Following on from Netwealth's five-year milestone, and as we look ahead to the next five years, it is perhaps worth bearing in mind the words of Benjamin Franklin: that the only things that we can be certain of are death and taxes. Even in economics, demographics and fiscal matters now occupy a pivotal place a quarter of a millennium after Franklin’s words.
Judging from the first fifth of the 21st century, two more certainties can be added to this short list: one is that shocks will hit the world economy hard as we have seen with both the 2008 global financial crisis and the 2020 pandemic; and the second is the resilience of the global economy, with its ability to bounce back, albeit helped by policy stimulus.
How the UK and world economy emerge from this pandemic and the steps taken will set the tone for the next five years. After the collapse in global activity last year, a strong rebound, helped by reflationary policies, is underway.
The persistence of global growth
Of the major economies, China was the only one not to contract because of the pandemic, although its pace of growth suffered significantly, slowing to 2.3% last year. For the others it is the US (which after contracting 3.5% last year is set to grow around 7% this year), followed by the UK, that will return to pre-pandemic levels in the coming months. But what then?
One of the remarkable features is the upward trend of the size of the world economy. At the turn of the century, in 2000, the world economy was just under $32 trillion in size. When the global financial crisis hit in 2008 it had grown to $63 trillion. Then, despite the global crisis and subsequent recession, the world economy rebounded.
Now, following the contraction induced by the pandemic and the subsequent rebound, the latest projections from the International Monetary Fund (IMF) suggest the global economy will grow to $100 trillion next year and to $122.4 trillion by 2026.
Of course, there is ongoing demographic change across the globe, with young populations across Africa and south Asia, while some countries, including Japan, China and many across western Europe have ageing populations. Also, not all parts of the world will share in this economic growth.
One of the challenges we face in the UK and across western Europe is the sluggish underlying pace of economic growth. In the wake of the 2008 global financial crisis, the UK’s trend rate of growth has been revised down by economists, from just over 2% a year to around 1.4%, although views vary. At 2.1% an economy takes 34 years to double in size. At 1.4% the time taken is 51 years.
Pre-pandemic there were conflicting messages across the globe: China’s rapid expansion continued, while much of the west was caught in a low growth environment – referred to as secular stagnation – with the US proving the exception, helped by its pre-eminence in technology.
My view is that the pandemic will trigger change in a number of ways: grassroots, as people may have become more supportive of local business and as firms build more resilience into their global supply chains; green, as there is a greater focus on environmental as well as on health issues; and geopolitics, with a move towards a G2 world, with the Chinese and US spheres of influence and impact. The latter may trigger rising geopolitical tensions.
That being said, two dominant pre-pandemic trends are likely to be evident in the economic outlook: the technology revolution that was already set to impact the future of work, and which is likely to gather pace with the emergence of artificial intelligence, allowing globalisation to continue despite the pandemic; and the regional shift in global growth and focus away from trans-Atlantic to trans-Pacific, with the growing importance of the IndoPacific region stretching from India to the US, and including east Asia.
This shift in the balance of economic power, with the US still playing a lead role, was a central feature of my 2014 book, The Consolations of Economics, which argued that the main longer-term influences were: hard power; soft power; the impact of institutions; combined with economic and financial drivers. That remains the case.
One of these drivers is the green economy, and the need to address externalities such as carbon emissions, and to ensure that a green agenda and economic growth are aligned. The challenge is the cost of moving at a sensible pace to a carbon-free economy, particularly given the growing demands for energy and the dependency the global economy has on hydrocarbons. Cheap energy is needed to sustain strong economic growth, and this requires continued investment alongside a shift towards renewables.
The inflation debate
One of the current hot debates is whether the present rise in inflation passes through and is temporary, persists or proves permanent. After the inflationary 1970s, triggered in part by two oil price surges, there was a sea change towards the end of the 1980s as we witnessed a shift to low inflation and lower interest rates and yields.
Many factors accounted for this including globalisation, the impact of technology and a squeeze on the share of wages, as well as anti-inflationary policies and lower inflation expectations. I don’t think we are moving from a low to a high inflation environment, as many factors such as global competition and the impact of technology will persist.
Also, the current rebound in demand and supply bottlenecks including higher transport costs have pushed prices higher and may prove temporary. But there is much uncertainty, and it would not be a surprise if some of the current rise in inflation persisted for a while, with what happens to wages, competition and policy of critical importance.
The challenge of economic policy
Economic policy poses the biggest challenge. At a global level, China is moving up the value curve to offset the impact on growth of an ageing population. Can India, with its huge young population, unleash the growth dynamic that China has witnessed over the last 40 years, and can the US continue to lead in technology and innovation? It’s possible that each of these scenarios occur.
The world economy is characterised by unconventional monetary and fiscal policies. How these evolve will have a clear impact on the next five years. Global public debt is at an all-time high. There was a clear justification for the more active fiscal policies witnessed during the pandemic, with governments taking advantage of low borrowing costs to intervene. Now, though, emerging from the crisis, many countries face similar challenges on how to close budget gaps.
If we take the UK, where public debt to GDP is close to 100%, the best approach would be to heed the lesson following the second world war, when debt to GDP was around 250% and fell steadily, reaching 100% by 1961 and continued to trend lower thereafter. The solution was higher growth, that boosts tax revenues and lessens the pressure on public spending, alongside what was termed financial repression, as interest rates remained low, although they were far higher than present levels.
Central banks, too, need to be mindful of their exit strategies from cheap money. Monetary policy has become the shock absorber for the UK and the global economy since the 2008 financial crisis. But low rates mean that markets do not price properly for risk, and unconventional monetary policy cannot provide the solution to many of the current economic challenges. While rates and yields look likely to remain low for now, it would not be a surprise if they settled at higher levels.
After last year’s deep recession, the UK looks set to grow strongly this year, close to 8%, and while growth may decelerate next year it will still be solid, around 4%. The UK economy is imbalanced and fiscal and monetary policy challenges exist. If the UK adopts a private sector friendly pro-growth policy, then trend growth should rise, possibly significantly.
Please note, the value of your investments can go down as well as up.