103. It’s Time To Live With Higher Inflation

0:11Hello and welcome to The Rest is Money with me Robert Peston and me Steph McGovern. Today, we're delighted to be joined by Mohamed El-Erian. He's a world-class economist. He worked for years at the International Monetary Fund, which is a sort of global policeman of how governments manage their economies. And then he became boss of PIMCO, the most powerful investor in government bonds. Mohamed was also chair of President Obama's Global Development Council. And amongst his many contributions to the world of economics, he's written two New York Times bestselling books. And his recent book, Permacrisis, was co-authored with Gordon Brown and Michael Spence.

0:55So here's our chat with Mohamed El-Eri. And he's joining us from Cambridge, where he's president of Queen's College. Mohamed, so great to see you. In your latest book, you used the scary phrase that we were in a perma crisis. Do you think there's any evidence we're coming out of it? Not as yet. The perma crisis is this sense that we are going from one big disruption to another. And in the process of doing so, two things happen. We lose resilience, either human or financial. and second, it becomes harder to put us back on the right course. And I think that if you see what has happened over the last 12 to 24 months, there's further evidence that we are in this phase of perma crisis.

1:46So how do you get out of it then? We think that you get out of it by addressing three major causes. The first is that we've lost the ability to grow our economy in a durable, sustainable and inclusive manner. And if you don't grow, it becomes much harder to reconcile all sorts of discrepancies, all sorts of competing claims. And that has not just economic and financial consequences, but also political and geopolitical. The second is to stop making policy mistakes. We seem to be making the same policy mistakes over and over again and not learning from them. The third and the most difficult one is better global policy coordination.

2:27Some of the big problems we face today, like climate change are common to many countries and can only be solved collectively. So if you can grow, if you can stop making mistakes, and if you can cooperate better across border, we stand a good chance of getting out of this. I think we're going to come back to the whole agenda for sustainable growth because of course it's so relevant to this country. But I just want to start with the last of your important points, which is so many of the problems we face globally, whether it's the kind of instability we're seeing, actually the worst instability, the appalling scenes that we see in the Middle East or in Ukraine, or whether it's climate change.

3:09So many of our problems are global problems where global coordination, global cooperation is essential if we're going to make progress. How worried are you that if President Trump Trump becomes president of the United States after November the 5th, actually, we're just going to be locked into years of perma crisis. So let me shock you by saying we overemphasize who is going to become president in the United States. The reality is that it also depends how Congress looks like. The roomful maneuver for presidents is more limited than we believe. Even in the foreign policy and defense sphere, because they do have enormous amount of personal power in that area.

3:57They do. They do. But if you look at what the fundamental difference between the two candidates would be, they speak less to foreign policy and more to a particular aspect of domestic policy. But even if Vice President Harris is elected, she will face massive problems internationally. and you cited a few, the horrible human suffering that's going on in Gaza, in Lebanon. You talked about the war in Ukraine. We have a war in Sudan. I mean, if you start adding up all these conflicts, they are resulting in tremendous human tragedies. And then you have climate change. Then you have supply chain, something we don't talk enough about.

4:39But every once in a while, we realize how vulnerable we are. These are problems that go way beyond who is in the White House. They require a level of the natural coordination that we haven't seen for a very long time. Also, I mean, these problems, you know, the new ones come and go, but we're always in conflict, aren't we? There's always geopolitics. There's always some part of the world where people are fighting for whatever reason. So that's never going to change, is it? It doesn't feel like we're ever just going to be at a point where it's going to be harmonious. So we're never going to get out of permacrisis, are we?

5:12You're right, Steph. It's a question of magnitude. So for decades, there was a common paradigm that people bought into. It was the ever closer globalization. It was the rule of law. It was international bodies that not only informed outcomes, but influence outcomes. And it was a belief, a wrong belief as it turned out, that the benefits would flow down to the most vulnerable segments of society and the most vulnerable countries. That was a buy-in into an international paradigm. Economists call that, and I know the word is awful, game theory, economists call that a cooperative approach to a common problem.

