#255: The emerging ‘modified consensus’

INCHING TOWARDS ACCEPTANCE?

As you may know, the interpretation long set out here is that the underlying ‘real’ or physical economy of products and services has deteriorated, via stagnation, into contraction. Partly because of a mistaken belief that monetary gimmickry can promote material expansion, a huge gulf now yawns between the ‘real economy’ and its ‘financial economy’ proxy. The financial system itself, understood as an aggregate stock of monetary ‘claims’ on the real economy of the future, is poised to fall into this chasm.

To understand this situation, we need to recognize the parallel existence of the ‘real’ and the ‘financial’ two economies, a concept which was examined at length in Life After Growth, first published in 2013.

A perennial question about this situation concerns how much ‘they’ – meaning decision-makers, or ‘the powers that be’ – know about these trends, as they are understood here.

A much better question, though, is ‘what would they do if they did understand it?’ The one thing of which we can be sure is that, if the situation was indeed understood, nobody in a position of authority could possibly come out and say so. To do this would be to precipitate a market crash, itself a prelude for the onset of generalised chaos.

In this situation, the only realistic course of action for the authorities would be a gradual retreat from over-sanguine assumptions around economic growth. They would need to manage expectations downwards, and this would require the crafting of a modified consensus. The authorities would not, and could not, say that economic growth has ceased, let alone that it has gone into reverse, and neither would any practical purpose be served by doing so. Instead, they would seek to steer expectations towards successively, but gradually, lower levels.

The view set out here is that this modified consensus has started to emerge. We need presuppose no conspiracy in this, or much in the way of co-ordination, because there’s no reason why different people and different institutions shouldn’t follow the same evidence to the same conclusions. For anyone in a position of authority or influence, the managed retreat labelled here ‘the modified consensus’ is the only practical form of response to economic deceleration.

Economic projections issued last month by the World Bank provide the first concrete evidence that just such a modified consensus is emerging. We might slot President Macron’s warning about “the end of abundance”, and Huw Pill’s highly controversial remarks about reduced prosperity, into this same trend.

Be that as it may, the astute observer needs to take early cognisance of this switch in perceptions, work out what it’s going to mean for expectations, and respond accordingly.

Anyone aspiring to a career in politics needs to start thinking about what happens when the existing reality of the rising cost of necessities collides with the soon-to-be-admitted fact of economic deceleration. For business leaders and investors, this would be a very bad time indeed to put capital into anything that presupposes resilience – let alone future growth – in households’ discretionary consumption.

Of logic and evidence

Those of us who understand the economy as an energy system rather than a financial one can advance two types of argument in support of the interpretation that prior growth in prosperity has been trending towards reversal as the fossil fuel dynamic winds down.

The first of these is the logic which connects the supply, value and cost of energy with prosperity in the form of material products and services. But logic can be a surprisingly hard sell, particularly where its conclusions are unwelcome. The generality of opinion is not about to be swayed by mere logic away from its insistence that control of money will enable us to enjoy ‘infinite growth on a finite planet’.

But the second category of argument – evidential observation – is a very different matter, and much harder to disregard. The Surplus Energy Economics view, evidenced in abundant statistics, is that we have been going to ever-greater extremes to fake ‘growth as usual’ over a very long period. Ever since the 1990s, we’ve been buying each dollar of reported economic “growth” with $3 of net new debt, supplemented, in recent years, by a rapid expansion in the aggregate of non-bank credit. Since the global financial crisis (GFC) of 2008-09, we’ve also been using extraordinary forms of monetary gimmickry to sustain a simulacrum of continuing expansion.

All gimmickry has its limits, and this legerdemain has now collided with reality in the form of two wholly predictable outcomes. The first of these is the resurgence of inflation, and the second is the emergence of extreme and worsening risk in the banking and broader financial system.

From evidence to modification

In short, the observational evidence in support of economic deceleration has become unanswerable. If the authorities sustain their commitment to monetary tightening, the consequences can be expected to include both a banking crisis and a severe recession. If, conversely, they revert to the easy money conditions of the recent past, runaway inflation beckons. If they are more fearful of the latter than of the former, their conclusion would be hard to fault, though their determination might be hard to sustain.

As we have noted, the authorities couldn’t possibly state publicly that the previous orthodoxy of robust growth in perpetuity has turned out to be fallacious. Their only recourse would be to managing expectations through gradual reductions in their forward guidance about economic prospects. In short, they would set to work on crafting a modified consensus.

It’s not too much of a stretch to perceive the first signs of just such a modified consensus emerging in the reassessment of economic prospects issued by the World Bank during its recent biannual conference with the IMF. This document repays study, and can be found here.

Essentially, the World Bank states that global growth capability, having fallen from 3.5% between 2000 and 2010 to 2.6% between 2011 and 2021, may now decline further, to 2.2%, during the remainder of the 2020s.

Moreover, the wording here is instructive – 2.2% references “potential” growth, and, says the Bank, the out-turn could be even worse “if financial crises erupt in major economies and, especially, if they trigger a global recession”. Many observers, perhaps even a majority of them by now, presumably recognise that both a financial crisis and a recession are likelier to happen than not.

The not unreasonable inference, then, is that global economic growth will be less than 2.2% between now and 2030.

Neither the World Bank nor any other institution in a position of authority is likely to make (or acknowledge) the connection between economic deceleration and energy deterioration, as those connections are routinely described here. Moreover, they do not need to do so, and the decline in growth can instead be explained by reference to conventional factors such as ageing demographics, weaker-than-expected international trade and investment, and the worsening consequences of environmental change.

