The world has grown up since Adam Smith penned the “Wealth of Nations” in 1776. Many economists believe that global integration and technological progress offer substantial and diverse benefits. But the cost of creating such wide benefits is more concentrated, which inevitability leads to rising inequality and political turmoil. To mitigate the growing pains associated with globalization, governments often increase redistribution and investment in education to lessen the localized pain hoping to get the balance right, and in time, to avoid a reversion to populist-driven nationalistic trends.
But the anemic yet steady economic environment that has persisted for the last number of years has led to growing angst amongst the developed world populist, as wage growth and living standards have stagnated. Add an increasing number of migrants from less developed and struggling economies who are looking for greener pastures and government officials behind the curve on strategy and implementation, one will find growing ranks of disaffected people seeking to balance the scales. (For more, see: The World's Top 10 Economies.)
Officials from around the world remember 1937 when the perils of tightening monetary and fiscal policy too early in a recovery pushed the United States back into a nasty recession. That experience led to the unprecedented and long-lasting loose monetary policy we are experiencing today. Looking forward, officials should pull out the textbooks on the economic perils of establishing barriers to trade and immigration. The infamous Tariff Act of 1930 (known as the Smoot-Hawley Act) marked the final chapter of increasing U.S. tariffs and nationalism, and put the nail in the coffin for global trade at the worst possible time.
Prior to the 1934 Act, high tariffs had kept imports out which increased demand for domestically-produced goods and, of course, domestic workers. Immigration supplied an endless number of workers, creating a win-win scenario for the U.S. industrial economy. However, cities became overcrowded, the physical capacity to absorb new arrivals decreased and immigration became a zero-sum game, where the economic gains accruing to immigrants were more than offset by losses suffered by natives.
In response, the Johnson-Reed Act of 1917 was implemented and was shortly followed by the 1921 Emergency Quota law, the first quantitative restrictions on immigration, which limited arrivals to 3% of the foreign-born population. Immigration was cut again in 1924 to 160,000 a year and by the late 1920s, was down to 50,000 a year. As the U.S. and global economy cratered at the start of the Great Depression, the 1934 Reciprocal Trade Agreements Act sought to reverse the Smoot-Hawley damage by liberalizing trade through bilateral or multilateral tariff reductions to restore economic activity, leaving immigration rules generally unchanged. At the time, the combination of protectionism through trade and immigration policies and lacking monetary policy in the midst of financial market panic was too much for the economy to take.
Experience is a wonderful thing, especially when that knowledge is applied to the present. The global economic integration path we have been on for the last six decades was formally interrupted by the recent populist vote in the United Kingdom to secede from the European Union (EU). It should not be the stop sign that some envision, but rather a detour along the path seeking to balance inequalities. In the end, as currently structured, cessation harms the U.K. more than the EU, and much more than the U.S. As EU members view the complications and economic impact on the U.K., it may lead to closer integration or it may be the first shot over the bow of the EU. (For more, see: How Brexit Can Affect the European Economy.)
It is the uncertainty surrounding the “type” of economic relationship the U.K. will have with the EU and the rest of the world and the potential ripple effects within the EU that is causing the current consternation. By now we have all been exposed to the headline information about many of the upcoming complications. We believe the uncertainty will likely delay capital investment and the longer the uncertainty lasts, the greater the economic impact.
The U.S. is not immune to populist movements seeking to cure inequalities left unchecked by current leadership. One only has to examine the support for Bernie Sanders and President-elect Donald Trump during their respective campaigns for president. But political sound bites cannot solve economic or humanistic situations. And much like watching sausage being made, politics is a gruesome process. Many politicians don’t have the stomach to make the right decisions and most voters don’t have the patience to let good decisions run their course.
One of the more significant issues constraining economic growth in the U.S. has been a prolonged lull in capital investment. While furthering demand for what has been cheap human capital (stagnant wages), taking the unemployment rate below 5%, the lack of capital investment has held back productivity growth, profit growth and economic growth. In addition, the World Trade Organization (WTO) calculates that global trade restrictions amongst G20 countries are rising at the fastest rate since 2009 (the first year of measurement). The Transatlantic Trade and Investment Partnership (TTIP) between the U.S. and the EU will now likely be placed on hold.
As a global leader, the Federal Reserve realizes its domestic monetary policy has an impact on the global economy. It may be the case that the U.S. is turning the corner on capital investment, and now the Fed has voted to raise interest rates thanks to continued job growth and signs of economic expansion in the second half of 2016. Are we seeing catalysts to create a rising tide to raise all boats? It is too soon to tell and investors will need to remain focused and selective as we follow what will be a very interesting next few months around the world. (For more, see: Trump's Economic Growth Plans.)
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