Opinion – Martin Wolf: How to think about policies in a polycrisis

Welcome to “polycrisis” – a world in which, as historian Adam Tooze puts it, “economic and non-economic shocks” are tangled up “to the end”. We have an inflationary shock that emanates from disruptions caused by a pandemic, from policy responses to that pandemic, and from an energy shock caused by a war.

This war, in turn, is related to the rupture of relations between great powers. Slow growth, rising inequality and excessive reliance on credit have undermined political stability in many high-income democracies. The glut of credit led to a major financial crisis whose aftermath included a decade of ultra-low interest rates and thus further financial fragility around the world. Adding to these tensions is the threat of climate change.

Indeed, it is convenient to think of the world in intellectual silos, successively focusing on macroeconomics, finance, politics, social change, politics, disease, and the environment to the exclusion of others. In a reasonably stable world, this might even work. The alternative of thinking about the interactions between these aspects of experience is also very difficult. But sometimes, like now, it becomes unavoidable.

It is not just theoretically true that everything depends on everything else. It is a truth that we can no longer ignore in practice. As my colleague Gillian Tett often warns, silos are dangerous. We have to think systemically. Economists need to recognize that the economy is interconnected with other forces. Navigating today’s storms forces us to develop a broader understanding.

This is not an argument against detailed analysis of individual image elements. Economists still must carefully examine the things they know, because they are complex and important in their own right. Thus, the data and analysis of the latest OECD World Economic Outlook remain invaluable and illuminating. But inevitably they also omit vital aspects.

Consider, then, what the report tells us about the economic situation.

First, the energy crisis itself is really huge. The share of OECD members’ GDP spent on final energy use is close to 18%, double what it was in 2020. In Europe, increases are expected to be much larger. The last time the ratio was this high was in the early 1980s, during the oil shock caused by Saddam Hussein’s invasion of Iran.

Second, inflationary pressures are strong and widespread. Again, this has echoes of the inflation of the early 1980s, which followed the high and fluctuating inflation of the 1970s. Today, the energy price shock caused by the war in Ukraine has followed negative supply shocks and positive demand triggered by Covid. This combination of supply and demand shocks with large reductions in real wages and losses in national income in net energy importing countries makes the job of central banks extremely difficult.

Third, there is likely to be a sharp slowdown in global economic growth between 2022 and 2023. The latter is forecast at 2.2%. Furthermore, most of this growth will be generated by Asian economies. The British and German economies are expected to shrink slightly, while those in the eurozone and the US are expected to grow by just 0.5%.

Fourth, while this is unsurprisingly a sad picture, it could be much worse. The energy outlook itself is highly uncertain, with a substantial risk that Europe’s gas reserves will be less next winter than this one, especially if the winters are cold or imports of liquefied natural gas very small. Rising interest rates could trigger more financial turmoil and deeper recessions than anticipated. Food shortages could cause greater problems in developing countries than expected, especially in a financially tight environment.

The OECD view, which I share, is that central banks should not take a spike in inflation as a sign that their job is done. It is essential that inflation be firmly controlled. In this context, it is also vital that fiscal policy is geared towards supporting those most affected by high energy prices. Equally important is boosting the expansion of renewable energy supply and improving energy efficiency. This is the “home front” in Europe’s conflict with Russia.

However, even this is an incomplete picture. Other elements are possible developments in the Ukraine war and what is needed to bring it to a satisfactory end. Another is how China will escape the trap of its zero Covid policy. Last but not least is finding ways to help developing countries with their impending financial problems by supporting their climate transition.

The thing is, we need to analyze within silos while also analyzing systemically across silos. The OECD, to its credit, created a unit called New Approaches to Economic Challenges (NAEC) for this purpose in 2012. As this unit’s latest and seemingly final report notes, we must analyze the interactions between social, economic, political, geopolitical, health and environmental developments to address the challenges we face. Humanity has created a world so interdependent that no other approach is possible. Of course, this is difficult. Tends to irritate professional specialists who work comfortably in their silos. But since the financial crisis, and especially in the last three years, it has become clear that such narrow-mindedness is foolish. It is being precisely wrong rather than daring to be approximately right.

So what did the OECD do with this endeavor? Some say it’s closing. It would be a mistake. If Naec is not good enough, improve it. The world we know today is not divided into organized silos. Our thinking must not remain trapped within them either.

_{translation of Luiz Roberto M. Gonçalves}