All they need to do – for now, anyway – is to steer growth expectations downwards. There’s plenty of time between now and 2030 to introduce further caution into their guidance.

The emergence of a less sanguine ‘modified consensus’ has far-reaching implications. It counsels that governments’ resources in the future are likely to be lower than has hitherto been supposed. It has stark implications, too, for the affordability of discretionary (non-essential) consumption by households. It also, incidentally, feeds through into lower expectations of the energy likely to be needed by the economy in the future.

Scenario analysis

The emergence of a modified consensus takes us into territory familiar to planners in the spheres of government and business. Typically, scenario planning sets out three forward cases, combining the expected or ‘central’ case with higher and lower alternatives. This technique allows planners to apply sensitivity analysis to deviations from their central set of projections. I propose to do some of this here, using three distinct scenarios.

The ‘high case’ in this exercise is the former consensus, which assumes trend annual world economic growth of 3.5%.

The ‘central case’ is the modified consensus, where I’ve taken the liberty of assuming that ‘2.2%, if nothing goes wrong’ equates to ‘1.8%, if quite a lot does’.

The low third case is, of course, the prosperity trajectory projected by the SEEDS economic model.

The assumptions used in each of the three case-studies are summarised in Fig.1. The tables show annual percentage rates of growth, plus GDP aggregates stated in constant dollars at 2022 values.

As you can see, the cumulative differences between the ‘consensus’ and ‘modified consensus’ case-studies are sizeable – by 2030, overall growth from the 2022 baseline falls from almost 32% on the former basis to less than 15% on the latter. At a projected $191 trillion (at constant 2022 values), global GDP in 2030 is 11% lower on the modified consensus case than on the consensus basis ($215tn).

Fig. 1

Additionally, it remains the consensus assumption that global population numbers will continue to rise, albeit at decelerating rates. With this taken into account, economic output per capita is projected to be 23% higher in 2030 than in 2022 on the consensus case, but this projected improvement falls to only 9.4% on the modified consensus analysis. Per capita equivalents of the aggregates are set out in Fig. 2, in which you will also see that SEEDS analysis puts per capita prosperity 8.5% lower in 2030 than it was in 2022.

Fig. 2

Broad implications

It will readily be apparent that a reduction in forward growth expectations has profound consequences, of which three are of primary significance.

First, we – and the authorities – know that the real costs of household essentials have been rising rapidly. An optimistic view might be that the rate of increase in the costs of necessities might slow, though monetary tightening exerts comparatively little pressure on products and services which consumers have to purchase.

But it would be extremely fanciful to suppose that any of the recent inflation in the cost of essentials might be reversed. Housing might, perhaps, become cheaper than it is now, but this isn’t going to happen to the costs of food, water, energy, transport or any other household necessity.

Our concept of the ‘real’ and ‘financial’ economies informs a specific interpretation of varying household experiences. Those whose fortunes are tied to the financial economy have fared pretty well during the ‘easy money’ era, whilst those whose incomes and costs are tied to the material economy have suffered worsening conditions. This goes a long way towards explaining the apparent dichotomy which is reflected in islands of affluence within a widening ocean of hardship.

Economic deceleration, taken in conjunction with continuing rises in the cost of living, suggest that popular demands for help will only increase. At the same time, though, government resources are going to be undermined by lower-than-expected economic growth. A global growth trend of between 1.8% and 2.2%, sharply lower than the previously-assumed 3.5%, means that some economies can anticipate no growth at all, whilst others might start to experience contraction.

What, then, can resource-constrained governments do about expenditure commitments? Public spending falls into two categories – the provision of services, and the enactment of transfers (such as pensions and benefits) in support of the less well-off members of society. It’s axiomatic that, as economic hardship worsens, the need for transfers increases, and so do the demands placed on public services.

This implies that two political pressures will arise – growing demands for redistribution, and an increasing need both to boost efficiency and to tighten priorities in the delivery of public services. States may feel compelled, not just to ask for larger contributions from the affluent, but also to take some necessary services into public ownership. The political battleground of the future might take on some of the characteristics of the past debate between ‘collectivist’ redistribution and ‘liberal’ preferences for lower taxation and a minimised state.

Second, the combination of lower-than-expected growth and rises in the cost of essentials implies significant contraction in sectors supplying non-essential products and services to consumers. This is an issue that needs to be watched, and might soon start to be reflected in expectations for, the activities of, and the market valuations applied to businesses operating in consumer discretionary sectors.

Thirdly, of course, even a deceleration in growth, by conflicting with prior expectations, can be expected to increase stresses in the financial system. This is a topic that we’ve addressed before, and that we might revisit, just as we might look further into the political and business consequences of affordability compression.

Extended scenarios

The charts set out in Fig. 3 carry global scenario analysis forward to 2040, and set out the equivalents for the United States, the United Kingdom and China. If the early forecast period for the British economy looks a little odd, it’s because nobody expects much in the way of growth in the near term.

In carrying the modified consensus forward, the assumption is made that the projected rate of global growth is revised downwards again by 2030, this time falling from 1.8% to 1.4%. By the 2030s, of course, the SEEDS trajectory has become decisively negative.

Even on the ‘modified consensus’ scenario, though, the world economy is likely to be almost 30% smaller by 2040 than it would have been on the prior-consensus basis.

As remarked earlier, the outlook for government and businesses are issues to which we can, and perhaps should, return.

For now, though, we can conclude that expectations are critical to behaviour, not least in government and in the capital markets. If we are indeed witnessing the emergence of a ‘modified consensus’, there is a compelling need to anticipate the way in which expectations are likely to be steered in the near future.

Fig. 3