House polarization scores, 1880-2017
1.25
May 2017
Estimate: 1.1
1.00
Polarization Scores
0.75
0.50
1880 1920 1960 2000
Source: Allianz Global Investors, voteview.org, H. Rosenthal,
Keith Poole. Data as at 2015. The most recent data point is an
estimate based on Philadelphia Fed Partisan Conflict Index, as at
May 2017. The higher the score, the more polarized the Senate
and House are. The score measures legislators liberal-
conservative positions using their roll call voting records.
 Page 3
It is worth noting that the recent populist surge is not a
sudden phenomenon: it has been building for some
time. Votes for populists began to rise in Europe back in
the 1980s (see Figure 1). In the US, which essentially has
a two-party system, the rise in the political polarization is
painting a similar picture (see Figure 2). It started to lift
off around 35 years ago, according to social scientists H.
Rosenthal and K. Poole, and has culminated in the elec-
tion of Donald Trump as president of the United States.
Income inequality holds the key
to populisms rise
We believe the key to understanding the growth of pop-
ulism lies in the global growth of income inequality since
the 1980s. For instance, in the US, the Gini coefficient
the traditional measure for income inequality is at a
roughly 90-year high after having troughed in the late
1970s (see Figure 3). Similar developments can be ob-
served in other countries, both advanced and emerging.
There are several interrelated factors that have contrib-
uted to growing income inequality.
First, from the early 1980s through today the biggest
beneficiaries of the trend towards automation and the
widespread use of computers have been more highly
skilled workers. By contrast, less skilled workers have
Figure 3: Income Inequality Is Near a
90-Year High
Gini coefficient (expressed as a percentage) in US, UK and
Germany from 1920-2013
50
Gini Coefficient in %
40
30
US
UK
Germany
20
1920 1940 1960 1980 2000
Source: Allianz Global Investors, University of Texas, OECD.
Data as at 2013.
The Economics of Populism | October 2017
seen their labour income decline (when adjusted for
inflation). Moreover, many middle-income jobs have
simply vanished in the last 40-plus years, replaced by
either high-income/high-skill jobs or low-
income/low-skill jobs.
Income inequality is rising; many middle-income
jobs have vanished in the last 40-plus years
The second factor contributing to rising inequality has
been international trade, which accelerated from the
early 1980s onwards. In advanced and emerging
economies, this has generated winners and losers,
both on a relative and absolute basis. This is not to say
that globalization was bad from a global perspec-
tive; quite the contrary, in fact. Overall, income ine-
quality and poverty has declined substantially over the
last 30 years or so, with household income and living
standards improving significantly most notably in
emerging-market countries.
The third factor that has worsened income inequality is
financial globalization that is, the deregulation of
financial markets nationally and internationally via the
opening of capital accounts. Efforts at financial globali-
zation have not been evenly spread within societies:
Those who have been in a position to invest since the
1980s, be it via physical or financial assets, have
watched their incomes and wealth go up in line with
the boom in credit, fixed-income and equity markets.
In addition, from the early 1980s through the financial
crisis that began in 2007, employees in the financial
industry particularly in the US securities business
saw a sharp rise in income. Yet when the bubble burst
10 years ago, many of those who hadnt enjoyed the
market boom still suffered from the deep recession that
ensued. As a result, many blamed the establishment
and, in particular, the financial system.
All three of these factors contributing to income
equality hit the middle class especially the ones who,
because of their ages or their lack of appropriate edu-
cation, were not able to adjust and retrain themselves
as the global economy changed around them. Of
course, these angry, overlooked people are also voters
and in the US, they made up much of the base that
elected President Trump.
Page 4 The Economics of Populism | October 2017

