The perils of populism

Principal Economist's View

If you thought Australian politics were turbulent – five more by-elections following the citizenship saga, a subpoena for Michaelia Cash (Australia’s Minister for Jobs and Innovation) over her involvement in raids on the Australian Workers Union, not to mention the dramas engulfing former Deputy PM Barnaby Joyce – think again. Australia pales in comparison to the turmoil facing the rising populism in the Northern Hemisphere.

The global dysfunction once again took centre stage this week. It all started in Italy, where President Sergio Mattarella sparked a crisis by blocking the appointment of a eurosceptic finance minister that led to the temporary collapse of a proposed coalition between the populist Five Star Movement and League (Lega) parties following the election in March. In scenes reminiscent of the debt crisis, Italian government bond yields spiked higher, with two year yields suffering the biggest one-day increase in over 25 years, eurozone banking stocks plummeted and global investors flocked to the relative safety of German and US bond markets. The move by Mattarella raised market fears of an imminent election, that was being viewed by the market as a quasi-referendum on remaining in the EU. Such fears have proven to be overblown, with the Five Star Movement and League reuniting to form a coalition that is expected to be sworn in on Friday.

While the immediate threat in Italy has subsided, significant risks remain over the longer-term. The coalition has proposed a government spending spree, tax cuts, a guaranteed basic income of 780 a month for the poor and a reversal of previous pension reforms. Popular policies, but expensive at a cost of as much as 6% of GDP annually. With government debt at 132% of GDP, the risk is that a populist government will push Italian public finances to an unsustainable level and struggle to implement difficult structural reforms required to boost productivity and competitiveness. The market turmoil this week serves as a reminder of the need for Italy to pursue fiscally responsible policies. But whether the populist parties will curtail to this pressure, or continue to rail against Brussels remains to be seen.

Just as the situation in Italy was starting to calm down, another populist threat was re-emerging in the US. The Trump administration announced on Thursday that it would impose 25% tariffs on steel and 10% tariffs on aluminium imports from the EU, Canada and Mexico; thereby suspending the temporary exemption that was given to the allies when the tariffs were announced in March due to a lack of progress in trade negotiations.

Europe, Canada and Mexico are all expected to respond with a tit-for-tat tariff hike. Canada has announced tariffs on a wide range of imports from the US, including steel, aluminium and other consumer products such as orange juice, bourbon, ketchup, insecticides and washing machines. The Canadian tariffs cover $12.8 billion of American imports, the same amount of Canadian steel and aluminium exports to the US in 2017. The EU is preparing tariffs on an estimated $2.8 billion of US products, including Levi jeans, Harley Davidsons and bourbon, while Mexico will also adopt equivalent measures on products, such as steel, lamps, pork, sausages, fruit and cheese.

In our view, the direct impacts of the steel and aluminium tariffs, including retaliation are expected to be limited. The hit to US real GDP growth from the measure is expected to be only around 0-0.1 per cent of GDP. This reflects the fact that total US imports of steel and aluminium are only around $50 billion, or just 2% of total imports. Tariff hikes of 25% on steel and 10% on aluminium, imply an increase in import prices of 0.35%, which would be expected to raise consumer prices by around 0.1% and lead to a reduction in real GDP by a slightly smaller amount. Of course, this calculation is based on all trading partners, and if we take into account the exemptions still in place, the hit to the US economy would be even smaller. Adopting similar logic, leads us to expect a small hit to the EU and Mexico of less than 0.1% of GDP from the proposed tariffs, while the hit to Canada may be slightly higher at around 0.1%-0.2% of GDP given the fact that Canadian exports of steel and aluminium to the US represent a larger share of the Canadian economy, at around 0.8% of GDP.   

Consequently, the direct impacts of the tariffs being discussed are small and should not derail the global economic recovery. Rather what we are concerned about is that the rise in populism causes events to spiral out of control; be it a tit-for-tat trade war the ensnares all US trading partners and products, the collapse of NAFTA, or a deterioration in public finances that sparks another sovereign debt crisis. While none of these outcomes are our central case, the perils of populism continue to cast clouds over the longevity of the global economic expansion currently underway.

Table 1: Financial market movements, 24 - 31 May 2018

Equity index



10-yr government bond



Foreign exchange



S&P 500





-11.8 bps

US Dollar Index (DXY)



Nikkei 225





-0.9 bps




FTSE 100





-17.1 bps









-13.1 bps




S&P/ASX 200





-13.5 bps




Source: Bloomberg

For the economic update by region, click here. 


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