Martin Sandbu Oct. 12, 2023 Financial Times
How to make some sense of our ignorance.
Greetings. The annual meetings of the World Bank and the IMF, that convene the world’s economic policymakers to Marrakech this week, will not create many headlines. The tragedy in the Middle East will overshadow whatever they may agree. It is a sad illustration — as it also was with the recent earthquake in Marrakech itself — of how the global economy is buffeted by external shocks that standard modelling has little hope of helping us understand. Today I offer some thoughts on how to think about the global economy in this changing world.
The short-term work must go on, of course, and the multilateral financial institutions are duly publishing their reports and forecasts. The IMF’s World Economic Outlook, for example, sees the global economy as merely “limping along”. No wonder, with interest rate rises beginning to bite, cost-of-living pressures still high and China still seemingly in real estate crisis freefall (see the IMF’s chart below).
The news is not all bad: the IMF shows that in many countries, the recovery from the pandemic has led to greater earnings equality in many countries, notwithstanding inflation.
But when uncertainty is this high, we paradoxically gain more from assessing the global economy at a more distant horizon. There can be no doubt that we are undergoing deep structural changes and are not going back to some status quo ante. What we end up with is even more uncertain than short-term forecasts, of course. But while those are at most qualified quantitative guesses, for the longer term we can try to identify patterns in the forces of change, which could be more informative than short-term prognostication.
I would like to focus on three overarching characteristics of the direction of economic change. The first is fragmentation — the raising of new economic barriers between countries and the end of the globalising impulse that has defined the world economy for nigh-on 40 years. The second is increased volatility — whether from intensifying climate events, more frequent and hereto unthought-of geopolitical shocks, or built-in instabilities in financial markets that we are discovering as interest rates go up.
The third characteristic is more of a catch-all category: I think of it as the rise of the supply side. The increased volatility and shocks we face seem increasingly likely to affect the supply side and the structural make-up of the economy. The supply side is also the main site of the return of state activism in economic management. From largely focusing on demand management (through independent central banks) and redistribution of the fruits of growth (through tax and benefit policies), governments have now embraced a responsibility for shaping the structure of the economy and the direction of growth. This new activism applies to huge policy areas ranging from geopolitical resilience (building domestic microchip supply chains), decarbonising the energy system, and managing the digital transition of our lives and livelihoods.
If these are three sensible headings around which to organise our thinking about what is happening, it is obvious what the potential economic risks could be. The potential cost of fragmentation is that of duplication — the cost of establishing and maintaining many “near-shored” value chains when a single global one would do. That of increased volatility is higher insurance cost, in the broad economic sense of resources that have to be diverted from alternative uses in order to guard against or mitigate damage that now may occur more frequently. And the potential cost of supply side dominance is inefficiency: the risk that as governments become more involved in managing supply-side disruption and structural change, they have more opportunities to choose bad policies.
These risks are, however, conceptual. In practice, it is a lot harder to know how things will actually play out. Take fragmentation. As I have argued before, what we are most likely to see is not “deglobalisation” but intensified “regional globalisation”, that is to say, more and deeper integration within economic blocs, even as links may weaken between blocs.
That this will be costly tends to be taken as an article of faith. But that really depends on what the optimal scale of the supply chain is. Perhaps the world can only efficiently fit one producer of the most cutting-edge microchips. (Or perhaps that number is none, given how it seems no such factory has ever been set up without ample public support.) If so, repatriating supply does come at an economic cost. But it seems unlikely that this is true for most sectors — say, electric vehicles. Given the size of a typical car plant, it’s hard to see what scale economies can be gained from producing, say, 50mn cars annually in China, that aren’t already maxed out when each of North America, Europe, and China produce 10mn-20mn each.
So, estimates that fragmentation will lead to a particularly high cost — such as the IMF’s modelling that trade disintegration could cost 7 per cent of world gross domestic product — must rely on ambitious assumptions about how big is big enough to exhaust economies of scale. But this is deeply uncertain. It is plausible that more intense regionalisation is less efficient than “full” globalisation — but it is also plausible that it need not be.
(Of course, trade can also be driven by differential resource endowments in different countries — but most modern trade is a matter of the most efficient use of technologies that become cheaper to use the larger the market. And to the extent the draw of full globalisation has been cheap labour in poor countries, note that this has served as a substitute for automation and other technological upgrading — and is therefore a cause of slow productivity growth.)
Volatility is more unambiguously costly — especially the real, physical volatility caused by things such as more frequent extreme weather events or acts of war. A greater share of society’s resources will have to be devoted to physical investments that protect against shocks (think flood defences and food and medicine stockpiles), and both financial insurance and countercyclical policies must be expanded.
Note, however, that fragmentation could mitigate volatility. If there are three regional supply chains instead of a single global one, there are alternatives when one link in one chain breaks. The new supply side dominance could also be helpful. The state’s increased role does not only bring the risk of inefficiencies — it can also contribute to greater stability, predictability and hence productivity. Policies can be designed so as to reduce volatility and uncertainty for businesses, for example by committing to a long-term path for carbon prices (like Norway does) or by credibly promising to create a market for certain goods (like the US’s Inflation Reduction Act does).
All of this is deeply unknowable. But it helps, in the face of uncertainty, to systematise our ignorance. Knowing what we do now know is, after all, a form of wisdom.
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Posted: to Wealth Management News on Tue, Oct 24, 2023
Updated: Tue, Oct 24, 2023