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Europe’s largest economy, Germany, is in recession. A number of recent banking failures point to strains in the financial system. In 2022 alone, households lost $8 trillion of wealth. When inflation and interest rates rose, many economies lacked resilience. Why?
The seeds of current vulnerabilities to more turbulent economic conditions were planted long ago. Over the past 20 years, the trajectory of global wealth and debt accumulation began to diverge from that of the real economy—an unsustainable state of affairs.
Also on the Forum Network: Six Faces of Globalization: Who Wins, Who Loses, and Why It Matters by Anthea Roberts & Nicolas Lamp
A. Roberts and N. Lamp explain why dissecting various narratives regarding globalisation is crucial to better understanding its real impacts on society as a whole. Banner image: Six Faces of Globalization: Who Wins, Who Loses, and Why It Matters, cover image
Before 2000, growth in global net worth had largely tracked GDP growth, but then something unusual happened. At around that point, net worth, asset values, and debt began growing significantly faster than GDP. Yet productivity growth among G-7 countries slowed from 1.8 per cent a year between 1980 and 2000 to only 0.8 per cent from 2000 to 2018, and inequality rose.
In aggregate, the global balance sheet—a tool that sums the world’s assets and liabilities that the McKinsey Global Institute has developed as a new lens on the health and wealth of the global economy—grew 1.3 times faster than GDP.
That development was not resilient, sustainable, or inclusive.
On the resilience front, a balance sheet whose expansion is not supported by real capital formation nor economic growth is prone to trouble as rates rise. Between 2000 and 2021, our new research shows that asset price inflation created about $160 trillion in “paper wealth” that would come under pressure if real interest were to rise materially. Every $1 in investment generated $1.90 in debt, and debt loads that are higher than after the global financial crisis will also prove difficult with higher rates. During the pandemic, partially in support of households and businesses during lockdowns, $39 trillion in new currency and deposits were coined by commercial and central banks—money that is now there to add to inflationary pressure from energy and supply shocks.
While global net worth grew from $160 trillion in 2000 to $610 trillion in 2022, the world has not been able to find the $3.5 trillion a year of extra investment needed to make the net-zero transition a reality.
With regard to sustainability, while global net worth grew from $160 trillion in 2000 to $610 trillion in 2022, the world has not been able to find the $3.5 trillion a year of extra investment needed to make the net-zero transition a reality. Large investment gaps in infrastructure and affordable housing remain.
Turning to inclusion, broadly only those who owned assets to begin with had even a modest chance of building their wealth—hardly inclusive. About 80 per cent of wealth formation came from asset price inflation, and only 20 per cent from savings and investment.
Now the chickens are coming home to roost. MGI’s new research modelled four plausible scenarios for economies and the global balance sheet from now to 2030. Volatility may prove temporary and balance sheet expansion may resume as savings bid up the price of existing assets once again rather than flowing to productive investments. Or high inflation and interest rates could persist, resembling the US economy after the 1970s oil shock. The worst case would look more like Japan after its real estate and equity bubble burst in the 1990s, with drawn-out deleveraging and a sharp contraction in asset prices. For instance, US equities and real estate values might drop by more than 30 per cent between now and 2030. Only one scenario, in which productivity growth accelerates, delivers strong growth in GDP and incomes and a healthier balance sheet.
To give an idea of what is at stake, the worst-case scenario in the United States would mean 1.7 percentage points less in annual average GDP growth versus a productivity acceleration scenario; household wealth would be $48 trillion lower.
So reallocating capital in such a way as to create a more resilient, sustainable, and inclusive balance sheet is required. Paper wealth needs to be replaced by real-world capital formation, and supported by higher productivity and income. There is no shortage of investment needs that will make our planet more sustainable, inclusive, and productive, from green technologies to affordable housing, infrastructure, and education. proactive policy to channel capital for such uses—and limiting the creation of new money and debt that finances asset price inflation—is the only route to a sustainable balance sheet in the long term.
But what will that take? In key areas, the rules of the game need to be changed.
Land market reform, for instance, is long overdue and is the key unlock for the construction of more affordable housing. Tools like transit-oriented development, inclusionary zoning, and land value capture to finance affordable housing and important infrastructure have been successfully applied in countries from Spain to Singapore. But NIMBYism and restrictive zoning remain the reality in most
Coordination, complementary infrastructure build-out, regulation, carbon pricing, subsidies, and more will be needed at a different level, not only for sustainability, but also for a healthier and more resilient balance sheet.
The world also needs to get serious about changing the rules to create positive investment opportunities to enable the net-zero transition. $3.5 trillion a year may look daunting, but the required two per cent of GDP uptick in investment is, in fact, less than the sustained downtick experienced in the United States and Europe after the global financial crisis. Coordination, complementary infrastructure build-out, regulation, carbon pricing, subsidies, and more will be needed at a different level, not only for sustainability, but also for a healthier and more resilient balance sheet.
Finally, could the rules of the financial system be adjusted to limit the creation of money-fueling asset transactions at ever-rising prices – while at the same time lowering the cost of financing new capital projects? Less than 15 years after the global financial crisis, several financial institutions have come under pressure—or failed—yet again from supposedly “safe” allocation of capital to government bonds or commercial real estate loans and rapid creation and accumulation of deposits that proved fungible. Yet funding the growth of small-and-midsize businesses, for instance, has in many cases fallen out of favour as it requires substantial regulatory capital.
In the heat of economic crises, it may be difficult to focus on anything but managing short-term turbulence, but that risks bad cycles simply repeating. Crises are also an opportunity for a more fundamental rethink—a rethink that can deliver a sustainable and inclusive economy and balance sheet for the long term.
To learn more, visit the OECD Economic Outlook website