Davos: No Talks about the Looming Debt Crisis

During the recent World Economic Forum (WEF) meeting, the participants spent a lot of time talking about global supply-chain problems. In fact, one could easily get the impression that lingering supply-chain issues was the only economic issue that concerned the meeting. 

This is odd, for two reasons: there is a greater, more serious economic problem that the world should be talking about; and the supply-chain problems are being emphasized far more than they deserve.

Supply-chain problems are not economic

Already late last year, media in both Europe and America suggested that the global economy would feel the pinch of supply-chain problems through at least 2023. Some even predicted that parts of the problems would last through 2024. They may or may not be right, but if supply disruptions continue, it is not because of the recent pandemic-related economic shutdown, and certainly not due to the recovery from it. 

In fact, there are no real economic reasons for widespread supply-chain problems. If we continue to see those problems, it will be primarily because of government policies: regulations, labor-market measures, and other forms of artificial incentives. 

Let us start with the macroeconomic basics. In order for the economy itself to create supply-chain problems, i.e., problems that are caused by forces of the market economy, there would have had to be a massive, and rapid, surge in demand-side economic activity. In relation to the pandemic, total spending in the world’s leading economies would have to substantially exceed pre-pandemic levels. 

The reason is simple: before the pandemic, in 2019, the supply chains of the global economy handily provided everything that consumers, businesses, and government demanded. When the pandemic-related shutdowns began, the production facilities, as well as the resources they required, did not go away. They were made to idle, which with some exceptions meant that when the economy opened up, those resources would again be available.

And, most important of all, they would be well dimensioned to meet demand as the economy opened up again. We can easily prove this. According to the Organization for Economic Co-operation and Development (OECD) national-accounts data, from the first quarter of 2019 to the first quarter this year—in other words, for a period of three years:

• The 27-member European Union economy has grown only 1.7%, adjusted for inflation;
• The economy of the UK increased 1.2%;
• The NAFTA economy, which includes the United States, Canada, and Mexico, is 3.9% larger;
• Japan has actually seen its economy shrink, by 3.1%.

For some countries, the OECD lacks 2022 data. Comparing numbers from the fourth quarter of 2021 to the fourth quarter of 2018 (again three years), we get a similar picture. Adjusted for inflation:

• The economy for all 38-member OECD economy grew by 3.8%;
• India experienced an 8.7% increase in their GDP while the Indonesian economy expanded by 7%;
• GDP growth in Brazil was 1.9% and 2.7% in Argentina.

The strong growth in India and Indonesia, welcome as they are, took place in economies that are far too small to cause any global supply-chain disruptions. Besides, these growth numbers are stretched out over three years; there are economies that grow by 7-8% in one year without experiencing crippling supply-chain problems. 

China is one example of a strong-growth economy that did not have major supply-chain issues before the pandemic. The problem with China is that the OECD does not report any recent numbers for their economy. One reason could be that Chinese national-accounts numbers are relatively unreliable. China has had problems with skewed national-accounts statistics for many years, plagued by incentives to over-report economic activity. 

Overall, it is reasonable to assume that China is not doing very well economically, and therefore cannot account for system-disrupting problems with supply chains. 

Government-created labor shortage

The growth numbers reported above are anywhere from modest to downright disappointing, and cannot account for any supply-chain problems. In fact, the production capacity of the global economy has grown no more strenuous since 2019 than it would over any normal three-year period. The compounded growth that has taken place since 2019 is well below what supply chains around the world normally cope with. The production capacities that existed around the world in 2019 should have no problem supporting the global economy of 2022. 

That is not to say there have not been supply chain problems—there have, and some still linger. However, the economic rationale for those problems is almost entirely absent. 

The main issue in the U.S. economy has been labor shortages that persisted through part of 2021. These shortages were the result of adverse incentives for workforce participation: the federal government paid out bonuses to the unemployed that in some cases briefly exceeded $6,000 per month. Less extravagant bonuses lasted long enough to create a culture of idleness.

By now, though, the bonuses are gone and the labor market is offering relatively generous compensation levels. According to the Bureau of Labor Statistics, workforce participation remains about 1% below where it was in 2019, meaning there is still approximately 1.5 million workers available.

In short, the aggregate production capacity of the U.S. economy is well dimensioned to handle current economic activity. 

The same is true for Europe, which had no labor-shortage problem. The reason is primarily a different approach to labor-oriented subsidies during the forced economic shutdown. Furthermore, with very few exceptions, Europe suffers from higher unemployment than the United States does, making labor shortage almost a contradiction in terms. 

In both America and Europe, businesses have invested adequately to keep production capacity up to par with overall economic activity. Therefore, neither of these two major economies can be said to suffer from any disruptive shortages in terms of production capacity. 

