Prepare for Europe’s Policy Shift

James Juliano Insights

There are essentially only two political parties in any country, and elections boil down to a growth party versus a redistribution party. History teaches us that voters can produce a uniform poverty or an uneven prosperity based on which party they choose. The preferred path is, of course, an uneven prosperity where the average family does much better. No one ever risked their life to escape into Eastern Germany or communist Cuba.

Ronald Reagan and Margaret Thatcher ignited an economic revolution that swept across the world. This was preceded by years of chaotic policy failures in most of the world that made their jobs of selling pro-growth alternatives much easier. Their cuts to marginal tax rates produced an enormous spurt in tax collections and in the incomes of citizens. For a time, especially in Europe, these lessons have been lost as a broad set of liberalism policies prevailed globally.

We have been highlighting for some time the “death of liberalism” here in the US. Signs are now emerging that this death of liberalism is happening globally, putting an end to the belief that government can solve problems and increase prosperity by inserting itself into the lives and choices of citizens. Europe is center stage of this transition, again.

In the summer of 2012 Europe entered into a new “green zone” that resulted in a 50% gain in European equity markets through mid-2014. Then Russian sanctions hit, and they hit Europe hard. Economic sanctions act as a 100% prohibitive tax on both parties to the transaction. Europe is a large trading partner with Russia and quickly felt the negative economic effects of such a large tax “wedge.” Sanctions also came at a time when the anti-austerity, pro-growth policy talk in Europe was still just talk. Many politicians were saying the right things but there were no pro-growth policies in place to help dampen the effects of sanctions. Europe quickly entered a yellow and then red zone by August 2014. For the past several months of 2015, European countries have been slowly emerging from that red zone. Germany and the Netherlands led the way and have been more recently joined by upgraded policy outlooks in France and Italy. Our explanation for these improvements centered upon the easing of Russian tensions and assumptions that sanctions would lessen until their eventual removal. Recent news threw a new and unexpected twist into our assessment.

There was a surprise victory in the British elections when David Cameron’s Conservative Party devastated Ed Miliband’s Labour Party. As recently as the day of the election both parties were running neck and neck polling around 33% of the popular vote. Pundits had predicted the election would be a close one and suggested there would be days of post-vote, backroom talk to thrash out a power-sharing deal. Both the polls and the pundits were wrong, as David Cameron and his Conservative Party claimed an outright majority in Parliament, with 331 seats out of 650, and can form a new government. The UK Conservatives now get to govern alone after five years in a coalition.

Importantly, this election was a repudiation of Labour’s redistribution polices in favor of Conservative’s more pro-growth ideas. Our friends at Bretton Woods Research point out, “Miliband’s Labour Party tax platform is redistributionist and calls for a mansion tax, raising the top marginal income tax rate to 50% from 45% and raising the corporate tax rate, which Cameron has reduced to 20% from 28%. But despite the tax increases, he is calling for more government spending.”

In sharp contrast, Cameron’s Conservative Party platform pledged tax cuts and is expected to institute fiscal consolidation measures. This election was the classic growth versus redistribution choice, and voters resoundingly chose growth. Reactions from UK equity and currency markets were as expected. Equity markets rallied on results and the UK’s Pound sterling currency strengthened.

A Cry for Growth, Investor’s Business Daily Soaring Sterling, Economist

This policy shock is an indication that the UK may be entering a new round of Thatcherism based policy that could spark a domino effect of policy improvements across Europe. Voters are not stupid, and their minds are not bound by borders. Part of the Conservative’s surprise victory can be credited to the failed anti-growth policies from President Hollande’s Left in France. British voters got to see what was failing in France and choose the opposite. Similarly, voters throughout Europe will now get to see what was chosen and can work in the UK and then shift their narratives. Just as failures in one country teach lessons to voters in other countries, policy success produces imitators.

Over the past few months it has been appropriate to begin thinking about redeploying capital into Europe, and now it may finally be time to accelerate that decision. The US may no longer solely hold the title of “least bad place to invest capital.” Europe, a responsible democracy, seems to be getting its act together, and pro-growth UK policies may spill over through the rest of the Eurozone.

Why Europe’s Left Are Serial Losers, The Wall Street Journal

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