Looking backwards, it’s possible to see a number of turning points in the political zeitgeist.  America moved toward (left wing) liberalism around 1964, then swung back toward (right wing) neoliberalism in the late 1970s, and then toward nationalism in recent years.  And these were worldwide trends, with nationalism also on the rise in Europe, Russia, Turkey, India, China, Japan, and many other places.

Tyler Cowen pointed me to an article that suggests another turning point, which many people missed at the time.  The new millennium ushered in an Age of Complacency:

The eminent political economist Ross Garnaut says the Great Australian Complacency, as he calls it, took hold of the political system from 2000. This locates it halfway through the Howard era.

How can he be so specific? Because, after John Howard and Peter Costello enacted their landmark reform of the tax system in 2000, they lost interest in further reform, on Garnaut’s reckoning.

And this marked the end of not only Howard-Costello reforms but an entire generation of near-continuous reform efforts that started in the years of the Hawke-Keating governments.

As is so often the case, people put far too much weight on specific local factors when thinking about these changes.  Thus America’s move toward liberalism was not triggered by the Kennedy assassination, nor was the neoliberal era triggered by the elections of Thatcher and Reagan.  These were worldwide trends.

The Aussies have done very well in recent decades, and have a right to be complacent.  But the same thing happened in the US.  Here is government spending as a share of GDP, which rose sharply after 2000:

I know what you are going to say; “That’s due to special factors—G/GDP rose due to the 2001 recession and 9/11.

There is some truth in that, but it’s not the whole story.  G/GDP did not fall back when we recovered from the recession.  And indeed both Bush and Gore were promising bigger government than Clinton—the country was getting tired of neoliberalism by 2000.  Soon we would have Sarbanes-Oxley, a big new Federal education program, and a massive expansion of Medicare.  And that was under a GOP President—once Obama took office we moved even further towards big government.  And yet if you read pundits on the left all you hear about is endless “austerity”, which is nowhere to be seen in the data.

The UK was not hit by recession in 2001, nor was it impacted by 9/11.  But at almost exactly the same time the Labour Party got tired of austerity, and began rapidly boosting government spending:

You need a trained eye to read these graphs properly.  The G/GDP ratio usually tends to be somewhat countercyclical, rising during recessions and falling during booms. The sharp rise in the UK’s G/GDP ratio after 2000 was an exception, and is a tell tale sign that fiscal policy was dangerously out of control.

This might suggest that neoliberal reforms require economic distress, so that the public will see the need for changes.  But of course the economic distress of the 1930s led to the exact opposite—the rise of statism.

Rather, it seems that neoliberal reforms require both economic distress and a perception that the problem is caused by bad government policies.  The stagflation of the 1970s is one example.

Neoliberal reforms can also be triggered when countries are doing poorly relative to their neighbors.  Thus back in 2004 the Germans compared their 11% unemployment rate with the 5% rate in the UK, and concluded that excessively high labor costs were the problem.  This led to one of the last successful policy reforms of the neoliberal era.  Today, those amazingly successful reforms are politically unpopular in Germany

PS.  Over at Econlog I comment on the two (rumored) new Fed picks.

Over the past 18 months we’ve seen three major shocks, each of which were expected to have a significant impact on growth:

1.  The late 2015 Chinese yuan devaluation/capital outflow shock

2.  Brexit

3.  The Trump election

Many people expected the Chinese economy to slow sharply in 2016.  It didn’t.

Many people expected the UK economy to slow sharply after mid-2016.  It didn’t.

Many people expected growth and inflation to rise significantly after Trump was elected.

The third prediction still might come true, but this FT article suggests that investors are moving away from the “reflation” trade.

We are nearing the anniversary of a great market turning point. Like most such turning points, it was not obvious as such at the time, but in early July last year markets reached the lowest point of their fear of deflation — falling prices amid a stagnating economy — and started to position for reflation.

