Peter Warburton – January 28, 2021
The catchphrases at virtual Davos this year are “Reviving the Social Contract”, “the Great Reset” and “Building Back Better”. The one I couldn’t find on the Davos website was: “Welcoming the return of inflation”! These thoughts are inextricably linked. The Covid-19 crisis has provoked some extraordinary public policy responses in advanced economies that look to have overturned the status quo ante. The expedient interventions of states to shield their citizens from the harsh realities of the pandemic have established new benchmarks in the provision of healthcare, social care and welfare payments. In the Anglo-Saxon countries at least, it is almost inconceivable that we will see a return to the profiles of early-2020. Whether this seismic shift justifies the epithet of a Great Reset remains an open question: this will depend, in part, on whether it materialises as a massive income redistribution within a sound fiscal and monetary framework or within an inflationary framework. My money is on the latter.
An astute observation by authors of a recent McKinsey Global Institute report* is that advanced nations with relatively low prior commitments to social contract spending** increased government expenditure significantly more in 2020 than those with higher prior commitments. Norway, Sweden, Finland, France and Denmark belong in the high commitment category and raised state spending by between 9 per cent and 15 per cent. Canada, UK, US and Japan sit at the lower end of the range of social contract spend and have increased government spending by between 28 per cent and 39 per cent. The inference is that these countries have been dousing fires in the healthcare and welfare systems with ill-targeted payments, while countries with more generous systems have needed to do much less in response to Covid-19. Switzerland, South Korea and Ireland are the interesting outliers.
We have remarked, in previous blogs, that socialism is expensive. The state is a high-cost producer, whether through inefficiency, indifference or insistence on higher standards. If we wind back 40-plus years, it was these very inefficiencies, restrictive practices, indifferences and inflexible behaviours that launched the Reagan-Thatcher revolution. It appears that we have come full circle. If it is the will of the people that the social contract is rewritten, that the public sector reclaims some of the territory that was taken in the lean-state, de-regulation and privatisation landgrab of the 1980s and 1990s, then pragmatic politicians will deliver it. But we do well to recall the mayhem of the second half of the 1970s. The danger is that this bold public sector initiative fosters unrealistic expectations and uncontrollable inflation.
To enhance the social contract, it will require some existing contracts, such as pensions, life insurance and investments, to be weakened. Since these contracts cannot be formally re-negotiated, without huge political fall-out, then their benefits must be diluted. To the extent that the tax system is unable to provide the requisite funding for the upgraded social contract, this burden falls to an inflationary surprise. For all their bland reassurances, central banks are taking all the necessary steps to facilitate a resurgence of inflation, with the beaming approval of their political masters.
*Covid-19 has revived the social contract in advanced-economies – for now. What will stick once the crisis abates?
by Anu Madgavkar, Tilman Tacke, Sven Smit and James Manyika
**For the definition of social contract spending, see the footnote to figure 1.
Figure 1
