Spiralling inflation, a war in Europe, and supply chain disruptions, the like of which have not been seen in decades. It's little wonder that stock markets have reacted adversely to the resumption of an upward trend in interest rates and the first moves to withdraw quantitative easing.
Leading Central banks, accustomed to decades of ultra-low interest rates and easy money, clearly saw the re-emergence of inflation as transitory, the result of short-term factors that will abate in time. And indeed, the War in Ukraine will eventually come to a resolution, the global energy supply will be remapped, and food security restored.
But there is something bigger happening. A trend established three decades ago is reversing, and it will have significant long-term consequences for cross border trade and the world economy. A global demographic revolution is underway. The working-age population as a proportion will fall everywhere, except in Africa.
Recent research by Professor Charles Goodhart and Manoj Pradhan based on UN population statistics ascribes much of the disinflationary trends of the past 30 years to globalisation and the rise of China. This global labour supply shock brought hundreds of millions of new workers into the urban economy, boosting the ratio of workers to dependents in a demographic sweet spot.
These forces will dissipate as the world population ages and global supply chains shorten. China's working-age population will fall 23% by 2050, and the size of the youth population is also declining in many countries. The days of moving work to cheaper sources of skilled labour as an alternative to investment and innovation are ending.
Labour will again take a more proactive role in a world short of workers and will reassert its role in the relationship with business and capital. A resurgence of inflation will follow. Central banks wrestling with inflation will look to increase interest rates. And Finance Ministers will resist in the face of mounting debt servicing and pension costs, under pressure from voters, angry at the emerging cost of living crisis.
But how likely is this scenario to play out? Is structural inflation returning, and is globalisation indeed in retreat, or will regular service be resumed as Central banks act to bring things under control?
In 1950 there were 2.5 billion people on the planet. In 2019, this had increased to 7.7bn. According to the World in Data analysis of UN statistics, the global population is expected to be 11.7bn by the end of this century. But this increase has been accompanied by an ageing population and a fall in the birth rate, resulting in rising median age and fewer young people in many countries. A phenomenon that Hans Rosling termed 'Peak Child".
According to the World in Data, "the future will be very different from the past. Over recent decades we have seen global demographic changes which will bring about the end to rapid population growth: Until the mid-1960s, each woman around the world had on average 5 children. Since then, the number of children has halved and is now just below 2.5 children per woman. The global fertility rate has halved. "
In their book, 'The Great Demographic Reversal' Professor Charles Goodhart and Manoj Pradhan predict that this fall in the birth rate will lead to fewer workers and an end to an abundant supply of cheap labour:
"A shift in the global availability of low wage workers in the larger global market, including China and Eastern Europe, have switched the underlying trend from a massive surplus of available workers to one in which the workforce is beginning to shrink. In the years before Covid, the bargaining power of labour had been trashed; now it is beginning to recover quite sharply and will remain stronger over the next few decades."
With many countries falling below the population replacement rate, the current shortage of workers may prove to be less transient and more structural than is currently appreciated.
So, what are the implications of the Great Demographic Reversal for the global economy and International Finance Centres in particular?
Output growth will decline as Moore's law runs out of steam. And the much-anticipated productivity gains from new technology fail to compensate for the shortfall. Still, a rapidly ageing population supported by fewer workers will exacerbate the caring crisis evident in much of the developed world.
Inflation may prove stubbornly resistant to Central bank prescriptions as labour driven wage increases escalate, and rising health and pension costs encourage governments to raise taxes. We have recently seen several incumbent governments in South America and Australia fall as voters express increasing disquiet at the rising cost of living. Central banks and governments hooked on low-interest rates, and high public debt are boxed in, with tighter monetary policy and a withdrawal of stimulus looking more like a poisoned chalice than a panacea.
Faced with a complex world that is challenged by shortages of all kinds, what are the implications for International Finance Centres, and what should their response be?
Fiscal pressures will see taxes and government debt rise, and weaker growth will drive public resentment at the significant increases in the cost of living. Incumbent governments will look for blame candidates. Governments alone do not have the financial resources to deal with their challenges. The Pandemic has left public finances in a weak state, and this problem will be aggravated by the energy and food crisis triggered by the invasion of Ukraine.
Society will need private capital in large quantities if the building blocks of any meaningful recovery are to be laid. Fortunately, the benign low-interest environment of the last 30 years means abundant private capital is available. It is estimated that total investible wealth exceeds $250 trn, and real estate assets add a further $235trn to this figure.
The recovery period will see exceptional demand for investment in energy and agribusinesses. Technology will be rewarded with new investment into innovative A1 and productivity-boosting measures, with services and manufactured goods increasingly designed, built, and delivered nearer to the markets in which they are consumed.
Still, whilst geopolitics will constrain globalisation, it is not about to disappear but is undoubtedly being reinvented. Notwithstanding, China and the US remain the two most influential economies in the world and continue to be mutually interdependent, despite the tensions of recent years. US imports of goods and services from China totalled $506bn in 2021, the largest from any country. US exports to China totalled $151bn.
China's most prominent business sector is still manufacturing, and unlike Russia, it is not energy independent. Access to the lucrative US and EU markets remains a critical export dependency and will likely remain so for years. The US, whilst advocating onshoring, has no near term prospect of moving the supply base of companies like Apple to the US, with supply chain reshoring overall tending to favour Vietnam and Mexico.
Higher investment demand as businesses position to grasp these new opportunities will create more significant openings for Private Capital, including Private Equity. Surging demand will lead to increased legal structuring work, audit and advisory services, ongoing fund administration, custody and depositary arrangements.
Some have predicted strong headwinds for Private Equity going forward, but we feel these fears are overdone. While Central bank actions to curb inflation will elevate interest rates, they are not expected to rise much above the 3 - 4% range. Private equity investment trusts give a window into the PE world, and many continue to trade at a discount to net asset value despite the interest rate outlook. Demand for the inflation-adjusted returns that Private equity provides shows little sign of abating. While returns may be harder to come by, we expect the sector to continue to flourish.
Those International Finance Centres and firms anticipating the impact of our outlined trends will invest in and nurture the best talent. They will promote diversity and inclusivity and support the drive to meet ever-higher governance and international regulatory standards. They will redouble their commitment to global efforts on sustainability, transparency, good business conduct and fighting financial crime. Adopting digital innovation will lower costs and provide a better customer experience.
In this new environment, Tax Havens that are slow to embrace these changes will continue to decline. But, the International Finance Centres that adapt, as transparent Investment Hubs, to a rapidly changing world, will flourish as demand for their services and a recognition of their contribution to the global recovery continues to build.
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