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8 March 2023

Today’s global economy may look like that of the 1970s, but the crises we face are worse

Drawing parallels between recent price shocks and the fiscal turbulence of 50 years ago is misleading.

By Wolfgang Münchau

Our economic situation is not only different to the 1970s, with its oil price shocks, trade union barons and incompetent central bankers: it is worse. I see three striking parallels between the 1970s and today, but one vital difference that swings the balance.

The first and most obvious parallel is the rise in inflation after a series of price shocks, and the way central banks are reacting to this. In the UK, the first oil crisis in 1973 led inflation to increase to 23 per cent by 1975. It came down in the two years that followed, but by less than economists had expected. With the second oil price shock, which started in 1978, inflation rose again. The Bank of England, and other central banks worldwide, started to cut interest rates too early.

[See also: With Western support for Ukraine flagging, a protracted war is in Vladimir Putin’s interest]

Today, core inflation in the UK, the US and the eurozone is between 5 and 6 per cent. The base rates in all of these countries is well below the level of inflation, just as it was in the 1970s. Again, central bankers are giving hints that the worst may be over. Andrew Bailey, the governor of the Bank of England, has been signalling that we are close to the end of the rate-rise cycle. So too, recently, has the governor of the Bank of France. This is more or less what was happening in the 1970s.

The second parallel is the deterioration of public finances. After the frugal 1950s and 1960s, governments in the 1970s started to use fiscal policy actively to counteract the sequential crises. The UK had its sovereign debt crisis and an IMF bailout in 1976. US fiscal deficits rose strongly during the 1970s.

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This is exactly what Western governments have done almost 50 years later, during the pandemic and then again after Russia’s invasion of Ukraine. Much of the stimulus spending was bankrolled by central banks through quantitative easing. The US approved a total of $5trn in stimulus from March 2020 to March 2022. During the Covid lockdowns, Western governments everywhere bankrolled companies and subsidised wages. After the rise in energy prices, they did it again, helping people and firms to pay their bills.

Modern fiscal policy operates under the guiding principle that we must do whatever it takes – an expression that describes the mindset of the past decade better than most. It was not always like that. Before the 1970s, the world laboured under hard budget constraints. There was stuff governments just could not do. The US went to the moon in the 1960s, but it started to neglect its cities. Yet now when we get hit by a pandemic and a war, life goes on as though nothing has happened.

The third parallel is a global policy regime shift. Between 1945 and the early 1970s, the Western world, plus Japan and Australasia, had locked itself into a system of semi-fixed exchange rates, in which the US dollar served as an anchor. Known as the Bretton Woods system, it ensured a long period of economic and financial stability. But, like all exchange-rate regimes, it broke down because economies diverged over the years.

Our regime shift today is not about exchange rates, but global trading relations. I wrote in my column of 8 February about the split of one-world globalisation into two halves. Geopolitics has intruded. We still trade with one another, but now we shift our trade and investments towards countries on our side of the divide. Offshoring is now friend-shoring.

[See also: Italy is too large to save but cannot be left to fail. Eventually, something has to give]

Here the parallels end. What is different today is that what comes next will be less benign than the Thatcherism and Reaganism that followed the 1970s. I was a student in those days, and I recall that at the time the radicalism of Thatcher in particular seemed extreme. It looks less scary from today’s perspective, and less scary than what might be about to hit us.

Thatcherism was part of a global shift in macroeconomic policy priorities towards free markets and deregulation. It was the result of an intense economic debate. There is nothing like this today. Just witness the absurd economic policy priorities of the two main parties in the UK. The Prime Minister promises to reduce inflation, and the opposition leader wants to outgrow the other G7 countries. Germany’s finance minister, meanwhile, wants the EU to revert to its pre-pandemic fiscal rules. I see the same paucity of ideas in other European countries too. As John Gray writes, the political centre, left or right, has nothing to offer but empty slogans.

Italy went down this road earlier and further than others. Over the past 25 years dissatisfied Italian voters have tried parties of the centre left and the centre right, interlaced with periods of technocratic rule. Since 2018 they have been turning to anti-establishment parties, such as Beppe Grillo’s Five Star Movement, Matteo Salvini’s Lega and Giorgia Meloni’s Brothers of Italy. The search will go on until they find someone who delivers. Maybe it is Meloni; I doubt it will be a politician from the centre.

Whatever comes next, I expect it to be more repressive and authoritarian, and less supranational. Brexit has been the most extreme example of the latter trend, but the era of European integration is past its prime in other places too. I also expect future political majorities to be less enamoured with free markets and institutions such as independent central banks.

So, yes, it probably will be worse than the 1970s. There were options back then that are no longer available. Nothing is ever certain, but another age of extremes is more likely, in my view, than the fairy tale of capitalism reforming itself. It is not what capitalism does.

[See also: Who killed Silicon Valley bank?]

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This article appears in the 08 Mar 2023 issue of the New Statesman, Why universities are making us stupid