Keating: Populism, the Good and the Bad

March 13, 2020

by Maryann O. Keating, Ph.D.

When ordinary people feel that politicians and experts lack answers to important questions, they respond to leaders offering a complete change of course. Such changes are often referred to as being populist.

Populism is a political philosophy directed to the needs of the common people and advocating a more equitable distribution of wealth and power. In practice, however, many populist leaders show ambivalence toward representative democracy and instead exhibit a streak of authoritarianism. Unfortunately, populist policies, which can be economically unsustainable, often end up hurting the very ones they were supposed to help.

Sebastian Edwards, an economist, in analyzing populist experiences in Latin America, distinguishes between “classical populism” in which leaders rise to power using nondemocratic means and are subsequently deposed and “new populism” which takes place under democratic rule. Traditional populist leaders tend to be staunchly nationalistic, opposing foreign investors and, in many cases, nationalizing multinational firms. New populists, both those who are right and left leaning, champion national identity and lament the loss of cultural heritage. Both types are characterized by protectionist policies, expansion of government and increased minimum wages (“On Latin American Populism and Its Echoes around the World, ”Journal of Economic Perspectives, Fall 2019, pp. 76-99).

Prior to a populist leader gaining power, a deeply dissatisfied population experiences economic stagnation or depression, rising prices for basic necessities, corruption and a high degree of income inequality. Once in charge, populist leaders ignore constraints on public sector spending and expand the domestic money supply.

At first, populist policies appear highly successful, as wages and employment react positively to the stimulus of increased demand. However, bottlenecks in supplying certain goods and services emerge, inflation rises, domestic investment declines, and a black market for foreign currency develops. The government responds by making periodic wage adjustments and offering subsidies for food and transportation.

In the prelude to collapse, price controls are intensified and business owners are portrayed as greedy or even criminals. The domestic currency is devalued and defaulting on foreign debt is considered. Real wages fall. Following this disaster and prior to regaining fiscal stabilization, household income, particularly for poor households, declines to a level significantly lower than that when the episode began.

“New populist” regimes are less likely to rely on money creation to redistribute income. Therefore, some inflation is tolerated initially as intrusive government controls and restrictions redirect income to particular groups. Inevitably, private investment is negatively affected due to uncertainty with respect to risk. “New populists” often increase the wages of government employees and may even promulgate new constitutions to further their redistributive goals.

Venezuela during the Chavez and Maduro administrations and Argentina under the KIrchners are examples of “new populism” in Latin America. The Venezuela experience evolved into hyperinflation along with economic and political collapse, as well as a massive out-migration. Under the Kirchners, Argentina experienced high but not hyper-inflation that ended in 2015 with a peaceful democratic transition to a new government led by Mauricio Macri.

In these and similar cases, the central bank is able to finance massive increases in public expenditures. It does this by its willingness to purchase government debt and provide credit to government-owned enterprises. In such regimes, an independent central bank is the first line of defense. However, one of the first steps taken by populist leaders in Latin America, according to Edwards, is to weaken or eliminate central banks’ attempts to constrain government deficits (p. 90).

A few countries in Latin America, such as Panama and Ecuador, use dollars for public and private transactions. Having abandoned local currencies for the dollar, populist leaders in these countries, like state governors in the U.S., cannot use monetary policy to implement their agendas.

However, the populist Correa administration in dollarized Ecuador was successful at first in reducing inequality because it was able to finance public debt with revenue from its oil reserves. When oil prices declined in late 2008, Ecuador restructured some of its sovereign debt with loans from China. In 2017, the new Ecuadorian government, aware that residents prioritized both price stability and dollarization, reverted to a tighter fiscal policy aimed at stabilizing and reducing the government debt-to-GDP ratio.

The similarities between Latin America and other part of the world are not confined to history. Some scholars argue that there are good and bad populists. A good populist creates an environment in which family, faith, learning, trading and society flourishes. A bad populist distributes coercively and tries, or pretends, to implement unsustainable popular measures.

After some time, however, deviations from sound economics are problematic. Consumers are hurt by protectionism. Excessive regulations slow growth and investment, and anti-immigration policies create bottlenecks in labor markets. Debt and unreasonably easy monetary expansion create bubbles and high inflation.

The first and foremost lesson to be learned is that “bad populism” feeds on injustice and corruption. Candor between those who rule and those harmed by existing policies is critical. However, one fact cannot be ignored: Excessive reliance on public sector debt to achieve policy objectives ultimately leads to disaster.

Maryann O. Keating, Ph.D., a resident of South Bend and an adjunct scholar of the Indiana Policy Review Foundation, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell.


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