What Brexit and the Trump election spell for the global economy
By Rhea Kumar
On November 8, international markets plummeted as it became increasingly clear that Donald Trump was going to be the next President of the United States. While the election results were surprising, the market’s immediate response was not. Throughout the year, Trump’s ratings had been negatively correlated with stock market performance. Investors expected the US stock markets to open at lower prices on Wednesday.
Instead, US markets rallied, closing more than 1% higher on Wednesday than on Tuesday night. The stock market mirrored the movements around Brexit in June, when markets tanked, then recovered. Yet, this time around, the recovery was much faster.
Stock markets are an aggregate of people’s expectations, and the upward movement indicates unexpected optimism about both Brexit and the Trump victory. Where is this optimism coming from, and should we expect it to continue?
A Wave of Anti-Globalization
The first contemporary wave of globalization occurred after the Industrial Revolution in the 19th century. As production of material goods in Europe soared, economists such as Karl Marx predicted that this era would not last. “[Free trade] breaks up old nationalities and pushes the antagonism of the proletariat and the bourgeoisie to the extreme point. In a word, the free trade system hastens the social revolution,” Marx argued in his 1848 speech, “On Free Trade.”
Today, Marx’s words point to many problems with free trade in industrialized societies, even if they do not quite predict the nature of the revolution. Today’s second wave of globalization, which began in the 1960s, includes not just trade flows of tangible goods, but also services, ideas, and people. Agreements such as the North American Free Trade Agreement (NAFTA) and the proposed Trans Pacific Partnership (TPP), promise to eliminate tariff-based restrictions on trade as well as enforce uniform labor and environmental standards. Furthermore, globalization has driven the economic growth of developing countries.
On the other hand, globalization relies on specialization and comparative advantage. Gabriela Hernandez, a lawyer and former Mexican government official who was part of the NAFTA negotiation team, compares trade to an orchestra in which every member specializes in one instrument to produce a melody. With globalization, Hernandez says, “Some sectors are hurt, but you specialize in others. Overall, there are positive figures.”
It’s a hard argument to sell to those once employed in manufacturing jobs in the US and Europe who have felt the adverse effects of outsourcing as a result of globalization. In the US, while the unemployment rate is close to its pre-recession levels at 4.9% of the labor force, the number of long term unemployed remains stagnant at 2 million people.
Due to its larger scope, this most recent wave of globalization carries greater benefits for some sections of the population than the first wave did. But it has also increased the number of people adversely affected by it, leading to severe political polarization. Permanent loss of manufacturing jobs has intensified conflicts between labor and capital, between the “bourgeois” in cities that benefit most from globalization and the “proletariat” in rural areas.
In a warped version of Marx’s predictions, we see an international trend towards a new wave of anti-globalization, xenophobia and overthrowing the status quo. Frustrated by job loss, dissatisfied with government policies, and fearful of losing their traditional way of life, rural middle class voters directed their anger towards the most visible sources of job loss: immigrants in the US from Latin America and Asia, and refugees from the Middle East into Europe and the UK.
Much of this anger, while understandable, is misdirected. Says Tom Maidment, a student at the University of Warwick and Editor of the Warwick Globalist, “The immigrants arrived while they [rural English citizens] were losing their jobs, but they wrongly associated their job loss with immigration. In reality, many of these jobs probably no longer exist.”
Scholarly research has shown most of the job loss in the US and Europe has been in professions in the middle of the skills spectrum, such as among automobile mechanics, machine operators, and administrative and sales people. The job loss has been attributed both to globalization and also to increased automation. Meanwhile, immigrants and refugees tend to work in professions lower down on the skills spectrum, as janitors, nannies or manicurists, and may also be willing to accept lower pay for the same jobs.
While academic and policy elites recognized that immigration is not the driving force behind job loss, the verdict in the US and UK shows that they were unsuccessful in relaying their opinion to voters and that they grossly underestimated the effects of an unemployed population who feel neglected. However, Maidment, who grew up in Taunton, Somerset, pointed out, “Outside of the metropolitan centers [in the UK], it wasn’t as surprising as the media maybe portrayed it.”
