by Damon de Laszlo, ERC Chairman
2021 started with chaos caused by the arrival of Covid 19 and the shutting down of large chunks of the world’s economy. It was quite understandable that governments reacted with shutdowns in the face of a pandemic, the scale of which had never been experienced in our lifetime.
While trying to understand the real dangers, events were largely driven by news and journalistic reports of impending Armageddon, before scientific evidence had really firmed up. Politicians were faced with a deluge of internet generated confusion compounded by the weakness of scientific and management competence in western bureaucracies.
We end the year in a similar state and it would seem that governments and their supporting civil services have learned little about managing a crisis. One of the most worrying effects of this is the plummeting lack of confidence of the public in western democratic institutions. Mass communication means that rumour and opinion touch more people and travel faster than fact and considered analysis. If the current rolling lockdowns reach the extremes of the earlier part of the year, the UK and European economies are going to be severely damaged. The US with its more laissez faire and de-centralised attitudes is in better shape and, at the moment, it is difficult to see where China and the ASEAN world is heading.
On all available evidence, the Omicron strain of Covid is much less dangerous than earlier strains and the roll-out of vaccinations to the older sections of the population is providing a major reduction in the severity of the infection. A government policy of age-targeted measures would probably be more effective and less damaging to the economy than lockdowns. Unfortunately, we are repeating the previous conclusion without considering the wider implications of lockdowns and their disproportionate effect on the socially disadvantaged.
Leaving aside the social damage, the most dangerous side effect of Covid is an exacerbation of inflationary trends. Twenty plus years of central banks’ government-friendly policies of driving down interest rates and flooding economies with liquidity as a reaction to every major and minor blip in economic growth, has meant that enormous resources have been misdirected and debt, particularly in the government sector, has piled up. Economic theory would have predicted inflation rising some time ago but in goods and services it has been held down by the movement of very large sectors of western manufacturing and processing, to China and other ASEAN countries. The arrival of cheap labour in China and the Chinese government’s policy of industrialisation, particularly after they joined the World Trade Organisation, deindustrialised large sectors of western economies and, at the same time, enormously extended supply chains. The general cost of goods had started to rise, albeit slowly, as Chinese government policy moved from encouraging labour-intensive production to a more sophisticated level, i.e., from making t-shirts to manufacturing motorcars. This trend of the last five to ten years has gained pace, but Covid had a sudden impact on supply chains, dramatically reversing the downward trend in the cost of moving goods around the world.
The impact of the change in costs has produced the inflection point where we see consumer prices 5+% higher in November than at the same time last year. Further underlying pressure is building as we see producer price inflation hitting 9% in November and raw materials prices up over 14%. Central banks lowering interest rates in the face of any economic problem is now going to reverse. The Bank of England raised interest rates from zero to 0.25% in November. Others will follow but already the habit of quantitative easing has reversed; this in itself will tend to push up interest rates.
Particularly worrying is governments around the world have been depending on their central banks to finance their deficits rather than raising taxes. The economic implications of this trend reversal will have consequences that will surprise a generation of bankers and investment managers who have never seen rising interest rates.
Other factors are also coming together to impact the cost of living. Global warming has really risen up the political agenda as its seriousness is taken on board by the population at large. Worrying, however, is the lack of policy and forethought on how it should be addressed. The idea that most of us will be driving around in electric cars before the end of the decade, and oil and gas will no longer be needed, is fantasy. As of today, the technology to create consistent power generation from alternative sources is not available. In crude terms, we could migrate from coal to gas, enormously reduce our carbon footprint, but that would require building gas-fired stations and expanding the supply, both of which policies are today politically untenable. The alternative green technology with a zero-carbon footprint is nuclear energy, but here again no serious plans have been put in place. The problem is we are likely, if we shut down more coal powered stations, in the next few years to have blackouts across Europe and the UK. Public appetite for banning mining and drilling will mean the current upward pressure on the prices of gas and raw materials, particularly for electrification, will grow, in addition to pushing up prices for food and energy. This will not be popular with the public who at the moment do not realise the cost implications of our current green energy policies.
The good news, however, is that wages are rising and the repositioning of manufacturing back to the West will create a revival in economic growth, particularly if governments encourage productivity enabling capital expenditure, something that has been missing for many years.
We are faced with the endemic problem of a lack of political forethought, whilst their civil service advisers lack planning and technical capabilities. We see this in many areas of government. However, there is a revival of entrepreneurial spirit as people decide to get on with life and learn to rely less on government support.
Damon de Laszlo
21st December 2021