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AK Party and Erdogan supporters congratulate the results of the referendum

Populism’s Continuing Challenges in a Year with Few Elections

November 16, 2018
By Wolfango Piccoli

Compared to previous years, 2019 will be light on big elections in Europe. Greece will have to go to the polls and Spain might, but the main political risk will not emanate from the electoral ballot.

Rather than populist forces making further inroads, political risk in 2019 will be defined primarily by political systems that are coming to terms with the more permanent presence of anti-establishment parties. This will continue to constrain centrist parties’ room to maneuver and cement a situation of elevated uncertainty for businesses.

The elections that are due in 2019 will probably be less important than these longer-term trends. This counts for the European Parliament vote, which will receive a lot of attention, but which will simply confirm that populist forces are now an established factor in European politics. Even where anti-establishment parties are doing worse than before in the polls, they will continue to complicate centrist policy-making. For example, the Greek elections are likely to be followed by difficult talks to cobble together a new government – even if it will likely be led by the center right rather than the far left of Prime Minister Alexis Tsipras.

In Spain, the parliamentary term is due to end in 2020, however new elections in 2019 are the most likely scenario. In power since 2018, the center left’s popularity will likely be contingent on the ability of the government to pass at least some policy changes. These would also make it easier for Prime Minister Pedro Sanchez to justify the postponement of early elections for as long as possible. But the necessary compromise to adopt some reforms might lead to the abandonment of some past policy promises, which in turn might make Sanchez’s Spanish Socialist Workers' Party (PSOE) vulnerable to the attacks of the far left Podemos.

Turkey, meanwhile, remains on its existing worrying trajectory, regardless of the local elections in 2019. Ankara’s relationship with its Western partners will remain problematic, if not worsen. An empowered President Recep Tayyip Erdogan will press harder for Turkey to be treated on an equal footing by all its allies and will likely continue to blame them for Ankara’s domestic political and economic problems. The potential structural problems posed (democratic backsliding, weakening of the rule of law and independence of key state bodies) by the new presidential system will not allow any progress in the already moribund EU accession process. Equally bleak are the prospects for Turkey-US ties. Erdogan will also continue to take a hard line on the Kurds, not just domestically but also in Syria and Iraq, further complicating ties with Washington.

In Germany, regional state elections in 2019 provide the opportunity for good results for the far right AfD – not least because one will be held in the city of Bremen, a former stronghold of the center left, and three in formerly communist East Germany, where the far right has traditionally been doing well. The penultimate full year of Angela Merkel’s chancellorship might therefore see a continuation of populist pressure on the political center.

Brexit: navigating populist pressures in action

But the biggest example of these continuous pressures will remain Brexit. The UK will leave the EU on 29 March at 11pm London time – midnight in Brussels. Yet the way in which the UK leaves remains subject of heightened political uncertainty. And the future relationship will only be resolved during the transition period lasting until the end of 2020 – if there is one at all.

The withdrawal agreement currently being finalized only serves the purpose of guaranteeing an orderly UK exit from the bloc. The one demand on which the Europeans have not moved, and will not move, as part of the withdrawal agreement is a fixed and legally watertight decision on whatever is required to prevent a hard border on the island of Ireland.

If this situation requires answers to questions of the future relationship, such as the shape of any customs union, they will have to be addressed before Brexit day in March 2019. This is because they affect the EU now, as they refer to questions of the border of the single market and of one of its member states, Ireland. It is this EU insistence on sorting the Ireland question now which is causing the UK problems at home, because it forces Prime Minister Theresa May to address contentious questions such as the extent and location of customs and product controls before the end of 2018, or risk a disorderly Brexit without a deal.

Importance of Symbolic Measures

Within these substantially unchanged margins, the EU remains very likely to take symbolic measures to help May sell any deal at home. On top of the withdrawal agreement, the separate political declaration on future relations will likely be “ambitious” and will entail further talks on May’s ideas for future customs relations.

In fact, such EU signaling is what we have been expecting for a while now: help from the EU via a political declaration that will enable May to claim at home that the divorce payment to the EU is “rewarded” with the prospect of a deep trading relationship, and which allows her to argue in the UK that her lofty customs plans will remain on the table for debate during the transition period. In terms of non-political substance, however, it is crucial to remember that the legally binding withdrawal agreement remains likely to simply state that the UK remains in the customs union, with no end date or mechanism for a unilateral departure attached.

Similarly, in the unlikely case that the UK were to change its mind on freedom of movement, the EU might help wrap this UK commitment into some Swiss-style labor market provisions which are largely meaningless but could still make the acceptance of freedom of movement easier at home. In the more likely case that the UK does not move on that front, the EU will likely help package its Northern Irish backstop by moving some controls away from the Irish Sea (for instance, via regulatory cooperation similar to that of the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada) and by underlining that the Irish Sea would legally not become a “full” customs border (despite the required product checks).

The bottom line, however, is that despite the EU’s readiness to help with spin and packaging, Brussels and the member states will likely insist on the UK signing up to the Northern Irish backstop now and not later, to sort the border issue in a legally watertight form before the UK departs. This, in turn, means that the most contentious questions will still need to be sorted in Westminster. For there to be a deal, May will still have to engineer support for factually staying in the customs union as well as for product checks in the Irish Sea.

If she succeeds, the risk is that the domestic backlash undermines her plans for close trade ties to be negotiated as of 2019. In any case, even in the most benign scenario, trade and political ties will, per definition, be weaker than they will have been when the UK was a member of the EU. For businesses, this will mean new frictions and disruptions, whether in services trade or in cross-continental industrial supply chains.

The central banks in 2019

All of this will be closely monitored by central bankers who are otherwise on a trajectory towards renormalizing monetary policy. How quickly they can proceed, however, will depend on the political risks in Europe in 2019. This is problematic, because what has in many ways underpinned the relative calm Europe has been enjoying lately has precisely been ultraloose monetary policy.

At the same time, ever since European Central Bank (ECB) President Mario Draghi’s 2012 promise to do “whatever it takes” to defend the euro, market pressure on governments to reform has decreased. This has left Draghi with little power to insist on the structural reforms he has been preaching ever since. Now that the Eurozone will have to do without his quantitative easing program as of 2019, the question will quickly be if and when rates begin to rise.

On the one hand, the changes that might be ahead in 2019 monetary policy normalization is positive because it will provide the ECB with ammunition for cuts in case of an economic downturn. On the other hand, once monetary policy normalizes, it will start to become clear that politicians have been complacent on the reform front over the last years. In that sense, the room for maneuver that rate hikes in 2019 might create for the central bank could come in handy much sooner than many might think.

If anything, the continued reliance on monetary policy in Europe shows one thing: politics remains the prime source of risks to businesses, investors and the overall economy also in 2019.

The views and opinions in these articles are solely of the authors and do not necessarily reflect those of Teneo. They are offered to stimulate thought and discussion and not as legal, financial, accounting, tax or other professional advice or counsel.

This article appeared in Teneo's Vision 2019 Book.
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