For more than two years the global economic debate has been all about increasing prices, increasing interest rates, and the likelihood of recession and rising unemployment. Ending 2023, that long debate is over.
Underlying inflation peaked more than a year ago in both Australia and the United States. It has been trending down since. If the trend continues, and there is good reason to expect it will, current inflation numbers will be moving within central bank target bands by the second half of 2024.
Far from recession, in Australia and the United States unemployment remains under four per cent. With inflation coming down and output growth slowing most central banks have stopped increasing interest rates. It will be quite a while before rates are cut, but the tightening phase is most probably over in the United States, Australia and Europe.
Both Covid-19 and the post-epidemic inflation episodes are now behind us. It is time to ponder what happens next.
One thing we know is that several important trends that defined our economic experience over the last three or four decades now matter less.
China’s economic size increased tenfold across the last 30 years, contributing more than a quarter of world economic growth. With China’s working age population falling since 2010 and productivity gains harder to find, China’s output growth will likely slow from around 5% this year to 4.5% next. In ten years its growth rate may be 3%, or less. China’s living standards will continue to increase, and more Chinese industries will move to the global technological frontier. As the first or second biggest economy in the world, China’s economy will matter as much to the world as America’s. But China’s outsized contribution to world economic growth, and to the rate of growth of exports of resource producers such as Australia, will steadily moderate.
Trade growth powered the first two thirds of the global economic upswing of the last 30 years. It probably won’t do so in the next couple of decades. Thirty years ago, exports were less than a fifth of global GDP. By 2008 they were nearly a third. Today, the share of exports in GDP is much the same as it was in 2008, meaning that exports have slowed to the growth of GDP overall. Rich economies mostly produce services, which do not as readily cross borders as goods. Globalisation, measured as the trade share of output, is not going backwards, but it has long steadied. That removes another driver of world economic growth.
Long term interest rates began trending down 40 years ago, responding first to lower inflation and then to central bank rates cuts to battle the 2008 financial crisis and later the Covid pandemic. In 1984 the US ten-year bond rate was 14%. By the middle of 2020 it was just above half of one per cent. Australian bond rates closely followed the US pattern. Lower rates helped along an eightfold increase in US share prices and a tenfold increase in nominal US wealth. That long downswing in interest rates is also over. US bond rates are back to where they were when this century began.
Reminded of the perils of inflation, central banks will not cut short term rates back to the very low levels of the last 15 years. Most governments accumulated considerable debt as they responded to the 2008 crisis and Covid. They have a continuing need to roll over debt, augmented by the deficits most governments are running. Central banks, meanwhile, are running down the stockpile of government bonds they have accumulated, adding to the debt governments need to sell to the market. It is difficult to see how government bond rates, the benchmark for most other interest rates, can come down much. It is true that a decline in opportunities might lower expected returns on investment, but it is also true that the ageing demography of China and most rich countries may lower the growth of household savings. The purpose of much household saving is, after all, to provide for retirement.
Finally, in an inventory of absences, there is productivity. Over the decades economists have not done a good job of predicting when productivity spurts will begin or end, or why. There is no doubt, however, most rich economies – including Australia, the United States and those in Europe – have not seen an upswing in productivity for quite a while. The growth of an economy can be thought of as roughly the growth of hours worked plus the rate of growth of output per hours worked, which is labour productivity. At various periods in the last 40 years productivity growth strongly supported overall economic growth. Not now – or at least, not yet. If slow workforce growth coincides with slow productivity growth, the result is slow growth in income and production.
So, what about the hectic pace of technological change, the possibilities of artificial intelligence, quantum computing, etc etc? And what about the huge transition to green technologies? Won’t these changes drive big increases in productivity? Perhaps they might. But as it happens the long spell of poor productivity growth has coincided with the rapid technological change of the last decade or so. Some technologies increase output per hour worked. Others only make our lives more entertaining, or more complicated. And bear in mind that electric vehicles replace petrol vehicles, and new forms of energy production replace existing forms of energy production. They are changes we need to make to save the planet – but hold no particular promise of increased productivity compared to the things they replace.
Coming out of a deep downturn, growth is usually higher than average as the economy recovers. But we are not coming out of a deep downturn. Consequently, we should not expect a recovery. We should, at best, expect a sustained period with average output growth markedly lower than over the last 30 or 40 years, and far more modest growth in the value of financial assets. That won’t be such a bad path, once we reconcile ourselves to its inevitability. But we should expect nastier fights over the distribution of income and wealth. When incomes are expanding strongly even the least well off make some gains. When incomes are expanding only slowly, it is hard to make one group better off without making another group worse off.