The writer is a professor of finance at the University of Chicago Booth School of Business.
A perfect economic storm is engulfing the industrial countries. Even before the pandemic, the US-China geopolitical rivalry hampered global trade and cross-border investment. The pandemic has skewed demand toward bikes and away from gym memberships.
Then continued lockdowns across the world disrupted production of these bikes. Normally, rising bicycle prices would have stifled demand, but the huge fiscal and monetary response to the pandemic in advanced economies has kept household purchasing power high. Even as jobs returned to meet this demand, workers became harder to find as older workers decided to retire and immigration slowed. The mix of high demand and limited supply triggered the inflation, which spread far beyond the narrow set of goods that had triggered it.
The war in Ukraine and the spread of lockdowns in China add to the turmoil. Both are slowing growth, while war is fueling food and fuel inflation and Chinese lockdowns are driving goods price inflation. Of course, the war could spread further in a catastrophic way.
Spare a thought for developing countries, where the situation is worse than in industrialized countries. Public spending during the pandemic has been very limited. Many middle-class households lost their livelihoods and fell into poverty.
Today, they face higher energy and food prices that threaten to reduce their consumption below subsistence levels. With interest rates rising, their governments are crippled by past borrowing and lack the capacity to help. All of this portends more protests and political conflict in the developing world, and more emigration to safer climes.
According to current trends, the future looks difficult. Sustained growth requires innovations that make it possible to produce more at a lower cost. As the pandemic has forced companies to rethink work processes – working from home saves time by dressing below the waist and on daily commutes – substantial gains are likely only to be achieved when obstacles to the provision of remote services will be reduced; telemedicine will not grow if local licensing requirements prevent doctors from prescribing remotely. In the absence of reforms, productivity growth is unlikely to exceed the pre-pandemic pace.
Likewise, the aging of the population will continue to reduce the labor force, further slowing growth. De-globalization through outsourcing and relocation of friends, and the consequent fall in global trade and investment, will make it more difficult for developing countries to grow and substitute their demand for declining demand from industrial countries. Military spending will increase everywhere, but this will hurt much-needed investments, including in the fight against climate change. Variants of secular stagnation therefore loom once the storm has passed – no wonder real 10-year rates in the US are still around zero.
At best, if central banks raise rates enough that everyone thinks inflation will be under control, but not so much that the economy collapses, they will gently dampen demand. The labor market will run out of steam, even if supply chains stabilize. We will land softly, but in lower growth than before the pandemic. At worst, we will have a recession compounded by financial strains, as the world suffocates with high rates and high debt levels. Central banks cannot get us out of our predicament.
To achieve better results, we need to revitalize growth through policies aimed at increasing investment and productivity. Ending this destructive war would be a first step, but let’s talk about what’s next.
The easiest solution economically, and the most difficult politically, is to reverse the trend of de-globalization. By all means, companies should diversify every element of their supply chain. They must also incorporate flexibility to minimize bottlenecks. But companies and governments shouldn’t aim to do business only with friends. And the IMF and World Trade Organization should work on rules of conduct and penalties for violations that will protect global trade and investment even as the world divides into political blocs.
Indeed, we need to find ways to improve the global trade in services that the pandemic, Zoom and other technologies have made possible. This 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 resisted change. A side benefit is that it could reduce income inequality within countries and globally.
Perhaps most importantly, we should unite to fight a war that we are losing, against climate change. Much of the world’s high-emitting capital needs to be replaced. Embarking on this task may be the boost the global economy needs to emerge from stagnation. The world’s major economic powers must come together, with clear plans for their own actions over the next decade and how they will distribute the responsibility for financing climate responses in the developing world.
More generally, we need bold political action, freeing us from the growing political constraints that limit our ambition. It won’t be easy, but it’s necessary, perhaps for our very existence.