The members of PIMCO’s Global Advisory Board, a team of world-renowned macroeconomic thinkers and former policymakers, recently joined the discussion at PIMCO’s annual Secular Forum, where they addressed critical factors likely to shape the global economy over the five-year horizon. The board’s insights constitute a valuable input into PIMCO’s investment process, and the views they presented helped inform the latest Secular Outlook, “Age of Transformation.” The discussion below is distilled from their far-ranging conversation.
Q: What is the outlook for the U.S. economy, as well as fiscal and monetary policy?
A: The U.S. has seen a relatively strong recovery, but looking ahead, we believe there is a lot of uncertainty about growth. As the large fiscal stimulus of 2020 and 2021 will likely not be repeated, we expect fiscal policy will effectively become a drag on growth in 2022. Likewise, U.S. monetary policy is likely to become somewhat tighter, with the U.S. Federal Reserve first tapering and then moving rates up gradually and opportunistically. Near-term, growth will also slow as economic slack is used up, in our view. Still, growth should be sufficient to support continued healthy job creation into 2022.
The high rate of inflation is a risk many investors are monitoring, as is the Federal Reserve, but as monetary and fiscal policy become more contractionary and as constraints on supply and labor diminish, we expect U.S. inflation will likely slow in 2022. There are some upside inflation risks: We could see a much slower recovery in labor supply and participation than expected, or supply chain issues could be more persistent. We also expect to see increases in house prices and rents gradually filter into U.S. inflation data in the next year. The Fed will be watching inflation expectations to be sure that they remain well-anchored near or modestly above its target.
Over a longer time frame, although growth in potential output has slowed, the U.S. economy appears to have become less volatile in general, with the global financial crisis and the pandemic looking like rare events disrupting a broader trend. Possible reasons for lower volatility in the longer term include more proactive monetary and fiscal policies, improved inventory management, and the reduced size of cyclically sensitive sectors like manufacturing. Another critical question for the secular horizon is whether technological breakthroughs, including recent developments in biotech that contributed to the rapid development of COVID-19 vaccines, will increase the economy’s underlying growth rate and lead to new investment opportunities.
Q: Aside from the typical trends in economic growth and inflation that experts monitor, what else might affect neutral interest rates over time?
A: An important factor to consider is the shift toward a net zero carbon economy. Estimates vary, but the magnitude of additional investment in energy infrastructure over the secular horizon could reach $2 trillion to $2.5 trillion per year – that’s roughly an extra 2 percentage points of current global GDP. The order of magnitude of just the energy infrastructure investment increase could make up for the broader investment shortfall we’ve seen over the past decade, and that does not include additional investment that will be required in other industries, beyond direct energy. Significant investment will also be needed in agriculture, for example, and in climate adaptation, in our view.
Although the transition would likely be neutral to disinflationary over the longer term, in the medium term, the net zero transition could put upward pressure on both inflation and the neutral rate of interest. In our view, carbon pricing, as there is in Europe, Canada, and other places, represents a sustained price shock. We believe the net zero transition is also a major supply shock: We expect there will be a wholesale restructuring of the power and transportation industries, but virtually every industry will be affected. Also, the geopolitical backdrop amid climate change and other factors is undergoing a secular transition. Carbon border adjustment taxes are one example, but broadly speaking, the shift toward deglobalization could gradually counter the steady global integration that has been generally disinflationary for decades.
Q: In the post-pandemic business environment, what is the longer-term outlook for labor and productivity?
A: Outside the travel and tourism sectors, few major U.S. corporations report experiencing a great deal of scarring through the pandemic-related economic shock. They seem relatively optimistic about the future. However, two significant short-term challenges – supply chain shortages and worker shortages – appear to be accelerating long-term strategic shifts. Many companies have for some time been slowly diversifying their supply chains, especially out of China, for economic reasons. We believe the pandemic accelerated an existing trend.
Turning to labor, many U.S. corporate leaders have observed a secular change in the relationship between companies and their workers. This shift was already underway before the pandemic, and many companies struggle each year to get and keep qualified employees. Competition for those workers is likely to persist. Employees in general have more bargaining power, and many employers are responding with efforts to improve productivity over the long term, both by upscaling their employee base and by investing in technologies that help workers be more productive. Companies seem to be anticipating that labor is going to cost them consistently more over time, so they are looking for ways to produce more with less labor, and they are prepared to make the investments to support that evolution.
Q: What is the outlook for China’s economy in light of recent policy changes?
A: Several significant policy shifts appear to have long-term implications for China, focused on creating a more self-reliant domestic economy, and on uniting the country under a strong leadership.
In pivoting to the manufacturing sector and to state-owned enterprises as critical areas of the Chinese economy, China’s leaders are making a trade-off – they appear willing to sacrifice some growth in order to bring about economic stability as well as social and political stability. The dual circulation economic model is designed to reduce China’s vulnerability to external risks, to make the domestic economy more efficient, and to utilize China’s sheer scale and market size to be the agent of its growth.
