The West now appears to be entering a period of stagflation and potentially even worse outcomes than the 1970s, since the oil shock era didn’t produce hunger and energy scarcity to the degree that is in store for Europe and even the US. Unfortunately, as happened then, these failures are being blamed on recent government spending policies. The fact that (only very nominally) liberals were in charge in the US, also like the 1970s, is giving underserved credence to right wing economic ideas. Russia unfortunately is also taking up a right-wing line, with Putin blaming the West’s mess on “money printing”.
My belief, but it will take more evidence to shore it up, is that the failings of the West were decades in the making, and recent monetary and fiscal policies are not the main drivers. Ironically, Putin’s focus on macro and monetary policies may also be doing Russia a disservice.
I’ll throw out some observations.
First, as Servaas Storm demonstrated in a data-driven but still very accessible recent paper, our current inflation is not driven by excessive demand. There are at least two major contributor that get either no or insufficient mention in orthodox conversations.
One is Covid. It is unquestionable that Covid-induced supply chain breakages are causing shortages that then lead to high prices and even scarcity at wholesale and retail. But the right wing is aggressively promoting the canard that public health policies that put well-being over profits are misguided and thus produce unwarranted restriction on “freedom”. Mind you, we never had policies like that. We has only Covid theater and vaccines. Only zero-Covid China is still holding that line, which is why the West has to bash them. The nominal liberals are also unwilling to admit our Covid policies have failed. Surely it is the fault of the unvaccinated deplorables, not CDC and FDA horrowshows of negligence and lying.
But the US also has undue faith that markets are self-correcting when we’ve made them fragile via long supply chains and just-in-time practices. Recall that the early depiction that the 2021 inflation was temporary was not crazy at the time. The inflation then was the result of very high inflation only in a few, but important sectors hit by Covid: autos due to chip shortages, which then led to a wild increase in used car prices; energy, due to wells being taken out of production when demand crashed during “work from home” and then came back suddenly with vaccinations being touted that everyone could go back to normal, and supply not coming back on line quickly; and food processing/distribution problems due to Covid labor shortages (aka some workers not wanting to take the disease risk in close quarters, plus off and on shortages due to outbreaks at workplaces).
But another factor, which Storm described in his paper, is the extreme measures companies are taking to preserve profits that in recent years have been at astonishingly high proportions of GDP. As Julius Krein explained:
The most intriguing and potentially alarming trends are visible in the oil market. In December 2019, before Covid, global oil consumption was about 100 million barrels per day, and the price of West Texas Intermediate (WTI) crude hovered around $50-$60 per barrel. At that time, the US operating rig count was around 800 (around 2,000 globally), according to Baker Hughes. After the pandemic hit, in 2020, global oil demand fell to about 90 million barrels per day, prices collapsed and briefly went negative, and the US rig count hit a low of around 250. Oil demand recovered about half the lost ground in 2021 and is expected to return to 2019 levels of 100 million barrels per day this year. In December of 2021, WTI spot prices were around $75, rose significantly after the Russian invasion of Ukraine, and currently sit around $110. Yet the US rig count is still around 700 (of 1,600 globally). The last time oil prices were above $100, before the crash of 2014, the rig count was over 1,800 (3,600 globally).
This trajectory is difficult to square with inflation accounts based on excessive demand. Oil demand has still not exceeded pre-pandemic levels; it is supply that has lagged. Meanwhile, far from being “too greedy”, companies seem to not be greedy enough — at least in the conventional sense of maximising profits. Instead of reinvesting their earnings in drilling new wells, even at profitable oil prices, companies have returned cash to shareholders.
Some have argued that oil companies are not drilling because of the Biden administration’s environmental regulations. As a critic of those policies, I am sympathetic, but they cannot account for the larger phenomenon, including international drilling. Others have suggested that ESG investing requirements have prevented the oil and gas industry from accessing capital. While there is no question that ESG as presently constructed is a disaster, this does not explain why companies are not reinvesting their own earnings. There are some time-lag issues — wells cannot be drilled overnight — but prices have now been elevated for months. Oil futures are also over $80 through most of 2024, meaning companies can hedge future production.
The best explanation is, therefore, the simplest one: shareholders prefer that companies return cash rather than invest, a preference widely discussed among industry participants and observers….
Short-termism is hardly new. Yours truly wrote in 2005 how it had hit the point that US companies for the past two years had been net saving, as in liquidating. They were not willing to invest in the business of their business. It was easier to play the game of starving, as in relentlessly cost cutting and offshoring.
But another way the US has eaten its own seed corn, or maybe its tail, is the breakdown of effective fundamental investment. Mariana Mazzucato in The Entrepreneurial State described how the Federal government, major academic centers, and business had long had collaborative relationships. A big reason was that only the government could take the risk of basic research; the payoffs were too uncertain for private industry. Mazzucato make clear that that has withered, and also described how Silicon Valley was so greedy that it was unable to fund production in the US for technologies that the DoD had pushed hard, for employment and potential spinoff reasons, to be here, such as LCD displays.
I have some ideas about Russia that may be off base that if true would be contributing to them holding up much better under the sanctions than anyone expected, including Russians themselves. Forecasters now anticipate that the GDP contraction will be 6.0% to 7.5%, down from initial estimates of 15%. Some are even saying it could be as low as 3.5%. The rate of inflation is falling and some prices are even deflating. Russian inflation is now close to the level of EU inflation.
The US does not do industrial policy except by default, which means via lobbying. So we have support via investment, subsidies, tax breaks, and financing guarantees to sectors that have become both large and inefficient: health care, the military/industrial complex, higher education, real estate. Cheap money has also supported the growth of the asset management industry, which the IMF and others have found slows economic growth, and even worse, leveraged speculation. Because “free markets” are a strong ideology, there’s no where enough interest in whether these subsides work even remotely as intended. Once they become established, they are treated as an entitlement.
By contrast, I have the impression, simply based on reader the minutes of a few recent meetings of Russia’s economic council, that its government intervenes at a lower level of the economy, rather than throwing money around and not asking many questions. This may be a holdover from central planning, or the result of the fact that the government owns major energy companies, and is so not afraid to kick corporate tires, and perhaps also because Russia’s government has been far shrewder in its defense development and procurement than we are.
If this is true, it may also result in Russia relying more on actual industrial policy to promote growth than the West, which more and more has come to default to macroeconomic policy, which over time has been turned into over-reliance on monetary policy, even though monetary expansion is no good at stimulating demand (it does so very inefficiently through the wealth effect). In this sense, Putin is correct when he calls out bad Western economic policies but he hasn’t identified the proper perp.
Specifically, my impression is that due to having had a weak currency until recently, and suffering the tender ministrations of the IMF after its 1998 financial crisis, Russia and particularly Putin have adopted very orthodox views about spending because Mr. Market would tank the rouble if they didn’t. The de facto hard budget constraint therefore may have led to Russia looking to other levers to promote growth.
A second factor that may have helped with Russia resilience is that (I am told) it does not use just in time manufacturing. Recall just in time was developed in Japan due to the lack of factory space (land is expensive in Japan) and then comparatively poor Japanese manufacturers also wanting to minimize inventory costs. Not only is Russia not scarce on space, but Russian winters = good odds of delivery interruptions and hence seeing inventories as an important hedge. I don’t know how much in inventories Russian companies typically hold, but those reserves helped dampen the worst of the supply shock.
Enough spitballing for now. Any input from readers who know more about the Russian economy would be very much appreciated.