The European trust crisis and the rise of populism Yann Algan, Sergei Guriev, Elias Papaioannou and Evgenia Passari Abstract We study the implications of the Great Recession on voting for anti-establishment parties, as well as for general trust and political attitudes, using regional data across Europe. We find a strong relationship between increases in unemployment and voting for non-mainstream, especially populist, parties. Moreover, increases in unemployment go in tandem with a decline in trust in national and European political institutions, while we find only weak or no effects of unemployment on interpersonal trust. The correlation between unemployment and attitudes towards immigrants is muted, especially for their cultural impact. To advance on causality, we extract the component of increases in unemployment explained by the pre-crisis structure of the economy, in particular the share of construction in regional value added, which is strongly related both to the build-up and the end of the crisis. Our results imply that crisis-driven economic insecurity is a substantial driver of populism and political distrust. Contact details: Sergei Guriev: EBRD, One Exchange Square, EC2A 2JN, London, UK. Email: [email protected]. Yann Algan is the Dean of the School of Public Affairs and Professor of Economics at Sciences Po and affiliated with CEPR. Sergei Guriev is Chief Economist at the European Bank for Reconstruction and Development, Professor of Economics at Sciences Po and Research Fellow at CEPR. Elias Papaioannou is Professor of Economics at the London Business School and a Research Affiliate at CEPR. Evgenia Passari is Assistant Professor at Université Paris-Dauphine. The paper was prepared for the autumn 2017 meetings of the Brookings Papers on Economic Activity. We thank Ivan Torre, Paul Vertier, Nikita Melnikov, Luis Scott and Alexander Stepanov for superb research assistance. We are grateful to Jim Stock (the editor), Jan Eberly, and our discussants, Catherine De Vries, Susan Collins and Francesco Giavazzi for detailed comments. We also thank George-Marios Angeletos, Olivier Blanchard, Gerald Cohen, Sebnem Kalemli-Ozcan, Kostas Matakos, Alan Krueger, Giacomo Lemoli, Greg Mankiw, Matthew Notowidigdo, Thomas Philippon, Valerie Ramey, Jay Shambaugh, Joe Stiglitz, Guido Tabellini, Marco Tabellini, Justin Wolfers and other BPEA conference participants. We also received useful feedback from seminar participants at the 2016 CRETE, Sciences Po, OECD and the 2016 HLEG Workshop on Measuring Trust and Social Capital. Yann Algan thanks European Community’s Horizon H2020 Programme (H2020-ERC-2014-CoG Grant Agreement n° 647870) for its financial support under the SOWELL project. All errors are our responsibility. The working paper series has been produced to stimulate debate on economic transition and development. Views presented are those of the authors and not necessarily of the EBRD. Working Paper No. 208 Prepared in February 2018 1 Introduction A spectre is haunting Europe and the West – the spectre of populism, as seen in the United Kingdom’s vote to exit the European Union, the election of Donald Trump as the US President, as well as a strong showing of Marine Le Pen’s National Front party in the French Presidential elections and the Alternative for Germany (AfD) party in the German elections of 2017. In continental Europe, the first significant successes of populist politicians took place even before – with parties such as the Freedom Party in Austria, AfD in Germany, Golden Dawn in Greece, Jobbik in Hungary, the Five Star movement in Italy, Law and Justice in Poland, Swedish Democrats in Sweden, UKIP in the United Kingdom gaining substantial ground since 2012. In France, Marine Le Pen’s National Front came first in the 2014 European elections and in the first round of 2015 regional elections. The rise of populism in the European Union is important for many reasons. The European Union is a historically unprecedented supranational unification project (Spolaore, 2013). It has been successful in preserving peace and integrating into the European democratic model the “periphery” countries of southern and eastern Europe (Gill and Raiser, 2012). However, the economic crisis has uncovered shortcomings in the design of European economic and political institutions. As we demonstrate below, Europeans appear dissatisfied with local and EU politicians and institutions. And this distrust fuels – and in turn is reinforced by – the rise of political extremism. There are two potential explanations for the decline of trust in the European Union, the rise of Eurosceptic populists and the electoral successes of radical left and far-right parties. The first is a cultural backlash against progressive values, such as cosmopolitanism