Shorter and more volatile cycles
Press headlines relating shortages of goods and production inputs have become daily staple and even with some improvement on the health front, there seems to be little let up in the articles reporting various frictions and related price spikes.
A closer look, however, shows a shift in the underlying causes, with more durable shifts related to supply chain organisation, new ways of living, digitalisation, the climate transition and the broader policy framework. Many of these shifts were underway already prior to Covid 19, but the crisis seems to have had an accelerating effect, suggesting that frictions could be here to stay for quite some time.
Sudden stops and fast-track reopening, driven by the hard to predict ebb and flow of the pandemic, have thrown multiple stokes into the lean global supply chains that emerged in recent decades and pre-cautionary behaviour, with stockpiling, is no doubt aggravating some of the present-day issues. More broadly speaking, businesses are rethinking the future organisation of supply chains to ensure greater resiliency, even if this comes with higher upfront costs. These ongoing shifts likely mean that it could take quite a few quarters yet before the impact of the pandemic on production and trade starts to fade. And, while higher inventories may offer resilience in the future, these can also amplify swings in the economic cycle. Moreover, tempting as reshoring may sound, globalisation has helped lift millions of people in emerging economies out of poverty.
A further challenge relates to shift in consumer spending patterns, driven by new ways of living, including increased frequency of teleworking and greater awareness on sustainability. The pandemic has also had an accelerating effect on digitalisation, be it for businesses, public services or consumers. Combined these forces entail significant implications for the demand of goods and services, covering everything from home furnishings to transportation and demand for real-estate, be it residential or commercial.
When it comes to the green and digital transitions, many governments are seizing the opportunity of the crisis to accelerate public investment and broader policy efforts. We are, moreover, not only seeing growing number of countries make climate pledges towards net zero emissions, but companies too are joining in with pledges of their own. The sheer magnitude involved in shifting the world’s energy system and the economic system around it, is a daunting task and while policy can help smooth the transient, it’s a narrow path full of the risk of unintended consequences, some of which is evidenced in the current spike in European electricity prices, albeit that the climate transition is far from the only cause. Further delaying the climate transition is not an option, as this would only seriously aggravate problems further down the road
Policy, more broadly speaking, is itself also one of the many moving parts undergoing shifts globally. In China, an important aim is to reduce the high reliance on the property sector as a growth engine, reduce it excessive financial leverage and ensure affordable homes. This links into the broader goal of “common prosperity”, ensuring that resources are focused to deliver sustainable long-term growth, even if there is a price to pay over the transition period.
Further policy shifts are found with the new monetary policy strategies set out by both the Federal Reserve and the European Central Bank, and in the case of the ECB, with a climate dimension. Several major central banks, including the People’s Bank of China, are also exploring central bank digital currencies, promising further notable change. In terms of global financial flows, moreover, focus also on the ownership of strategic assets, seems again only to have been accelerated by the crisis.
Turning to the fiscal front, we note what appears to be greater tolerance of fiscal expansion and while this may be helpful in smoothing a number of the transitions discussed above, it could also become a source of economic stress if public funds are misdirected and poorly used. There can be little doubt, moreover, that policy has an important role to play in managing demographic shifts, aid education and life-long learning to protect human capital and secure socially just transitions.
In economic circles these numerous shifts have new debates on the potential return of structurally much higher inflation and the implications for growth and financial markets. No doubt the jury will be out on this debate for some time yet. The question of how the many transitions outlined above will reshape the shape of economic cycles is receiving less attention. No doubt there will be many positive opportunities to be seized, but to our minds the many frictions that we are already seeing already now are likely here to stay for quite some time, and with this more volatile and shorter cycles.