The writer is professor of finance at the University of Chicago’s Booth School of Business
A perfect economic storm engulfs industrial countries. Even before the pandemic, US-Chinese geopolitical rivalry impeded global trade and cross-border investment. The pandemic skewed demand towards bicycles and away from gym memberships.
Then rolling lockdowns across the world disrupted production of those bicycles. Ordinarily, the rise in prices of bicycles would have quelled demand, but the enormous fiscal and monetary response to the pandemic in advanced economies kept household spending power strong. Even as jobs came back to cater to this demand, workers became harder to find, because older workers decided to retire and immigration slowed. The mix of strong demand and limited supply ignited inflation, which has spread well beyond the narrow set of goods that set it off.
The war in Ukraine and spreading lockdowns in China add to the turmoil. Both slow growth, while the war fuels food and energy inflation and the Chinese lockdowns drive goods price inflation. Of course, the war could spread further in catastrophic ways.
Spare a thought for developing countries, where matters are, if anything, worse than in industrial countries. Public spending in the pandemic has been very constrained. Many middle-class households have lost livelihoods and slipped into poverty.
Now they face higher energy and food prices that threaten to reduce consumption below subsistence levels. With interest rates rising, their governments are hamstrung by past borrowing and do not have the capacity to help. All this presages more protest and political conflict across the developing world, and more emigration to safer climes.
On current trends, the future looks challenging. Sustained growth depends on innovations that allow us to produce more at lower cost. While the pandemic has forced firms to rethink work processes — working from home saves time on dressing below the waist and on commuting — substantial gains will probably come only when the impediments to delivering services at a distance are reduced; telemedicine will not grow if local licensing requirements stand in the way of doctors prescribing at a distance. Absent reforms, productivity growth is unlikely to be higher than the pre-pandemic pace.
Similarly, population ageing will continue shrinking the labour force, further slowing growth. Deglobalisation through reshoring and friend-shoring, and the consequent fall in global trade and investment, will make it harder for developing countries to grow and substitute their demand for falling industrial country demand. Military spending will increase everywhere, but that will detract from much-needed investment, most importantly in combating climate change. Variants of secular stagnation therefore loom once the storm passes — no wonder 10-year real rates in the US are still around zero.
At best, if central banks raise rates enough that everyone believes inflation will come under control, but not so much that the economy craters, they will slow demand gently. The labour market will come off the boil, even while supply chains stabilise. We will land softly, but into growth lower than before the pandemic. At worst, we will have a recession augmented by financial stress, as the world chokes on high rates and high levels of debt. Central banks cannot get us out of our predicament.
To get better outcomes, we need to revitalise growth through policies to raise investment and productivity. Ending this destructive war would be a first step, but let us discuss what comes after.
The easiest solution economically, and the hardest politically, is to reverse the trend to deglobalisation. By all means, firms should diversify every element of their supply chain. They should also embed flexibility so they can minimise chokepoints. But firms and governments should not aim to do business only among friends. And the IMF and the World Trade Organization should work on rules of conduct and penalties for violation that will protect global trade and investment even as the world divides into political blocks.
Indeed, we should find ways to enhance global trade in services that the pandemic, Zoom and other technologies have made possible. That will require negotiations in areas such as licensing requirements, data privacy and protection, and dispute resolution, but can bring competition and productivity gains to sectors that have long been resistant to change. A collateral benefit is that this could reduce income inequality within countries and across the world.
Perhaps most important, we should band together to fight a war we are losing, against climate change. Much of the world’s emission-heavy capital needs to be replaced. Embarking on this task can be the boost the global economy needs to jump start its way out of stagnation. The world’s major economic powers need to come together, with clear plans for their own actions over the next decade and for the ways they will allocate responsibility for financing climate responses in the developing world.
More generally, we need bold policy action, breaking free of growing political constraints that limit our ambition. It will not be easy, but it is necessary, perhaps to our very existence.