World economy can avoid 1970s rerun, but not without some hurt

The world economy has a decent shot at escaping a full re-run of 1970s-style stagflation – and that’s about as far as the good news goes.

A historic surge in commodity prices after Russia’s invasion of Ukraine, coming on top of already-high pandemic inflation, has gotten investors and economists searching for parallels with the energy shocks of four decades ago and the prolonged slowdowns that followed.

They’re right to worry, says Maurice Obstfeld, a former chief economist at the International Monetary Fund. “The more protracted this period of continuing shocks,” he said, the more likely it becomes that economies suffer “something like the 1970s experience.”

On the whole, that fate can still probably be avoided, say most economists. But their reasons for thinking so aren’t entirely encouraging for companies and workers.

Weaker economic growth and perhaps even recession may be the price paid for conquering inflation, with emerging economies particularly vulnerable. “We should be more worried about significant deceleration of the global economic growth” than runaway inflation, said Kazuo Momma, who used to be the head of monetary policy at the Bank of Japan.

That’s in part because central banks like the US Federal Reserve have learned lessons from the prolonged inflation of the 1970s – enough to preclude going down that “dark path” again, according to Mark Zandi, chief economist at Moody’s Analytics.

“They’d rather push us into a recession sooner than get into the stagflation scenario and a much worse recession later,” Zandi says. Another key reason economists don’t anticipate a 1970s revival is that workers won’t be able to bargain up their pay like they did back then.

In the US and UK, labour unions have shrunk dramatically. Even in Germany, where they play a bigger role, there’s caution right now about pushing for big wage hikes. That means a repeat of the so-called wage-price spiral, which was key to the 1970s inflation episode, is less likely. It also puts households at risk of a big squeeze, as incomes fail to keep up with higher prices at supermarkets or gas stations.

There are still reasons for flicking through the history books. The 1970s featured twin energy spikes linked to the OPEC oil embargo of 1973 and the Iranian revolution six years later.

The weeks since Russian President Vladimir Putin ordered troops into Ukraine have seen the cost of crude propelled past $130 a barrel — alongside a much wider range of price jumps. Russia is a key producer of commodities from wheat and fertilisers to nickel, and US-led sanctions have roiled those markets.

In both the 1970s and today, the shocks hit economies that already had inflation problems. For example, data is forecast to show the US consumer price index accelerated 7.9 per cent in February from a year ago, which would be the most since 1982.

There were also several sources of inflation. In the 1970s there was the departure from the gold standard, leading to dollar devaluation, and the hangover of 1960s stimulus. In the past year, Covid-19’s legacies of frayed supply lines, large government spending and easy monetary policy ignited prices. Europe was already facing an energy crisis even before the Russian invasion.

One difference is that developed economies are much less energy-intensive than they were back then. “Oil consumption as a share of GDP is much lower and energy efficiency has improved,” says Paul Donovan, global chief economist at UBS Wealth Management.

And it’s not just energy: “We’re a lot less commodity-intensive, too. Only 20 per cent of the price of a loaf of bread is the wheat.”

Still, some of those numbers may shift in the current crisis. In Europe, which gets the biggest chunk of its oil and gas from Russia, the “energy cost burden” on the economy is likely to be the highest since the 1970s, according to Alex Brazier, a former Bank of England official who’s now managing director of the BlackRock Investment Institute.

The latest wave of commodity-driven price rises means an even harder balancing act for central bankers, who have to juggle the risks of sustained inflation and a slowdown or reversal of growth.

In the US, at least, investors still expect six quarter-point Fed interest-rate hikes this year, starting next week. Economists at Citigroup predict at some point the central bank will deliver a half-point hike.

Relying on the Fed to rein in prices may cause unnecessary economic damage, said Isabella Weber, an economist at the University of Massachusetts Amherst. She said there should be at least a serious conversation about government controls on the prices of essential goods. That suggestion drew a vitriolic response from orthodox economists when Weber first made it in December, in part because of the memory of 1970s price controls in the US. But she said the case is even stronger now, as food and energy prices soar.

There are signs that key decision-makers, in government and beyond, are eager not to repeat 1970s mistakes by letting prices and wages spiral up. In the US, President Joe Biden has warned companies against gouging. When he announced a ban on Russian oil imports on Tuesday, Biden said his administration will be scrutinising the gasoline industry for any signs of “excessive price increases or padding profits.”

On the wage side, in some countries – like the US and UK – negotiating power has fallen so much since the 1970s that labour has little leverage to bargain with. Germany, where unions remain relatively stronger, offers a telling example of some lessons learned. After the 1973 oil shock, labour unions responded to inflation of close to 8 per cent by pushing through double-digit pay rises. That helped tip the economy into its worst slump since World War II – and effectively ended full employment.

Now, unions and employers are turning to the government for help. IG Metall, Germany’s largest union, and employer association Gesamtmetall lobbied in a March 4 statement for a “comprehensive package of measures” to offset inflation.

Other countries like France and Spain are also using fiscal policy to cushion the inflation shock, with subsidies to help households with higher inflation bills. Some economists back a similar approach in the US too.

All of this adds up to a global economy that’s more resilient than it was in the 1970s, according to Christopher Smart, chief global strategist at Barings. He reckons any period of stagflation is likely to be short.