By NOURIEL ROUBINI*
Advanced economies and emerging markets are increasingly involved in inevitable “wars”. Therefore, the future will be stagflationary. And the only question is how bad it will be
Inflation rose sharply throughout 2022 in advanced economies and emerging markets. Structural trends suggest that the problem will be secular – not transitory. Specifically, many countries are now engaged in various “wars” – some real, some metaphorical – that will lead to even larger fiscal deficits, further debt monetization and higher inflation in the future.
The world is going through a form of “geopolitical depression” crowned by a growing rivalry between the West and mutually aligned (if not allied) revisionist powers such as China, Russia, Iran, North Korea and Pakistan. Cold and hot wars are on the rise. Russia's brutal invasion of Ukraine may yet expand to involve NATO. Israel – and therefore the United States – is on a collision course with Iran, which is on the verge of becoming a nuclear weapons state. The Middle East, broadly speaking, is a powder keg. And the US and China are clashing over who will dominate Asia and whether or not Taiwan will be forcibly reunited with mainland China.
Consequently, the US, Europe and NATO are rearming, as are virtually all countries in the Middle East and Asia, including Japan, which has now embarked on a military build-up, the biggest in many decades. Thus, higher levels of spending on conventional and unconventional weapons (including those of the nuclear, cybernetic, biological and chemical types) are virtually guaranteed, and these expenditures will weigh heavily on public accounts.
The global war on climate change will also be costly – for both the public and private sectors. Mitigating and adapting to climate change could cost trillions of dollars a year for decades to come; it is foolish to think that all these investments will drive growth. After a real war that destroys much of a country's physical capital, a wave of investment can, of course, produce economic expansion; however, the country will be poorer for having lost much of its infrastructure. The same applies to climate investments. A significant part of the existing social capital will have to be replaced, either because it has become obsolete or because it has been destroyed by climatic events.
We are also now waging an expensive war against future pandemics. For a variety of reasons – some of them related to climate change – disease outbreaks with the potential to become pandemics will become more frequent. Even if countries invest in prevention to deal with future health crises, after the event happens, they will incur higher costs on an ongoing basis. Now this will add to the growing burden associated with an aging society which will burden private health systems and pension plans. This implicit burden of unfunded debt is already estimated to be close to the level of explicit public debt for most advanced economies.
In addition, it will be necessary to wage more and more wars against the disruptive effects of “globotics”, that is, the combination of globalization and automation (including artificial intelligence and robotics), as this technology is threatening a growing number of manual or intellectual occupations. Governments will be under pressure to help those left behind, whether through basic income schemes, massive fiscal transfers or expanding public services.
These costs will remain high even if automation leads to increased economic growth. For example, sustaining a meager universal basic income of $1.000 a month would cost the US around 20% of its GDP.
Finally, an urgent war must also be waged against rising income and wealth inequality. If not, the malaise that afflicts young people and many middle-class and even working-class families will continue to generate reactions against liberal democracy and free market capitalism. To prevent populist regimes from coming to power and pursuing reckless and unsustainable economic policies, liberal democracies will need to spend a fortune to bolster their social safety nets – as many are already doing.
Fighting these five “wars” will be costly; economic and political factors will limit the ability of governments to finance them with higher taxes. Tax-to-GDP rates are already high in most advanced economies – especially in Europe – and tax evasion, avoidance and arbitrage will further complicate efforts to raise taxes on high incomes and capital gains ( assuming such measures can overcome backlash from lobbyists and center-right parties).
Thus, these necessary wars will increase government spending and transfers as a share of GDP—probably without a commensurate increase in tax revenues. Structural budget deficits will grow even larger than they are now, which will certainly produce unsustainable debt. Now, this will raise borrowing costs, but it could culminate in debt crises, with obvious adverse effects on economic growth.
For countries that borrow in their own currencies, the most convenient option will be to allow higher inflation to reduce the real value of long-term nominal debt when it bears fixed interest rates. This approach works as an additional tax against savers and creditors and in favor of borrowers and debtors. Because the “inflation tax” is a subtle and sneaky form of taxation that does not require legislative or executive approval, it appears as a default path of least resistance when deficits and debt become increasingly unsustainable.
This option can be combined with complementary and draconian measures, such as financial repression, heavy taxes on capital and acceptance of full default in certain cases (for example, for countries that borrow in foreign currencies or that maintain a large short-term debt or a total debt indexed to inflation).
I have focused mainly on demand side factors and these will lead to higher spending, higher deficits, more debt monetization and more inflation. But there will also certainly be many negative aggregate supply shocks in the medium term and these could increase stagflationary pressures, which are already present today, thus increasing the risk of recessions and cascading debt crises. The “great moderation” is dead and buried; the “great stagflationary debt crisis” is very much alive and thriving.
*Nouriel Roubini, professor of economics at the Stern School of Business at New York University, he is chief economist for the Atlas Capital Team. Author, among other books, of MegaThreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them (Little, Brown and Company).
Translation: Eleutério FS Prado.
Originally published on the portal Project syndicate.
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