A Fragile World Economy and New Opportunities for Investment Migration

An article written by Andres Solimano FIMC, Chairperson of the Investment Migration Council for the IM Yearbook 2023.

Andres Solimano, IMC Chair as well as founder and chair of the International Centre for Globalisation and Development, analyses the current economic climate and its effects on investment migration.

The world economy is uncertain and experiencing a deterioration that is expected to continue in 2023 only to recover in 2024. Currently, the global economy is effected by an unpleasant combination of high inflation, higher interest rates and serious geopolitical risks. Moreover, there is the possibility of a new debt crisis in low-income countries and highly indebted emerging economies.

In the last three years, the global economy has experienced the effects of the Covid-19 pandemic followed by a global recession. World GDP contracted in 2020 due to forced lockdowns, which created a supply side shock as people could not go to work and supply chains broke down. While there was a rapid turnaround with a strong recovery in 2021, more structural challenges such as climate change, entrenched inequality, the replacement of fossil oil energy matrix to support green growth, and environmental fragility remained. Global institutions such as the International Monetary Fund, the World Bank and others still expect growth in 2022 and 2023 for the world, although they have adjusted their projections downwards.

Nonetheless, this uncertain economic environment may have positive effects on investment migration flows as the insurance value of programmes is rising. Investors will make an extra effort to find more secure locations where to invest their money and secure a better environment. Countries offering more stability, predictability and good investment opportunities will benefit from this development.

The shift to high inflation

After decades of 2% to 3% inflation per year in industrial economies, since the Covid-19 pandemic, and exacerbated by the war against Ukraine, inflation has accelerated and reached annualised levels of around 8% in 2022.

Large economies such as the US, UK, Germany and Spain are experiencing annual inflation above 10%. Some countries, such as the Baltic ones, have an inflation rate hovering around 16% to 20%.

Several demand and supply factors have contributed to the acceleration of inflation in the world economy since 2020-21. One reason is the accumulation of household liquidity due to a lack of consumption opportunities during the lockdown period. When mobility restrictions were lifted, this excess liquidity went directly to the market, pushed up prices in the process.

Tied to this are also the fiscal transfers and subsidies granted by national governments to households in the Covid-crisis era. These have contributed to increase aggregate demand, leading to fiscal-led inflationary pressures.

Moreover, cost-push effects associated with supply constraints due to strains on maritime transport facilities and the subsequent rise in freight rates along with other disruptions in supply chains increased prices, while the rise in food and energy prices, which started in 2020 but exacerbated after Russian’s invasion of Ukraine in February of 2022, added to “headline inflation”.

A concern is that these inflationary pressures may become entrenched. Inflation dynamics over the next two years will also depend on second-round effects such as the response of wages to previous price hikes as well as price adjustment policies by governments.

A key player in the future evolution of inflation are central banks. Nowadays, around the world, monetary authorities are tightening monetary policy through higher interest rates to reduce inflation.

The sources of inflationary pressures vary across economies. While there is some consensus that inflation in the US is largely associated with an ‘overheated’ economy’ due to exaggerated levels of demand in both the goods and the labour market relative to the potential supply, it is an open question whether this is an accurate description of the economic reality of America. Low unemployment is used as an argument to back the hypothesis of “excess demand in America”.

For Europe, the diagnosis is different, and it focuses on the very sharp increases in the price of gas and oil, imported from abroad, mostly Russia. Thus, a supply- shock story describes the inflationary situation in Europe better while a demand- side story is more plausible for America. Among emerging economies, inflation is closely related to the energy price and food price shocks coming from international markets, so we are dealing with a mix of supply-shock and imported inflation.

An impending recession?

As mentioned, the IMF, the World Bank, the OECD, and the European Central Bank have all adjusted downwards their GDP growth forecasts for 2022 and 2023. In turn, recessions are anticipated in 2023 for Germany, Italy and Russia, while the two major powerhouse of the world economy – the US and China – will experience slowdowns.

The causes of the global slowdown are related to the effects of higher interest rates to fight inflation, compounded by supply energy and food price shocks and the effects of increased uncertainty affecting private investment and consumption, two main drivers of aggregate spending and economic activity.

In addition, world trade has declined due to supply disruptions and new geopolitical realities, shaped by embargoes and a shift to ‘secure sources’ of supply – a major change when compared to the previous rule of “cost minimisation” that governed globalisation in the last three decades. All these factors are affecting global growth.

The risk of a debt crisis

During the Covid-19 crisis of 2020-21 many governments were forced to increase their levels of foreign borrowing. They needed financing to fund Covid-related support programmes set up to protect the living standards of their people who could not go to work and generate the necessary income to sustain themselves.

Importantly, this borrowing was contracted, mainly in US dollars and took place at generally low interest rates. However, during 2022, macroeconomic and financial conditions have changed dramatically. A sharp rise in interest rates, a very strong dollar and portfolio capital outflows from developing nations at the periphery to advanced economies at the centre may eventually trigger a new debt crisis.

For context, in the early 1980s, a very similar combination of economic factors affected the world economy following inflation stabilisation policies in the US pursued by the Federal Reserve: interest rates increased, the dollar appreciated against main world currencies and currencies of the periphery. In addition, capital flight was the norm with money flowing from economies of the global south to the US and other advanced economies. The result was the onset of a debt crisis in several large economies of Latin America, Turkey and the Philippines including forced debt rescheduling, debt cancelations and debt defaults. These episodes were also accompanied by currency crashes, recessions, dwindling investment and portfolio capital outflows.

We have seen several debt crises in the last three to four decades: the East Asian crisis in 1997-98, the convertibility crisis in Argentina in 2000-01, debt stresses in Brazil in the late 1990s and the global financial crisis of 2008-09.

Yet, history does not need to repeat itself. After four decades of repeated debt crises around the world there are better mechanisms to anticipate them and cope with them if they take place. Exchange rates regimes in developing countries are more flexible now than then, international reserves in the hands of central banks are higher and fiscal policy has become more ordered and predictable. Moreover, today, the IMF has in place a set of new financing instruments, several of quick disbursement, that could help avert the repeat of debt crises. However, there is little space for complacency as financial conditions are fragile even in large mature economies. Just think of the sharp decline in the value of the pound and bond prices following the Truss- Kwarteng regressive tax cut and spending increase package of late September in the UK, a policy mix that was later reversed.

Investment migration

An important consequence of the current economic difficulties is that the global economy is becoming more fragmented, risky, and unpredictable. How can these developments affect investment migration? Two main channels are relevant: First, in a world of heightened economic, geopolitical and security risks, an increase in the demand for investment migration is likely to follow. Option theory predicts that a vehicle, programme, or policy – think of investment migration – that enhances opportunities in risky environments carry a positive price, or insurance value.

Second, governments in tough times are in increased need of foreign capital, talent, entrepreneurial capacities, and cash, and therefore will view investment migration more favourably. This already happened after the 2008-09 global financial crisis and is bound to happen again in the current circumstances. Even though, the golden years for investment migration of the 2010s might be largely over for various reasons, the economic need of countries for foreign financing, along with a personal/ household demand for geographic risk diversification, remains. Therefore, it is very likely that investment migration will continue to thrive for quite a while.

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