5:55And economists will tell you, you cannot solve common problems uncooperatively. And we had a structure that ensured a certain level of cooperative agreement. And I can cite the various problems that we were able to deal with. All that started breaking your part in 2008, got worse in 2017, and it's even worse today. So you're right, Steph, there's always a level of conflict. It's the magnitude. And what we have is we no longer have a unifying paradigm that ensures buy-in. Just on that point, and I don't want to sort of overdo the Trump part of the conversation, but he, more than any significant leader of the democratic rich world, has no confidence in those very institutions that we relied upon to produce the cooperation that meant we managed these conflicts better.

6:50So that is why I would say, if Trump is elected, it is a significant and worrying moment. So you're right that he has less trust in multilateralism. You're absolutely right. But he's not the only one. China has less trust in multilateralism today. China believes that the system that exists reflects the world of yesterday and doesn't make enough room for the new powers and the new middle powers of today. India feels the same way. But just on that, Mohamed, they're right, India and China. But they're absolutely right. These institutions do need to be reformed to reflect those important voices. They're absolutely right.

7:26And we had the hope when the G20 was created in 2009, with Gordon Brown here pushing it and President Obama pushing it in the US, we had the hope that you had a different construct that would allow for the reforms of these organizations to make sure they reflect the realities of today and tomorrow. Unfortunately, the G20 has not performed as expected. So what, Mohamed, then do you think, how do we get to that point where we have collaboration? Because I feel like we're describing some utopia that's just we're never going to get to. And for businesses or for organizations trying to navigate through all this, it's like that's never going to happen.

8:03So we've just got to find our own way through it, haven't we? So I'm a little bit more hopeful, Steph. I think recognition is a first important factor. We can look at the case of the UK today. Everybody's talking about growth. People have understood that we need to use the Labour government's phrase, a growth mission, that we need to focus on growth because while growth isn't everything, without growth, you get very little. So there is growing recognition that not only do we have problems, but we also have a set of solutions. Now, there is no Big Bang. This is going to be incremental. There is one other development.

8:40And as a dad of two kids, a 21-year-old and a 28-year-old, I apologize to them every once in a while for the world we're leaving them. We're leaving them with a world of high debt, high inequality, insufficient growth, and a climate crisis. But we're also leaving them with very powerful tools. What is happening in artificial intelligence, what is happening in life sciences, what's happening in sustainable energy. These are serious transformational opportunities that hopefully will allow us to get to a better path. I think ultimately, and you may think I'm too hopeful, I think we are on a very bumpy journey to a better destination.

9:18We just have to navigate the journey better. I love hopeful though. I'm definitely the optimist out of mine and Robert's relationship, I think. Listen, I hate it when you tell me with the badge of pessimist. I'm not a pessimist, I'm a realist. I don't think you can fix problems unless you open your eyes to them. Though the issue of debt, which you just raised, we should remind people that you had this very important role running the world's biggest sort of investor in trader in public sector debt, PIMCO. There is a sort of debate about whether we overstate the seriousness of the debt burden bearing down on the public sectors, the governments of many developed and indeed developing nations.

10:04Are we overstating that issue? Or do you believe, as some economists believe, that this is a mega crisis waiting to happen? Robert, you're going to hate my answer. It's both. If we don't do anything about it, is a mega crisis that's waiting to happen. And it can happen much faster than anybody expect. Just go back to two years ago on the List Trust when the market lost confidence and the pension system almost collapsed. It was unthinkable that within a few days and weeks, the whole UK pension system could collapse. And if it wasn't for the Bank of England's intervention, it would have collapsed.

10:46So we are in a fragile situation. We have more time to fix it if we choose the right solution, because the right solution buys the patience of the market. But just on this, therefore, is the problem the numerator or the denominator? In other words, is it the absolute quantum of debt, or is it the fact that our economies aren't big enough? It's the denominator. So there's four ways to solve a debt problem, the good way and three bad ways. The good way is by growing your economy, by growing the denominator. So that's the denominator, just to remind people, just so that people are listening. Growing the economy means what you're concentrating on is the denominator.