The shock of last summer’s Brexit referendum brought bond yields, the market’s most direct expression of its belief in deflation, to a historic low. The rebound started as the effects of China’s economic stimulus were felt, while it grew clear that Brexit had not sparked a financial crisis.

It gathered momentum after Donald Trump’s victory in the US presidential election. The theory was that the Trump administration would pick up the baton from China, which looks over-leveraged and will soon need to ease off its stimulus, and would bring in its own growth-friendly policies, including tax cuts and infrastructure spending. From “reflation off”, we moved emphatically to “reflation on”.

Stock markets have risen this year, but 2017 has seen a gradual shift back to “deflation-off”. Short-term inflation expectations have moved sharply in recent weeks. The bond market’s implicit forecast for US inflation over the next two years, once at 2.15 per cent, has dropped to 1.35 per cent.

In each case I expected some effect, but less than the consensus.  In the case of China and Brexit, even the very mild slowdowns I predicted proved too bearish. I’ve learned my lesson from Brexit, and in the future will pay no attention to “uncertainty shocks”.  Always a skeptic, I am now convinced that uncertainty has virtually no significant business cycle effects.  And never bet against Chinese growth. Someday it will falter, but no one can predict when.

[In macro, the forecast most likely to be true is, “Not much will change”.  However the way to build a reputation is to forecast dramatic changes.  You will usually be wrong, but the public will forget those mistakes and give you undeserved praise on the few occasions when you are correct.]

I’m sticking with my prediction that Trump’s policies might lead to a couple tenths of a percent faster NGDP growth.  Monetary offset will keep inflation close to 2%, and Trump’s supply-side reforms are likely to be modest (at best).  An extra couple of tenths of one percent NGDP growth is so small it will be almost impossible to tell if I am correct—especially given that growth is likely to slow as we approach full employment.  If there is a recession, however, or 5%-6% NGDP growth persisting for a few years, then I will clearly be wrong.

Maybe the French will give us another shock later today.

PS.  I still believe that Brexit itself will reduce UK growth.  This post discusses the effect of pre-Brexit uncertainty, not Brexit itself, which is still years away.

PPS.  I believe the US should withdraw from the IMF.  Not because the IMF is not good enough for the US, rather because America is not good enough for the IMF. If we don’t leave, I hope the other IMF members expel us:

Finance ministers and central bankers from around the world have dropped a pledge to resist protectionism, in a further sign that the new US administration’s stance on trade is shifting the global debate.

The group from International Monetary Fund member countries issued a statement on Saturday saying they would “promote a level playing field in international trade” but did not reiterate a previous commitment to “resist all forms of protectionism”.

The change of stance mirrors a similar move made by the finance ministers and central bank governors of the G20 countries after they met in Baden-Baden in March. On that occasion, the US was unwilling to endorse forthright language on protectionism.

Sad!

W. Peden directed me to this article:

Andy Haldane said low rates kept some “zombie” firms alive, but the trade off was far more people stayed in work.

A Bank modelling scenario found that years of 0.25% rates probably kept 1.5 million in jobs, he said in a speech.

He would not have sacrificed those jobs for an extra 1% or 2% productivity.

This sort of thing makes me want to pull my hair out.  Start with the fact that he’s reasoning from a price change.  I suppose his defenders would claim he meant “an easy money policy that caused low interest rates also tended to hurt productivity”. But of course that’s not what happened.  In fact, UK interest rates fell to very low levels because of extremely low NGDP growth after 2008, which was in turn caused by tight money.  In a counterfactual where the BoE adopted ECB style policy, NGDP growth would have been even slower, and interest rates would have been ever lower (indeed negative.)

Although BoE policy was far better than ECB policy, it was still too contractionary. But for simplicity let’s assume it was about right—that will make it easier to explain what’s wrong with Haldane’s comments.