Populism is not a fad Clearly, populist parties are in direct alignment with
a general shift in the worlds overall political mood,
With inequality remaining at historically high levels,
even though the agenda of many populists and
we expect populism to be not just a passing trend, but
movements can differ significantly (see Figure 4).
a political force for a considerable time.
Some are explicitly market friendly such as the popu-
This shift in the political mood in favour of populists is lists within the US administration or the Brexiteers.
not entirely surprising, particularly if one follows the Others pursue policies characterised by significant state
argument of Harvard economist Dani Rodrik. He believes intervention into business life for example, Syriza in
that societies cannot pursue globalization, strong nation Greece or Marine LePens National Front in France.
states and democratic rights at same time: One objective
always has to give.
Some populist parties have market-friendly
That may explain why today, the pendulum may be
policies, but others seek significant state
swinging away from deep economic integration and
towards individually stronger nation states. For intervention into business life
example, the pro-globalization mindset of a previous
era favoured global trade agreements, used the World
Trade Organization to settle trade disputes, and At the same time, several beliefs are similar across
constructed strong economic and monetary unions. most populist organizations. Chief among them are
Today, populists are fostering national sovereignty the desire to foster national sovereign rights at the
rights and cancelling international agreements the expense of supranational and international organi-
Brexit vote and the new US administrations withdrawal zations, and a preference for direct democracy over
from the Trans Pacific Partnership are prime examples. representative democracy.

Figure 4: Despite Mixed Views, Populists Clearly Share Certain Values

Party programmes show almost universal support for strong nation states and direct democracy

Globalization Nation State Democracy Economic Policy

Country Party/ Movement Trade Immigration Sovereignty Representation Redistribution Corporate Taxes Banking Sector Other
\
Germany AfD Mixed Populist Populist Populist Mixed N/A N/A Liberal/Consensus

France FN Populist Populist Populist Populist Populist Populist Populist Populist

Netherlands PVV Mixed Populist Populist Populist Liberal/Consensus N/A N/A Liberal/Consensus

Austria FP Mixed Populist Populist Populist Populist Liberal/Consensus N/A Liberal/Consensus

Finland Mixed Populist Populist Populist Populist Mixed N/A Mixed

Eurozone

True Finns

Belgium Vlaams Belang Populist Populist Populist N/A Populist Liberal/Consensus Mixed Liberal/Consensus

Italy M5S Populist Populist Populist Populist Populist Populist Populist Populist

Spain Podemos Populist Liberal/Consensus Populist Populist Populist Populist Populist Populist

Portugal Left Bloc Populist Liberal/Consensus Populist Mixed Populist Populist Populist Populist

Greece Syriza Populist Liberal/Consensus Populist Populist Populist Populist Populist Populist

UK Brexit movement Mixed Populist Populist Populist Liberal/Consensus Liberal/Consensus Liberal/Consensus Liberal/Consensus

Sweden Sweden Democrats N/A Populist Populist Populist Liberal/Consensus Liberal/Consensus Mixed Liberal/Consensus
EU ex Eurozone

Norway Progress Party Mixed Populist Populist Populist Liberal/Consensus Liberal/Consensus Liberal/Consensus Liberal/Consensus

Denmark Danks Folkeparti Populist Populist Populist Populist Populist N/A N/A Liberal/Consensus

Poland PiS Mixed Populist Populist Liberal/Consensus Populist Liberal/Consensus Populist Mixed

Hungary Fidesz Mixed Populist Populist Populist Populist N/A Populist Populist

US Trump government Populist Populist Populist Populist Mixed Liberal/Consensus Liberal/Consensus Liberal/Consensus
other

Russia United Russia Mixed Mixed Populist N/A Mixed N/A N/A Mixed

Source: Allianz Global Investors, University of Texas, OECD. Data as at 2013.

