There’s been a lot of political drama around the world over the past year or more – Brexit, Trump, and the UK and French elections. New Zealand’s last election had the odd twist and turn and the upcoming election will no doubt also have some surprises; we’ve already seen a shock early in the current campaign with a change in the Labour Party leadership.
Governments control large resources, pass laws, set taxes, and spend vast amounts of money. Surely, therefore, surprising shifts in political direction will have serious implications for markets and the returns we get on our savings? Changes in policies that result from shifting political winds will ultimately have a lasting impact on investments if they affect peoples’ spending and saving behaviour and company earnings. The reality, in most established democracies, is that such policy changes are rare.
Why govts. struggle to make big economic changes
A key reason why governments usually have difficulty in making economic changes that really shift the dial for markets is because political systems require compromise. We currently see that in the US, where the Trump administration is having a lot of trouble making economic changes, despite his Republican Party dominating Congress. UK Prime Minister Theresa May is grappling with differing views within her own party on the country’s exit from the eurozone. Here in New Zealand, our proportional system means governments often must modify their intentions to keep other parties happy.
Another barrier to unfettered policies are the checks and balances built into political systems. On the economic side, this includes legal limits on spending, the size of deficits, and debt. Coupled with modern requirements for transparency, this prevents governments from spending up a storm. New Zealand governments have a good record in recent decades of keeping a tight rein on their finances. The risk of being imprudent is one governments here try to avoid. It’s notable that, in advance of the upcoming election, the major political parties have pledged to stick to prudent guidelines for government finances.
Free flow of money and the ability of investors to “walk with their money” is another reason for expecting modesty in the policy arena. Even if a political party can minimise compromises and bypass checks and balances, policies that are seen as financially irresponsible could make foreigners less willing to lend to a country and cause higher interest rates. This ultimately leads to poorer economic outcomes. It is a constraint that is particularly acute for New Zealand, which depends a lot more than many other countries on access to overseas capital.
Is real change possible?
Are governments totally toothless? Not at all in my view. Sound and stable government is critical to delivering fair regulations, good quality services and support for society. When standards materially slip, voters notice and change often occurs. But seldom do these changes have lasting and meaningful impacts on markets. When things are ticking along, markets tend to focus on the usual course of economic cycles and prospects for companies.
Major, market-moving changes have been made in the past by governments in New Zealand and overseas. New Zealand’s reforms in the 1980s and ’90s are an example. Governments here and offshore made critical decisions in response to the global financial crisis after 2008 that shored up confidence and prevented economic catastrophe. However, these types of developments generally happen once in a generation, or in several generations, in response to severe economic pressures.
In more normal times large policy changes that have lasting effects on markets are infrequent. For a time, select sectors or industries may be affected. The odd market blip can occur when a particularly surprising political result occurs. But, it takes a lot more than blustering politicians and swathes of articles in newspapers to get most investors hot and sweaty, which is why markets have continued their merry way in recent times, despite political ructions around the world.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any investment decisions.
John Carran, Senior Economist at Gareth Morgan Investments
You can read more articles by John on our blog.