The Economics of Populism in the Present

Author: Felix Kersting

Review: Prof. Dr. Nikolaus Wolf

This is an essay of the writing workshop "A new critique of a new mainstream", published on 15 May 2019

In the last couple of years, we have observed increasing vote-shares for nationalist and populist parties in Western countries. Numerous empirical studies in economics analyze the factors behind this rise. I review this literature and stress that economic factors (e.g., trade shocks and economic crisis) play a crucial role in the rise of populist parties; however, the discussion of mechanisms driving this trend remains unsatisfying. In particular, the research largely fails to explain why right-wing parties gain votes while left wing parties mostly do not. More generally, this new literature shows the potentials and width of empirical research in economics. The literature reviewed here includes at least four main reasons for the rise of populism: trade shocks, economic and financial crisis, migration shocks, and cultural change. Building on this review, I will discuss shortcomings of the existing research and propose further steps to improve our knowledge of the reasons for the current success of right-wing populist parties.

Before presenting the empirical findings, it is important to discuss the different concepts of populism used in this literature. Some studies, for example Acemoglu et al. (2013), follow the classic definition in economics of Dornbusch and Edwards (1991), according to which populism is about “overly expansive macroeconomic policies” in the context of leftist governments in Southern America. Therefore, populism is by definition a left-wing phenomenon. This understanding of populism, however, is not helpful for analysis of the present as it is primarily used to explain populism in Southern America. Others define populism as a movement against elites without differentiating between left- and right-wing types of populism. They thus partially follow the influential definition from the political scientist Cas Mudde (2007) according to which populism is a “thin ideology” that considers society to be separated into two antagonistic groups, the people versus the elite. For instance, Dani Rodrik (2018) builds upon this concept and defines populism as: “an anti-establishment orientation, a claim to speak for the people against the elites, opposition to liberal economics and globalization, and often (but not always) a penchant for authoritarian governance.” I will argue in this essay that it is problematic not to differentiate between left and right populism because this makes it more difficult to understand why right-wing parties gain and left-wing parties do not. If populism, as often happens, is understood as a movement against elites, the definition rests on some specific aspects of political rhetoric. It would be important also to address the political orientation and program, for instance by using the concept of “thick ideologies” from Mudde. Following Mudde, populism as “thin ideology” can be attached to all sorts of “thick ideologies” like socialism or nationalism. This combination of “thick” and “thin” ideologies would help to understand the specific agendas of populist parties. Next, I will discuss the empirical findings of the economic research on populism.

Trade shocks: Scholars argue that increasing import competition, especially from China after it has become a member in the WTO, has led to higher unemployment, lower wages, and more governmental transfers in Western countries (see e.g. Autor et al. 2013 for evidence for the US and Dauth et al. 2014 for Germany). Responding to economic upheaval, people tend to vote for more polarizing candidates in U.S. elections (Autor et al. 2017), as happened with the formation of the Tea Party. Similarly, researchers found that these trade shocks lead to more votes for populist parties (Dippel et al. 2018 for Germany; Colantone & Stanig 2017 for several European countries). In these studies, small regional units are the unit of analysis. By combining disaggregated employment statistics with trade statistics, these studies calculate trade shocks for regional units. The trade shocks in turn are regressed on political outcomes, mostly election outcomes. According to Dippel et al. (2018), distortions on the labor market link trade shocks and political outcomes. Autor et al. (2017) attribute the success of the Republican candidates to such trade shocks, which increased competition for support from the welfare state. They argue that the trade shocks lead to increasing pressure on labor markets, e.g. regarding unemployment, and thus to more governmental transfers. Given limits for the supply of these transfers, Autor et al. (2017) argue that the competition for governmental transfers then increases, and right-wing populists tend to propose exclusion along ethnic lines as a solution (so-called welfare chauvinism). However, it remains to be seen why it is precisely candidates of the Republican Party who can have such great success if they aim to limit migration, but also aim to limit the welfare state by abolishing “Obama-Care”, thereby limit the benefits for welfare chauvinism and in fact, why left-wing parties cannot benefit from this (for a detailed ethnographic study on this paradox see Hochschild 2016).

