A McKinsey note for CEOs draws up multiple scenarios of how the global economy will perform in the next twelve months
While volatility from macroeconomic and geopolitical factors dominated business in 2022, things appear to have shifted a wee bit in 2023. Energy prices are off their peaks and inflation is no longer accelerating and economic growth seems to be holding up – at least for the moment. Are these truly indicators of things to come or just the calm before a storm?
A recent thought paper from McKinsey and Company says “these positive signs make it tempting to expect a narrower range of potential macro outcomes and, as in any new year, seek a fresh start. We see 2023 as a test of whether such a fresh start is now possible.”
The report warns that geopolitical tensions remain high, key supply–demand imbalances are unresolved, and interest rates continue their upward march. Does this mean we should contemplate comparisons to the 1970s and consider them appropriate or will the path forward resemble more familiar business cycles?
Here’s what we see in the rearview mirror
In 2022, the world faced numerous tests starting from the Omicron virus early in January that led to fractured production supply chains remaining unrepaired and this during a time of record demand. Commodity prices rose 30 percent while global container shipping rates rocketed by as much as tenfold.
Add to this, the labor market saw severe imbalances, more acute in the US and the UK where wages were boosted up to two times the pre-Covid levels. And then came inflation that broke generational records. As the world battled these conditions, Russia invaded Ukraine and the energy crisis was added to the already convoluted mix.
The inflation story is where it all went wrong
From March 2020 to November 2022, consumer prices rose nearly 16 percent in the United States, 15 percent in the eurozone and the United Kingdom, 16 percent in India, and 21 percent in Brazil.
These increases are two to three times greater than what would have been expected based on pre-COVID-19 outcomes. Even in Japan, which has been fighting deflationary pressures for decades, prices in November 2022 were up 3.8 percent during the previous 12 months, the highest monthly inflation rate recorded in more than 40 years.
Several conflicting views have been traded around the origins and reasons for inflation. A recent finding by economists at Brookings Institutions has some simple answers:
- The direct impact of commodity shocks and supply chain dislocations: disruptions in oil, gas, and basic food markets, and supply–demand mismatches (for example, when semiconductor shortages caused used car prices to spike)
- The pass-through of businesses’ higher material costs: commodity shocks and supply chain dislocations slowed production and raised business material costs, and
- The pass-through of higher wage costs: the shock to labor markets led to a doubling of wage growth as businesses compete for scarce workers to meet surging demand.
The McKinsey research presents some scenarios around what could happen over the next 12 months. Here are a couple of them:
The first scenario involves individuals, businesses, and governments renewing their commitments to accelerating global cooperation.
- Societies commit to absorbing the costs of ensuring resilience, reliable access to critical sectors, the vitality of local economies and communities, and promoting regulations that expand affordable supply. The conflict in Ukraine and other international tensions escalate no further and perhaps even begin to wind down.
- Economic policy makers in the eurozone and the United States create incentives to boost public and private-sector investments that help resolve near-term energy supply–demand imbalances. Coordinated actions by central banks steer 2023 without a recession. Inflation begins returning to central bankers’ 2 percent targets and real GDP growth accelerates to approximately 3 percent as growth returns.
- The commitment to global cooperation and effective economic-policy choices together create long-term incentives for investment and innovation and deliver strong productivity growth and supply expansion. This helps counter the demographic headwinds of aging societies and enables an affordable energy transition.
In the second scenario, we have individuals, businesses, and governments determining that the costs of global cooperation outweigh the benefits.
- Interregional flows stagnate amid disagreement over new rules to address the effect of outsourcing on local economies, the vulnerabilities of concentrated dependence on raw materials, and the system’s lack of resilience. The conflict in Ukraine continues to reinforce these vulnerabilities.
- Amid this more difficult international environment, central banks in the eurozone and the United States move more aggressively against inflation, tipping these economies into recession in 2023. Despite the purposeful slowdown, inflation comes down only gradually, forcing central banks to abandon their 2 percent targets to avoid a prolonged downturn. Inflation persists at 3.5 percent or higher while growth in the short term recovers to about 2 percent in the United States and the eurozone
- The combination of stagnating global economic cooperation and more restrictive economic-policy choices create poor long-term incentives and slow the rates of investment and innovation. This weakens productivity growth and makes it harder to produce the technology required for an affordable energy transition.
Now it remains to be seen how industries and their governments respond to the crisis. Whether they decide to collaborate or compete could form the rest of the story.