There’s much talk of a return of stagflation – that mix of high inflation and slow growth reminiscent of the 1970s. This is both too optimistic, and too pessimistic.
It’s too optimistic because growth will have to accelerate a lot if we are to emulate the 1970s. Between the first oil shock in 1973 and the election of the Thatcher government in 1979, real GDP per person in the UK grew at an annualised rate of 2.1 per cent. That’s twice the rate it has grown in the past 10 years. And this isn’t because of the pandemic; in the 10 years to 2019, growth was only 1.3 per cent a year.
We’ve had the “stag” part of stagflation, then, for years – and not just in the UK: Larry Summers was talking about it in 2016. A big reason for it was pointed out way back in 2005 by then Fed chairman Ben Bernanke – that there is a "dearth of domestic investment opportunities" in developed economies. There are many reasons why this should be. Robert Gordon says there is a shortage of revolutionary new ideas. Nick Bloom and colleagues point out that the productivity of researchers and scientists “is declining sharply.” Michael Roberts says there has been a worldwide downward trend in returns on capital which has sapped the motive to invest. Or it could be that companies have learned from William Nordhaus’s finding that only a “minuscule fraction” of the total returns to innovation go to corporate profits and so are doing less of it. And low wages and a lack of wage militancy mean there’s less incentive to invest in labour-saving technologies.
These are not the only forces for stagnation. Joel Mokyr has pointed out that societies only remain dynamic for short periods before vested interests wanting to protect their privilege act to suppress the creative destruction necessary for economic growth. Thomas Philippon, Brink Lindsey and Steven Teles and Brett Christophers (the latter with more of a UK focus) have all documented how rent-seeking has risen in recent years to the detriment of entrepreneurship.
Stagnation, then, is not merely an artefact of high energy costs. It is the product of deep structural forces in the economy.
Until recently, this has not led to inflation because demand has been as weak as supply thanks in part to tight fiscal policy and because, unlike in the 1970s, there has been no wage militancy. These disinflationary forces are still present: real wages are falling and the OBR expects cyclically-adjusted net borrowing to fall by 1.7 per cent of GDP this fiscal year. What’s changed is that energy bills are soaring and that the recovery from the pandemic has created mismatches between supply and demand. Both, though, might well be temporary simply because if we’re handing all our money over to energy companies we cannot afford to pay higher prices for other things: Tesco’s recent pledge to hold down prices was making a virtue of necessity. Economists expect CPI inflation to fall to just 2.1 per cent by the end of 2023, and the gilt market is pricing in sub-4 per cent RPI inflation by 2026 – consistent with sub-2.5 per cent CPI inflation.
“Flation”, then, might well be temporary. “Stag”, however, is very likely here to stay.
