Global stagflation won’t be just a squall that’ll blow over

The new reality with which economies must reckon is higher inflation and slowing economic growth. And a big reason for the current bout of stagflation is a series of supply shocks that have curtailed output and raised costs. The covid pandemic forced many sectors to lock down, disrupted global supplies and produced a persistent reduction in labour supply, especially in the US. Then came Russia’s invasion of Ukraine, which has driven up various prices. China’s draconian lockdown in major economic hubs has squeezed supplies further. But even without these short-term factors, the medium-term outlook would be darkening. There are many reasons to worry about stagflationary conditions haunting the global economy with higher prices, lower growth, and possible recessions in many places.

For starters, we have seen a retreat from globalization and a return to protectionism. This reflects geopolitical factors and domestic political motivations in countries where large cohorts feel ‘left behind’. Geopolitical tensions and the supply snarls are likely to beget greater re-shoring of manufacturing from China and emerging markets to advanced economies, or near-shoring to allied countries. Either way, production will be misallocated to higher-cost regions.

Meanwhile, demographic ageing in many markets will continue to reduce the supply of labour, causing wage inflation. A sustained backlash against immigration in advanced economies will also reduce labour supply and apply upward wage pressure. Similarly, the new cold war between the US and China will produce wide-ranging stagflationary effects. Sino-American decoupling implies fragmentation of the global economy, balkanization of supply chains and tighter restrictions on trade in technology, data, and information.

Climate change, too, will be stagflationary. After all, droughts damage crops, ruin harvests and drive up food prices, just as hurricanes, floods and rising sea levels destroy capital stocks and disrupt economic activity. Making matters worse, the politics of bashing fossil fuels and demanding aggressive decarbonization has led to underinvestment in carbon-based capacity before renewable energy sources have reached a scale sufficient to compensate for a reduced supply of hydrocarbons. Under such conditions, sharp spikes in energy prices are inevitable. And as the price of energy rises, ‘greenflation’ will likely hit prices for the raw materials used in solar panels, batteries, electric vehicles (EVs) and other clean technologies.

Public health is likely to be another factor. Little has been done to avert the next contagious-disease outbreak, and we already know that pandemics disrupt global supply chains and incite protectionist policies as countries rush to hoard critical supplies such as food, pharmaceutical products, and personal protective equipment.

We must also worry about cyberwarfare, which could cause severe disruptions in production, as recent attacks on pipelines and meat processors have shown. Such incidents are expected to become more frequent and severe over time. If firms and governments want to protect themselves from this threat, they will need to spend hundreds of billions of dollars on cybersecurity, adding to the costs that will be passed on to consumers.

These factors will add fuel to the political backlash against stark income and wealth inequalities, leading to more fiscal spending to support those ‘left behind’. Efforts to boost labour’s income share relative to capital, however well-intentioned, imply more labour strife and a wage spiral of inflation.

Then there is Russia’s war on Ukraine, which signals the return of zero-sum great-power politics. For the first time in many decades, we must account for the risk of large-scale military conflicts disrupting global trade and production. Moreover, the sanctions used to deter and punish state aggression are themselves stagflationary. Today, it is Russia against Ukraine and the West. Tomorrow, it could be Iran going nuclear, North Korea engaging in more nuclear brinkmanship, or China attempting to seize Taiwan. Any one of these scenarios could lead to a hot war with the US.

The weaponization of the US dollar that underpins sanctions is also stagflationary. Not only does it create friction in the international trade of goods, services, commodities, and capital, it also encourages US rivals to diversify their foreign-exchange reserves away from dollar-denominated assets. Over time, that process could sharply weaken the dollar (making US imports more costly and feeding inflation) and lead to the creation of regional monetary systems, which would further balkanize global trade and finance.

Optimists may argue that we can still rely on technological innovation to exert disinflationary pressures over time. That may be true, but the tech factor is outweighed by the 11 stagflationary factors listed above. Moreover, the impact of technological change on overall productivity growth remains unclear, and the Sino-West decoupling will restrict the adoption of better or cheaper technologies (think 5G), thereby increasing costs.

In any case, artificial intelligence, automation and robotics are not an unalloyed good. If they improve to the point where they can create meaningful disinflation, they also would probably disrupt entire occupations and industries, widening already large wealth and income disparities. That would invite an even more powerful political backlash than the one we have already seen—with all the stagflationary policy consequences that are likely to result. ©2022/Project Syndicate

Nouriel Roubini is professor emeritus of economics at New York University’s Stern School of Business and chief economist at Atlas Capital Team