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The new social contract and your money


This article is an on-site version of Martin Sandbu’s Free Lunch newsletter. Sign up here to get the newsletter sent straight to your inbox every Thursday

If your email inboxes are anything like mine, they are heaving with lists of what to watch out for in 2022 and what the biggest risks are to investors/economic growth/world peace. Do check out the start-of-year newsletters from my colleagues — such as Unhedged on what will affect markets, Energy Source on the top three energy themes of 2022, or Trade Secrets about the minefield of trade challenges awaiting us this year.

I have refrained from inflicting my own list on you. Partly because there is little added value in repeating the same possibilities that are already on everyone’s minds (inflation accelerating! inflation dropping and monetary policy turning out too tight! war over Ukraine! war over Taiwan! a worsening energy crisis! a coup in the US!). And partly because the biggest risks are the ones most of us, at least myself, are blind to.

Instead, it could be useful to dwell on the bigger tectonic shifts happening in how our economies are governed, and how anyone with money at stake should think about them. To me, today feels like 1945 or 1979-81 — pivot points in history where our entire thinking about how to manage the economy (and more besides) changed fundamentally in a short time. The social contract is being rewritten again.

The way I have described it in the past is that the old Washington Consensus is giving way to a new Washington Consensus (and a new Brussels-Berlin consensus may be emerging too). Then, the role of the state was at most to set the traffic rules and redistribute the free market’s rewards, but otherwise keeping its hands off the economy. Now, economic planning and state-led economic activity are back.

For a good overview of the many ways policymaking is shifting, see the special report on the new interventionism in this week’s The Economist, with articles dedicated to industrial policy, competition policy, regulation and corporate taxation, all four of which demonstrate that governments are more willing to get dirt under their nails in their handling of the economy.

The Economist being The Economist, it warns that the tools of economic interventionism were previously “gathering dust for a reason”. But there are good reasons why governments are choosing a less hands-off approach too. One is the by now obvious failures of the past 40 years, which saw slow productivity growth, low investment and too many people excluded from prosperity. Public policy failed to prevent value creation from being distorted into rent extraction.

Another cause for a new interventionism is that the 21st-century economy will require some enormous structural shifts that only the state is well-placed to make happen. Above all, co-ordination is needed for all parts of the economy to shift simultaneously to a low- and zero-carbon solution, including huge investments in new infrastructure. Also, the role of public goods is increasing — because the economy increasingly depends on skilled and well-connected populations, and because the cutting-edge activities increasingly involve intangible products and digital services that require smart regulation.

Finally, a variety of geoeconomic factors — the fear of strategic dependence on China, Europe’s unwillingness for its decarbonisation efforts to be undercut by polluting trading partners, the fact that more and more trade is in politically sensitive services — mean that the era of purist trade liberalisation is over.

How should investors think about these shifts? First, acknowledge that they are big and that things will not go back to the status quo ante. If anything, these changes are likely to intensify.

Second, consider that while individual companies may think they are freer to pursue profits the less governments get involved in the economy, that is not true for the private sector collectively. Preventing market power abuse, controlling “externalities” (where one company’s actions affect the profitability of another), reducing consumer uncertainty about product quality, and ensuring that companies that want to align themselves with decarbonisation are not undercut by those that do not — all these things both increase economic efficiency and require state action. Indeed, the economy is changing in ways that suggest efficiency requires a more active (if not necessarily a bigger) state than in the past.

Third, this means that the private sector — and its investors — may benefit from the new interventionism. If it makes for a more efficient economy, there will be more economic surplus from which profits could be paid (and the benchmark is not the status quo ante but an economy under ever more risk from climate change). Enlightened self-interest is real, and different from narrow maximisation.

That goes for investors too. They may want to think about how recalcitrant companies, which lobby against or otherwise resist these epochal changes, may harm the other investments in their portfolio. They may also want to have an open mind towards companies that align themselves with broader goals than short-term profits (or even merely long-term profits). Indeed, they may even prefer company leaders that support the right kind of state engagement with the economy.

The upshot is that investors’ role is changing too. Passive investors — and here I mean passive in two senses, that of allocating capital passively based on an index and that of not exercising shareholder rights to influence management decisions — are free riders on active ones. But how investors actively influence the companies they own matters more and more when the social contract is rewritten to be less laissez-faire than it was. And that means the free riding of passive investors becomes more and more egregious too.

Other readables

  • As many will tell you, US inflation reached a 40-year high, with consumer prices rising 7 per cent year on year in December. What most will not tell you is that the month-on-month change, however, fell for the second consecutive month, though remained high at 0.5 per cent.

    Chart showing month-on-month percentage changes in  the US consumer prices index in 2021

    As I have written before, year-on-year differences are a poor guide to price dynamics that are changing fast. In the months to December, US food price inflation slowed (adjusted for seasonal patterns of course). Services inflation slowed. Energy prices are now falling outright. The one subcomponent of inflation that is not slowing is commodities outside food and energy, which picked up strongly at the end of the year. Might Christmas have anything to do with it?

  • I have received a lot of reader comments on recent pieces — keep them coming! Before Christmas, I offered a back-of-the envelope costing of a universal basic income, to go with our film about the case for UBI. Nikhil Woodruff shared a link to an online calculator that does a much more thorough job — try it yourself! I was relieved to find that while it estimates the cost of my example to be a bit higher than I did, it is in the same (expensive but affordable) ballpark. Separately, a friend reminded me of the bizarre tale of then US president Richard Nixon’s push for a UBI.

  • The iPhone is 15 years old, and its maker is worth $3tn. But what has it done to our brains?

Numbers news

  • In the last quarter of 2021, the rate at which unemployed Americans are finding jobs jumped, says the Conference Board (see chart below). This is the high-pressure economy inflation hawks want to rein in.

Chart showing the number of people moving from unemployment to employment

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