Finance & economics
The Economist October 9th 2021
The world economy
Stagflation sensation
WASHINGTO N, DC
Soaring energy prices and a faltering recovery invite comparisons with the 1970s.
But the past is not the best guide to the present
I
t is nearly half a century since the Organisation of the Petroleum Exporting
Countries imposed an oil embargo on
America, turning a modest inflation problem into a protracted bout of soaring prices and economic misery. But the stagflation of the 1970s is back on economists’
minds today, as they confront strengthening inflation and disappointing economic
activity. The voices warning of unsettling
echoes with the past are influential ones,
including Larry Summers and Kenneth Rogoff of Harvard University and Mohamed
El-Erian of Cambridge University and previously of pimco, a bond-fund manager.
Stagflation is a particularly thorny problem because it combines two ills—high
inflation and weak growth—that do not
normally go together. So far this year economic growth across much of the world
has been robust and unemployment rates,
though generally still above pre-pandemic
levels, have fallen. But the recovery seems
to be losing momentum, fuelling fears of
stagnation. Covid-19 has led to factory closures in parts of South-East Asia, hitting
industrial production. Consumer senti-
ment in America is sputtering. Meanwhile,
after a decade of sluggishness, price pressures are intensifying (see chart 1 on next
page). Inflation has risen above centralbank targets across most of the world, and
exceeds 3% in Britain and the euro area and
5% in America.
The economic picture is not as bad as
the situation during the 1970s (see chart 2
on next page). But what worries stagflationists is less the precise figures than the
fact that an array of forces threatens to
keep inflation high even as growth slows—
and that these look eerily similar to the factors behind the stagflation of the 1970s.
→ Also in this section
70 The energy crunch
71 A capex bonanza
72 Mint the $1trn coin?
72 Government debt goes green
73 Buttonwood: Emerging markets
74 Free exchange: Inflation expectations
One parallel is that the world economy
is once again weathering energy- and foodprice shocks. Global food prices have risen
by roughly a third over the past year. Gas
and coal prices are close to record levels in
Asia and Europe (see next story). Stocks of
both fuels are disconcertingly low in big
economies such as China and India; power
cuts, already a problem in China, may
spread. Rising energy costs will exert more
upward pressure on inflation and further
darken the economic mood worldwide.
Other costs are rising too: shipping
rates have soared, because of a shift in consumer spending towards goods and covidrelated backlogs at ports. Workers are enjoying greater bargaining power this year,
as firms facing surging demand struggle to
attract sufficient labour. Unions in Germany, for instance, are demanding higher
pay; some workers are going on strike.
Stagflationists see another similarity
with the past in the current policy environment. They fret that macroeconomic
thinking has regressed, creating an opening for sustained inflation. In the 1960s
and 1970s governments and central banks
tolerated rising inflation as they prioritised low unemployment over stable prices. But the bruising experience of stagflation helped shift thinking, producing a
generation of central bankers determined
to keep inflation in check. Then, after the
global financial crisis and a period of deficient demand, this single-minded focus
gave way to greater concern about unemployment. Low interest rates weakened fis-
69
70
Finance & economics
cal discipline, and enabled vast amounts of
stimulus during 2020. Now as in the 1970s,
the worriers warn, governments and central banks may be tempted to solve supplyside problems by running the economy
even hotter, yielding high inflation and
disappointing growth.
These parallels aside, however, the
1970s provide little guidance to those seeking to understand current troubles. To see
this, consider the areas where the historical comparison does not hold. Energy and
food-price shocks typically worry economists because they could become baked
into wage bargains and inflation expectations, causing spiralling price rises (see
Free exchange). Yet the institutions that
could underpin a new, long-lived era of labour strength remain weak, for the most
part. In 1970 about 38% of workers across
the oecd, a club of mostly rich countries,
were covered by union wage bargains. By
2019, that figure had declined to 16%, the
lowest on record.
Cost-of-living adjustments (cola),
which automatically translate increases in
inflation into higher pay, were a common
feature of wage contracts in the 1970s. But
the practice has declined dramatically
since. In 1976 more than 60% of American
union workers were covered by collectivebargaining contracts with cola provisions; by 1995, the share was down to 22%.
A paper published in 2020 by Anna Stansbury of Harvard and Mr Summers argued
that a secular decline in bargaining power
is the “major structural change” explaining
key features of recent macroeconomic performance, including low inflation, notwithstanding the decline in unemployment rates over time. As dramatic as the
pandemic has been, it seems unlikely that
such a big shift has reversed so quickly.
