A ‘Great Stagflationary Debt Crisis’?

In his recent book Megathreats, economist Nouriel Roubini, nicknamed ‘Dr Doom’ for his correct forecast of the 2008 global financial crisis, has again come up with some dire predictions about the global economy in the not-too-distant future. This time, he foresees a ‘Great Stagflationary Debt Crisis’ due to some interconnected ‘megathreats’ looming over the global economy.

The megathreats Roubini talks about span economic, financial, political, technological and environmental concerns. Some of these, like climate change, artificial intelligence displacing white-collar jobs, Covid-like pandemics, ageing and declining working-age populations in many countries, are relatively new ones.

Other issues such as deglobalisation, trade wars, debt crisis, Superpower Cold War, stagflation (co-existence of inflation and slow growth) have existed periodically in the past. But these lost much of their significance as global problems in the globally-integrated post-1990 world (after the breakup of Soviet Union, entry of China into the global economy, emergence of a unipolar world and economic unification of Europe) but are now coming back with a vengeance. Populism, authoritarianism, extreme partisan polarisation -- considered exclusive problems of some emerging economies – are spreading to many developed countries.

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Currently, global debt, including both public and private, exceeds 350% of the global GDP. To a large extent, this is due to the cheap money policy pursued by the major central banks, first to combat the so-called “Great Recession” in 2007-8 and then again to finance the massive stimulus packages following the onset of the Covid pandemic. Now, the chicken have come home to roost as sticking to expansionary monetary and fiscal policy to combat recession is no longer possible without aggravating the record-high inflation situation all over the world.

The problem is deadlier when one counts ‘implicit debt’. According to OECD estimates, unfunded/underfunded government pension liabilities for the top 20 economies of the world amounts to a mind-boggling $78 trillion, a ‘ticking time-bomb’. This is going to be aggravated in future with a steady rise in the ‘dependency ratio’, due to shrinking working-age populations and rise in the number of pensioners and life expectancy in a growing number of countries.

Central banks all over the world are going in for unprecedented rate hikes to fight inflation which was initially caused by supply-side disturbances (Covid and Ukraine war contributing to higher energy, food and transport costs) but then became more generalised as a result of massive stimulus spending and release of pent-up demand by using the savings accumulated in the Covid days. The high inflation situation is no longer considered a ‘transient’ phenomenon. So, fighting entrenched inflation with tight money policy in the coming days is going to cause a further slowdown in GDP growth. Growth slowdown, in turn, would raise the Public Debt/GDP ratio further by lowering the Tax/GDP ratio (and correspondingly raising the Fiscal Deficit/GDP ratio).

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Servicing huge debt at much higher interest rates would pose serious problems for both private and public sectors. Rising fiscal deficit (or government borrowing), specially to finance ‘unproductive’ expenditures like pensions and interest payments, would mean adding to aggregate demand without adding to corresponding productive capacity, which would push up prices.

Monetary authorities would be forced to hike interest rates further to control inflation, triggering a kind of an inflation-interest rate spiral, at least for some more time until either the supply-side cost-push factors are resolved (not likely so long as the Ukraine war and the Covid-induced disruptions in production and transportation continue) or a general recession and a steep rise in the cost of loan-financed spending (specially on housing and consumer durables) forces a cut back on private expenditures and employment causing huge hardships to a large number of people.

Rise in corporate debt-servicing cost would lead to slashing of new investment expenditure, worsening the supply-side constraints in the future. In addition, a rise in bankruptcies and inability to service past debt would imply worsening financial health of the banking sector, triggering a financial sector crisis.

The ongoing de-globalisation process and fragmentation of global supply chains (‘onshoring’ and ‘friend-shoring’) along new geo-political alignments and blocs would cause a further rise in costs and prices as supply (specially of energy, food, fertiliser and industrial components) from some of the cheapest sources are blocked by escalating tariff and non-tariff barriers and new restrictions are imposed on immigration of cheap workers from abroad.

The weaponisation of energy (by Russia) and financial services (by the West) is adding a totally new dimension to the global economic scenario. The rapidly worsening geopolitical climate is going to make international cooperation and coordination of policies that much more difficult. The post-World War II multilateral institutions/forums like the UN, WTO, IMF, World Bank, the EU, the G-7 and G-20 are often becoming places for acrimonious exchanges, instead of meaningful discussions and cooperative actions to resolve urgent global issues like the climate crisis, terrorism, pandemics, rich-poor divide, civil wars and armed conflicts between countries.

All these tendencies together mean a world resembling something close to the “tumultuous and dark decades between 1914 and 1945”. In addition, war is taking newer forms, like cyber warfare and remote-control destruction of cities, water and power networks by missiles and drones. Rapid urbanisation and deforestation are increasing the chances of the advent of new Covid-like pandemics. The inequality of income and wealth is rising alarmingly within most countries. A growing number of people are losing faith in the democratic system of governance. Opportunistic political leaders and demagogues are taking advantage of this swelling discontent to strengthen the forces of hyper-nationalism, non-democratic governance, and to direct popular discontent against minorities and foreigners.

Finally, there is the role of labour-saving technology in the form of AI, with the prospect of massive job losses among white-colour workers. This would aggravate unemployment even among better educated people, income inequality, popular discontent, and ballooning public debt to finance subsidies for the rising number of long-term jobless.

These threats are, no doubt, real. However, it is not inevitable that Roubini’s doomsday scenario should come true. Cynics would say that “economists have predicted nine of the last five recessions”. Nonetheless, given Roubini’s enviable track record, his analysis deserves serious attention.

Ultimately, a lot would depend on human ingenuity, in the form of new technology (like green energy from hydrogen and fusion) and changed behaviour, arising out of voluntary or forced learning from past mistakes, which has saved the world from many earlier megathreats, such as the Malthusian spectre of overpopulation leading to acute global food shortage, or a catastrophic nuclear war.

(The writer is a former Professor of Economics, IIM, Calcutta, and Cornell University, USA)