Economic and Financial Crisis: Other research highlights the role of the financial crisis. By collecting data on financial crises and elections, Funke et al. (2016) show that nationalist parties have gained in the aftermath of crises in 17 Western countries over the last 140 years. In particular, they argue that it was financial crises, not other types of economic crises that had this radicalization effect. Moreover, they show that government majorities tend to shrink, while parliamentary fractionalization rises. Their findings suggest that financial crises put a strain on democracies. However, due to the long time horizon of their analysis, the discussion of more specific mechanisms remains a bit vague. Other research looks more closely into the effects of the 2008 financial crisis on political outcomes by analyzing the role of trust, labor markets and austerity. Following Guiso et al. (2017), the current crisis reduced the trust in markets (via the financial crisis) and state institutions (via the globalization crisis; for a similar argument see Dustmann et al. 2017). Thus, economic and political insecurity increased, which populist parties took advantage of by blaming the elites for the crises and promising short-term protection. Moreover, the current crisis led to decreasing turnouts in elections, also due the aforementioned reasons. Guiso et al. (2017) show evidence for their findings by using European survey data. It is important to stress that this crisis – in contrast to others – consists of a crisis of both, market and state, institutions. Following the argumentation by Guiso et al. (2017), the authors would not expect a populist reaction if, for example, market institutions would have been held exclusively responsible for the crisis, because if so governments would be able to solve it. Instead, the crisis highlighted the inability of governments to provide shelter against the failure of markets. Algan et al. (2017) focus on the labour market effects of the financial crisis and show that increasing unemployment leads to decreasing political trust in mainstream parties and in consequence to increasing vote shares for populist parties in Europe. Next to rising unemployment, austerity was one of the most discussed aspects of the crisis in Europe. Fetzer (2018) provides evidence that voters who lived in regions that were more exposed to austerity measures tended to vote with a higher likelihood the “UK Independence Party” (UKIP), by exploiting within-individual and within-region variation in a panel setting.

Immigration: Without doubt, much of the public discussion in populist movements focuses on immigration. Several economic studies analyzed the effect of immigration on the success of right-wing parties. Halla et al. (2017) show that the success of the “Freedom Party of Austria” (FPÖ) is partially driven by immigration, which has led to adverse labor market effects, especially for lower skilled people. Similarly, Becker and Fetzer (2017) find that migration from the new EU member states in the East to the UK had a positive impact on the Brexit vote. Other studies come to different results: Dustmann et al. (2016) show strong evidence for heterogeneous effects for Denmark: immigration to urban areas leads to increasing support for more left-wing parties, while immigration to rural areas has the opposite effect. Studying the so called “refugee crisis” in 2015 and the years after in Austria, Steinmayr (2018) finds that a higher share of migrants corresponds to a lower success of the nationalist FPÖ, similar results are also found for Germany by Cantoni et al. (2019). However, in border regions that were part of the main route to Germany the FPÖ had more success. This result raises the question of how exactly migration, if not concretely visible in regions, functions as an important trigger for right-wing populism. For example, it would be interesting to investigate which conditions lead to understanding migration as a social problem and how it is related to “welfare chauvinism.” This also includes the role of media representation. Using large-scale surveys and experiments in six countries, Alesina et al. (2018) find that there exist large misconceptions of the number and characteristics of immigrants, especially among supporters of right-wing parties. These biased beliefs about migration correspond also with less support for redistribution. Thus, labor markets as well as the perception of immigration might mitigate the effect of immigration on support for right-wing populists. 

Cultural Change: Another prominent thread understands the rise of populism as a phenomenon of cultural change, namely a cultural backlash against multiculturalism, leftwing identity politics, and the like. Research in economics attempts to link the rise of populist parties to the persistence of past events and past cultural traits (Ochsner & Roesel 2017; Cantoni et al. 2019). Cantoni et al. (2019) show that people in regions with a higher vote share for the NSDAP in the 1930s vote more often for the “Alternative für Deutschland” (AfD) after the party started to focus on their nationalist anti-migration rhetoric in 2015 and propose transmission within families as crucial mechanism. Ochsner and Roesel (2017) show that the influx of former Nazis from the Soviet occupation zone to the US occupation zone after 1945 has lasting effects even today on a higher vote share for the right wing party in Austria. However, in both cases it partially remains unclear what drives this persistency. It would be important to know how exactly the voting patterns of the NSDAP are related to the voting patterns of the AfD: Is it solely based on transmission within families? Or is it just the fact that similar regions were hit during the Great Depression and Great Recession? What role does selective migration from east to west play after the fall of the wall? Without convincing answers on these kind of questions, this research might imply some overly deterministic elements by arguing that people in certain regions are with a higher likelihood nationalistic without any particular reason besides living there.

