When the psychology of leaders goes macro

When policy is governed by rules, the psychology of the leader is constrained. When rules give way to discretion, the leader’s psychology becomes a macroeconomic variable.

David Nellor

12 August 20264 min read

The erratic imposition of tariffs and the disruption of shipping through the Strait of Hormuz are very different events but both show how decisions taken by leaders become global economic shocks. For Australia and other open Indo-Pacific economies, those shocks are transmitted rapidly through trade, energy prices, supply chains and security relationships. To manage economic risk, Indo-Pacific governments must now account not only for interests and institutions, but for the behaviour of leaders with the discretion to disrupt them.

Psychology enters the economy not as a temporary shock, but as part of a cycle of political and economic instability.

Conventional geoeconomic analysis focuses on the instruments deployed and the interests served. It pays less attention to the behaviour of leaders deciding how to use them. The US–Iran war revived Norman Dixon’s (Opens in new window) compelling 50-year-old book (Opens in new window) arguing that the psychology of military leaders explains catastrophic military decisions throughout history. The same insight now deserves to be applied to economic policy.

Institutions and established practices act as guardrails between a leader’s psychology and its economic consequences. Independent central banks limit politically convenient monetary decisions. Fiscal frameworks restrain opportunistic spending. Trade agreements restrict abrupt protectionism. The legislative process and the checks and balances of institutional responsibilities expose proposals to evidence and competing views.

These arrangements narrow the space for unchecked decisions. They constrain not only what leaders can do but how personal impulse can become economic policy.

In today’s disrupted world, many of these guardrails have been pushed aside (Opens in new window). Technology, climate and other change have produced constituencies for disruption: industrial communities exposed to automation and import competition, households bearing the cost of energy transition, and younger people excluded from housing and secure work. Many regard existing institutions as unresponsive or complicit. The resulting discontent has increased the appeal of outsiders promising decisive action and prepared to break rules that voters believe have failed. As authority becomes personalised, the behavioural characteristics of the leader acquire economic significance.

In the era of the rules-based order, a tariff proposal was defined by its economic purpose, typically to protect an industry. The proposal was assessed through an institutional and political process culminating in a decision to adopt (or not) the measure. The process made policy understandable and constrained abrupt change.

Irrespective of the purpose of the latest US tariffs (Opens in new window), none requires policy to be conducted through dramatic announcements, personal demands and repeated escalation and reversal, as has occurred in the second Trump Administration. For businesses and partner-country governments, this unpredictable pattern matters as much as the tariff itself.

Businesses and governments must forecast not only economic conditions but the policymaker.

While policy objectives can explain why a tariff is employed (e.g. it creates revenue for government; it protects certain favoured industries), policy can’t explain why tariffs would be imposed, removed, reduced, increased, and reduced again.

Only the leader’s behavioural profile can help explain the unstable way tariffs are used. How that leader treats advice that contradicts their tariff preferences, whether resistance to tariffs produces compromise or escalation, and whether a stable outcome with a trading partner matters less than a visible victory will all shape the way the leader uses their discretion to impose trade measures. This is where psychology enters economic analysis.

Personalised policy thus creates another element of uncertainty. Businesses and governments must forecast not only economic conditions but the policymaker. Policy risk concerns different outcomes under known rules. Policy uncertainty arises when the rules may change. Psychological uncertainty goes further; whether and how the rules change depends on the response of one powerful individual.

That uncertainty is itself macroeconomic. A tariff raises prices but personalised tariff-making changes expectations, delays investment and redirects resources towards access and hedging. The study of leadership psychology does not replace the analysis of interests, incentives and institutions but its importance rises as authority becomes concentrated, institutional challenge weakens and the instruments under a leader’s control acquire greater economic reach.

For Australia and other Indo-Pacific economies, this changes the meaning of external risk. Exposure depends not only on trade shares, shipping routes and alliance commitments but on how much discretion foreign leaders possess and how they exercise it. Economic and strategic analysis must therefore examine recurring behaviour alongside interests, institutions and capabilities.

Until credible new guardrails emerge, economic actors will adjust at significant cost. Firms will preserve optionality, diversify supply chains and hesitate before making irreversible investments. Households will build precautionary buffers. Indo-Pacific governments will hedge relationships that once rested on durable economic and security commitments. These responses may be individually rational, but collectively they will reduce investment, productivity and growth.

There is a further danger: this adjustment may become self-reinforcing. Lower investment and weaker growth deepen the dissatisfaction that brought disruptive leaders to power, eroding support for institutional restraint. Psychology enters the economy not as a temporary shock, but as part of a cycle of political and economic instability.

About the author

David Nellor

David Nellor is a Senior Fellow at the Lowy Institute. He is a PhD economist with extensive international experience across economic policy, development, financial markets, and the climate and energy transition. His work combines applied economic expertise with advanced data analytics to support policy design, market analysis, and strategic decision-making.

Topics

Economy United States World Leaders