The economic consequences of Mr Xi
Globalisation means that we are all exposed to the functioning of political institutions in large economies such as the US, the EU and China. Large country decision-making on trade, monetary and fiscal policy, or security and climate change, has direct international repercussions. The introduction on Thursday of tariffs on steel and aluminium by the US is yet another example. The quality of large country political institutions matters at home and abroad.
There has been much concern expressed about populist risks to political institutions in developed countries over the past couple of years. Indeed, assets across several advanced economies have attracted a political risk discount of a type familiar to emerging markets. The weak USD regime is one example of this. And the euro and GBP are moved as much by political dynamics as by changes in the yield differential.
However, despite concerns about an unravelling of norms and institutions, many advanced economies have proven relatively resilient. US political and civic institutions seem to be holding up; and fears of a populist wave in Europe reduced after the electoral results in France and the Netherlands in the spring of 2017. Progress has been made in advancing trade liberalisation, with strong leadership from the EU, Japan, and others. There are of course serious economic and political issues outstanding in developed countries. Things could yet go wrong in the US in the context of deep partisan divides, from Fed independence to trade policy; and there are risks around the Italian elections this weekend, as well as challenges in eastern Europe, from Poland to Hungary.
But events this week have reminded that emerging markets are a key source of systemic political risk, and increasingly so. News came on Sunday afternoon that the two-term limit on the Chinese Presidency was to be removed. This was not altogether unexpected, but it is still a bracing moment – and perhaps one of the defining days of the early C21. The return of personalised rule brings to a halt the gradual process of institution building in China designed to reduce the chances of the chaos of the Mao era returning.
The period of economic reform and opening up has been in hiatus for some time under President Xi, but this decision takes matters to another level. It is not clear that this move precedes a particular economic policy agenda – but the argument that the consolidation of power is a necessary precursor to economic reform is increasingly weak. There are fewer checks and balances in the Chinese system as power consolidates, and removal of term limits will weaken the consensus-style model of decision-making. The past century of Chinese history does not provide much confidence in personalised governance; which is why this term limit was established in the first place.
At a minimum, the consolidation of power raises the risk profile of China significantly. The economic outlook will increasingly be contingent on decision-making by one person. It may be that President Xi makes sensible policy decisions for a time, but there is less to stop poor decisions – which are inevitable at some point. The probability of things going badly wrong is higher. In my last Observer note, I noted the dangers of hubris by large powers that were unconstrained by economic or political disciplines. This risk already seems much higher than when I wrote the note.
And unfortunately these autocratic tendencies are not unique to China. Examples can be seen in the strongman rule of Mr Erdogan and Mr Putin, to the weakening of political institutions in Asian countries such as the Philippines, Thailand and Cambodia. The EIU’s democracy index confirms a weakening in the strength of democracy around the world, particularly in emerging markets.
These developments matter directly for the citizens of these countries, in terms of their freedom and prosperity. But these trends also have a systemic effect. Relative to 20 years ago, the global economic outlook has a more significant political risk dimension. Advanced economies are subject to political risk, as noted above, but the often less-developed political institutions in emerging markets create significant potential for disruptive political shifts. And as emerging markets continue to grow in importance, the global economic and political risk profile will also increase.
China matters particularly because it is increasingly at the centre of the global economic and political system. The growing political risk profile in China translates directly into a higher global economic risk profile, both in terms of the impact of disruption within China as well as in China’s relations with the rest of the world.
Small advanced economies are at the sharp end of this, because of their acute exposure to the global economy. And recent analysis I have done reveals a particular exposure of small advanced economies to emerging markets. Small economies have strong domestic political institutions. But they remain deeply exposed to changes in political institutions and norms in large economies.
I remain positive on the global economic outlook, and on the outlook for small advanced economies. 2018 has started well, with robust numbers on trade, industrial production, and consumer spending. But the global economy does not run independently of the international political environment; and there is growing political risk across emerging markets, the increasingly dominant part of the global economy. (With apologies to John Maynard Keynes), the economic consequences of Mr Xi include a series of substantial global economic and political risks.