and multiculturalism, and a shift towards national identity. The second explanation emphasises economic insecurity, stemming from either globalisation and technological progress (outsourcing, increased competition from low-wage countries, automation) or the sharp increase in unemployment in Europe in the aftermath of the recent crisis. While these two explanations are not mutually exclusive and certainly interact, much of the public debate has been about the cultural backlash. This paper explores the economic roots of populism, focusing on the impact of the Great Recession. The recent financial crisis has had a major impact on the European economy. The EU-wide unemployment rate increased from 7 per cent in 2007 to 11 per cent in 2013. Unemployment dynamics have been uneven. After a short-lived spike in 2008-09, unemployment in Germany fell to pre-crisis levels; in Greece and Spain, it climbed above 20 per cent. There has been substantial heterogeneity in unemployment dynamics within the periphery and the core (often associated with Germany and neighbouring economies) and even within countries. For example, in 2016 the national unemployment rate in the UK was at 5 per cent – lower than in 2007. However, in a median NUTS2 region,1 the unemployment rate was two percentage points higher than before the crisis. In northern Greece, unemployment in 2012-14 hovered around 30 per cent while in the Aegean and Ionian Sea islands it fluctuated between 15 per 1 The Classification of Territorial Units for Statistics (NUTS; French: Nomenclature des unités territoriales statistiques) is a geocode standard for referencing the subdivisions of countries for statistical purposes. The standard is developed and regulated by the European Union, and thus covers the member states of the EU in detail. For each EU member country, a hierarchy of three NUTS levels is established by Eurostat in agreement with each member state; the subdivisions in some levels do not necessarily correspond to administrative divisions within the country. From the NUTS Regulation, the average population size of the regions in the respective level shall lie within the following thresholds: at the NUTS 1 level: between 3 million and 7 million; at the NUTS 2 level: between 800,000 and 3 million and at the NUTS 3 level: between 150,000 and 800,000. cent and 21 per cent as tourism mitigated the shock of the crisis. Likewise, unemployment in Italy in 2012-15 ranged from 6-7 per cent in the north (Trento, Veneto, Friuli-Venezia) to above 20 per cent in the south (Campania, Calabria and Puglia). We show that the differential impact of the crisis explains the rise of anti-establishment, often populist, parties and the respective drop in trust towards political parties and the European Union. Globalisation in general and the European Union have been successful in promoting growth but have not done as well in terms of sharing the gains. Large parts of society have felt left behind and have risen against the establishment and national and European institutions. The recent vintage of populism unites extreme-right and far-left politicians in their criticism of the elites and the cross-border integration that these elites represent. In some cases, the rise in unemployment fuels support for far-left parties (such as Podemos in Spain) and in other cases, for far-right nationalistic and xenophobic parties (as in Hungary and the Netherlands). Sometimes, rising unemployment fuels support for both radical left and ultra- right nationalistic parties that are increasingly coordinated (as for example the coalition between Syriza and the Independent Greeks). We first conduct a descriptive analysis of the evolution of unemployment, voting and trust- beliefs across Europe before and after the crisis, showing that the economic crisis has moved in tandem with a political trust crisis and the rise of populist, anti-establishment vote. Second, we study the relationship between unemployment and voting for anti-establishment (radical left, far-right, populist and Eurosceptic) parties at the subnational level. We compare the regions that greatly suffered from the crisis with those that weathered the crisis relatively well – controlling for pan-European or country-group-specific time trends. We document that rising voting shares for anti-establishment, especially populist parties, follow increases in unemployment. It is the change in unemployment – rather than its level – that correlates with voting for non-mainstream parties; this (to the best of our knowledge) novel result echoes the findings of the literature on the role of economic losses on self-reported well-being and happiness (Layard, 2006). Our methodology accounts for time-invariant regional factors and unobserved country-group dynamics;