Watching America’s leaders scramble in the closing days of 2012 to avoid a “fiscal cliff” that would plunge the economy into recession was yet another illustration of an inconvenient truth: messy politics remains a major driver of economic developments.
In some cases during 2012, politics was a force for good: consider Prime Minister Mario Monti’s ability to pull Italy back from the brink of financial turmoil. But, in other cases, like Greece, political dysfunction aggravated economic problems.
Close and defining linkages between politics and economics are likely to persist in 2013. Having said this, we should also expect much greater segmentation in terms of impact—and that the consequences will affect both individual countries and the global system as a whole.
In some countries—for example, Italy, Japan, and the US—politics will remain the primary driver of economic-policy approaches. But elsewhere—China, Egypt, Germany, and Greece come to mind—the reverse will be true, with economics becoming a key determinant of political outcomes.
This duality in causation speaks to a world that will become more heterogeneous in 2013—and in at least two ways: it will lack unifying political themes, and it will be subject to multi-speed growth and financial dynamics that imply a range of possible scenarios for multilateral policy interactions.
With an election looming in Italy, the country’s technocratic interim administration will return the reins of power to a democratically elected government. The question, both for Italy and Europe as a whole, is whether the new government will maintain the current economic policy stance or shift to one that is less acceptable to the country’s external partners (particularly Germany and the European Central Bank).
Monti may or may not be involved in the new government. The further removed from it he is, the greater the temptation will be to alter the policy approach in response to popular pressures. This would involve less emphasis on fiscal and structural reforms, raising concerns in Berlin, Brussels, and Frankfurt.
Japan’s incoming government has already signaled an economic-policy pivot, relying on what it directly controls (fiscal policy), together with pressure on the Bank of Japan, to relax the monetary-policy stance, in an effort to generate faster growth and higher inflation. In the process, officials are weakening the yen. They will also try to lower Japan’s dependence on exports and rethink sending production facilities to lower-wage countries.
The economic impact of politics in the US, while important, will be less dynamic: absent a more cooperative Congress, politics