Two years – 1982 and 2007 – frame the window of my experience as an economist at Morgan Stanley. When I walked in the door a quarter century ago, my focus was on a $3 trillion high-inflation US economy that was mired in the depths of its worst recession of the post-World War II era. Today, all eyes are on a low-inflation, increasingly integrated $52 trillion world economy. There couldn’t be a greater difference between then and now.
As I look back on the journey, I am struck by three macro milestones:
Macro milestone #1: Disinflation
At the top of my list is the extraordinary disinflation of the past 25 years. When I began working at Morgan Stanley, the ravages of America’s double-digit inflation were just starting to recede. Following nearly a 12% average annual increase in the CPI in 1980-81, the 6% increase that was unfolding in 1982 came as welcome relief. Interestingly enough, no one at the time really believed it would stick. The shock was that it did. US inflation settled down to a 3.5% trajectory over the balance of the 1980s and memories of the Great Inflation finally started to fade. This was the defining development for the greatest bull run in modern financial-market history. On the back of sharply receding inflation, yields on 30-year US Treasuries (the bond market benchmark at the time) were literally cut in half – falling from 11% in early 1983 to around 5% at present – and the S&P 500 went up about fifteen-fold over the same 25-year period.
During the second half of the 1970s and the early 1980s, we agonized endlessly on how to arrest the Great Inflation. In retrospect, the cure was painfully simple – a wrenching monetary tightening. It took the vision and courage of Paul Volcker to pull it off – at one point in 1981 pushing the federal funds rate up to 19%. Ironically, central banks may be better equipped to fight high inflation than they are to preserve the gains of low inflation.
While the new religion of monetary discipline succeeded in keeping inflation and inflationary expectations in check, the confluence of two powerful structural forces – the IT revolution and globalisation – took a secular disinflation to the brink of an unwelcome deflation. Japan fell into that trap in the 1990s and the US came dangerously close a decade later – occurrences that in both cases were unmistakable outgrowths of the bursting of major asset bubbles. As the multiple-bubble syndrome of the past several years suggests, the authorities still have a lot to learn in managing low-inflation economies – and in avoiding the liquidity-driven pitfalls that come from exceedingly low nominal interest rates.
Macro milestone #2: US productivity growth
America’s productivity revival stands out as a second milestone of the past 25 years. When I started at Morgan Stanley, trend US productivity growth was around 1%. Today the underlying trend is closer to 2 1/2%. The explanation of the difference between now and then is still a subject of hot debate. The productivity bulls wax eloquently on America’s innate attributes of flexibility, innovation, de-regulation, and risk taking. The sceptics focus on “capital deepening” and cost-cutting – in effect, the substitution of capital for labour and the concomitant transformation from one technology platform to another that drove the IT revolution in the 1990s. I’ve been on both sides of this debate – as one of the first productivity bulls of the early 1990s and then, unfortunately, as one of the first to abandon this view in the mid-1990s.
In retrospect, this was one of the biggest mistakes of my forecasting career. My concern was that Corporate America had taken its penchant for cost-cutting too far – running the risk of a hollowing out that could compromise its ability to maintain market share in a rapidly expanding US and global economy. I failed to appreciate the breadth, depth, and duration of the IT-enabled transformation of the US economy – as well as the broader leverage that ultimately would flow from the new technologies of the Information Age.
The US productivity revival of the 1990s turned the global competitive sweepstakes inside out. At the end of the 1980s, conventional wisdom had it that America was “over” – in effect, beaten into submission by the world’s new competitive behemoths, Japan and Germany. In retrospect, of course, nothing could have been further from the truth. At the dawn of the 1990s, Japan and Germany were peaking out and, courtesy of a wrenching restructuring, the United States was about to emerge from its long slumber. Fast forward to mid-2007, and the debate has come full circle. America’s productivity growth has slowed to 1%, and the jury is out on whether this is a cyclical or structural development.
While the recent downshift in US economic growth underscores the apparent cyclicality of this development, the culmination of capital deepening – an IT share of total equipment spending that peaked at around 51% in 2000-03 – raises the distinct possibility that the IT-enabled productivity acceleration may have finally run its course. Meanwhile, there are encouraging signs of a long overdue revival in German and Japanese productivity growth. Recent history tells us that the pendulum of competitive prowess can change much more quickly than we might think. That’s something to keep in mind in the years immediately ahead.
