The global economy on the brink

L'arrêt des livraisons de gaz russe à l'Europe pourrait faire plonger l'activité manufacturière des pays de l'Union.

Posted on September 7, 2022 at 4:55 pmUpdated on September 7, 2022 at 19:12

The state of the world economy is no different from that which prevailed over the course of the 1970s. Except that “the current context is in several respects potentially more explosive.” This is the observation of Jézabel Couppey-Soubeyran, professor of economics at the University of Paris 1 Panthéon-Sorbonne and co-editor-in-chief of “The World Economy 2023”, a book that is published every year and presented on Wednesday by the Study Center. Prospectives and International Information (Cepii).

The war in Ukraine and its consequences on global supply chains, energy prices and food prices are dashing hopes for a post-Covid-19 pandemic recovery. Environmental pessimism is fueled by inflationary pressures, which are expected to persist, and the energy crisis that promises to be severe in Europe.

The parallel with the stagflation of the 1970s is not optimistic.

Thomas Grjebine Economist at Cepii

“The parallel with the stagflation of the 1970s is not conducive to optimism,” says Thomas Grjebine, an economist at Cepii. At that time, to curb the inflation generated by the two oil shocks and the indexation of wages to inflation, the central banks had raised interest rates sharply. Consequence: a global recession accompanied by a debt crisis in developing countries. History could well repeat itself.

Europe put to the test of fragmentation

Since 2010, the global economy has experienced the largest, fastest and most synchronized wave of debt in 50 years, the economist observes. The increase in public debt is a real danger for countries that borrow in foreign currency. “This is the case in the euro zone because the European currency is like a foreign currency for member countries that borrow in a currency they do not control. A fragmentation of the euro zone cannot be ruled out”, fears Thomas Grjebine. The concern concerns, above all, the countries of the South, which have very high levels of public debt (200% of GDP in Greece, 150% in Italy, 123% in Spain).

Emerging and developing countries also raise fears as their foreign currency debt represents 25% of their public debt compared to 15% in 2009. What about private debt in these countries which amounted to 142% of GDP in 2020 versus only 32% at the end? from the 1970s? The looming US monetary tightening could trigger a new debt crisis, like the one in 1979 for Latin American countries, followed by a default by Mexico in 1982.

Another similarity pointed out by Cepii, the evolution of wages and inflation. As in the late 1960s, the current period is witnessing the rise of strong wage demands. The social crisis of May 1968 had been the marker of the rejection by the employees of the income distribution conditions that prevailed then. “The purchasing power of the minimum wage increased by 130% between 1968 and 1983. At the same time, the average wage increased by around 50%”, observes Thomas Gjrebine. Social tensions then fuel inflation which, in turn, leads to new wage demands. Until the political leaders decide to eliminate this loop that will materialize in particular with the deindexation of wages in the 1980s.

Fall in real wages

Today, with the return of inflation and globalization, the implicit commitment that was established in the 1980s may well be broken. This compromise was based on modest wage increases offset by gains in purchasing power linked to imported disinflation generated by the globalization of trade. The current demands for salary rebalancing that reveal the tensions in the United States since the pandemic in the form of numerous strikes and the phenomenon of the “great resignation” attest to this. Elsewhere, real hourly wage growth is now negative in most OECD countries, weighing on household purchasing power and consumption. Social tensions are to be feared.

A complete stoppage of Russian gas imports could cause a drop in German GDP of between 3 and 8%.

Global growth should be affected. Especially since the Chinese engine, which in the last twenty years has represented a quarter of world growth, is stalling. Not only because of the government’s “zero Covid” policy. Other structural factors are at play: “The working age population peaked in the early 2010s and future growth is expected to slow. And productivity growth, like in Japan and South Korea in previous decades, is slowing.

Europe is still a little more threatened by a major energy shock. The effects of the conflict in Ukraine could be greater than expected due to interruptions in the supply of Russian gas throughout Europe. According to the OECD, we can expect a drop in output in the manufacturing and market services sectors of almost 3%.

These effects could be underestimated, especially if companies stop production altogether, Cepii fears. “Many industries, particularly those that consume more energy, such as metallurgy, could go bankrupt. A total interruption of Russian gas imports could cause a drop in German GDP of 3 to 8%”, fears Thomas Gjrebine.

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