Page 5
With a few exceptions, many populist platforms have
other shared planks, such as implementing anti-
immigration policies and restricting the free movement
of goods and services. Addressing inequality is also a
common theme in many populist groups, though
certainly not all of them.
Interestingly, however, and contrary to what one
might have expected after the financial crisis, tougher
regulation of the financial sector is not a widespread
goal of populist parties. President Trump wants to re-
duce banking regulations, and the UK government is
trying to minimize Brexits minimum impact on its
financial system in the hopes of keeping Londons
position as the leading global financial centre.
Tougher regulation of the financial sector is not a
widespread goal of populist parties
Markets have recently shrugged off
populist wins
If we are right to expect that populism will not fade any
time soon, what are the likely implications for economic
growth and capital markets? When looking at market
movements in 2016, the answer becomes less obvious
than one might think:
The UKs unexpected pro-Brexit vote was
swallowed by the markets within days.
The markets shrugged off President Trumps
surprise election victory within hours.
Hardly anyone recalls the market blip that occurred
after the December 2016 referendum in Italy,
in which Premier Renzi lost out to the opposition
led by the Five Star Movement.
The markets reactions to these recent events feel like
outliers one expects the market not to like political
surprises but is that justified? Unfortunately, the
answer is not clear.
Academic work by Professor Schularick (University of
Bonn) et al. on countries where populists had come to
power shows that, based on 27 historical observa-
tions, the two- and five-year median inflation-
adjusted performance numbers of equities, bonds
The Economics of Populism | October 2017
and currencies in these countries was not that bad.
Economic growth tended to benefit from a rise in
government spending and investment activity.
However, there are several reasons why using
Mr Schularicks empirical work to draw firm
conclusions about how populism affects economies
today may be a questionable endeavour. Even though
the median returns shown in this study were positive,
its performance numbers covered a wide range. In
addition, and most importantly, the majority of the
countries included in the analysis had small economies
and/or were governed by populists who rose to power
in the three-decade-long run-up to the financial crisis.
These were years characterized by decent global
growth and globalization, which may have skewed
the results toward the positive side.
7 reasons why populism could create
serious long-term headwinds
This begs the question of what could happen today if
major economies, notably the US and the UK, began
trying to turn back time and pursue anti-globalization
policies. Would the results be as positive as the ones
shown in this study?
We believe that if todays populist trends turn into
policy, we could see several negative economic and
market implications some of which may be severe.
1
Closed borders could hurt growth
Anti-trade and anti-immigration policies are gen-
erally detrimental to productivity, which is the key
driver of economic growth in the long run. Various aca-
demic studies clearly show that free trade is conducive
to growth. This is not only because free trade enhances
productivity gains through a better division of labour on
an international level, but also because it enables a
transfer of know-how. In the same vein, migration is a
productivity-enhancing activity particularly, but not
exclusively, when a foreign labour force with different
skills is being added to a local workforce.
If populist trends turn into policy, there could be
sever economic and market implications
Page 6
Moreover, almost all advanced economies are facing
labour shortages in the coming decades, and migration
would help to alleviate this problem. As a result, erect-
ing walls is at least from an economic point of view
the opposite of what is required to stimulate growth.
Unfortunately, the number of walls at national borders
worldwide has increased more than threefold since the
financial crisis, according to the Financial Times.
Consequently, as populist parties increasingly
implement their agendas, trend growth a countrys
long-term average economic growth rate is likely to
be limited in advanced economies. Against this back-
drop, the US administrations ambition to lift trend real
GDP growth to more than 3 per cent each year is
inconsistent with the results it should expect from
implementing its anti-globalization agenda.
Trend growth in advanced economies is likely
to slow as populist parties increasingly imple-
ment their agendas
Figure 5: As Markets Soared, Compensation as a Share of Profits Fell
Inflation-adjusted S&P 500 vs. employee comp as a percentage of net corporate products
Inflation-Adjusted S&P 500
Compensation of Employees as % of Net Corporate Product (Inverted), rhs
8.0
low share of employee
compensation
S&P 500/CPI
4.0
2.0
1.0
1965 1975 1985
Source: Thomson Reuters DataStream, Allianz Global Investors. Data as at May 2017.
The Economics of Populism | October 2017
2
Protectionism could cause inflation
Anti-globalization policies become inflationary as
imported goods become more expensive for
example, because of tolls or tariffs. Alternatively, prices
may rise implicitly if domestic goods are preferred over
imported goods at same prices even if the quality is
lower. As a result, we believe that rising populism
globally means that inflation premia are set to rise.
3
Rising wages could hurt risk assets
The wage share is likely to rise and the profit
share set to decline in a world governed by popu-
lists. Why? Reducing globalization, whether in goods or
in labour markets, means shielding domestic labour
markets from international competition, which could
drive up wages. Moreover, this could, at the margin,
reverse the 40-year trend toward a flatter Phillips curve
the model that central banks use to measure how in-
creased levels of employment result in higher inflation.
As a result, we believe that rolling back globalization
means wages would, at the expense of the profit share,
increase by more than expected (see Figure 5). While
this development would be supportive for private con-
sumption, it would if past experience is any guide
also turn into a headwind for risk assets such as equities.
0.64
Comp/ as % of Corp. Product (Inverted)
0.66
0.68
0.7
0.72
0.74
high share of employee
compensation
0.76
1995 2005 2015
Page 7
4 6
The country factor will come into play
Investors will need to pay more attention to vari-
ances between countries as different risks arise.
Populists wont come to power everywhere but even
when they do, some will have market-friendly policies
while others will not. This country factor can be seen
at work within the Group of Seven nations. Consider
Germany, Canada and Japan on the one hand: These
are safe countries because populists are not enjoying
a resurgence there and the fewer anti-globalization
policies are enacted, the better for economic growth.
On the other hand, in countries such as the US and UK,
where populism is on the rise, investors may encounter
greater risks to growth. Consequently, we expect to see
a pick-up in the global dispersion of economic growth
rates which is currently close to a two-decade low.
5
Real yields could move higher
Real yields may rise in developed economies
particularly if populists implement redistribution
policies that cause a drop in ex-ante (projected)
aggregate savings and an uptick in ex-ante aggregate
investment plans. Why?
Private households with lower incomes could see
their incomes rise due to redistribution policies
and/or higher wages. These low-income earners
have a lower propensity to save. At the same time,
the rise in income may have a positive impact on
their real estate plans.
Governments would likely save less, and
instead would increase investment and
consumption spending.
Companies profit shares could come down, which
would most likely cause them to save less. The
impact on investment plans is unclear: While
deglobalization implies more domestic rather than
international investment, the lower general growth
outlook will have an offsetting effect. Projected
savings and investment plans can, in such a
scenario, only match when real yields rise .
The Economics of Populism | October 2017
Yesterdays winners could become todays
losers
Countries and regions that have benefited
most from globalization by building current account
surpluses are particularly at risk if the anti-globalization
trend takes root. This is especially true for emerging
economies, but it also applies to developed nations.
Consider Germany, which has a current account
surplus of 8 per cent of gross domestic product. This
gives Germany a strong economic footing, and it may
also help keep in check the support for populists who
are very much against globalization. Germanys
economy stands to lose from an eventual worldwide
anti-globalization trend.
Many countries are seeking new trade
agreements to fight the populist-driven
anti-globalization trend.
As a result, we are already seeing significant attempts
by various countries to make profound changes to their
economies. China is among those nations attempting
to shift their existing growth models away from exports
towards domestic and consumption-driven growth.
Other countries are working on bilateral and regional
trade agreements to fight the populist-driven
anti-globalization trend. Among the more significant
examples of this are:
The Comprehensive Economic and Trade
Agreement (CETA) between the European
Union and Canada.
The Japan-European Union Free Trade
Agreement (JEFTA).
The Regional Comprehensive Economic Partnership
(RCEP) between the ten Association of Southeast
Asian Nation (ASEAN) countries plus six more in the
Asia-Pacific region, including China and Japan.
Page 8 The Economics of Populism | October 2017

