Dr. Adam Posen: Key Economic Forecast
At Institutional Investor's the Endowments & Foundations Roundtable West in Scottsdale, Arizona, Dr. Adam Posen spoke to the state of the economy before a live audience of asset allocators, consultants, and investment managers. Building on his January 2024 paper, "Economic Outlook for the United States and Other Major Economies Peterson Institute for International Economics," he expounded at the event on his observations to speak to the risk of recession, the effect of interest rates on equity markets, and an evaluation of emerging market trends.
Here are some key excerpts from his paper. The full report is available below.
Medium-term themes for 2024 (likely relevant through 2028)
Long-term interest rates in the G7 will not come down very much in coming years, even if short-term rates are cut heavily by central banks. The equilibrium safe rate (aka r*) has gone up versus 2019 pre-COVID. While demographics and deglobalization continue their unchanged downward pull, fiscal demands will be at a sustained higher level due to demand for green investment, national defense, and industrial policies. Assuming realistically that there will be no substantial pay-fors in terms of tax increases or spending cuts, the structural public deficits will rise by 1-2% of GDP and stay up. This should be worth at least 0.7% on the US 10-year Treasury average rate.
International financial fragmentation – notably between savings glut China and savings importing US, but due to geopolitics more broadly – will increase interest rates further. For balance of payment deficit economies, like the US, they will be funding their (rising) public debt from a shrinking pool of savings, increasing the cost of debt. Arguably, surplus countries, like China, will see their long rates go down as excess savings are trapped at home in lower yield assets. The net effect for the world, however, will be tighter credit conditions, as the US and other G7 economies set the floor for global interest rates, particularly for smaller and lower-income economies. In the 1980s, Germany and Japan saw their interest rates rise with US rates, even though they were in ample surplus.
I believe that the trend productivity growth rate in the US has risen and that this faster rate will be supported by widespread adoption of AI over the next two-to-five years. This is a material change in my view; I have been a tech pessimist for all innovations after the 1990s internet in terms of moving the macro (productivity) needle, and that was proven correct. The last three quarters of positive productivity data in the US seem to me to reflect real factors. We see over-investment crowding in to the AI and related sectors in a way we haven’t seen since the mid-1990s, but which preceded/accompanied all past general use technology booms; a rise in productivity growth is the simplest way of explaining what looked like labor hoarding by employers (hiring unjustified by growth projections).
So, I am building into my forecast a rise in trend US real growth of 0.5% to 2.25% in 2024, and expect that to rise by another up to 1.0% over 2025-2028, as AI investment starts to prompt adoption and change in the private sector. This productivity acceleration would also raise real long-run interest rates by a like amount, but with neutral or positive effects on public debt sustainability.
The spread and speed of similar productivity acceleration in other advanced economies remains to be determined. I do not expect much in other G7 economies in 2024-2025, because I argue that the current rise (preceding most AI utilization) is driven by labor market reallocation unique to the US. Potentially, the adoption by the private sector of AI in other countries could be fast in coming years, given the very low upfront capital costs and widespread availability of the technology. Political economy of labor markets, however, goes the other way.
The corrosion of globalization continues in the critical areas of foreign direct investment, technological exchange, and business/research networks, between the US and China, and to a lesser degree the EU. This development is underappreciated for two reasons: international trade in goods remains more politically salient than services or R&D, and trade is predictably resilient, with some re-routing. In contrast, the macroeconomic effects of these forms of fragmentation are not immediately apparent, accumulating over time. This will likely lead to divergences in technical standards, impeding the speed and breadth of adoption of useful AI and green technologies.
China will find various fiscal and monetary stimulus policies ineffective, bearing out the Economic Long COVID analysis. For similar reasons, even direct measures addressing real estate capitalization and oversupply will yield smaller growth benefits than expected – while a genuine problem, it is a manageable one, whereas widespread fear from Chinese households is more significant. This will feed further pressures for financial and human capital to exit China, and, in combination with self-sufficiency concerns, it will lead to an expanding SOE sector.
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