The new reality with which economies must consider is high inflation and slow economic growth. And a big part of the current bout of inflation is a series of supply shocks that have cut production and increased costs. The COVID pandemic forced many sectors to close, disrupted global supply and produced a persistent shortfall in labor supply, especially in the US. Then came Russia’s invasion of Ukraine, which has pushed up various prices. China’s stringent lockdowns in major economic centers have further curtailed supplies. But even without these short-term factors, the medium-term outlook will be bleak. There are many reasons to worry about stagflation conditions plaguing the global economy with high prices, low growth and a possible slowdown in many places.
For starters, we have seen a retreat from globalization and a return to protectionism. This reflects geopolitical factors and domestic political motivations in countries where large groups feel ‘backward’. Geopolitical tensions and supply disruptions are likely to lead to greater re-shoring of manufacturing from China and emerging markets to advanced economies, or near-shoring of allied countries. Either way, production will be mis-allocated to high cost areas.
Meanwhile, demographic aging in many markets will continue to reduce the labor supply, leading to wage inflation. The continued backlash against immigration in advanced economies will also reduce the labor supply and apply wage growth pressure. Similarly, the new Cold War between the US and China will create widespread stagflation. Sino-US decoupling means fragmentation of the global economy, balancing of supply chains and tighter restrictions on the trade of technology, data and information.
Climate change, too, will lead to stagflation. Eventually, drought damages crops, ruins crops and drives up food prices, as do hurricanes, floods and rising sea levels that destroy capital stocks and disrupt economic activity. Making matters worse, the demand politics of fossil fuel bashing and aggressive decarbonization have led to less investment in carbon-based capacity before renewable energy sources have reached a scale sufficient to compensate for the short supply of hydrocarbons. Under such circumstances, a sharp jump in energy prices is inevitable. And as the price of energy rises, ‘greenflation’ will impact the prices of raw materials used in solar panels, batteries, electric vehicles (EVs) and other clean technologies.
Public health is likely to be another factor. Little has been done to prevent the next infectious-disease outbreak, and we already know that pandemics disrupt global supply chains and incite protectionist policies as countries consume critical items such as food, pharmaceutical products and personal protective equipment. rush to collect the supplies.
We should also worry about cyber warfare, which can cause serious disruption to production, as evidenced by recent attacks on pipelines and meat processors. Such incidents are expected to become more frequent and severe over time. If firms and governments want to protect themselves from this threat, they will have to spend hundreds of billions of dollars on cyber security, adding to the cost to consumers.
These factors would add fuel to the political backlash against massive income and wealth inequalities, leading to greater financial spending to support the ‘backward’. Efforts to raise the income share of labor relative to capital, although well-intentioned, lead to a wage spiral of greater labor conflict and inflation.
Then there is Russia’s war on Ukraine, which signals a return to zero-sum great-power politics. For the first time in several decades, we must account for the risk of large-scale military conflicts disrupting global trade and production. Furthermore, the sanctions used to deter and punish state aggression are themselves stagflationary recessions. Today against Ukraine and the West is Russia. Tomorrow, it could be Iran nuclear, North Korea engaging in greater nuclear capability, or China attempting to seize Taiwan. Any of these scenarios could lead to a heated war with the US.
The weaponization of the US dollar that eases sanctions is also stagflation. Not only does this create friction in the international trade of goods, services, commodities and capital, but it also encourages US rivals to shift their foreign exchange reserves away from dollar-denominated assets. Over time, this process can rapidly weaken the dollar (making U.S. imports more expensive and feeding inflation) and lead to the creation of regional monetary systems, which further strengthen global trade and finance. weakens more.
Optimists might argue that we can still rely on technological innovation to exert deflationary pressure over time. This may be true, but the technical factor outweighs the 11 stagflation factors listed above. Furthermore, the impact of technological change on overall productivity growth remains unclear, and Sino-West decoupling will restrict the adoption of better or cheaper technologies (think 5G), leading to increased costs.
In any case, artificial intelligence, automation, and robotics are not an amalgamation. If they improve to the point where they can cause meaningful deflation, they will probably also disrupt entire businesses and industries, exacerbating already large wealth and income inequalities. This would invite an even more powerful political response than what we have already seen – with all stagflation policy outcomes that are likely to result. ©2022/Project Syndicate
Nouriel Roubini is Professor Emeritus of Economics at New York University’s Stern School of Business and Chief Economist on the Atlas Capital team.