Inflation prognostication tends to come down to reading statistical tea leaves. Friday’s report of strong US job growth looks like a sign of economic strength that keeps inflationary pressure high. Recent declines in commodity prices reassured some analysts that the danger could be receding.
This focus on short-term price movements and the resulting interest-rate manipulations of central banks is only natural. But it obscures larger tectonic forces that dictate inflationary trends over years, even decades, and that can’t be controlled by the US Federal Reserve or European Central Bank. Though there’s no shortage of causes for these cycles, one stands out: globalization. Understanding this connection can help solve some of the economic puzzles of recent years — and suggest what’s in store for the future.
A good to place to start is this year’s Tawney Lecture, delivered at Cambridge University in April at the annual meeting of the Economic History Society. The 2022 honoree, Princeton University historian Harold James, used the opportunity to investigate the “causal relationships and interdependence between inflation and globalization.”
James noted that he was hardly the first person to make this connection. In 2005, former Fed Chair Alan Greenspan had raised the unsettling possibility that the era of low inflation and reduced volatility that defined the years following the inflationary blastoff of the 1970s might owe as much to globalization as to the competence of central bankers like himself.
Greenspan noted in a speech that year that the increase of cross-border trade meant that “many economies are increasingly exposed to the rigors of international competition and comparative advantage.” He added, “In the process, lower prices for some goods and services produced by our trading partners have competitively suppressed domestic price pressures.”
This hypothesis was at odds with much of the economic literature of the day, which held that globalization had almost no impact on inflation. But James pointed out that this view of cause and effect is rooted in a focus on short-term forces rather than historical trends that play out over many years.
He argued that the increased flow of capital, people and goods across national borders has the power to keep inflation in check. It just takes time.
Consider, for example, what happened in the 19th century.
In the 1840s, England and other nations wrestled with food shortages. After struggling with inflation and misguided policies, they began removing restrictions in order to allow the import of cheaper food from abroad. The lowering of trade barriers went hand in hand with increased international migration, and then the adoption of the gold standard, which encouraged more cross-border capital investment.
The result was an era of globalization between 1870 and 1914 characterized by what my Bloomberg Opinion colleague, the historian Niall Ferguson, once described as “relatively free trade, limited restrictions on migration, and hardly any regulation of capital flow.”
Significantly, inflation remained low during this period, with some countries even registering sustained periods of mild deflation. This was understandable: As transportation costs fell and competition played out on a global scale, prices dropped while volatility subsided.
World War I smashed the international order, and the pieces wouldn’t be reassembled until many years later. Yet the globalization cycle would restart in the 1970s, when the oil shock set off by a Saudi-led embargo aimed at supporters of Israel helped spark inflation. James described this as “the same move to an initial inflation, then a push to globalize to alleviate scarcity, and then a long disinflation.” The dynamic of the mid-19th century repeated itself.
The features of this wave of globalization included the cross-border movement of funds accumulated by oil-producing nations; the expansion of international capital markets; the near-universal adoption of standardized shipping containers; and, eventually, the expansion of intricate global supply chains.
While Paul Volcker, Fed chair during most of the 1980s, is often credited with slaying inflation with punishingly high interest rates, this narrative obscures the fact that he happened to take charge in 1979, at precisely the moment when the forces of globalization had achieved a critical mass. In 1970, global trade in goods represented 9.5% of global GDP. A decade later, that number had risen to nearly 15%. Other measures of globalization tell a similar story.
Over the course of the 1980s, globalization accelerated, as did offshoring and other cost-cutting moves that depressed the power of workers and put further downward pressure on prices. The end of the Cold War integrated previously isolated swaths of the global economy. At the same time, China became increasingly integrated into the rest of the world, culminating in its membership in the World Trade Organization in 2001.
For the next 20 years, inflation remained largely in check. Policy makers actually worried more about deflation, particularly in the wake of the 2008 financial crisis. Somewhat belatedly, a growing number of economists began to explore the ways that globalization, as much as domestic conditions, can determine inflation rates.
But eras of globalization don’t last forever. An earlier one ended with a bang in 1914. Our own may die a more protracted death. Well before the recent inflation scare, cracks began appearing in the globalization facade. After the Great Recession, more economists and scholars began to talk about ” onshoring.” US President Donald Trump launched a trade war, curtailed immigration and began chipping away at the foundations of the international order. The UK left the European Union in 2020. All of this was before the coronavirus pandemic, the collapse of global supply chains and the outbreak of a land war in Europe.
These developments don’t all spring from related causes, but they work toward a common end, throwing one wrench after another into the carefully calibrated global economic machinery built over the past five decades.
Perhaps the recent inflation scare will prove transitory after all. But if the assault on globalization continues, history suggests that the days of stable low prices are likely to become a thing of the past.