Nobel Winner Spence Sees Non-Trivial Chance of US Recession: Q&A
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In an interview on Aug. 17, Michael Spence, Nobel laureate and both a professor and dean emeritus at the Stanford Graduate School of Business, discussed prospects for the US, Chinese and European economies and the consequences of China’s slowdown for the world.
Spence, who is a senior adviser to General Atlantic LLC and chairman of the firm’s Global Growth Institute, also gave his view on the biggest risks facing the global economy.
Here’s a partial transcript of highlights from the interview, lightly edited for brevity:
Q: Has inflation peaked?
A: Overall, I think inflation has peaked but it may not settle down at an acceptable level anytime soon. There are different degrees of transitoriness if I can put it that way. A spike in a whole variety of commodities will likely abate as the system adjusts.
But we have very major changes in labor markets and in the configuration of the global economy. We went through more than two or three decades of bringing more productive capacity online in developing countries. And every time demand ramped up, the supply side responded. There isn’t that degree of elasticity on the supply side anymore, which means that shifting from a demand-constrained world to a supply-constrained world is almost a regime change in the global economy.
Q: Is recession fear over?
A: I think recession fear is receding, but I don’t think it’s over. There are still people who are worried that inflation will be persistent enough to force the Fed to really clamp down. There’s still a non-trivial possibility that we’ll have a recession or a dramatic slowdown.
The Federal Reserve has a responsibility to get inflation down. So it will keep the pressure on, but the magnitude of interest-rates increases may vary.
They take seriously their inflation mandate. They’re probably worried that their lack of concern about inflation when it started to appear caused some damage to their credibility, so they don’t want to do that again. On the other hand, they have a dual mandate, and they definitely don’t want to crash the economy.
Q: Sentiment among investors has clearly shifted and markets are rallying. What are some of the biggest risks you’re seeing?
A: Financial markets are much more sensitive to interest rates, forecasting and forward guidance. And we’re in a world in which asset prices were dramatically elevated over a long period of very low interest rates.
The rebound we’re seeing in financial markets is a rebound from fear of a very rapid and dramatic change in interest rates, which would change discount rates. And when there is some evidence that perhaps the extreme scenario isn’t going to manifest, then you get a fairly big financial-market reaction from it.
We’re in a world in which asset prices are going to be reset, not just in public markets, but in private markets, where valuations have come down dramatically. There’s probably a whole collection of former unicorns that aren’t unicorns anymore.
I don’t expect these things just to collapse, but an asset-price reset in the downward direction seems pretty inevitable.
Q: The US labor market remains strong. What are some of the major shifts you’re expecting?
A: There have been shifts in labor-market behavior. Some people who were willing to work in a variety of jobs that were either low paying or relatively insecure are just not going back to those jobs. A lot of people are retiring because they have the assets that they think are adequate to do that. And then there’s a whole generation of people, especially younger people, who think lifestyle is pretty important and there are certain kinds of jobs they’re not willing to do.
Another part is labor is gaining power relative to the past, and pressure from employers is diminishing. In part because of geopolitical tensions and also due to congestion in global supply chains. There is a genuine shift on the supply side in terms of who’s willing to do what kinds of work and for what kinds of compensation.
So labor is getting more powerful and my feeling is these are not temporary shifts — there isn’t an infinite supply of low-cost labor anymore. There’s a beginning of a fairly substantial regime change in the way the global economy is put together. And that would affect the labor markets for sure.
Q: What are the biggest risks for the US economy?
A: The biggest risk is still the expansion of geopolitical conflict. Something going wrong in Taiwan would be a disaster. Along with it is a rising set of climate-related risks. If I had to pick one more it could be a complete loss of functionality in government. We had a pretty good run recently, thanks to some leadership and politics: the infrastructure bill, the semiconductor and science one — what’s encouraging is they will all involve investments that are critical for longer-term economic performance, including growth and productivity.
Q: How long will China’s slowdown last and how can it be managed?
A: The Chinese slowdown looks to be real. That affects not only global supply chains, but domestic demand. The imbalances in the real estate area are big enough to produce significant risk. I think they can manage that, but in managing it, that will further slow the economy down.
And then you pile on top of that the geopolitical tensions and disruption of trade flows that started on the US side with the Trump administration.
China is still doing a lot of things right — they continue to invest heavily in things that have the potential to produce a modern economy. The medium- to longer-term prospects in China are pretty good, but in the short term there are pretty powerful headwinds.
Q: What are some of the most important implications for rest of the world?
A: When China slows down, global growth is directly affected.
It affects trading partners and investments. And now we’re going through delisting of Chinese companies and we may get a pretty substantial separating of the Chinese and Western financial systems.
That’s not good in the short run — it makes people nervous and inhibits investment. But in the longer term that’s also a bad outcome.
Q: When will the Chinese economy start recovering?
A: I expect it will rebound in the next two to three years unless there’s bad luck. We we’re moving into an era where tech and digital are going to be regulated. China is on a similar path, but it stepped into regulation in an extremely aggressive way. As a result of that, I think it has diminished some of the dynamism and animal spirits in the economy in a way that might have been avoided with a slightly more thoughtful, gradual approach to regulating the tech sectors.
I think once the party congress is over and the president has been put in place with a third term, there’s a reasonable chance you’ll get a rebalancing of the policy agenda in the direction of focusing on economic, and social progress performance. Whereas it got lost in the shuffle in the geopolitical tensions and the pandemic.
Q: What are your biggest concerns for the European economy?
A: In the immediate future it’s energy and Ukraine. The big shocks are likely to come this winter. If we run short of gas and start telling companies to stop operating for two days a week, there’s serious potential to drag the economy down or even cause a crisis. Euro depreciation tends to produce additional inflationary pressures.
The UK seems to be in a very tough spot now. With very high rates of inflation, lots of people are getting hurt.
The chances of a recession in Europe are still clearly quite high, if not already in place. It’s going to be a tough period until they make the energy transition.
Q: What are some of the biggest shifts in the global economy that concern you?
A: A very large fraction of the world is what you might call non-aligned. They don’t want to choose up sides, whether it’s Russia or China, and they’ve made it clear that they have not endorsed the sanctions. There’s a fairly large part of the world that doesn’t want to play the game that’s being played right now.
Whether or not that has a big economic effect is a different question. But we’ve lost a fair amount of the underpinnings of the global economy and we’re really not getting started building a new architecture. And that’s pretty important to a fairly large number of people on the planet, especially in a wide range of developing economies and emerging economies.