For more than two years, the global economic debate has been all about rising prices, rising interest rates, and the possibility of a recession and rising unemployment. Once 2023 is over, that long debate will end.
In both Australia and the United States, underlying inflation peaked more than a year ago. It has been on a downward trend since then. If this trend continues, and there is good reason to expect it to, current inflation rates will be within the central bank's target range by the second half of 2024.
Far from being in recession, unemployment rates in Australia and the United States remain below 4%. Most central banks have stopped raising interest rates as inflation falls and output growth slows. It will likely take a considerable amount of time before interest rates are cut, but the tightening phase is likely over in the US, Australia, and Europe.
Both the coronavirus pandemic and post-pandemic inflation are now a thing of the past. It's time to think about what will happen next.
One thing we do know is that some important trends that defined our economic experience over the past 30 to 40 years are no longer as important.
For decades, economists have struggled to predict when productivity spikes will begin and end, and why.
The size of China's economy has increased tenfold over the past three decades, contributing to more than a quarter of global economic growth. China's working-age population has been declining since 2010, and productivity growth is unlikely to improve, so China's production growth rate is likely to slow from around 5% this year to 4.5% next year. The growth rate after 10 years is likely to be less than 3%. China's living standards will continue to improve, and more Chinese industries will enter the world's technological frontiers. As the world's first or second largest economy, China's economy will become as important to the world as the US economy. However, China's significant contribution to global economic growth and export growth rates for resource-producing countries such as Australia will steadily slow.
The first two-thirds of the global economic turnaround over the past three decades was fueled by trade growth. That probably won't happen for the next few decades. Thirty years ago, exports accounted for less than a fifth of global GDP. By 2008, they were almost a third. Currently, exports as a share of GDP are about the same as in 2008, meaning that exports are slowing relative to overall GDP growth. Rich economies primarily produce services, which do not cross borders as easily as goods. Globalization, measured as the trade share of output, is not in retreat; it has been stable for a long time. This removes another driver of global economic growth.
Most wealthy economies have not seen productivity growth for quite some time (Andreas Arnold, via Getty Images)
Long-term interest rates have been trending downward for 40 years, first in response to falling inflation and then in response to central bank interest rate cuts to combat the 2008 financial crisis and the subsequent COVID-19 pandemic. did. In 1984, the interest rate on the US 10-year bond was 14%. By mid-2020, it was just over half of 1%. Australian bond rates broadly followed the US pattern. Due to lower interest rates, U.S. stock prices have increased eight times as much as hers, and U.S. nominal wealth has increased ten times as much as hers. The long decline in interest rates has ended. U.S. bond interest rates are back to where they were at the start of this century.
Central banks, reminded of the dangers of inflation, are unlikely to lower short-term interest rates to their lowest levels of the past 15 years. Most governments accumulated large amounts of debt in response to the 2008 crisis and the coronavirus. They continue to need to defer debt, compounded by the deficits most governments run. Meanwhile, central banks are running out of accumulated government debt, increasing the amount of debt governments need to sell to the market. It is difficult to see how Treasury rates, the benchmark for most other interest rates, could fall significantly. While it is true that fewer opportunities may reduce expected investment returns, it is also true that population aging in China and most rich countries may reduce growth in household savings. After all, the purpose of most household savings is to prepare funds for retirement.
We should expect more nasty fights over the distribution of income and wealth.
Finally, there is productivity in inventorying absenteeism. For decades, economists have struggled to predict when productivity spikes will begin and end, and why. But there is no doubt that most wealthy countries, including Australia, the United States and European countries, have not seen productivity growth for quite some time. Economic growth can be roughly thought of as an increase in working hours plus the rate of increase in output per working hour, in other words, labor productivity. At various times over the past 40 years, productivity gains have strongly supported overall economic growth. That's not the case now – at least, not yet. When slower labor force growth is coupled with slower productivity growth, the result is slower income and output growth.
So what about the dizzying pace of technological change, the promise of artificial intelligence, quantum computing, and more? And what about the massive transition to green technologies? These changes will bring huge productivity gains Isn't that the case? Maybe it is. However, coincidentally, the long period of sluggish productivity growth coincided with rapid technological change over the past decade. Some technologies increase output per labor hour. Others only make our lives more enjoyable or more complicated. And keep in mind that electric cars will replace gasoline cars and new forms of energy production will replace existing forms of energy production. These are changes we need to make to save the planet, but they don't come with any particular promise of increased productivity compared to the alternatives.
As the economy recovers from a deep recession, growth rates are usually higher than average. But we are not out of a deep recession. Therefore, you should not expect recovery. At best, we should expect a sustained period in which average output growth is significantly lower than in the past 30-40 years, and financial asset value growth is much slower. Once you accept its inevitability, it's not such a bad path. But we should expect even more thorny battles over the distribution of income and wealth. When incomes are expanding significantly, even the least wealthy can reap some benefits. When income growth is slow, it is difficult to improve the situation of some groups without worsening the situation of others.
