Boom, Bust, and Ballot Box: How Hyper-Inequality Fuels Political Turmoil
The US economy continues to grow and equity markets seem unstoppable - so why is the American political landscape so volatile?
Make no mistake, the United States living standards are still growing by one measure, but the long-term trend and its impact on domestic politics and foreign policy is worrying.
Geopolitical Strategist Dimitri Zabelin paired up with Senior Strategist Daniel Dubrovsky to offer insights on the connection between markets and politics. Let’s take a look ⬇️
Author: Daniel Dubrovsky, Senior Strategist at DailyFX
If someone were to ask you how to gauge a country’s economic output, you might think of using Gross Domestic Product (GDP). It is the total value added in the production of all the finished goods and services within a nation’s borders during a timeframe. But, what if you wanted to estimate the contribution of each person? By dividing GDP by a country’s population, you arrive at GDP Per Capita.
We can also adjust this for inflation, creating Real GDP Per Capita (RGDP/Capita). Economists often use this gauge to look at a nation’s prosperity, as well as get a glimpse at living standards. Some of the highest readings can be found in Luxembourg, Ireland and Norway. However, this is mostly due to their relatively small populations and unique roles in the global economy, such as Luxembourg being a financial hub.
As of May 2023, the United States is just a little bit further down the list, wedged between Qatar and Iceland. In the first quarter of 2023, US Real GDP Per Capita was approximately $60.6k, representing a growth rate of 1.3 percent compared to the previous year. That is just below the 1.5% average seen in the period between the 2008 Financial Crisis and Covid.
Just before the latter, RGDP/Capita peaked at about $58k, dipping to a post-Covid low of $52k. It only took about 6 quarters to surpass the previous peak. A much slower pattern happened around the 2008 Financial Crisis. The gauge reached its peak at $52k in Q4 2007, then dipped to a low of $49.4k in Q2 2009, before finally surpassing $52k again in Q3 2013. This took about 23 quarters or nearly 6 years!
The speed at which living standards recovered after Covid was a remarkable feat. That said, and as we shall see, a closer look at the data reveals that the trend’s long-run evolution is worrying. The chart below is RGDP/Capita since 1947. After World War 2, the gauge clocked in at just shy of $15k. Since then, the time series has exhibited an exponential trend, represented by the red line on the chart below.
When the blue line was above the red line, it indicated that living standards were outperforming the trend (in hindsight), and vice versa. Do you notice what happened after 2008? Real GDP Per Capita fell below the trend, and although it has continued rising, it remains below the red line. The gap between the two is also widening. But we will need to transform the time series to see this more clearly.
The first step in this process will be to remove the curved trend and steady the time series. This can help RGDP/Capita exhibit a consistent growth rate. Imagine you go from having $1 to $2 from January to February, it will indicate 100% growth. If you go from $2 to $3, you still added $1, but this represents a slower 50% increase. We want to show the blue line maintaining a steady growth rate.
A logarithmic transformation does the trick, which is shown below. This transformation allows us to fit a straight line through the series more accurately. The first chart was better characterized by a curved trend. Applying this transformation allows us to estimate the average growth rate. US living standards have increased about 0.5% every quarter since 1947.
To understand the next chart, you need to keep the following in mind: we know that US living standards have been growing over time and the series is trending upward. Economists are often interested in the business cycle, or the cyclical upswings and downswings of growth. You can observe this in RGDP/Capita by looking at the two charts above and visually identifying when the line is rising and falling.
But, we can make this easier to see. By leveling and flattening the linear trend (represented by the red line above), we obtain the chart below. The blue line now represents the distance between RGDP/Capita and the trend at each point in time. It is a simple equation: (RGDP/Capita – Trend) = Result. In this case, the result is referred to as the 'residual'.
Think of the red line below as the trend that is rising over time (living standards growing) even though the line is flat. When the blue line is rising above the red line, that means living standards are growing above trend. Conversely, when you see the blue line falling under the red line, that means living standards are decelerating relative to the trend.
Remember about how the trend’s long-run evolution is worrying? After the 2008 Financial Crisis, although living standards eventually returned to pre-crisis levels, growth did not follow the previous trend. In fact, relative to the trend since 1947, Real GDP Per Capita has been rapidly decelerating. As of the beginning of 2023, the United States was in its 57th (14.25 years) consecutive quarter of sub-trend growth.
In other words, despite RGDP/Capita surpassing pre-Covid levels, living standards are still about -8.6% below the trend. In Q4 2019, the deviation was about -6.6%, reaching a peak low of -17.7% in Q2 2020. In fact, the slowdown in RGDP/Capita since the 2008 Financial Crisis marked a major turning point from the impressive streak of growth seen from the mid-1960s up until the 2000s Dot-Com Bust.
