Populism Is Bad Economics, Lessons For Donald Trump From Latin America
Populists sometimes have good ideas. Taking advantage of historically low interest rates to launch a stimulus plan, for example, is a good idea. Standing up to China, which is massively subsidizing its steel exports and restricting freedom to invest in the country through law and might, is another good idea. So too is rethinking certain agricultural, environmental and banking policies that are counter-productive. Fighting measures that lead to cash-strapped governments and lower wages is smart and right as well. More generally, wanting to reform capitalism to make it fairer and more inclusive is a good idea.
So why then does history show us that populism always fails?
Economists Rudiger Dornbusch and Sebastian Edwards carried out the most meticulous study to date on the populist policies implemented in Latin America in the 1980s and 1990s. The U.S. isn't Argentina or Peru but we can be certain that the International Monetary Fund will not be happy with Donald Trump's upcoming presidency.
Economies nowadays are no longer threatened by inflation. It's deflation that's the problem. But there are many plans that Trump shares with Latin American countries, so making a comparison is still relevant. At first, these countries were all successful in implementing populist policies. Similarly, the U.S. stock market rose after Trump's victory. It always looks like it's working at the beginning. Unfortunately, the economy soon goes adrift and extracts a frightening cost from the very groups that were supposed to benefit from populism.
Latin American populism was built on three pillars that can be also be found in Trump's rhetoric. First, a political message that rallies the people, for the people. It used to be the poor in Latin America, it's now the white working-class in the U.S. Second, a strong government that promises to raise wages and boost manufacturing that previous governments were too cowardly or corrupt to take on. Finally, a rejection of traditional economic constraints like inflation, the deficit and exchange rates, which are dismissed as exaggerated or false.
Dornbusch and Edwards think that those who advocate for such policies are sincere. So let's set aside our doubts and assume that billionaire Mr. Trump has honorable intentions. Populists rely on a stagnating economy, the profound dissatisfaction of a majority of the population, and anger from groups who feel abandoned.
What are populist solutions? In a nutshell, control and spend. The first policy is redistribution. The second is a fiscal stimulus plan to launch a public works program. This expansive set of policies is expected to kickstart the economy. In Trump's case, tax breaks will also benefit the wealthy, who spend less. This approach works at first.
But the economy soon gets stuck in bottlenecks. Consumption leads to imports. The trade deficit gets larger and inflation rises. The government has to start controlling prices, capital flows, and the currency's exchange rate as it slides. Then comes the time when wages have to be capped even as inflation continues to rise, which cripples people's spending power. The same government that promised to rein in the economy sees it escape from its grasp. The crisis becomes political, unrest spreads, protests become violent, the government is overthrown. In Argentina, Brazil, Chile, Peru, Mexico, Nicaragua, Venezuela, the populist experiment ended in the same way — with failure and bankruptcy.
Maduro, a populist strongman in Venezuela — Photo: DiarioCritico Venezueal
In their study, Dornbusch and Edwards conclude that the "profound ignorance" of populist leaders in how the market economy works is the underlying cause for these catastrophes. Ignorance or disdain, it all boils down to the same result, and the backlash is brutal.
The U.S. is the world's largest economy and the dollar is king, which means that Trump won't be affected by many of the constraints that brought his predecessors in Latin America down to their knees. How things will unfold in the U.S. isn't set in stone. Though not as reliant on other economies as some countries, the U.S. economy is no longer autonomous.
The Federal Reserve has held its interest rates steady for a year to avoid weakening the global economy — something that would hit the U.S. with a return shock. Should Trump's plan be implemented, the budget deficit will grow by 3% and debt by 25% within 10 years. What effect will this have on the U.S. dollar, on inflation, on net salaries, on imports and, thereby, employment in manufacturing? In the end, the white working-class could very well be the victim of Trump's policies.
Populists do have good ideas. But how their ideas are designed never seems to work out. A new kind of capitalism will be difficult to implement. It requires intimate knowledge of how the market works, great humility, pedagogy and, most of all, vision. It requires us to think about a reinforced globalization, and not a return to nationalization. In other words, it requires the exact opposite of what Trump wants.