Political risk - addressing the drivers

Extreme political risk is usually seen as a characteristic of emerging markets rather than developed.

The experience of countries just in Latin America seems proof of this with Argentina swinging violently from extreme left to extreme right governments, Brazil’s president under investigation, and Venezuela in chaos and repression.

Yet that view is more prejudice than reality: emerging markets are seeing changes of government for the better across the globe. Economic growth in developing markets is significantly higher and likely to remain so for years, if not decades, to come.

Political risk is increasing in the developed world and the underlying drivers need to be addressed. Developed markets are experiencing anti-establishment political movements evidenced by the Brexit vote, the US’s Donald Trump, and France’s Emmanuel Macron.

The world is experiencing a seismic change as emerging markets rapidly grow their economies, and the relative cost base of their educated labour creates a powerful arbitrage to switch manufacturing away from the developed world. A consequence of that swing has been the loss of large numbers of middle-class, well-paying jobs in developed markets.

A corollary of the loss of manufacturing jobs and the rise of the service economy has been the creation of ‘winner takes all’ businesses. The FANGs in the US – Facebook, Amazon, Netflix, and Google – exemplify the phenomenon. They dominate their respective marketplaces and are crushing ‘bricks and mortar’ companies that compete with them. Shareholders and employees of these companies do extremely well. Those in the companies that are crushed to oblivion fare badly.

It is a good example of Joseph Schumpeter’s idea of “creative destruction” that drives development. That is the nature of capitalism. The real problem for the developed world is that the new industries that are being created in the developed world are just not paying as much as the old. Conversely, emerging markets are seeing an explosion in the size of urban middle-class jobs paying far more than the agricultural jobs that employed the mass of labour a generation ago. 

Populist politicians in the developed world may be able to put sand in the machinery to slow down these seismic changes, but they cannot prevent them. They must cope with both an economic arbitrage driving middle class jobs to emerging markets, and the rise of ‘winner takes all’ in developed markets. It is a challenge few politicians seem equipped handle. It is possible, but it takes vision and very long-term thinking – including radical ideas such as Finland’s experimentation with universal basic incomes. Until more politicians find a means to think so radically, political risk will only increase in the developed world.

See IPE