Welcome to the “polycrisis” – a world in which, as historian Adam Tooze puts it, “economic and non-economic shocks” are intertwined “end-to-end”. We have an inflationary shock that emanates from the disruption caused by a pandemic, the policy responses to that pandemic, and an energy shock caused by a war. This war is in turn linked to the breakdown of relations between the great powers. Slow growth, rising inequality and overreliance on credit have undermined political stability in many high-income democracies. The credit boom led to a great financial crisis whose outcome included a decade of ultra-low interest rates and therefore even more financial fragility around the world. Added to these constraints is the threat of climate change.
It is indeed convenient to think of the world in intellectual silos, focusing alternately on macroeconomics, finance, politics, social change, politics, disease, and the environment, to the exclusion of others. In a reasonably stable world, it may even work well. The alternative of thinking about the interactions between these aspects of experience is also too difficult. But sometimes, like now, it becomes unavoidable.
It is not only theoretically true that everything depends on everything else. This is a truth that we can no longer ignore in practice. As my colleague Gillian Tett often warns, silos are perilous. You have to think systemically. Economists must recognize how the economy is interconnected with other forces. Navigating today’s storms requires us to develop a broader understanding.
This is not an argument against detailed analysis of individual elements of the image. Economists should always look carefully at the things they know, because they are both complex and important in themselves. Thus, the data and analysis of the latest OECD report Economic outlook continue to be both invaluable and enlightening. But, inevitably, they also omit vital aspects.
So consider what the report tells us about the economic situation.
First, the energy crisis itself is truly enormous. The share of OECD members’ GDP spent on energy end-use is close to 18%, double what it was in 2020. In Europe, increases need to be much bigger than that . The last time the ratio was this high was in the early 1980s, during the oil shock caused by Saddam Hussein’s invasion of Iran.
Second, inflationary pressures are both strong and widespread. Again, this echoes the inflation of the early 1980s, which followed the high and variable inflation of the 1970s. Today, the energy price shock caused by the war in Ukraine followed negative supply shocks and positive demand shocks triggered by Covid. This combination of supply and demand shocks with deep real wage reductions and national income losses in net energy importing countries makes the job of central banks extremely difficult.
Third, there will likely be a sharp slowdown in global economic growth between 2022 and 2023. The latter is forecast at 2.2%. Moreover, most of this growth will be generated by Asian economies. The British and German economies are expected to contract a little, while the Eurozone and US economies are expected to grow by only 0.5%.
Fourth, while this is, unsurprisingly, an unfortunate picture, it could turn out to be much worse. The energy outlook is itself highly uncertain, with a substantial risk that gas reserves in Europe will be lower next winter than this one, especially if winters are cold or liquefied natural gas imports are too low. Rising interest rates could trigger more financial turmoil and deeper downturns than currently expected. Food shortages could cause deeper distress than expected in developing countries, especially in a financially restrictive environment.
The view of the OECD, which I share, is that central banks should not take a spike in inflation as a sign that their job is done. It is essential that inflation be firmly under control. In this context, it is also essential that fiscal policy aims to support those most affected by high energy prices. It is equally important to encourage the expansion of renewable energy supply and the improvement of energy efficiency. This is the “home front” in Europe’s conflict with Russia.
Yet even this is an incomplete picture. Other elements are possible developments in the war in Ukraine itself and what is needed to bring it to a satisfactory end. Yet another is how China will escape the trap of its zero-Covid policy. Last but not least, finding ways to help developing countries through their impending financial difficulties, while supporting their climate transition.
The point is that we need to analyze within the silos, while analyzing systemically across them. The OECD, to its credit, created a unit in 2012 called New Approaches to Economic Challenges to do this. As the most recent and seemingly final report of this unit notes, we need to analyze the interactions between social, economic, political, geopolitical, health and environmental developments to address the challenges we face. Humanity has created a world so interdependent that no other approach is possible. Of course, such an approach is difficult. This is sure to irritate professional experts working comfortably in their silos. But since the financial crisis and especially in the past three years, it has become clear that such narrowness is madness. It is being precisely wrong rather than daring to be more or less right.
So what did the OECD do with this company? Some say he is closing it down. It would be a mistake. If the NAEC is not good enough, improve it. The world we know now does not divide into orderly silos. Our thinking should not get stuck in them either.
martin.wolf@ft.com
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