Suppose NGDP growth in the UK were appropriate.  And suppose you saw falling interest rates and falling productivity growth in that environment.  How would you interpret those facts?  I’d make the following claims:

1.  The UK was probably hit by an adverse supply shock.  I can think of at least three components; falling North Sea oil output, a big decline in banking jobs in “The City” after the crash of 2008, and a drop in manufacturing jobs because of the collapse in world trade in 2008-09.  Of course the 2008-09 shock is a demand shock at the global level, but at the UK level it shows up as a supply shock.

2.  In oil, banking, and manufacturing, worker productivity is much higher than for the economy as a whole.  So when those sectors suddenly decline, overall productivity will take a hit. This has nothing to do with monetary policy.

3.  If monetary policy is sound (reasonable NGDP growth), then the workers losing jobs in those three sectors will initially re-allocate into less productive sectors, mostly in the service sector.  Again, overall productivity will suffer.

4.  I also suspect that the UK is suffering from some of the same “Great Stagnation” problems that are affecting the US and other developed countries.

If the BoE had adopted a very tight money policy, causing a big drop in NGDP, then the re-allocation of workers from declining sectors to growing sectors would have been less complete.  This might have actually raised productivity slightly, as the least productive workers often are the ones who have the hardest time getting re-employed.

To summarize, neither a low interest rate policy nor monetary policy more generally reduced UK productivity.  Rather productivity fell as part of the natural adjustment process in a free market economy, as workers get re-allocated out of high productivity sectors into lower productivity sectors.  To its credit, the BoE refrained from the sort of tight money policy adopted by the ECB, which would have led to much more unemployment, but which also might have led to slightly higher productivity in the short run.

The BoE is not a fireman that rescued the UK labor market at the cost of lower productivity; rather the ECB is an arsonist who trashed the eurozone labor market.

The leave campaign to force Brexit was built on a set of lies, such as the claim that leaving the EU would free up 350 million pounds a week for the NHS.  This was an imaginary number pulled out of thin air, as virtually everyone now agrees.  There will be little or no benefit to the UK Treasury.

Today another lie was exposed.  Leave campaigners like Boris Johnson assured us that the UK would remain within the EU single market.  Theresa May has now admitted that it will be a hard Brexit, with Britain leaving the single market as well as the EU customs union.  Of course there is talk of setting up new trade arrangements (which I applaud), but that’s all very speculative.

It’s no surprise that the campaign was based on lies, that’s standard operating procedure for right-wing nationalist/populist campaigns.  Trump did exactly the same.  Here is a typical Trump lie:

“The EU was formed, partially, to beat the United States on trade, OK?” he asked rhetorically. “I don’t really care whether it’s separate or together.”

And here’s what really happened:

After World War II, the United States and its allies attempted to create a new world — one defined by rules and order, in which such a devastating war could never happen again.

Do you recall those dystopian novels where they postulate a history where the US lost WWII, and is a colony of Germany and Japan?  I feel sort of like we’ve entered one of those, where a Russian agent has become President of the United States:

Donald Trump just lobbed a grenade into the normally staid world of European-American diplomacy, using a joint interview with two of Europe’s biggest newspapers to call NATO “obsolete,” predict that the European Union would fall apart and announce that the US wouldn’t really care if it did, and threaten to potentially start a trade war with Germany over BMW’s plans to build a manufacturing plant in Mexico. . . .

Bashing NATO and the European Union, and alienating Germany, is a plan for tearing apart US relations with the EU — for weakening the agreements that underpin America’s status as the sole superpower and that maintain peace on the European continent.

It also means that Trump is talking about radically reshaping US foreign policy in a way that would significantly boost Putin’s influence while leaving America’s allies scrambling to figure out where they stand and how much they can trust in the future stability of an international system that has brought unprecedented economic strength and stability to the continent for decades.

“What Trump proposes is [American] geopolitical suicide,” Daniel Nexon, a professor at Georgetown who studies great power politics, writes at the Lawyers, Guns, and Money blog. “Make no mistake: you should be very worried right now.”

The article then points out how Trump is undermining the economic, political and military agreements that have led to the best period of world history since 1945.  It concludes with this warning.

