by Damon de Laszlo, ERC Chairman
As is often the case, we seem to be at a tipping point – the moment when the tide, having gone out, hasn’t apparently started to come back in, is very much the feeling I have when I look at inflation. It is basically receding – prices of necessities are still rising but at a much, much slower rate, commodities are steady and, in some areas, declining, the prices of goods in general are declining, but the problem revolves around core services, i.e., labour intensive industries where the major cost is wages and salaries.
This is facing central banks with an extraordinary problem as interest rates have very little impact on service costs. If they do not lower interest rates, they are getting to the point where there will be a recession as the general economy slows down. This will in fact reduce wage costs by precipitating a high level of unemployment. Their dilemma is exacerbated by growing government debt, which is draining resources out of the productive economy. The apparent prosperity caused by flushing an increasing money supply into the service economy works in the short term, but the diversion of resources from manufacturing reduces the general productivity of the economy. The ability to improve the productivity of a waiter or civil servant is very limited, giving central banks today a major headache.
Added to their problem is the extraordinary lack of competence in Western governments. There is a chance that the UK may fare better with a new government with a solid majority able to drive reform. So far, they have talked about a serious building programme and overriding bureaucratic glue in planning. This is the only way of bringing down housing costs, but it is not an easy target to reform. Pre-election, they were also talking about focusing on infrastructure but as most of this will cost the government, it may be shelved in favour of raising wages to placate their public support. In the UK, however, we can hope to have a moderately consistent government unlike the ‘revolving door’ of Ministers and civil servants that have caused almost a complete lack of policy implementation for the last ten to fifteen years.
Whether the Bank of England moves interest rates by ¼ point or so, it will have minimal impact on the productive economy, but it will encourage the City to reinvigorate its private equity activities and other financial engineering tricks that negatively impact productivity, and disproportionately reward the City’s financial and legal engineers.
The American central bank faces a similar conundrum, but the pressure on them is mainly coming from the political area and to a lesser extent from the financial services area. Trump has made threatening noises about sacking the Chairman of the Fed if he doesn’t lower interest rates, and the Democrats haven’t made much noise yet as the prospective Democratic presidential candidate has yet to say much on policy. The US, however, is in a far better position than Europe to improve the country’s general productivity and living standards, which have slipped in the last five to ten years. The biggest Western economic worry is really Europe. In spite of the label ‘European Union’, there is very little cohesion in European economic policy. The lack of leadership, or even ability to lead from Brussels, means individual countries’ leaders are tending to go their own way. Germany, the driving economic force in Europe is rapidly losing its industrial leadership to China. Its motor industry is not aligned with demand for electric vehicles and its infrastructure is not in place to make their use popular. This applies to the UK as well. China, in particular, is way ahead on electrification and EVs although their markets are suffering from their own economic retrenchment.
Back to the tidal analogy. When we get through the US elections both presidential candidates are likely to present more economic stability and encourage US innovation. There are massive potential growth areas that are embracing what is a very new world of super-powerful computers and AI that promise enormous increases in productivity and will compensate for a declining population.
Recent developments in medicine will greatly improve healthcare, sustainable energy development will reduce damage to the environment and human health, and food security and the cost of food has great potential to improve by the application of new science. The same would apply to Europe if the regulators don’t paralyze development by the constant focus on risk. In microcosm, the UK focus on green energy is almost exclusively on windfarms, ignoring the stable and consistent output from nuclear energy, which is thwarted by governments’ unwillingness to put in the infrastructure to distribute electricity. Private enterprise will invest in energy, but the government controls the distribution system which is woefully under invested. Europe, with the exception of France, is to some extent suffering from the same constraints.
One of the issues for the West which seems to be a major problem to decision taking, is the enormous amount of noise that is encouraged by media and internet platforms, making it difficult to gather real information and economic data. Opinions of the uninformed, sound bites and titillating flashes of so-called information, drown out real thought, and leave informed opinion unheard. This phenomenon, however, will hopefully subside as people learn to deal with the deluge of sound bites.
We are still not through the potential economic downturn, but the outlook is probably more optimistic than it has been for some time.
Damon de Laszlo
29th July 2024