The policy theme of common prosperity is likely aimed at uniting the country. After decades of economic reform and high economic growth, the income and wealth disparity in China has become an issue. The public is complaining about the ugly side of capitalism, the lack of worker protection, and property prices beyond the reach of many people. President Xi Jinping, a student of Chinese history, knows that dynasties have declined because of social unrest, so we believe he has undertaken policy moves in an effort to ensure China does not implode from within. Domestic risks likely have been reduced, which should be positive for China in the medium to longer term.
Q: Which geopolitical trends and risks will likely have the greatest impact on the global economy over the secular horizon?
A: We will likely see a less integrated global economy in the next five years. As China amasses and asserts more power, it will likely become more disentangled, though not completely decoupled, from the West. While there will likely be some cooperation in areas like climate change and nonproliferation, we can expect competition to dominate the U.S.–China relationship. The U.S. and its Western allies will likely continue to diversify certain supply chains (e.g., those related to national security and public health) away from China and look to maintain a competitive advantage in sensitive technologies, such as semiconductors. While President Xi will likely seek to stabilize things heading into the Winter Olympics and the 20th Party Congress in 2022, the U.S.–China bilateral relationship can be expected to continue to spiral downward over the mid to long term. Our view is that China’s leadership believes the U.S. is in decline and time is on their side; the U.S., meanwhile, is focusing on investing in the drivers of American competitiveness at home while shoring up relationships with allies and partners in the region.
The messy execution of the withdrawal from Afghanistan damaged U.S. credibility in some quarters and may affect President Joe Biden’s ability to rally support for his foreign policy agenda. Among adversaries, the withdrawal fed the narrative of U.S decline and isolationism, which in turn may encourage competitors to test U.S. resolve in other areas. Meanwhile, an unstable Afghanistan will likely be a source of a massive humanitarian crisis and radiating instability in the region, though the situation likely won’t have substantial long-term impacts on the global economy.
Another geopolitical risk is a war we don’t expect. Anytime a major war occurs, it is a huge disruption with economic ripple effects. Consider North Korea, Iran, China, the India–Pakistan border: While none of these is likely to cause the next war, they are all areas to monitor. Miscalculations can escalate into confrontations or crises, likely not based in deliberate policy, but because situations get out of control.
Q: What is the high-level outlook for foreign policy and global trade?
A: Despite a strong economic recovery, the COVID pandemic will likely continue to restrict trade and travel, and should cause supply-side bottlenecks and lower economic activity for some time. With insufficient cross-border cooperation to foster worldwide vaccination (only 6% of people in low-income countries have received at least one dose, according to Oxford’s Our World in Data), there are continuing fears that new mutations where the disease spreads uninhibited will come back to haunt even the fully vaccinated and further disrupt travel, trade, and the return to work.
Nationalism, reflected in protectionism, great power competition, and populism, is likely to persist as the dominant ideology of the age. This makes it difficult to envision a world trade agreement (regional and bilateral agreements will likely become more common) or an effective G-20; meanwhile, China and America are edging toward a future of “one world, two systems.” Many nations’ foreign policy decisions appear to embed a zero-sum thesis – “if I win, you lose” – instead of considering the win-win that can come from expanding trade. The COVID-induced supply chain disruptions have temporarily obscured what are likely to be the longer-term impacts of rising protectionism on global trade, but we can expect a shortening of supply chains as companies and countries emphasize resilience over efficiency. Despite its rebound in 2021, global trade in the 2020s seems unlikely to repeat the rapid rise of the last two decades.
Q: What is the longer-term economic outlook for Europe and for the U.K.?
A: Europe is not immune from inflationary pressures, but even though COVID uncertainties (and rising infection rates) remain a barrier to economic activity, European near-term growth is higher than after the global financial crisis. Policymakers not only moved quickly to respond to the pandemic, going beyond Europe’s already well-developed automatic stabilizers with costly measures for job protection, but also, unlike 2009, prepared a European-wide fiscal recovery plan. However, looking at the secular horizon, trend growth in Europe may not rise much beyond 1%, and long-entrenched divisions over fiscal and monetary policy between northern and southern Europe will likely surface around the resumption of the Stability and Growth Pact in 2023.
Leadership is another secular issue: Angela Merkel handed the reins to an uneasy coalition; Emmanuel Macron faces a difficult presidential election in 2022; Mario Draghi is likely to move from Italian prime minister to the more honorific position of president; and the European Commission and Council presidents struggle to assert themselves. Less effective leadership could mean that while Europe has been a global first-mover in many areas – digital regulation, trade rules, a global minimum tax, and the net zero carbon transition – the region likely remains vulnerable, not least because of disagreements over its stances on Russia (and energy dependence) and on China.
The U.K. also seems to be struggling to find a role amid its secular transition away from Europe. Amid damaging trade disputes and with a smaller labor force, the U.K. is forecasting only 1.3% growth by 2024. The 2020s in the U.K. and Europe may well be a low growth decade, driven by relatively low levels of investment and productivity, by fiscal pressures (including the cost of climate change – despite the fact that renewable energy and electric cars should be an opportunity for growth), by an aging population, and possibly by continuing uncertainties about pandemics.
For PIMCO’s insights into the longer-term trends shaping the global economy and market environment, please read the latest Secular Outlook, “Age of Transformation.” To learn more about PIMCO’s forums and how they inform the firm’s investment process, please watch this behind-the-scenes video.