We Must Make No Mistakes

The economy is definitely in a cooling phase. The fat years are over. Clearly, two developments have contributed: the pandemic and the war. But even if these events had not occurred, the economy would still have entered a slowdown.

Why?

Commodity and food prices were rising even before the pandemic, in part due to adverse climate change and global population growth. The pandemic and the war have amplified these trends and added negative factors. Whether a global recession can be avoided depends on how long the war lasts, what impact it has on inflation, and whether the major central banks continue to raise interest rates.

Some statements from central banks seem to confirm that they are aware of an imminent sharp slowdown in the economy. Could interest rate hikes be smaller than expected several months ago?

This could be the case. There are such voices at the European Central Bank and the US Fed. Concerns about rising unemployment and recession could put the brakes on the rate hikes. Central banks started to tighten their policies too late and ignored rising inflationary pressures before the outbreak of the war, and they are now concerned that demand may shrink too much.

Could the smaller appetite of central banks mean that high or “merely” elevated inflation will stay with us for longer?

Many factors seem to suggest this. Rising food and commodity prices, rising manufacturing costs, disrupted supply chains, the cost of the energy transition: all this drives inflation. Rising inflation, in turn, drives wage expectations, which then again drive manufacturing costs. It is a classic price-wage spiral that will not be stopped easily.

How to try and stop the spiral?

Unfortunately, the two options are: further rate hikes and cooling inflation expectations or spending cuts and no wage increases. Neither solution is popular with politicians, so only a miracle could save the day.

Governments in many countries are saying: first we had to protect citizens and companies during the pandemic crisis, and now during a war.

Nobody expected a global pandemic or the outbreak of war. These are classic examples of “black swans”: phenomena whose probability is small but whose impact is enormous. To avoid chaos, fiscal and monetary policies had to be relaxed, that much is obvious. However, some support schemes continued too long, resulting in the current rise in inflation and debt.

Are you expecting a wave of spending cuts in many countries?

Yes, especially countries with high debt. Over the years, organisations such as the World Bank and the International Monetary Fund have put a lot of effort into mobilising governments to increase budget revenues in order to build a strong foundation for economic growth. Unfortunately, this is a very slow process and revenues in many developing countries are growing much more slowly than spending. Vulnerable groups had to be protected during the pandemic so budget spending increased and so did debt.

The World Bank has recently published its latest International Debt Report 2022 and the conclusions are very worrying. The poorest and developing countries will be hit the fastest by rising debt servicing costs and falling government revenues, which could push them deeper into a debt spiral. This could be a rerun of the past as the problem recurs every decade or two: an increase in poverty and social unrest, and the consequent need to cancel the debt of those countries. The process started during the pandemic, when many countries fell into the debt trap. The time of war is also bad for many countries: due to rising market risk, their debt servicing costs rise (driven by rising interest rates and depreciation of local currencies), and more and more countries are turning to international institutions for debt restructuring.

The debt will have to be restructured, but given the debt structure, it will be more complicated than in the 1980s or 1990s.

How does Poland fare in comparison?

Poland is an open economy, and all these factors affect it. Poland cannot avoid a slowdown, which is already there. There is the price-wage spiral, and inflation was rising in Poland even before the war. It was driven by rising food prices, manufacturing costs, the cost of services, and now that everyone is feeling the impact of inflation, workers are demanding an increase in wages. This means that high inflation is here to stay for a long time, unless companies start cutting costs, including cutting jobs. This either means rising unemployment or persistent inflation.

The private sector will be the first to cut costs. Global corporations in the USA have already announced cost cutting programmes, which may impact their subsidiaries and investments in other countries. In the longer term, government salaries and employment may be frozen, which is a global trend. This is because governments will fund social spending for as long as possible and cut investments, which will be bad for economic growth. The slowdown may be softer but the recovery will be more difficult and take longer.

On top of that, general elections will take place in some countries, which will probably influence politicians’ decisions.

There are always elections somewhere in the world (laughs). I have recently followed the US Congressional elections, and the trends are similar: politicians are more likely to promise social spending than to reduce it, with the consequence that investments are cut because the effects are not immediately visible.

Money from the National Recovery Plan would certainly help Poland.

The plan was developed to support investment. In the absence of that money, Poland is still waiting at the station while other trains are leaving. Investments in RES, among others, will now be more expensive than a few years ago.

Won’t countries like Poland grapple with demographics, which may have a negative impact on the competitiveness of the Polish economy?

Indeed, Polish society is ageing, which will inflate social costs and the cost of pensions. This can be counteracted by an open immigration policy so it is a good thing that Poland opened up its labour market to residents of neighbouring countries a few years ago and now the Ukrainians have arrived. Hopefully, after the war, the Ukrainians who are now fighting the Russian aggressor will return to Poland.

What are the key risks facing Poland?

The biggest risk is that the armed conflict will spill to the West. Let’s hope it doesn’t happen, because there would be no winners in another war.

Poland is evolving into an advanced economy. It is not yet there but it is close. For example, according to the World Bank classification, Poland is a high-income country. Poland is still dependent on foreign investors and needs to pursue a prudent economic policy and avoid mistakes that could discourage investors.

Some economists are talking about disinflation. Is there any hope that inflation will start to fall in 2023?

Inflation may fall year on year in some months due to the base effect, but it is now closer to 15‒20 percent while the inflation target is 2.5 percent. Actual inflation is far above the target. The price-wage spiral shows how important it is to keep inflation low, which is good both for producers and consumers. We should make every effort to bring inflation down to the target, which may mean that wages will grow slower than inflation.

How do we do that?

There is no easy solution. You can raise interest rates quickly, which would have negative economic consequences, so politicians both at home and abroad will not go for it. Everyone is afraid of a rapid cooling of the economy, so central banks are cautious to take action. I don’t think any central bank will decide to go for big interest rate hikes.

The economic slowdown and the end of the war could bring inflation down the fastest, globally and in Poland.

Investors are still choosing Poland, even though we are a front-line country.

There could be more investments such as the recently announced Mercedes investment in Jawor. Poland benefits from shortened supply chains. Companies want to have trusted partners who will deliver components for production.

Poland is a great place to invest: aside from the war, we have a relatively large population, good access to raw materials and to the sea. I expect more investments to come. Manufacturing costs are still lower in Poland, and many companies are closing factories in Asia and shortening supply chains. A smart economic policy would encourage this. We must make no mistakes. ©℗