War is a major economic disruption. The Vietnam War threw the US economy into disarray. The Korean War (1950–1953) and the Yom Kippur War (1973) both resulted in massive price hikes for essential items. This time, too, a war directly involving Russia, the world’s largest energy exporter, and Ukraine, a major exporter of many other goods, most notably cereals, is driving up prices and slashing consumer real wages. Worse, the war has exacerbated already severe strains on economies, international relations, and global governance. Last week’s G20 summit saw western ministers and central bankers walk out while the Russian delegation spoke, highlighting our divided globe.
Even before Russia invaded Ukraine, the world had yet to recover from Covid’s economic costs, let alone its wider social and political consequences. There were widespread supply interruptions, and inflation had risen to unexpectedly high levels. The Federal Reserve was expected to tighten monetary policy significantly. The likelihood of a recession was considerable, exacerbated by defaults and financial instability. Growing tensions between China and the West, as well as their opposing policies on Covid, have to be factored in.
In the end, the war is a disruptor in an already unsettled world. Higher commodity prices, trade disruption, financial instability, the humanitarian impact, including millions of refugees, and governmental responses, like sanctions, are the five main ways via which it operates economically. All of this adds to the sense of unease.
For the second time in a row, the IMF has downgraded economic growth projections while raising inflation expectations in its latest assessment of the global economy. Disappointment has crept in after the thrill of the unusually quick rebound from the Covid-induced recessions of 2020. Since October 2021, forecasts for global economic growth this year have been cut by 1.3 percentage points. The projection for high-income countries has been decreased by 1.2 percentage points and for emerging and developing countries by 1.3 percentage points. Estimates of potential output are also generally below pre-pandemic expectations.
Forecasts for inflation have also been revised upwards. It is currently expected to rise to 5.7% in high-income countries and 8.7% in emerging and developing economies. This isn’t solely due to increasing commodity costs or other supply constraints. This inflation is “demand-driven and persistent,” according to Jason Furman of Harvard’s Kennedy School. Strong demand, like in the 1970s, might perpetuate a wage-price spiral as employees try to keep their actual salaries. The Fund counters that oil is no longer as significant as it once was, that labor markets have evolved, and that central banks are independent. All of this is correct. However, the interaction of policy errors and supply shocks might still cause stagflationary pandemonium.
It is easy to imagine far worse outcomes than those suggested by the Fund in its baseline forecast, which assumes that the war remains limited to Ukraine, that Russian sanctions do not tighten further, that a more lethal form of Covid does not arrive, that monetary policy tightening is modest, and that no major financial crises occur. Any (or many) of these dreams could be dashed.
One silver lining to recent calamities is that absolute dictatorship is losing favor. Concentrating power in the hands of a single imperfect human being is dangerous at best and disastrous at worst. The Putin administration is a dreadful example of what might go wrong in such an environment. However, Xi Jinping’s attempt to eradicate a highly infectious but non-lethal virus from his country is just another example of the dangers that uncontrolled authority can bring. Democracy has not been without flaws, but its leaders may be dismissed at the very least.
But, regrettably, we share the world with these regimes, particularly China’s. China, unlike Russia, is a superpower, not just a dying country with unending resentment and thousands of nuclear weapons. At a minimum, the west will need to work with China on debt management in developing countries.
More essentially, we require peace, prosperity, and environmental protection. These goals cannot be met without some level of collaboration. The Bretton Woods institutions are a tribute to the attempt to accomplish this. Many people hoped we were on the way to achieving what mankind required twenty-five years ago. Unfortunately, we are once again on the way to a world divided, disrupted, and dangerous.
The current disturbances should be overcome if no new shocks occur. However, we have been reminded that massive shocks can occur and are virtually invariably negative. It is necessary to oppose Russia. However, if we are unable to maintain even modest levels of cooperation, the world we will be forced to share is unlikely to be one we want to live in.