Transformative Trends Influencing The Landscape of Global Finance

The global economy today shows marked contrasts to its state just a few years ago. The COVID-19 pandemic has triggered significant changes, leading to ongoing structural transformations. Major influences such as deglobalization, decarbonization, demographic shifts, rising debt levels, and digitalization are shaping the landscape of the global economy and financial markets.

These five pivotal forces contribute to a challenging decision-making landscape for policymakers and investors alike. A comprehensive evaluation of these elements is crucial, as they hold the potential to drive substantial changes.

1. Deglobalization

The shift away from globalization is picking up speed due to rising trade conflicts, geopolitical issues, and a closer look at supply chain vulnerabilities. This has led to a resurgence of economic nationalism and regional trade efforts. The International Monetary Fund (IMF) has noted a significant increase in global trade barriers, with the annual number rising from about 1,000 in 2019 to over 3,000 in 2023. This number is likely to grow further, especially with the new Trump Administration's plan to increase reliance on U.S. tariffs.

Deglobalization presents major challenges for economic growth and raises inflationary pressures. Trade fragmentation reduces the efficiency gained from specialization and competition, while also limiting economies of scale. Moreover, financial fragmentation restricts cross-border capital flows and increases macro-financial instability. Research from the IMF and the Bank for International Settlements (BIS) shows that countries with open trade policies tend to have lower inflation rates, even when considering other factors that contribute to inflation.

The effects of deglobalization are likely to differ greatly between regions. Emerging and developing countries are especially at risk because they depend heavily on foreign direct investment and are vulnerable to issues related to energy and commodity supplies. The strong position of the dollar in global transactions indicates that its ongoing strength might worsen the difficulties faced by these countries. Additionally, the move towards deglobalization could slow down worldwide efforts to tackle urgent problems like climate change.

On the other hand, some countries or regions might discover new opportunities as old trading partnerships break down and new ones form. For example, Southeast Asia is seeing new trading patterns develop as the relationship between the United States and China declines.

2. Decarbonization

Renowned climate scientist Veerabhadran “Ram” Ramanathan has raised an urgent alarm regarding the rapid increase in global warming. He warns that if emissions are not controlled, climate change could hit a crucial tipping point similar to the COVID-19 pandemic by 2030. The impacts of climate change are already visible, with extreme weather events on the rise, including widespread wildfires in Australia, heavy rainfall in Dubai, severe flooding in Europe, and stronger hurricanes in the United States.

These events are causing inflation because they require large government spending to return to normal. The urgency to adapt and protect against weather-related issues is growing. No matter how fast climate change happens, adaptation will need funding and financial help, which adds to inflation since there isn't a matching rise in productivity or tax income. While the market for green bonds and sustainable loans is growing, it is still not enough to tackle these urgent problems, showing that some type of government support will be necessary to fill the gap.

3. Demographics

Changes in demographics, especially the increase in older populations, are leading to a smaller workforce. Longer life spans and lower birth rates make it harder to manage the costs of healthcare and retirement for older people. Recent talks at the Federal Reserve's Jackson Hole meetings pointed out that financial markets are becoming more sensitive to these economic pressures and how they might affect monetary policy. The uncertainty around changing social contracts, along with a rising elderly population and higher dependency ratios, is causing lower productivity and increased inflation, which adds to the financial difficulties.

4. Debt

The rise in government spending is likely to increase obligations that are already at record levels. According to the World Economic Forum, global debt has reached a historic high of $307 trillion, mainly driven by developed countries. The financial actions taken during the COVID-19 pandemic played a major role, raising government debt in these nations to an astonishing $50 trillion. With interest rates now higher than they have been in the past two decades, this scenario is expected to lead to greater risk premiums for new debt and higher costs for servicing existing debt. In the United States, forecasts suggest that by 2025, the expenses related to debt servicing will exceed the defense budget, and this trend seems likely to continue.

High debt levels limit a government's ability to invest in important areas like infrastructure, education, and research, which are vital for long-term economic growth. This issue, called the crowding-out effect, can worsen when continuous government borrowing leads to higher interest rates, raising capital costs for private businesses. This is especially troubling for U.S. companies with high-yield debt, as they face a large amount of debt maturing soon, with about $200 billion due in 2024-25 and around $1.1 trillion maturing from 2024 to 2028.

5. Digitalization

Despite the significant challenges to global economic growth, the move towards greater digitalization stands out. Advances in digital technology, especially artificial intelligence (AI), are viewed as a possible solution to the issues hindering growth. For example, the economic effects of generative AI (GenAI) are impressive, with forecasts indicating a productivity boost of about 1.5% each year and total economic benefits estimated between $2.6 trillion and $4.4 trillion across different industries due to the widespread use of GenAI. Although past technological changes require some caution, the special qualities of GenAI—its ease of use and adaptability—might help it overcome the obstacles that have previously restricted the benefits of new technologies.