What would it take to bring living standards back to the trend? As of the first quarter of 2023, Real GDP Per Capita needs to increase by about $5.4k – see chart below. It seems the last nearly 15 years have not been as prosperous as before. In turn, this has had its consequences, especially on the political spectrum.
Author: Dimitri Zabelin, Geopolitical Strategist at Pantheon Insights
It’s not surprising to see that a pronounced slowdown in real living standards has also led to a commensurate rise in domestic and international political volatility. In the US, hyper-polarization has led to numerous legislative gridlocks and erosion in public discourse from both parties. It is certainly a multivariate problem, but to quote James Carville: “It’s (mostly) the economy, stupid.”
Source: Pew Research Center
While collective wealth has grown, the perception that others have asymmetrically benefited from economic growth has created a corrosive resentment. There is a growing body of literature about inequality and the notion of fairness that shows even monkeys have a conception of it.
This has created fertile ground for political fringes across the political aisles to push radical agendas and capitalize on the disparity in prosperity. The result is ever-growing polarization, led by a political periphery with a loud voice and misguided conviction. While this trend goes back decades, it has accelerated recently.
Source: Council on Foreign Relations
A study conducted by Brown University found that: “In 1978, the average American rated the members of their own political party 27 points higher than members of the other major party. By 2016, Americans were rating their own party 45.9 points higher than the other party, on average. In other words, negative feelings toward members of the other party compared to one’s own party increased by an average of 4.8 points per decade”.
What does this mean for policy?
Countries all over the world have elected/supported officials who turned away from global cooperation and fostered growth-inhibiting, nation-first policies to appease a base of disillusioned voters or solidify their authoritarian grip.
Whether it was the “America First” slogan and trade wars of Donald Trump, or Xi Jinping’s Wolf Warrior style diplomacy and aggressive expansion in Asia, all have one thing in common: a departure from the post-Bretton Woods system of globalization, which markets and economies have built their supply chains and businesses around.
As I argued in my report for the London School of Economics - and as the data above shows - the 2008 financial crash and subsequent recession was a key catalyst in this paradigm shift:
The 2008 recession was not only a financial cataclysm that subsequently plunged the global economy into a recession, but also the start of a general erosion of trust. Blind belief in the system back then, created an underlying complacency. As Oaktree Capital Management Co-Founder Howard Marks put it (quoting Peter Kaufman); ‘as any system grows toward its maximum or peak efficiency, it will develop the very internal contradictions and weaknesses that bring about its eventual decay and demise’. In other words, the stability and efficiency of the system itself, ironically created the circumstances for its own collapse. Confidence led to arrogance, then complacency, and in this subdued state policymakers and Wall Street executives let go of the wheel and drove the economy into an abyss. This behavioral change was also evidenced in the cycle of market ‘booms and busts’; strong economic times lead to confidence, strengthened optimism leads to higher risk-taking behavior, due-diligence protocols are relaxed until the fantasy wears off and the reality is undeniable.
The subsequent handling of the crisis and the asymmetry of the recovery led the vast majority of Americans to believe that the institutions were not working for them. Faith and trust in the government began to plummet. What then followed were widespread protests, such as the ‘We Are the 99%’ protests, and intellectuals questioning the validity and functionality of the current system. This involved a deep questioning of long undisputed policies like globalization, the nature of third-party institutions like the IMF and WTO and even the government itself. Looking beyond the hysteria, the main resounding outcome was the significant increase of inequality in difficult times. It should be noted that inequality in and of itself is a natural phenomenon and should not be discouraged, but there is a point at which its extremity will lead to a ‘mobilization of resentment’ and create a political climate of distrust and disorder.
As a result of this new climate, countries are prioritizing nation-first security over hyper-efficient economic integration - and this isn’t exclusive to the left or right. Under Trump, we saw a decoupling from China vis-a-vis trade wars. Under Joe Biden, we are seeing what I have characterized as a Promethean War: restrictions of strategic technologies to China with Beijing leveraging its position in the global supply chain of key minerals to strongarm the US. What both parties and administrations have done and are doing is weaponizing interdependence to achieve a geo-strategic end. This is a key characteristic of the new global paradigm.
Whether the policies are strategically prudent or not is irrelevant. What matters is it signifies the departure from the old system into a new one. Specifically, a new global political economy that businesses, heads of state, and investors alike all have to contend with for the foreseeable future. Pantheon Insights was born in response to this paradigm shift, and offers strategic insights to its clients for navigating the labyrinth of this new global political economy.