Macro milestone #3: globalisation
Globalisation is certainly on a par with the other two milestones of the past 25 years. In this case, the comparison between 1982 and 2007 is like day and night. I walked into this job when global trade stood at just 18% of world GDP; this year, that ratio is likely to hit a record 32%. The problem with globalisation is that we have done a lousy job in understanding and explaining it. And by “we” I mean my fellow economists, policy makers, politicians, business leaders, and other pundits. Far from the nirvana promised by the imagery of a “flat world” and the ecstasy of the “win-win” mantra, the road to globalisation has led to saving and current-account imbalances, income disparities, and trade tensions – all having the potential to spark a very destabilizing backlash. The threat of just such a backlash remains a clear risk in today’s environment.
Notwithstanding those concerns, globalisation has been a huge success – at least on one level. Despite persistent and devastating poverty in many poor countries, there has been a doubling of per capita GDP growth in the developing world over the past decade. What is still missing in this newfound prosperity is a key element of sustainability – the emergence of consumer-driven growth models in these still largely export- and investment-led economies. At the same time, in the rich countries of the developed world, the benefits of globalisation have accrued far more to the owners of capital than to the providers of labour; labour shares of national income in the major developed economies are at record lows, whereas the shares going to capital are at record highs. Moreover, the distribution of gains within the labour share of the developed economies has become increasingly skewed toward the very few at the upper end of the income distribution – at the expense of those in the middle and at the lower end.
Therein lie the seeds for a potentially powerful backlash: As the pendulum of economic power has swung from labour to capital, the pendulum of political power is now in the process of swinging back from a pro-capital stance to that which provides support for labour. The case for trade protectionism – especially in the United States – is alarmingly high as a result. Sadly, this is antithetical to the global stewardship that is so desperately needed in today’s world.
Global economy: looking to a post-transition climate
In one sense, these past 25 years have been an era of powerful transitions – transitions from high to low inflation, from stagnant to rapid productivity growth, and from closed to open economies. Transitions, by definition, have a finite duration. A key challenge for the global economy and world financial markets is what happens after these transitions have run their course – when disinflation comes to an end, when the productivity revival has crested, and when globalisation hits its structural limits in terms of import penetration in the developed world and investment-led growth in the developing world.
Don’t get me wrong – a post-transition climate need not be characterized as a return to rapid inflation, stagnant productivity growth, or trade protectionism. The endgame could be considerably more benign – modest inflation, “adequate” productivity growth, and a levelling out of the global trade share of world GDP. While these outcomes offer less dynamism to the global economy than we have seen in recent years, they do not represent relapses to more problematic macro climates. At the same time, such post-transition scenarios may well deny world financial markets the high-octane fuel that has produced such spectacular results over the past 25 years.
The jury is obviously out on these important questions – as well as on the inevitable transitions to come. My favourite candidates in that regard: productivity catch-ups in the developed world, consumer-led growth in the developing world, a world coming to grips with climate change, and financial solutions to the demographics of aging. There can be no mistaking the world’s increasingly robust coping mechanisms in dealing with recent and prospective challenges. In fact, as I look back on the past quarter century, what astonishes me the most is speed – how quickly the world has come to grips with structural issues like productivity and globalisation and how equally quickly the Great Inflation was brought to an end. All this underscores the one lesson from economic history that rings truer than ever – the axiom of an ever-accelerating pace of change. Just like Moore’s Law, it’s always hard to envision the next wave of time compression – even though it never fails to occur.
The world today is obviously a very different place than it was 25 years ago. But let me assure you that back in 1982 there was no inkling of what was to come. I have been privileged to bear witness to an utterly astonishing period in the transformation of the global economy. I have relished the financial-market debate that has arisen out of this transformation. I wouldn’t trade that experience for anything. And now it’s off to Asia – the epicentre of the Next Wave. My role will change, but I can assure you the lens won’t. Stay tuned.
By Stephen Roach, global economist at Morgan Stanley, as first published on Morgan Stanley’s Global Economic Forum