A World of Heat and Headwinds

By Michael Spence

PORTOVENERE, ITALY – As recently as three months ago, the global economy seemed to be on track for a relatively robust recovery. The supply of COVID-19 vaccines had expanded in the developed countries, raising hopes that it would spill over to developing countries in the second half of 2021 and into 2022. Many economies were posting impressive growth numbers as pandemic-suppressed sectors reopened. While clogged supply chains had produced a host of shortages and high prices for key inputs, these were seen as merely transitory problems.

The world looks very different now. The Delta variant is spreading rapidly, including in developed countries and among cohorts who were hitherto less vulnerable to the virus. The unvaccinated parts of the world – mostly lower-middle and lower-income countries – are now more vulnerable than ever.

Moreover, the vaccine supply chain is failing. The principal reason is that developed countries have option contracts to buy many more vaccine doses than they need (even after accounting for an expansion of their programs to vaccinate younger people and administer booster shots). This lengthens the vaccine queue, thereby delaying the arrival of vaccines in much of the developing world.

The rich world’s “excess orders” need to be released and made available for purchase by other countries. A program to fund such purchases would not be very costly in global terms (on the order of $60-70 billion), and would yield immediate and long-term benefits in controlling the virus and preventing the emergence of dangerous new variants.

Another problem is that global supply chains have been more severely disrupted than previously thought. It is now apparent that the resulting shortages – in labor, semiconductors (which are used in countless industries), construction materials, containers, and shipping capacity – are not going away anytime soon. Surveys indicate that the inflationary effects are widespread across sectors and countries, and are likely to act as a persistent headwind to recovery and growth.

Adding to the uncertainty, there have been pandemic-induced shifts in domestic and global supply chains that are not yet well understood and will most likely be difficult to reverse. Indeed, the disruptions coming out of the pandemic are broader and appear to be exerting a stronger drag on the economy than did the recent trade war between the United States and China.

But the most eye-opening development of the past three months has been the dramatic increase in the frequency, severity, and global scope of extreme weather: storms, droughts, heat waves, higher average temperatures, fires, and floods. Earlier this month, the Intergovernmental Panel on Climate Change delivered a new report that has been bluntly characterized as announcing “code red for humanity.” The collective judgment of the scientific community suggests that this year’s brutal experience is not an outlier; it is the new climate normal.

We therefore can expect more of the same (and probably much worse) for the next 20-30 years. The window for preventing the kinds of events we have seen this summer is closed. The challenge now is to accelerate the pace of reduction of greenhouse-gas emissions to avoid even more serious – and potentially life-threatening – climate-driven outcomes in the coming decades.

Given the economic and climatic headwinds confronting the world, and that they will blow over a longer time horizon, future growth and development are in peril. In addition to being an obvious drag on growth, today’s supply-chain disruptions may contribute to inflationary pressures that will demand a monetary-policy response.

Similarly, a constantly morphing virus that becomes a semi-permanent feature of life will retard global growth and specialization. International travel will continue to struggle to recover. And while digital platforms can serve as partial substitutes, the impediments to mobility eventually will hit all the global economic and financial ecosystems that support innovation.

In the past, extreme weather events were infrequent and local enough that the risks did not really affect the global macroeconomic outlook. But the new pattern already seems different. It is hard to think of a region that is not subject to elevated weather-related risks. A recent US Federal Reserve paper warns that climate change could increase the frequency and severity of economic contractions, thereby reducing growth. Apart from the resources devoted to driving the recovery, this new reality must eventually be reflected in asset and insurance prices.

The bottom line is that climate change is quickly becoming a noticeable factor in macroeconomic performance. Though we lack precise measures of economic fragility (that is, resilience in the face of shocks), it is hard not to conclude that the global economy, and especially some of its more vulnerable parts, is becoming more fragile. Lower-income developing countries already face significant challenges when it comes to demographic trends, adapting growth models to the digital era, and solving localized governance problems. Add fiscal constraints, climate-related volatility and pressure, and the long queue for vaccines, and you have the makings for a perfect storm.

Much of this is already baked into our immediate future. But not all of it is. Capital markets, for example, appear to be adjusting to the new reality, and solving the global vaccine supply challenge is neither impossibly complex nor prohibitively expensive. All that is needed is multilateral focus and commitment.

The United Nations climate-change conference (COP26) in Glasgow this November will be crucial, and even more difficult than past climate-change conferences. The objective is to strengthen the national decarbonization commitments made in Paris at COP21, so that the global aggregate is consistent with a carbon budget that limits global warming to 1.5°C relative to the pre-industrial level.

Finally, since extreme climate events will occur more frequently and globally – striking randomly almost anywhere – private and social insurance systems will need a major upgrade to become multinational in scope. We may need a new international financial institution to take this on, working closely with the International Monetary Fund and the World Bank.

Michael Spence, a Nobel laureate in economics, is an emeritus professor at Stanford University and a senior fellow at the Hoover Institution.