Moreover, stagflation in the 1970s was
exacerbated by a sharp decline in productivity growth across rich economies. In the
decades after the second world war, governments’ commitment to maintaining
demand was accommodated by rocketing
growth in productive capacity (the French
called the period “les Trente Glorieuses”).
But by the early 1970s the long productivity
boom had run out of steam. The habit of
stoking demand failed to help expand productive potential, and pushed up prices instead. What followed was a long period of
disappointing productivity growth.
Since the worst of the pandemic, however, productivity has strengthened: output per hour worked in America grew at
about 2% in the year to June, roughly double the average rate of the 2010s. Booming
capital spending could mean such gains
are sustained.
Another important break with the 1970s
is that central banks have neither forgotten
how to rein in inflation nor lost their commitment to price stability. In the 1970s
The Economist October 9th 2021
1
Parting ways
Global composite purchasing-managers’
indices*, compared with previous month
70
Input prices
↑ Expanding
60
50
Output
40
30
↓ Contracting
20
2020
Source: IHS Markit
2021
*Based on a survey of purchasing executives
even some central bankers doubted their
power to curb wage and price increases. Arthur Burns, then the chairman of the Federal Reserve, reckoned that “monetary
policy could do very little to arrest an inflation that rested so heavily on wage-cost
pressures”. Research by Christina and David Romer of the University of California at
Berkeley suggests that Mr Burns’s view was
a common one at the time. But the end of
the era of high inflation demonstrated that
central banks could rein in such price rises, and this knowledge has not been lost.
Last month Jerome Powell, the Fed’s current chairman, declared that, if “sustained
higher inflation were to become a serious
concern, we would certainly respond and
use our tools to assure that inflation runs
at levels that are consistent with our longer-run goal of 2%.”
The new fiscal orthodoxy likewise has
its limits. Budget deficits around the world
are forecast to shrink dramatically from
this year to next. In America moderate
Democrats’ worries about excessive spending may mean that President Joe Biden’s
grand investment plans are pared down—
or fail to pass at all.
What next for the world economy, then,
if it does not face a 1970s re-run? Rocketing
energy costs pose a serious risk to the re2
Regime shifts
United States, annual average % change
Consumer prices
GDP per person
-4
-2
0
2
4
6
8
Great Inflation
1965-82
Great Moderation
1983-08
Post-financial crisis
2009-19
Covid-19 pandemic
2020
Covid-19 recovery
2021
*
†
Sources: Bureau of Economic Analysis;
Bureau of Labour Statistics; World Bank
*August
†Q2 at annual rate
covery. Soaring prices—or shortages, if
governments try to limit rises—will dent
households’ and companies’ budgets and
hit spending and production. That will
come just as governments withdraw stimulus and central banks countenance tighter policy. A demand slowdown could relieve pressure on supply-constrained sectors: once they have paid their eye-watering electricity bills, Americans will be less
able to afford scarce cars and computers.
But it would add a painful coda to nearly
two years of covid-19.
Another important respect in which the
global economy has changed since the
1970s is in its far greater integration
through financial markets and supply
chains; trade as a share of global gdp, for
instance, has more than doubled since
1970. The uneven recovery from the pandemic has placed intense stress on some of
the ties binding economies together. Panicking governments could hoard resources, causing further disruption.
Past experience, therefore, is not the
clearest lens through which to view the
forces buffeting the global economy. The
world has changed dramatically since the
1970s, and globalisation has created a vast
network of interdependencies. The system
now faces a new, unique test. 
Fossil fuels
Can’t live without
them. Yet
The age of energy abundance is dead
F
or much of the past half-decade, the
operative word in the energy sector was
“abundance”. An industry that had long
sought to ration the production of fossil
fuels to keep prices high suddenly found
itself swamped with oversupply, as America’s shale boom lowered the price of oil
around the world and clean-energy sources, such as wind and solar, competed with
other fuels used for power generation,
such as coal and natural gas.
In recent weeks, however, it is a shortage of energy, rather than an abundance of
it, that has caught the world’s attention. On
the surface, its manifestations are mostly
unconnected. Britain’s miffed motorists
are suffering from a shortage of lorry drivers to deliver petrol. Power cuts in parts of
China partly stem from the country’s attempts to curb emissions. Dwindling coal
stocks at power stations in India are linked
to a surge in the price of imports of the
commodity.
Yet an underlying factor is expected to
worsen the scarcity in the next few years: a