‘We’re at a turning point in history’

Richard Portes has written extensively on globalisation, sovereign borrowing and debt, European financial markets, credit default swaps and international capital flows. Andrew J Scott’s research focuses on longevity, an ageing society, fiscal policy and debt management, and has been published widely in leading journals. Here, they discuss the forthcoming global trends that may usher in a new economic reality.

What’s the biggest threat to growth in 2022?

Richard Portes (RP): I think there are three big threats. One is overly tight US monetary policy, not just because it will slow down the US economy, but because it might well provoke a substantial capital flight from the emerging-market countries, which would be a hit to economic activity in those countries. The second threat is debt. We are coming out of the pandemic with high levels of debt; not just government debt, but also corporate debt and even household debt. There is inevitably going to be a rise in interest rates, which will affect the ability to service that debt for governments, for corporations and for households, and that is a threat to economic growth. The final threat is energy prices. Historically, oil prices in particular have been a major factor in determining economic activity. If oil prices were to go significantly higher than where they are now, I think we’d be in deep trouble.

Andrew J Scott (AS): It does feel like the problems are coming in left, right and centre. There’s just so many things to worry about. But I agree that inflation is the biggest risk, with all the shocks that we are seeing, allied to the fact that there’s very limited scope for policy to deal with lots of the issues, because too big an increase in interest rates is going to trigger a debt problem. Governments have to do a really fine balancing act right now – there’s big shocks and there’s limited room to manoeuvre.

What is the likely impact of the war in Ukraine?

AS: Aside from the tragedy, from an economic point of view it’s bad news for the global economy. There was a hope that we might get a robust recovery from Covid, but the war is clearly greatly impeding that. The likely impact will be different in different places. If you’re in the UAE, you’re probably quite excited about higher oil prices and the reflowing of capital flows, but it’s bad news for the economy at a time when we wanted recovery.

But I think you’ve got to go beyond just economics. A major global political realignment is underway now that will have significant implications for globalisation. It continues this trend of the resurgence of politics relative to economic issues. It’s going to put a lot of pressure on Chinese and US relationships, and the unwinding of all the Cold War dividends and complexities around supply chains. There’s a lot of uncertainty – we don’t know where or how this ends. We’ve had a wonderful period of technology, globalisation and deregulation, for over 30-odd years. Now we have a major global political realignment, a major change in the zeitgeist, with the growing importance of politics in defining our country’s interactions, rather than economics.

RP: I have one specific point with respect to the effect of the war in Ukraine on food prices. Wheat, and to some extent corn, our major exports from Ukraine, are being cut off. The effect on prices for a number of countries that import food will be a big hit. And it’s the poor – in the advanced economies, in the low-income countries and in the emerging markets – who are suffering most, as usual.

What about Covid? Are we suffering some sort of economic long Covid now?

RP: Long Covid has a big economic effect. Estimates in the US suggest that 15% of the fall in the labour force is due to people who can’t work because they’ve got long Covid. So, it’s not just a question of the people dropping out briefly, but also those who are dropping out long term. Looking more broadly at that question, where we clearly aren’t over Covid is in China. The policy now in Shanghai and elsewhere in China seems to be to continue to lockdown and not to vaccinate as widely as they should and not to use the most effective vaccines. This is very bad news for the rest of us, because of the role of China in the global economy.

AS: If we are getting to a different stage of Covid the question is, how do we address public finance issues? I think this is the start of the next chapter of the economics of Covid. Again, it’s why the current shock of the war is such a problem, because there’s not much capacity to respond. In the global financial crisis, we saw big central bank intervention, but I’m not sure we saw the structural changes that were necessary – I think we’ve had a bit of a hiatus and our long-term response needs to be faster than the response to the global financial crisis. We seem to be moving into a new historical epoch and I think we might see more economic reality come through more quickly this time around.

RP: One of the potential effects of long Covid is disruption to supply. The supplies of various important raw materials have been endangered and, to some extent, blocked. That’s making for a lot of volatility in the prices of commodities and that is being reflected in the markets, so we could see a lot of market disruption in the coming months.

Will interest rates keep rising?

AS: I always tell my students that the most important thing in talking about the economy is to give no numbers and no dates! Yes, interest rates are going to keep rising. The question is, for how long and by how much? I agree with Richard that a really big problem is the US raising interest rates too much. Unfortunately, the US is overheating and does need higher interest rates, but I’m not sure the rest of the world does to the same degree. My biggest worry about interest rates is that I’m not sure central banks really have a framework to understand what’s been happening to inflation in the last five or six years and how they’ve operated monetary policy. I think they were surprised by how stable and low inflation was, which makes it hard to understand why it’s rising so much now.