Stephen Roach, former Chief Economist at Morgan Stanley and now a Professor at Yale, was rather surprised at the election results. But he attempted to explain the phenomenon in its aftermath: “Win-win arguments of globalization don’t have traction with labor, they have traction with capital, and voters identify more strongly with labor.”
Building Roads, and Economic Imbalances
Part of the stock market rally after the election can be explained by the belief among investors that Trump’s economic policies will restore jobs, particularly in the manufacturing and construction sectors, which notably accounted for the majority of stock market gains. Business news sources hypothesized that the upward movement in stock markets was driven by Trump’s victory speech, which focused on bringing jobs back to America and rebuilding its infrastructure via more fiscal spending and tax cuts.
Yet the US faces a massive savings shortfall that will only be exacerbated by increased fiscal spending and tax cuts. “Right now, the US savings rate is at a third of the historical norm, and we’re going to come out of these next few years with an even lower national savings rate,” Roach argued. Mounting debt and low savings were major factors behind the Great Recession in 2008, and fiscal spending, while important to economic recovery, could easily repeat some of these patterns if it remains unrestrained.
The only way to fund infrastructure spending would be to attract foreign capital through US exports or the sale of US government bonds. Yet Trump’s proposed trade tariffs may prompt retaliatory measures from other nations, many of whom are large buyers of US government bonds. Nowhere will this be more apparent than with China, the US’s third largest export market, the largest holder of US Treasury bonds, and the second largest economy in the world. If Trump were to impose tariffs on Chinese products, China could retaliate with higher tariffs. Worse still, Roach argues, “One day the US Treasury would be auctioning a lot of bonds. And China wont be a buyer.” While the US’s trade deficits are alarming, reversing tariffs overnight will only distort international economic relationships and hamper plans to expand fiscal spending and economic growth.
Closer to home, repealing NAFTA would hurt both the US and Mexico. While Mexico, which exports 80% of its goods and services to the US, might feel the negative effects of NAFTA more strongly than the US, the US is not sheltered from the negative effects of a NAFTA repeal either. Mexico is the US’s second largest export market, and the exports to Mexico support about 1.1 million jobs in the US according to the Department of Commerce. Roach points out that any stop to trade, with Mexico, China or elsewhere will “only raise the cost of goods produced and sold in the United States, and tax the middle class Trump claims to help in the first place.”
Will the Policies Water down in Practice?
However, Hernández wants to avoid jumping to conclusions. “To be honest, I don’t even know if he [Trump] has a policy at this stage,” she said. She hopes that there are enough smart people on both sides of the border to prevent a complete elimination of the NAFTA, at the very least.
Roach echoes Hernández’s sentiments. “He (Trump) is certainly mindful of the dark history of trade wars,” Roach said. “He said a lot of things that were controversial to gain votes. Now he has to pick…what aspects of the program he wants to defend, and those that he wants to step back away from.”
On November 3, the British High Court ruled that the UK cannot leave the EU without Parliamentary approval, which could prevent Brexit from becoming a reality. Maidment, however, feels Brexit is inevitable, sooner or later. “I don’t think we can stay in…realistically,” he said. “I think they [those who voted for Brexit] would see it as the ultimate betrayal if we voted not to leave.”
Either way, the Brexit decision has already affected the UK economy. Many Britishers, including Maidment and his father, work for European companies that have begun shifting their operations to financial centers in continental Europe. Maidment acknowledges that there are problems with the EU, but he voted to Remain because he believed a hard Brexit would damage the UK’s economy even more. “A lot of people who voted out are likely to suffer the most,” he argued.
So what lies ahead for the stock markets and the American people? “It’s just putting popular politics ahead of macro analysis,” Roach said on Trump’s rhetoric. One can only hope that he realigns his priorities after the elections. Otherwise, this wave of nationalism could soon turn into an uncontrollable tsunami.
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Rhea Kumar is a junior Ethics, Politics and Economics major in Branford College. Contact her at rhea.kumar@yale.edu