The Banking Executive Magazine - December Issue 2022

the BANKING EXECUTIVE 10 ISSUE 168 DECEMBER 2022 growth in advanced economies’ trad- able sectors was subdued, even when the activity did not shift to emerging economies. Labor’s bar- gaining power was reduced in devel- oped economies, and the negative pressure on middle- and low-income wages spilled over to non-tradable sectors as displaced labor in manu- facturing shifted to non-tradable sec- tors. But that process is largely over. Many emerging economies have become middle-income countries, and the global economy no longer has any more large reservoirs of accessible low-cost labor to fuel the earlier dy- namic. Of course, there remain pools of underutilized labor and potential productive capacity, for example in Africa. But it is unlikely that these workers will enter productive export sectors fast enough and at sufficient scale to prolong the pre-turning point dynamics. The Lewis turning point will have profound consequences for the global economy. The forces that have been depressing wages and inflation over the past 40 years are receding. A wide range of emerging and devel- oped economies are growing older, reinforcing the trend, and the COVID-19 pandemic has further re- duced the labor supply in many sec- tors, possibly on a permanent basis. Under these conditions, the four- decade decline in labor incomes as a share of national income is likely to be reversed – though automation and other rapidly advancing labor- saving technologies may counteract this process to some extent. In short, now that several decades of developing-country growth have ex- hausted much of the world’s unused productive capacity, global growth is increasingly constrained not by de- mand but by supply and productivity dynamics. This is not a transitory shift. One clear consequence of this process is that inflationary forces have shifted fundamentally. After vanishing or flattening for an ex- tended period, the Phillips curve (which describes an inverse relation- ship between inflation and unem- ployment) is probably back, permanently. Interest rates will rise along with inflationary pressures, which are already forcing major cen- tral banks to withdraw liquidity from capital markets. A highly indebted global economy (the legacy of years of low interest rates) will go through a period of tur- bulence as debt levels are reset for a “new normal” interest-rate environ- ment. Portfolio asset allocations will be adjusted accordingly, and the ex- tended honeymoon during which risk assets outperformed the econ- omy will end. It is anyone’s guess how abruptly this will happen. Specific outcomes are impossible to forecast precisely. The global economy’s encounter with the Lewis turning point will be a period of considerable uncertainty, which is to be expected with any tectonic shift. Many parts of the global economy will experience a fundamental regime change. Several decades of growth in emerging economies have driven a massive increase in middle- income consumers and overall pur- chasing power, while simultaneously removing the world’s ultra-low-cost productive capacity. Of course, there may still be periods of demand-constrained growth, fol- lowing crises like the pandemic or future climate-driven shocks. But the underlying pattern will be one of supply- and productivity-constrained growth, because the remaining reser- voirs of underutilized productive ca- pacity simply are not large enough to accommodate growing global de- mand.