by Damon de Laszlo, ERC Chairman
May probably was the tipping point for Western economies when the projected economic downturn started to appear in the statistics. June is showing more evidence with property prices clearly going off the top and defaults now starting to rattle the banks’ view of their property loan book. Lay-offs are increasing across the financial sectors and in the technology area, but industry is still holding up by-and-large as the final backlogs are cleared, but the number of job vacancies seem to be falling although supply is still tight. Countering the downturn is an increase in defence spending precipitated by actual military Russian aggression in Ukraine, which has precipitated a major revision of NATO expenditure. The numbers involved are significant, big enough to distort global GDPs. One estimate of last year’s 4% rise in global defence spending came out at $2.24 tn. A 3% rise in US military expenditure for the year to 2024 is estimated at $886 bn. Across the world the increase in military expenditure will be financed by debt which will inevitably put upward pressure on interest rates and inflation.
With East/West relations deteriorating and bringing deglobalization in its wake, it is highly unlikely that Central Banks can bring inflation down to anywhere near the 2% target. The rising standard of living that the majority of the world has experienced in the last twenty years or so has been, to a large extent, brought about by globalising manufacturing, which took advantage of enormous pools of low-cost labour in Asia. To reverse this trend will require enormous capital expenditure by Western manufacturers, hampered by the depletion of the skill base to implement automation and the new computer systems that go with it.
Rising interest rates will hamper the appetite for increased company expenditure on training and capital expenditure, but the banks only have one lever to pull, and having started a year or so too late they are now likely to overdo it, as businesses take longer than the speed of the interest rates rises to react. The likely consequence, therefore, is a rapid drop in expenditure and increased bankruptcies as the over-extended borrowers react or are forced to react to the increased cost of debt. The unpleasant result of this will be the destruction of demand, itself driving down prices.
This short-term gloomy outlook can only be exacerbated by the necessary but disjointed decarbonisation initiatives. Before one looks at the simplistic idea that windmills and solar panels are the answer, the real world means that in the UK alone some 460,000 Km of new onshore electricity cables will have to be installed by 2050, compared with the current installed base of some 820,000 Km. Under current planning systems, along with the regulatory environment of OFGEM and others, this is challenging as the whole system gets bogged down in regulation and judicial review. The same regulatory systems apply to the only alternative serious source of constant electricity supply – Nuclear. Here again regulation has made it prohibitively expensive, largely as a result of government indecision and disconnected regulatory oversight.
On a global basis, the amount of raw materials required for electrification using low density sources, wind and solar, is staggering. Copper demand alone, before one thinks about rare earths, is many times the current world production. Somehow the West has to realise that long term strategic planning is going to be critical if we are going to achieve a very serious need to move away from fossil fuels as a power source. Unfortunately, long term strategic planning is not part of democratic governments’ playbook.
On a slightly more optimistic front, an economic crisis historically has tended to result in more cohesive government thinking as political parties, and factions within political parties, focus on a few major issues. On the economic front, a crisis, sharp and hopefully short, works to create Schumpeter’s famous concept of creative destruction. Moribund businesses disappear, so freeing up resources for talent and capital to be applied in more productive ways. If there is an economic crisis at the end of 2023 – beginning of 2024, it’s quite possible in our electronically connected world that a strong recovery could start towards the end of 2024 going into 2025. One caveat being that the State needs to roll back its intervention in almost every decision that businesses have to take.
Damon de Laszlo
26th June 2023