RP: I’m not sure I agree entirely. It’s not obvious that interest rates are as effective [in bringing inflation rates down] now as they were in the past. I also think it’s the wrong way to go. I think that would bring lots of other problems in terms of pulling capital out of emerging-market countries and in terms of servicing debt, and so forth. Let’s remember that even if rates go up significantly, as long as inflation stays relatively high, real interest rates are going to be very low because of the way in which inflation has peaked. It’s not clear that real rates are going to end up being much higher than they are now.

What will happen to energy prices?

RP: A lot depends on the war and on responses to it. In particular, what will Europe do about imports of oil and gas from Russia? It’s a strange thing – if you’re thinking about the economics of this, you might think that if, say, Germany were to stop oil and gas imports from Russia, demand would fall, so prices would fall. But actually, it’s not obvious that that’s the case. Germany will still need to get oil and gas from somewhere. That’s likely to mean getting it at higher prices than before. And what will happen to world supply? The Russian oil can and will be sold elsewhere and there will be some degree of substitution in world markets, but the Russian gas can’t be sold elsewhere, so some of the supply of gas to the global economy will fall. So, we have to look very carefully at the implications for energy prices of this war.

AS: Certainly for consumers prices may go even higher, even if we don’t see any further increase in energy prices. This is a big gouge in people’s standard of living. As Richard said earlier, it has a bigger impact on lower-income households. It’s hard not to think this is anything but bad news in the short term. Europe’s going to have to look at its whole energy supply and we’ll start looking at renewables more. We may well get an increase in the supply of renewables relative to non-renewables, which may be good news in the very long run – but you have to peer through the binoculars to see that!

What changes might we see in the workplace?

AS: From a macroeconomic perspective you’ve got two issues. The first is the fall in labour force participation in the wake of Covid. The second is the productivity effects of work from home. On the former, a lot of this withdrawal from the labour market is coming from older workers. In the 10 years before Covid this age group was the most important source of employment growth, so if they are withdrawing that’s an issue – for the macroeconomy and for individual retirement planning. We don’t know yet why this has happened, but how it unfolds will be key for the economy and also inflation. As for work from home, the key issue there is what impact this will have on long-run productivity growth. These are big changes in the structure of labour markets.

RP: With regard to social relationships, I’m very concerned that the disintegration that we saw during the lockdowns, with real restrictions on contact, is persisting. I don’t want to look back to the ’50s and ’60s as being the ideal social structure by any means, but you did have structures that gave people fairly stable incomes, jobs and social relationships. It was being disrupted before Covid, but Covid brought major changes in that respect, and I think that can have big social costs. And that means economic costs, because I don’t think we can divorce the way people function in their workplaces from the way they function in the rest of their lives.

AS: I go back even further to the industrial revolution – GDP started to do very well, but workers weren’t doing so well from it. There was a big change in living standards and workers lost support networks and community identity. That led to protests on the streets and the rise of the labour movements to try and make sure that, as we adapted to new technologies in order to be more productive and get the GDP benefits, there were also benefits for society as a whole. In the ’50s and ’60s, everyone felt they were getting some benefits from economic growth by harnessing modern technology. We don’t seem to be there yet. How do we get there? What are the political movements that will start to generate change that’s good for the economy and good for society in an inclusive way? Covid seems to be a turning point in terms of the business cycle, a turning point in terms of the recent history of geopolitics, and a turning point in the longer-run history of how we adapt and develop post-industrially.

Are there any grounds for optimism?

AS: It’s not a time for wild optimism, is it? The risks are skewed to the downside. But at least the tensions around globalisation that have been rising for a long time are now starting to be addressed. The shifting acceleration away from fossil fuels has to be a good thing in the long run. Perhaps the greatest reason for optimism is that, in the early days of Covid, everyone was terribly concerned about a pandemic that would cause far more loss of life than the tragic number we’ve seen already. But, so far, it seems that we have managed to come through the pandemic. Yes, there are a lot of problems and challenges, but perhaps we can take some hope from the fact that we developed a vaccine quickly and we didn’t see that massive loss of life – it could be worse.

RP: I think there’s another factor and this is a long-term issue. We saw a slowdown, over a few decades, of technological progress. Some scholars said it was because all the big inventions had been discovered already – the major changes in life had come from electricity, for example. But we may just be turning the corner there, too, in two respects. First, the amazingly fast development of vaccines has highlighted the huge progress in medical technology. The second, which I think will also accelerate, is artificial intelligence. What you can do now, for example in machine learning and artificial intelligence, are things we just couldn’t have imagined that computers could do even 10 or 15 years ago. I’ve never believed that innovation of that kind or any other kind in the long term results in higher unemployment or displacement of workers who never find other jobs. I think we could well see some major technological changes that will raise productivity and make people a lot better off.

Listen to Richard Portes and Andrew J Scott’s full conversation in the Think at London Business School podcast The economic outlook: what you need to know