Leaders must confront austerity, sovereign risk, and financial regulation
Business and political leaders heading for the World Economic Forum in Davos this week face an unusually complex set of economic challenges. Foremost among them is the strength and sustainability of the economic recovery—but other important issues include how better to mitigate market risk and avoid financial crises in the future, and how to adapt to a world undergoing profound and increasingly rapid structural change.
It is vital, of course, that leaders make the right economic calls in the short term. But at McKinsey we would urge a more fundamental debate about the appropriate response, particularly in developed countries, to the unstoppable long-term economic trends. Here are five themes I would like to see on everyone's agenda in the next few days.
The first is how to continue with unavoidable austerity measures in many developed economies while steering a course between the twin evils of inflation and a double-dip recession. One urgent question is how to encourage private-sector investment in order to generate jobs and demand to offset the impact of public-sector cutbacks. The argument about the correct monetary policy in the face of renewed inflationary pressures is another near-term dilemma, which all leaders must address responsibly.
The next big issue is the growing threat of sovereign risk; it's an issue that has crept up on us in the wake of government interventions to save the banking system. The WEF has highlighted fiscal crises and the associated economic consequences as among the most pressing risks facing the world economy. We are in uncharted waters, especially in Europe.
The third challenge is to get the right balance in financial regulation—and design regulation around the needs of the future rather than the latest crisis. Regulators have taken radical action to reduce the chances of another crisis. Yet going too far will stifle economic growth and hamper competitiveness. From the United Kingdom's point of view this means not only ensuring that London's financial services sector continues to thrive but more broadly making sure the United Kingdom retains its hard-won reputation as a welcome location for restlessly mobile multinationals.
A longer-term challenge will be how to meet the growing need for higher investment over the next 20 years in both developed economies and emerging markets. Our analysis suggests that the long era of cheap capital is set to end as developing countries embark on one of the biggest investment programmes in history, coupled with major reinvestment by developed markets in infrastructure and green energy. This will put sustained upward pressure on real interest rates.
Finally, there is an overarching challenge for all developed countries to restore economic growth to something resembling its long-term trend. Despite the inevitable focus on the short term, we would urge businesspeople and policymakers to look at more distant horizons—as our recent report on the UK economy pointed out, a drop in the rate of GDP growth from its historic 40-year average of 2.5 percent per annum to say 1.5 percent for each of the next 20 years would be far more damaging to wealth and jobs in this country than a double-dip recession some time in the next 12 months.
Every year at Davos seems to be an important one. Perhaps this year, participants will make real progress on the challenges we face today and whose outcome may well reshape the world economy for at least a generation.
Charles Roxburgh is a director, McKinsey Global Institute.
This article originally ran in Times of London Online.