Political Economy

Political economy’ can be summarized as the social science which analyzes how economics influences politics and how politics influences economics. This study took off in the 70s when it became increasingly evident that, when not interrupted by revolutions or world wars, politics and economy were intertwined.

The impact that economics has on politics is rather straightforward and finds plenty of support in history. When it comes to the U.S. elections, for example, the research contained in ‘Presidential and Congressional Vote-Share Equations’ (2009) shows that over 1916-2006 and 23 observations, there is strong evidence that the economy, specifically GDP growth and inflation, influences the vote share. The infamous ‘It’s the economy, stupid!’ slogan from the 1992 Bill Clinton campaign was anchored in facts.

Since economics has an impact on politics, there is a ginormous incentive for politics to influence economics. According to the idea of ‘political business cycles’ brought to mainstream economics by William Nordhaus in 1975, governments manipulate economic drivers to maximize reelection probabilities. However, as outlined in a comprehensive paper summarizing leading research on this topic over decades, there is mixed evidence of such occurrences, at least in advanced industrial economies. This is not to say that governments around the world do not try to influence economic cycles, only that they do not systematically succeed when they do.

The fact that politics does not appear to influence the macro cycle is supported by the following observation: while the degree of political polarization in the U.S. is deemed to be extreme at present, I have yet to see two sets of 2021 economic forecasts that depend upon the outcome of the upcoming elections. This means that the expected impact of the next administration’s fiscal, regulatory and trade policies on post-election macroeconomic trends does not to differ widely whether Mr. Trump or Mr. Biden wins. This does not mean that the election will not have ‘winners’ and ‘losers’ amongst the electorate, but rather that the net impact on the domestic economy appears to be largely independent from the outcome of the elections.

Therefore, once again, pre-election economic trends, as opposed to anticipated post-election economic trends, will play a critical role in influencing the upcoming U.S. elections. Protests, the handling of COVID-19 and the characters of the candidates will play a role too, but, in relative terms, less so, especially in a polarized post-truth world. Whilst interesting and entertaining, books such as The Room Where It Happenedby John Bolton will certainly not make any difference.

Like the revenue pattern of the ‘Average Joe’ in the industrial technologies space, the U.S. gross domestic product is expected to get back to its 2019 level in 2022, which suggests that the economic activity is and will remain below its potential in the foreseeable future. That said, the third quarter GDP performance will most likely be unsurprisingly spectacular, suggesting strong momentum, assuming that any second COVID-19 wave is successfully managed (which is my assumption). Fundamentally, there is a new economic cycle ahead, money is practically free and fiscal policy is accommodative. So the one real question is the following: what will prevail in the mind of voters in November, the dreadful state of economic affairs or its positive trend?

Over time, the growing focus on long term sustainability observed in the corporate world may reach the broad electorate, at which point economic factors will be de-emphasized to the benefit of environmental, social and governance ones. But as long as a large section of the population feels economically disfavored, it is unlikely to happen. Therefore, until then, economics will continue to influence politics. And politics will keep trying to influence the economic cycle. In vain.


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