By Henry Boucher
For some time our thesis has been that, in many areas of global activity, future progress will be slower than in recent decades. Companies no longer ride on the incoming tide that used to lift all boats. Economic momentum is weak now that China’s construction and export-led frenzy can’t compensate for the depressed state of the large European and Japanese economies.
In the background, the demographic drivers of growth have slowed – since 1950 the world population has nearly tripled and billions of productive young workers have been added to the global economy, but this is being offset by the rising population of dependent retirees. And productivity growth, another major component of growth over the last century, has slowed sharply in the last few years.
Economists are puzzled by this productivity shortfall, especially at a time of major technological advances: is it just more difficult to measure? Have low interest rates distorted the economy? Are weak companies being saved from bankruptcy, tying up workers in unproductive activities while newer, potentially more productive firms are starved of growth opportunities? Or maybe the advantages of the latest technology are all an illusion and the endless emails and social media are in fact reducing our productivity…
Other factors must also be added to the ‘slower-world’ picture. Expanding debt has provided a big boost to economic activity and the cost of borrowing has fallen steadily for 30 years. According to the McKinsey Global Institute, global debt increased by an average of $7.8trn each year in the seven years before the financial crisis; but far from the debts being repaid after the crisis, the pace of borrowing has sped-up, with global debt expanding at an average rate of $8.8trn p.a. in the seven years since (a large chunk of it in EM). Passing on such liabilities to the next generation is unsustainable, especially if interest rates start rising, but the tolerance for high debt, particularly public sector debt, remains the subject of heated debate.
Globalisation was never a smooth process, but indicators suggest the volume of trade is hardly growing and parts of the global economy are potentially showing signs of fragmentation. The slowdown in trade may reflect both cyclical and structural factors, but governments have played a part, seeking to insulate their domestic economies from foreign competitors by imposing murky protectionist measures. Recent concerns over competitive devaluations by emerging markets are another example of the heightened trade friction between economies. China has suffered particularly from the devaluations of the yen and the euro.
Unsurprisingly, economic fragmentation has corresponded with a rise in political fragmentation. Disgruntled voters have increasingly turned to anti-establishment parties offering promises of change. In the EU the reintroduction of border controls in the Schengen area seems emblematic of a reversal of a political process that promised progress and prosperity. Too often recent economic growth has papered over the cracks in governance systems that then come under pressure when economic growth is not delivered. As Brazil is discovering, tolerance of corruption and nepotism among ruling elites when times are good can quickly vanish.
The critical importance of good governance applies to companies too. The Volkswagen emissions fraud is yet another example of weak governance in the corporate sector. The damages for VW from fines and lost sales could reach €100bn and the multiplied economic costs for Germany more than they might have faced from Grexit.
So what strategy to set for a structurally slower world? The old era was one of relatively indiscriminate expansion, sloshing liquidity, imperfect governance and capital ill-discipline, driving rising prices of assets – a tide on which all boats rose. The new era is not one where demographics, QE or financial engineering will do as much of the work. It is an era of reinvention, a technological and industrial revolution from within that creates a new world through innovation and restructuring. Companies and investors need to innovate, to be on the right side of change, with the right governance, and so benefit from disruption and avoid being disrupted. With inflation trends remaining soft and monetary policy loose, returns on cash and bonds are likely to stay low. Equities remain the asset most likely to generate the best medium to long-term returns but weaker global growth implies lower average returns than in the past. By nature, companies will continue to find solutions to the world’s problems, and there are enormous future opportunities – it may just require harder work and very careful stock selection to achieve decent returns.
Henry Boucher is partner and deputy CIO at Sarasin & Partners
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