Oil and semiconductors

But what about raw materials? The most commonly mentioned issue here is oil. There is a little bit of a problem here, at least as far as the United States is concerned. According to the Energy Information Agency, as of March this year, domestic oil production stood at 11,655 barrels per day, which is almost exactly where it was in February 2019. 

Since U.S. oil consumption has stayed largely unchanged since 2019, the current price hikes are not due to any disruptive shortage in domestic supply. 

A similar assessment applies to Europe. According to Eurostat, the quantity of output of refined oil products in the European Union was approximately 2.6% lower in late 2021 than it was in late 2019. Monthly quantities of oil production were almost exactly the same.

In other words, the pandemic has not disrupted the ability of either America or Europe to supply their economies with oil. The same applies in large part to other main economies in the world. 

Rising prices are more likely due to interventions by governments. It is possible, even likely, that the continued roll-out of policies by governments on both sides of the Atlantic Ocean favoring electrically powered means of transportation over internal-combustion vehicles, have in part contributed to rising gasoline prices. 

A more recent factor, of course, is also the war in Ukraine. While it has not had a systemic impact on the world’s oil-production capacities, it has created a great deal of uncertainty as to economic and political stability. 

This, however, is not a supply-chain problem per se. It is a matter of market psychology disrupting the balance between supply and demand. 

However, there is one industry that has suffered genuine supply-chain disruptions: semiconductors. Here, there seems to be more substance behind the shortage. Taiwanese companies that dominate the market made production decisions during the pandemic with ripple effects in terms of industry response to the recovery. 

This industry cannot afford to be disconnected from the market for any meaningful period of time. Technological advancements and engineering progress are rapid enough to leap ahead of producers over a period of time, such as this pandemic provided.

Then again, the semiconductor shortage started showing up already in 2020; if it were entirely up to the private sector, we would very likely have been out of the shortage by now. The response from the private sector has been comprehensive, and while there has been some interest from governments in stimulating more semiconductor production, you can always trust government to cause delays and increase costs. 

In short, to the extent we actually still have supply-chain problems around the world, it is very likely due primarily to a disruptive government presence in the economy. Furthermore, it cannot be ruled out that some businesses with dominant market positions may be taking advantage of the perception that there are supply-chain problems. It should not be ruled out that they make decisions that further profit margins over production volume. 

However, until substantive evidence of such practices are at hand, the overall conclusion is that with the exception of government interference, there are few if any real economic reasons why supply-chain problems should exist in the first place. 

The looming debt crisis

With that said about the supply-chain issue, which the World Economic Forum talked about, let us now shift to the elephant that was not in the room in Davos.

The looming sovereign-debt crisis. 

According to the official agenda for the meeting, there was no discussion about the rather obvious risks for a new fiscal crisis in Europe. This is a serious omission, given the major impact that a new wave of government-debt problems would have on the global economy. 

A debt crisis is absolutely nothing to joke about, nor is it to be casually ignored by the world’s supposedly most astute intellects. Governments all over the world have gone deeply into debt in recent years, and that is only partly due to the pandemic. Based on data from the OECD for 31 of its 38 member countries, the money borrowed in 2020 was on average responsible for less than 10% of their total debt in 2021. 

In 2019, the last year before the pandemic, the most indebted industrialized economies in the world had the following debt-to-GDP ratios:

• Japan, 235%
• Greece, 201%
• Italy, 154%
• United States, 136%
• Portugal, 136%
• France, 123%
• Belgium, 120%
• Germany, 119%
• Spain, 118%
• Canada, 107%

Every single one of these countries had a higher debt-to-GDP ratio in 2020, ranging from 142% in Canada all the way up to 258% in Japan. Even though a recovering GDP for the most part means a lower debt ratio, it does not mean less debt. In every one of the 31 countries for which the OECD has government-debt data for 2021, the actual debt was larger in ’21 than in ’20. The increase varied from 3% in Japan to 18% in the Czech Republic. 

As we saw recently, the debt keeps rising into 2022.

Last time Europe suffered from a debt crisis, in 2009-2011, the loss of market confidence in European sovereign debt resulted in a deep economic crisis, the repercussions of which reverberated through the continent for many years. That time, the United States and Canada were kept out of the debt crisis; that is not likely to be the case this time. Even though U.S. public finance has recovered from the pandemic, the federal government’s debt level is still at record levels and predicted to worsen. 

A debt crisis that sweeps across both Europe and North America has the potential of bringing about a new global depression. Governments of the two continents would have no room to use fiscal policy to mitigate the crisis, and their monetary policy capabilities have already been depleted in responding to the recent pandemic.

It would have been valuable to hear from the world’s ‘brightest minds’ on this issue. Unfortunately, they missed the opportunity. It remains to be seen what that means for the world’s ability to avoid a new debt crisis.