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Greetings. The annual meetings of the World Bank and IMF, which convene the world’s economic leaders in Marrakech this week, will not generate many headlines. The tragedy in the Middle East will overshadow anything they might agree on. Like the recent earthquake in Marrakech itself, it is a sad example of how the global economy is hit by external shocks that we can hardly understand using standard models. Today I offer some thoughts on how to think about the global economy in this changing world.
The short-term work must of course continue and the multilateral financial institutions are duly publishing their reports and forecasts. The IMF’s World Economic Outlook, for example, assumes that the global economy is merely “limping along”. No wonder, as interest rate hikes are starting to take hold, cost of living pressures are still high and China still appears to be in housing crisis free fall (see the IMF chart below).
The news isn’t all bad: The IMF shows that the recovery from the pandemic has led to greater income equality in many countries, regardless of inflation.
But when uncertainty is so high, paradoxically we get more out of it by looking at the global economy from a more distant horizon. There is no doubt that we are undergoing profound structural changes and will not return to a status quo ante. The outcome is of course even more uncertain than short-term forecasts. While these are at most qualified quantitative guesses, in the longer term we can try to identify patterns in the forces of change that may be more meaningful than short-term forecasts.
I want to focus on three overarching features of the direction of economic change. The first is fragmentation – the emergence of new economic barriers between countries and the end of the globalization impulse that has dominated the global economy for almost 40 years. The second reason is increased volatility – whether from worsening climate events, more frequent and previously unforeseen geopolitical shocks, or built-in instabilities in financial markets that we are discovering as interest rates rise.
The third feature is more of a catch-all category: I think of it as the rise of the supply side. The increasing volatility and shocks we are facing appear to be increasingly having an impact on the supply side and the structural design of the economy. The supply side is also the main site of the return of state activism in economic governance. From focusing largely on managing demand (through independent central banks) and redistributing the fruits of growth (through tax and benefit policies), governments have now taken responsibility for shaping the structure of the economy and the direction of growth. This new activism applies to major policy areas, ranging from geopolitical resilience (building domestic microchip supply chains) to decarbonizing the energy system to addressing the digital transformation of our lives and livelihoods.
If these are three sensible headings by which we can organize our thinking about what is happening, it is obvious what potential economic risks could exist. The potential cost of fragmentation is that of duplication – the cost of establishing and maintaining many “proximate” value chains when a single global value chain would suffice. The reason for the increased volatility is higher costs of insurance, in the broadest economic sense, of resources that must be diverted from alternative uses to avert or mitigate damage that may now occur more frequently. And the potential cost of supply-side dominance is inefficiency: the risk is that the more governments become involved in managing supply-side disruptions and structural change, the more opportunities they have to take bad actions.
However, these risks are conceptual in nature. In practice, it is much harder to know how things will actually turn out. Let’s take fragmentation. As I have argued, what we are most likely to see is not “deglobalization,” but increased “regional globalization,” that is, stronger and deeper integration within economic blocs, even as the connections between blocs may become weaker.
That this will be costly is often viewed as an article of faith. But that really depends on how big the supply chain is optimally. Perhaps the world can only efficiently accommodate a single manufacturer of the most advanced microchips. (Or perhaps that number doesn’t even exist, considering that no such factory appears to have ever been built without sufficient public support.) If so, there is an economic cost to repatriating supplies. However, it seems unlikely that this will apply to most sectors, such as electric vehicles. Given the size of a typical automobile plant, it is hard to imagine what economies of scale can be achieved by producing, say, 50 million cars per year in China that are not already exhausted by the time North America, Europe and China each produce 10 million. 20 minutes each.
Therefore, estimates that fragmentation will result in particularly high costs – such as the IMF’s modeling that a trade collapse could cost 7 percent of global gross domestic product – must be based on ambitious assumptions about how large enough to exploit economies of scale. But that is deeply uncertain. It is plausible that more intensive regionalization is less efficient than “full” globalization – but it is also plausible that this is not necessarily the case.
(Of course, trade can also be driven by different resource endowments in different countries – but in most cases modern trade is about the most efficient use of technologies, the larger the market, the cheaper it becomes to use. And to the extent that Full globalization is increasing (Note that this has served as a substitute for automation and other technological modernizations – and is therefore a cause of slow productivity growth.)
Volatility is clearly more costly – particularly the real, physical volatility caused by, for example, more frequent extreme weather events or acts of war. A greater proportion of society’s resources must be devoted to physical investments to protect against shocks (think flood protection and food and medicine supplies), and both financial insurance and countercyclical measures must be expanded.
However, note that fragmentation could mitigate volatility. If there are three regional supply chains instead of a single global supply chain, there are alternatives if one link in a chain breaks. The new dominance of the supply side could also be helpful. The increasing role of the state not only carries the risk of inefficiencies, but can also contribute to greater stability, predictability and thus productivity. Policies can be designed to reduce volatility and uncertainty for companies, for example by committing to a long-term path for carbon pricing (as Norway does) or by credibly promising to create a market for certain goods (as Norway does). the USA Inflation Reduction Act). does).
All of this is profoundly unknowable. But in the face of uncertainty, it helps to systematize our ignorance. Knowing what we know now is, after all, a form of wisdom.
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