Most of the aforementioned studies claim to find causal relationships between the independent variables and political outcomes. They do so by using the typical identification strategies, for example instrumental variables or differences-in-differences estimations, and thus follow recent trends in mainstreams economics described as the “credibility revolution” (Angrist & Pischke 2010) or “the age of the applied economist” (Backhouse & Cherrier 2017). However, as the discussion of the different explanations showed, it often remains unclear why it is largely right wing parties who increase their vote share and left wing parties do not. Building on standard political economy theory (Meltzer & Richard 1981), one would expect that left wing parties gain if economic conditions become worse for the bottom half of the distribution. Thus, the findings for the present are at odds with standard neoclassical political economics.

There are at least three interesting ways to overcome these shortcomings in the explanations: first, by trying to form a synthesis of the literature; second, by developing new theories; and third, by the incorporation of insights from other social sciences. In his synthesis of the literature on the “economics of populism,” Rodrik (2018) emphasizes the importance of the salience of different societal cleavages on which populists focus. Left-wing populists gain if the globalization shock is mainly external, for instance austerity policies forced by the EU or financial crisis, e.g. 2008 or in Southern America in the 1999s. By contrast, right-wing populists gain after an internal shock—most notably, migration. However, this synthesis is at least partially at odds with some evidence presented above. For instance, increasing import competition (understood as an external globalization shock) leads to more support for right-wing parties (see Autor et al. 2017 as well as Calantone and Stanig 2018).

Given the difficulties of providing convincing explanations, other theoretical perspectives might be an interesting path for further research. An open question is why we observe so little political support for more redistribution (given the assumption that right-wing populists do not support redistribution)? A small theoretical literature deals exactly with this question (for a review of this theoretical literature in political science see Iversen & Goplerud 2018). Theoretical work from identity economics, most notably Shayo (2009), predicts a decline for redistribution and an increase in support for nationalist parties if the status and salience of the national identity relative to the class identity is more prevalent. While these theoretical considerations are rarely brought to the data, they do seem convincing: Given the decline of trade unions it is plausible to argue that the salience and social status of class identity has decreased over the last decades. The model from Shayo (2009), unlike older models, allows for two dimensions: economic status and national identity. Models that include at least two social cleavages predict that coalition-building becomes more difficult. New research from Piketty (2018) supports the theory that multidimensional political conflict is an accurate description of the political systems in France, the U.K. and the U.S.. Based on this description of the political system, Piketty argues that coalition-building in favor of redistribution becomes more difficult, as the social cleavage pro- and anti-globalization divides those who are in favor of redistribution. However, this gives only a partial explanation for the rise of right-wing populist parties, because coalition building for conservative parties also becomes more difficult.

Finally, insights from other social sciences could also help to explain the current political developments. Gidron and Hall (2017) explain the success of right-wing populist parties, especially among working-class men, by linking economic and cultural developments. The latter includes e.g., increasing role of gender and racial equality. They argue against the widespread dichotomy of class vs. identity politics. Some researchers, most notably Inglehart and Norris (2016), build upon this dichotomy by analyzing which factor better explains the current success of populist parties. In contrast, the main hypothesis from Gidron and Hall (2017) states that both economic and cultural developments increase status anxiety. They provide evidence based on survey data for their hypothesis, without claiming causality or providing a concrete mechanism. A detailed analysis of the exact link between economic and cultural developments, however, is missing, as echoed by Gidron and Hall (2017). It might be interesting to find out whether one of the two developments comes first or whether there are some interaction effects. Still, this research from sociology and political science shows some potential for better explanations.

In summary, the new research in economics provides some first interesting findings on reasons for the rise of populist parties in Western Europe by analyzing the role of trade, crisis, migration and culture. The findings suggest that economic developments play a crucial role in our understanding of current political developments. However, more discussion on mechanisms, synthesis of the findings, and theoretical concepts would be helpful in getting a more complete picture, especially concerning the question why right-wing parties gain and left-wing parties do not.

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