Localisation and state capitalism

Steen Jakobsen
Chief Investment Officer

Summary:  When Germany joins the ranks of 'no-holds-barred' spending, we know that free markets have died.

"Human beings are born with different capacities. If they are free, they are not equal. And if they are equal, they are not free." 
— Aleksandr Solzhenitsyn 

Over the past three decades, after the end of the Cold War and especially with China’s momentous admission into the WTO in 2001, the world has become ever more connected and integrated through technology and globalisation. But starting with the Trump presidency – and with a breathtaking acceleration over the space of just a few months thanks to the Covid-19 pandemic – it feels like the world is breaking apart, driven by self-interest, distrust and a game of us versus them. The my-nation-first impulse is now the modus operandi not just in political circles, but also in companies’ supply chain plans, which have been sorely tested during this crisis.  

This great turning away from world-spanning supply chains, plus an impulse shading towards autarky, will bring widespread reshoring and incentive programmes to produce “at home”. The first areas in focus will be medical supplies, after the embarrassingly dire lack of preparedness nearly everywhere for what was arguably an inevitable pandemic. But the new need to measure political accountability in terms of national self-sufficiency in pivotal industries will mean that energy, food supplies and (last but certainly not least) technology will all be declared “mission critical”. Potential higher marginal costs for producing locally will prove less important than the political imperative to prove robust self-sufficiency. In short, prices will rise for nearly everything – and in real terms, not just through price inflation. 

This will be extremely expensive: for the consumer, for governments (through the need for increased fiscal spending) and for jobs (marginal costs will be higher than marginal productivity). But what could prove far worse than the implications of deglobalisation is the unfortunate reality that Covid-19 has accelerated the death of free markets as the driver of economies. The move to bail out everything is understandable, but deepens the risk that real GDP growth will continue to trend downwards on the zombification of the economy.  

Even a notoriously austere country like Germany has gone full Keynesian in a desperate attempt to replace the demand collapse and lack of productivity. Germany’s government spending now eclipses any other EU member – some 38% of GDP, including new spending, loan guarantees, supply-side tax relief and more. When Germany joins the ranks of ‘no-holds-barred’ spending, we know that free markets have died.  

When states spend money, it looks like support for the economy and does provide a temporary boost. But it risks coming at the cost of low productivity, zombification and the crowding out of private capital – all leading to lowered real GDP prospects. 

Markets need to self-correct as an exercise in clearing out unproductive behaviours and actors in the economy. Once again, it is worth pulling out the great and overused – but very apt – metaphor viewing financial markets and the economy as a forest. Multiple small forest fires are needed to keep the ecosystem healthy and prevent the build-up of fuel that makes conditions ripe for The Big One, a devastating firestorm.  

The Covid-19 crisis was immediately devastating precisely because our debt-saturated economies are so very highly tuned and fragile. In more traditional “Austrian” terms, the critical function for markets (and growth) as defined by Joseph Schumpeter is the “creative destruction” concept, which is “the incessant product and process innovation mechanism by which new production units replace outdated ones”. With ZIRP, NIRP and bailouts for everyone all the time, this has been forever abolished. No more “forest fires” to leave fertile new ground for new actors to jump-start the economy and hence a future of ever-lower productivity and real GDP growth inside a massive debt burden. 

The impact on markets (and employment) will be extremely negative when the stimulus runs out. Through direct and indirect lending, bailouts and grants, government spending in many countries will be more than 50% of GDP. Government interests will have a strong voice in boardrooms, and new government regulations are on the way to “save the economy and jobs” with taxpayer money. 

The great irony is that although Covid-19 and who knows what future viruses can bring massive human and economic impacts, the even bigger risk is our response to the crisis. At best we are suspending market-based economies, at worst we are replacing them with state capitalism. That model can never ever win, as open markets are required to best drive price discovery, allocation of goods, innovation and even democracy. 

The combination of localisation, my-nation-first and state capitalism brings massive headwinds for growth, employment, the social fabric and the markets. These approaches to tackling the Covid-19 crisis are a one-way street into a narrowminded, provincial, nostalgic narrative that states can go it alone. But fighting both the pandemic and future similar risks needs a more global approach, not a local one. 

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