Figure 6: Historically, High Political Uncertainty Means Higher Volatility

CBOE Volatility Index versus Economic Policy Uncertainty Index, 1990-2017

300 75
Economic Policy Uncertainty Index
Economic Policy Unvertainty

250 Volatility Index (VIX), rhs

200 50
Index

VIX
150

100 25

50

0 0
1995 2000 2005 2010 2015

Source: Chicago Board Options Exchange. Data as at September 2017.

7
Political uncertainty could raise volatility
With economic policy uncertainty increasing
due to populists gaining voters backing, one
would expect capital markets to price in higher risk
premia. So far, this has not happened: The improve-
ment in cyclical data since last summer has masked the
populists wave (see Figure 6). However, once econom-
ic data start to weaken, markets may begin to reconsid-
er the environment of heightened political uncertainty.
The benefits of active investing in an
increasingly populist world
The rise in populism is a clear signal from voters who
feel left behind by globalization and have suffered from
growing income inequality. We believe populism is not
just a temporary phenomenon; it will remain a
challenge to the current order for some time.
Moreover, populism may cause potentially serious
headwinds for both economic growth and markets,
though this fallout will likely be felt more over the long
term than in the immediate future. Of course, other
factors notably valuation and structural growth
trends remain of utmost importance for long-term
investors. But populism must be reckoned with rather
than dealt with passively, because the waves it could
cause may be severe to those who are unprepared.
Active managers who understand the economic di-
mensions of politics well should help investors take
advantage of the opportunities and manage the risks
associated with this powerful political force.

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