By Caelan Rafferty
As one watched with dismay and awe the tumultuous stumble of financial markets during the Global Financial Crisis, one might almost feel a similar sense of déjà vu in examining the current state of global politics. Leadership spills, coups and corruption seem to have become the twenty-first century norm amongst those practicing the sacred Athenian concept of democracy. This disunity plagues not only our social compact, but our global marketplaces which depend upon our representative institutions for guidance and support. As this phase of democratic practice is explored by the world, examining the implications arising from political instability on financial markets has never been more important.
Political instability is defined as ‘the propensity of a change in the executive either by “constitutional” or “unconstitutional” means’, and the issue is not isolated to contemporary politics. One only has to look to the reign of Julius Caesar and the subsequent crumble of the Roman Empire, the French Revolution or World War I to see that political instability is a prominent feature throughout global development. In all these cases, instability led to the collapse of the domestic or international polity, resulting in the subsequent failure of the local or global economy. While these examples demonstrate the extreme effects of political instability, even minor transgressions can have a marked impact on economic environments.
An illustration of minor transgressions can be seen in the makeup of Australia’s Federal Parliament since 2010. The Rudd-Gillard-Rudd years, as did the Abbott-Turnbull years left voters, the international community and, importantly, businesses, confused as to Australia’s leadership and direction. The recent federal election did little to ameliorate political stability with the Coalition forming a severely weakened majority Government, coupled with the addition of a hostile Senate. To the public, this situation has become a farce, yet to businesses, this atmosphere has far deeper consequences.
A number of studies concerned with politics and the economy indicate a correlation between economic growth and political stability. Instability has been found to create uncertainty in the markets, owing typically to volatility concerns regarding new political mandates, thereby reducing investment leading to a slowing of economic growth. A reduction in domestic investment occurs as businesses become increasingly risk-averse, while foreign investment falls as a result of less certainty regarding government policy and property rights. In both circumstances, there is less incentive to engage in productive practices thus limiting production and conversely hindering consumption.
Instability may also drive currency devaluations as demand for domestic currency internationally weakens, potentially driven by decreased foreign capital flows or slowdowns in tourism. This could be illustrated by the current situation in Turkey where the recent coup by the military may drive prospective tourists away for fear of their personal safety. Further instability can arise due to poor economic performance, sowing added unrest. This in turn may drive politicians to view only short-term goals in the hope of maintaining government, engendering a climate fraught with long-term sustainability issues. Cumulatively, these economic and social behaviours can create a self-reinforcing outcome.
A topical reference can be made to the Brexit referendum outcome. After the decision was finalised and broadcasted, the British Pound fell quickly to its lowest levels since 1984 as investors hurried to escape the fallout arising from uncertainty. The decision, one could argue, was formulated on the basis of an emotional, nationalistic response to a global climate of fear and hatred, illustrating the idea that political instability leads to a focus on the short-term. The subsequent resignation of David Cameron adds to short-term instability as the changeover to Theresa May creates inevitable inefficiencies. While the full extent of the decision and its implications for both Britain and the global economy remain unknown, one cannot disagree that as Britain renegotiates its position in the European Union, and the World, the international community and businesses alike will remain risk-averse in the region.
Yet, despite the challenges political instability brings economically, it can be viewed favourably in two circumstances. Firstly, high levels of instability may be welcomed if the current government is inept or corrupt, allowing a transition towards a stronger, more accountable government. Secondly, an increase in political instability may inadvertently reduce political uncertainty, as both the international community and businesses become certain that the current government will collapse. However, in both circumstances, there is very little evidence to suggest the newly elected government will be in anyway superior or for that matter, known to the wider public.
Ultimately, while one may lament the decline in political stability in recent years, one may happily draw a parallel to economic thought; cycles can be broken. In the long-term, the pains produced through instability can be managed successfully with prudent fiscal and monetary measures and the continued support of the global community. Thus, while we wait in the short-term, all we can do is work past our denial and anger, and accept the times for what they are; interesting.