To me, the most troubling reality highlighted by the Brexit outcome is the destructively circular relationship between the forces which cause the anti-establishment discontent and the consequences which result from the popular outrage.
Living standards for a majority of households in developed economies have been declining, despite positive real economic growth, because current levels of income inequality allow the mean income to increase while the median income still decreases. As income inequality worsens, for a given unit of economic growth, an ever larger portion of the population may see their real income and standard of living fall1. Globalization also appears to have intensified income inequality in developed market economies, because the beneficiaries of globalization were the owners of capital – primarily the top 1% of income earners in DM – and competitively-priced labor in emerging markets, a.k.a. the “global middle class.” Middle-income households in developed markets were left behind, with no growth in income2 (see chart). As the economic plight of these households has worsened, their discontent has fueled a sense of outrage, and a desire to rebel against globalization and income inequality. At the same time, the number of households affected in this way is growing, and at least in the case of the UK, they now represent the vox populi.
In my view, DM economies desperately need to reverse declining median living standards. The only solution is to grow more quickly economically, and for that growth to be shared in a more broad way across income strata3. At the same time, there is growing acceptance of the idea that potential growth rates in developed economies are restrained by unfavorable demographics and languishing productivity4. The only practical ways to increase potential growth rates in the DM economies are to increase the growth rate of the working age population, or to increase the growth rate of productivity per worker. Unfortunately, each of these two levers is directly threatened by anti-globalization/protectionist political success.
The growth rates in the working age populations in DM economies which are implied by demographic calculations are not good. For the US, our working age population is set to grow at about 0.4% over the next 7 years, and it’s worse elsewhere in DM. Practically speaking, an economy can “fix” a demographic issue with slow working age population growth through immigration, but protectionist political success would almost certainly result in fewer, rather than more immigrant workers entering the labor force.
With demographics seemingly intractable, the only way to restore higher levels of growth to the developed world is through dramatic productivity gains. This seems plausible, but short of wholesale changes in education policy which take a generation to pay off, improving productivity is accomplished through business fixed capital investment. That is, businesses invest in machinery, infrastructure, worker training, and technology that increase the output per worker. Notwithstanding anecdotes to the contrary, generally in DM fixed investment has been lackluster, but this leaves room for potential improvement.
Specifically, undertaking productivity-generating fixed capital investment requires creative, risk-tolerant, trenchant businesses. The future prosperity of developed economies rests on the confidence of its business leaders to invest and accept risk, and that confidence may have taken a serious beating last week. Potentially that confidence was undermined because fixed capital investment is funded (by definition) by the owners of capital, who have benefitted from globalization (chart) and are squarely on the receiving end of anti-establishment rhetoric. If disruptive political outcomes sap business confidence (and in my view, they will), the outlook for future productivity gains darkens, and by extension, so does the outlook for broad-based economic growth.
The views expressed in this blog are the views of the authors and do not necessarily reflect the views or policies of JPMorgan Asset Management (JPMAM).