This morning, I want to return to populism.
I don’t know what you feel about populism. You might feel that it’s a long overdue process of “taking back control”. You might feel that it’s a silly temper tantrum on the behalf of people who should know better.
But as an investor, you have to understand it.
And I’ve just read a paper that’s given me more food for thought on the matter than anything else I’ve read so far.
You need to get your mental map sorted
I’ve noticed that the bulk of opinion columns on populism tend to fall into two main categories at the moment: sneering or patronising.
The first category reads something like this. “These people are idiots. They don’t realise that what they voted for is the opposite of what they thought they voted for. I can’t wait to see the looks on their faces when everything goes pear-shaped and I get to say ‘I told you so’. That’ll put them right back in their boxes.”
Or: “These people are idiots. But there are good reasons for them to be idiots. I read the back cover blurb on Hillbilly Elegy in Waterstones the other day and it gave me a deep understanding of and a newfound compassion for the global working class, which I will now pass on to you. And then we can put them back in their boxes.”
I’m sure these pieces are fun to write. The authors of the second category might even genuinely feel that they’re being insightful.
But none of this is of much use to investors. If your starting point is that people are irrational, or just plain thick, then you’re going to struggle to understand what’s driving this shift and what might come next. And if your mental map is based on all the wrong assumptions, it’ll lead you down all the wrong roads.
Of much more use is a piece I just read from (as always) US asset manager GMO. “The deep causes of secular stagnation and the rise of populism”, by James Montier and Philip Pilkington, is an intelligent, data-backed polemic that gives a very convincing view on what lies at the heart of both our ultra-low interest rate environment, and our turbulent politics.
(I’ll put a link to the whole piece – which you should read – at the bottom, but I’m going to force you to read through my summary first.)
How a flawed view of economics crushed the workers
The GMO paper is 22 pages of densely-packed argument, so I can’t do it full justice here. But I’ll try.
Montier and Pilkington’s first point out that the “secular stagnation” (today’s world of low interest rates and low growth) that the likes of former US Treasury Secretary Larry Summers keep complaining about, is a direct result of central bank and government policies that people like Summers presided over.
Why? Because these policies created a world where “the workers” were crushed by globalisation, declining trade union power, and central bank and government policies that fetishised a flawed inflation measure over encouraging full employment.
Meanwhile, we have a very flawed version of capitalism that prioritises short-term shareholder returns over long-term investment. As a result, managements of publicly owned companies with flawed compensation packages have every incentive to focus on financial engineering (to boost their own pay packets) and to avoid long-term investment (because it dents short-term profits).
And everyone in the system is incentivised to take on more debt. Workers with little bargaining power use debt to supplement inadequate wages. Companies use debt to fund payouts to shareholders in the absence of sufficient profit-generating capacity to do so from genuine growth.
It’s an unsustainable system, and one that blew up very visibly in 2008. That was when people started to wake up to the fact that the system wasn’t working. And when “citizens of various countries around the world gradually woke up to the fact that the quick-fix solutions put in place after the crisis merely kept a lopsided and increasingly dysfunctional system ticking over, they rebelled”.
What happens when trust breaks down
You almost certainly won’t agree with everything that Montier and Pikington have written – I’m pretty sure I don’t. But their narrative is compelling, and what’s important is that it’s rooted in an understanding that our system does need reform.
2008 didn’t come out of the blue, or as a result of some random piece of bad luck. It was an inevitable result of flawed policies and flawed structures and we haven’t really addressed those yet.
Having society in thrall to any one special interest group – be it capital or labour – is incredibly unhealthy. And over the last 40 years or so, the skew has been very much towards capital.
Look at our tax system. It’s almost designed to discourage anyone who has to earn a living through their labour. At both ends of the spectrum (the very bottom and the very top – or rather, £100,000-plus), marginal tax rates on income are stratospheric, due to various allowances or tax credits being taken away at certain points.
The tax treatment of capital and debt, on the other hand, is far more benign. As a result, our tax system incentivises individuals and companies to spend as much time engaged in changing the way that their affairs are structured, as in doing genuinely productive work.
And meanwhile, the assault on workers continues. Every day we’re hearing about robots taking over our jobs – the subtext being that you’d better not ask for a pay rise. You can view companies such as Uber (Izabella Kaminska over at FT Alphaville has written extensively about the idea of techno-feudalism) and the rise of the gig economy as yet another way to erode workers’ share of the wealth.
You might find all this a bit “lefty”. And you can overstate the case. We might not like where we are, but I don’t think most people are keen to go back to the 1970s either.
And lots of columnists would at this point mount a vigorous defence of abolishing minimum wages, maximising shareholder value, and outsourcing manufacturing to nations that do it better and cheaper.
However, the point I’d like to make is that what you think of these arguments is not the main issue here. It’s easy for us to assume that the way things are, is just the way that things have to be. That’s not the case.
Every economic and political system is a human construct. They survive as they are because the majority of individuals within the system accept and abide by the rules that sustain the construct. That requires trust.
Once trust breaks down, the construct is unsustainable. The economy and political system has to change. Change is usually painful, but the degree of pain depends on the flexibility of the society. Change can be catastrophic (as in the Soviet Union) or it can be more incremental (as hopefully Brexit will be, for example).
But for investors, this matters. If the pendulum swings back from capital to labour, then that implies many things. On the upside, it implies a focus on longer-term investment, improved productivity and wages, and a move towards equity and away from debt.
On the downside, it implies that companies, which are overvalued on the basis of financial engineering, poorly paid workers, and arbitraging regulatory conditions between one end of the world and the other, will struggle. And that’s a lot of companies.
Anyway, I’d recommend you read the paper – here’s the link. It’s definitely food for thought, and Montier and Pilkington also have some interesting policy ideas for moving on from where we are.