There is only country that benefits from all of these moves: Vladimir Putin’s Russia.

Putin’s fundamental foreign policy goal is to restore Russia’s place as one of the world’s most powerful and influential nations. To do so, he wants to restore global politics to the way it was in the 19th century — when European countries saw each other as rivals rather than partners. This kind of “balance of power” world order would allow Russia to divide European powers by forming selective partnerships with some against the others — thus restoring Russian greatness.

As I look back on 2016, several patterns stand out.  Consider the recent Brexit vote in the UK.  Millennials in the UK were strongly in favor of staying in the EU.  They might dream of studying in Italy or working in France.  They like vibrant cosmopolitan cities, and may have friends who are from the immigrant community. When you are young, nationalism is the furthest thing from your mind—the world seems like a big adventure.  (Yes, I’m old, but at least I can still recall what it was like to be young.)  Even though the younger voters were overwhelmingly opposed to Brexit, it passed by almost 4 points, based on strong support among the far more numerous elderly voters.

For years we’ve been told that demographics is destiny, and that America was going to inevitably become a browner country.  Obama said that just a few days ago.  But these pundits missed an equally momentous demographic change, which seems to be affecting politics even more dramatically. The world is aging rapidly. In the 21st century, the world will become dominated by the old for the first time in human history.  This may create a demographic split on values going forward:

Liberalism  —  authoritarianism

Cosmopolitanism — xenophobia

Optimism — fear

Change — tradition

Reform — reaction

The elderly voters will dominate—pushing politics to the right.

Japan already has a “silver democracy” where 60% of the electorate are over 55, and a far higher percentage of actual voters are over 55.  Hillary won the 18 to 44 year olds by a Reaganesque landslide of 14%, whereas Trump won the (more numerous) 45 and older voters by about 8%.  Pot legalization in Arizona failed due to opposition from the elderly.  (I believe the combined age of Trump and Hillary was the highest in US presidential election history–can someone confirm?)

Going forward, an important issue will be how voters change as they grow older.  I suspect they will become more conservative on some issues (economics, crime) but less willing to change on others (pot, gay marriage).  It depends how their views have been shaped by life experience.

At the international level, part of the friction will be between a young Muslim world, and a rapidly aging Western, Hindu and Chinese world.  That will ramp up the level of bigotry on both sides, as compared to if the average ages in each group were similar.

While the elderly tend to be nationalistic, they are also risk averse.  So they oppose total war.  Instead, wars will continue to be fought in developing countries.

It goes without saying that it will be increasingly difficult to cut entitlements aimed at the elderly.  I’m less confident in predicting monetary policy, as Abe won in Japan on a promise of increasing inflation.  For now, I think 2% inflation continues to be the most likely outcome (a view shared by the markets.)

Also keep in mind that we are in the early stages of this demographic transition. The bulk of the Baby Boomers have not yet reached 65, so the proportion of elderly will continue to grow rapidly for many years.  The 45-64 years olds were just as likely to vote for Trump as the 65 and older group.  The big issue is what happens to the politics of 30 to 44 year olds as they move into the over 45 group.

Although immigrants will make up an increasing proportion of the US and European population, non-immigrants will be older, and will continue to have a disproportionate influence on politics.

The elderly are more likely to be NIMBYs—hence the post title.  Bad news for millennials seeking a place to live.

Overall, however, 2016 was not a bad year.  Although the global rise of nationalism is certainly very discouraging, the big story continues to be the boom in China and IndoAsia, the best thing that has ever happened.

PS.  I first tried to coin the term ‘IndoAsia‘ about 3 years ago.  Now Goldman Sachs seems interested in the idea, but has not yet adopted my name for the group.  (Developing countries between Pakistan and the Philippines, with the core region being India to Indonesia.  Well over 2 billion people.)

PPS.  Merry Christmas to all my Christian readers and Happy New Year to everyone.  Blogging will be spotty over the holidays.