Economic Growth

Do you know your trickle-down economics from your zombie firm?

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Conditions around the world remain tough to navigate and the road ahead uncertain. Image: Unsplash/Mathieu Stern

Emma Charlton
Senior Writer, Forum Agenda
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Financial and Monetary Systems

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  • Inflation and uncertainty are two words that characterize the global economy according to the International Monetary Fund’s latest assessment.
  • Global economic activity is slowing and inflation is at multi-year highs.
  • There’s a difficult course to chart to restore price stability and shield citizens from cost-of-living pressures.
  • That’s seen the revival of some economic terms, including trickle-down economics, stagflation and zombie companies - here’s what they mean.

“Inflation and uncertainty.”

That’s how the International Monetary Fund (IMF) characterized the world economy in its latest assessment as it forecast global growth will slow to 2.7% in 2023, from 3.2% this year.

The organization painted a muted picture, with global economic activity seen slowing more sharply than expected and inflation at multi-year highs. On top of that, a wide-ranging cost-of-living crisis, tightening financial conditions and Russia’s invasion of Ukraine are clouding the outlook and exacerbating volatility.

Infographic showing World Economic Outlook growth projections.
Economic outlook darkening. Image: IMF

Policymakers, politicians and officials have a difficult course to chart, as they seek to restore price stability and shield citizens from cost-of-living pressures while also fostering growth.

Against this backdrop of turbulence, here are five economic terms you need to know:

1. Trickle-down economics

Fostering growth by lowering taxes and decreasing regulation is known as “supply-side” or “trickle-down” economics. It’s been in the headlines in recent weeks after former UK Prime Minister Liz Truss announced sweeping tax cuts for businesses and the well-off, prompting financial market turmoil for UK assets.

Over the years, politicians from many countries have argued in favour of the trickle-down effect. In 2017, US President Donald Trump said his tax cuts would be “rocket fuel” for the economy and allow the well-off to hire more and invest more.

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But there is little academic evidence to back this up.

Tax cuts for the rich had no effect on economic growth and unemployment, according to a London School of Economics analysis of 18 OECD countries over five decades. The research showed, on average, each major tax cut resulted in a rise of 0.8 percentage points in the top 1% share of pre-tax national income.

“We find that major tax cuts for the rich push up income inequality, as measured by the top 1% share of pre-tax national income,” the authors of the study, David Hope and Julian Limberg wrote. “Turning our attention to economic performance, we find no significant effects of major tax cuts for the rich.”

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2. Stagflation

Stagflation refers to a period of high inflation that coincides with a slow rate of growth or a recession. The risk with stagflation is that central banks increase interest rates to quell price increases, but this stymies growth even more, creating a downward spiral.

Earlier this year, the World Bank warned that even if the global economy avoids recession, stagflation could persist for several years.

“Several years of above-average inflation and below-average growth are now likely, with potentially destabilizing consequences for low- and middle-income economies,” the Bank stated in its June 2022 Global Economic Prospects report. “It’s a phenomenon - stagflation - that the world has not seen since the 1970s.

Infographic about stagflation.
Stagflation risks. Image: World Bank

The World Bank suggested that a key learning from the 1970s is that central banks need to act early to stop inflation getting out of control and that governments also need to support that strategy through fiscal policy.

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3. Wage-price spiral

High rates of inflation also increase the risk of a wage-price spiral, where higher prices prompt demands for increased wages which then fuels price growth.

The prospect of this was investigated in the most recent IMF economic outlook, which concluded that it was unlikely to occur at this time.

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“Although wage growth has generally stayed below inflation so far, some observers warn that prices and wages could start feeding off each other,” the IMF report said. “Risks of a sustained wage-price spiral appear limited since underlying inflation shocks come from outside the labor market and monetary policy is tightening aggressively.”

4. Zombie companies

Another feature of the current economic climate is increasing borrowing costs. With inflation around the world at multi-year highs, many central banks around the globe, including the US Federal Reserve, are increasing interest rates, which bolsters borrowing costs for most loans - both for households and businesses.

This puts so-called zombie companies - those firms that make enough profit to pay the interest on their debts but enough not pay the debts off - in difficulty, as their borrowing costs increase. More than a decade of low interest rates and central bank support helped keep these companies afloat, but those dynamics could be set to change.

In the UK, as many as one in five companies was a zombie as of March 2020, according to research from thinktank Onward. In the US, estimates from the Federal Reserve suggest a lower proportion of around 10% of public firms and 5% of private firms.

Chart showing zombie firms in the US.
Zombie firms in the US. Image: US Federal Reserve

5. Downside risks

Downside risks, essentially mean a whole host of things that could go worse-than-expected.

“Risks to the outlook remain unusually large and to the downside,” the IMF said in its latest outlook - as it predicted a 25% chance of global growth falling below 2% in 2023.

These so-called “downside risks” might be further food or energy price shocks, it said.

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What’s clear from these five words that partly characterize current economics, is that conditions around the world remain tough to navigate and the road ahead uncertain.

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The views expressed in this article are those of the author alone and not the World Economic Forum.

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