11:22Yeah. Get a second job, and not only can you maintain your standard of living and increase it, but you can pay off your debt. Grow your income is number one. Number two is austerity. We've tried that, and austerity works maybe for six months, but it does not work as a recurring strategic approach. Number three is something else we've tried, is artificially low interest rates. You tax creditors and you subsidize debtors. It distorts all sorts of things in your economy and causes all sorts of vulnerability. You can't rely on that. And then the fourth one is you default, and that has enormous costs.

11:59So if you look at the four ways to solve high debt, growth dominates, and the markets understand that and the market are much more tolerant of governments and companies that pursue growth and use debt to pursue growth than they are of those who simply use debt to pursue day-to-day activities that don't result in higher growth. So do you think what we're hearing then now from our new government in the UK that we are going to get growth? Do you think they're doing the right things? Because I know you've talked about planning reforms and fostering innovation and that type of thing to encourage growth.

12:36Are you hearing that now? Are you feeling optimistic that it will be achievable in the UK? So I go back to what Robert said and I wrote it down here. You have to open your eyes to the problem. The eyes are open. They're wide open. And I think the articulation of the approach in terms of the growth mission is a major step forward. But talk is cheap. Implementation is much, much harder. We're going to have a major tests coming up with the budget. There are very, very difficult choices to be made. They've inherited one of the messiest fiscal situations I've ever come across. And these choices will signal how serious the government is about pursuing economic growth.

13:16So on that, one of the things that we were both shocked by in the run-up to the election campaign, during the election campaign is the extent to which Rachel Reeves, who was then shadow chancellor, simply closed down any suggestion that she should modify her so-called fiscal rules to allow more borrowing for productive investment. Now, it's quite clear to me, I'm sure to you too, that there has been a significant shift since she's become chancellor, significant shift in the treasury. And we are going to get a modification of those rules, which will allow more significant borrowing to fund the kind of productive investment that stands a chance of improving productivity and growth.

14:12If you were designing the system, how would these rules about how much you can borrow for investment, how would you design that system? So I'm one of the people who signed a letter to the Financial Times that's fed into a really big discussion going on that says that the fiscal rules we have today served a good purpose, but they are way past their use-by date. And they're way past their use-by dates in three ways. And this is no different than a parent who uses a simple rule to change behaviors, but once behaviors change, you evolve the rules. So there are three problems with the fiscal rules we have today.

14:52One, you just cite it. It doesn't differentiate enough between what you're spending money for. And that is a huge problem. Second, it imposes artificial time horizons. And these time horizons get in the way of economic logic. And then the third way is definitions. They are partial definitions. They were shortcuts at a time when you just wanted to shock the system into different behavior. Yes, Robert, the time has come to modify the fiscal framework. And I suspect we will see modifications. There will be lots of conversation as to what it is. Watching the budget is like watching a football game with play-by-play analysis.

15:39Every day, something else comes onto the field and then we all pay attention to it. Is it the fiscal rules? Is it which taxes? Is it how big is a black hole? That black hole has varied between 22 and 40 billion. So we're watching a play-by-play analysis and we just have to wait till the 30th of October to get the result. But can I just ask you one question on one of her rules that is as yet lacking quite important detail. So she's got these two rules. One of them, which we know she's going to change, is that the gross value of public sector debt has to be falling as a share of GDP in five years' time.

16:23We know that she's going to modify that to an extent to strip out borrowing for investment. But there is a second rule, which almost nobody focuses on, which is very constraining for her, which says at the moment that, quote, over time, the amount that is spent on day-to-day public expenditure, whether it's wages or welfare, over time that will move towards being totally covered by taxation, that there will be no borrowing to fund day-to-day spending. Rather strikingly, and I'm rather surprised that nobody much has focused on this, she hasn't put a time horizon for getting the so-called current budget into balance.

17:07What is the right time horizon? So that's known as the golden rule, and that actually makes a lot of economic sense. You want to balance your current expenditures with your current revenues in order to give yourself flexibility to respond to crises, to invest in the future drivers of growth. Otherwise, you have a structurally weak budget. It's no different than us. If we are spending more than we're earning on our day-to-day living, if the fridge breaks down, if something happens, we simply will not be able to do it. So that is actually a good rule. And I think this is a rule that will stay in there.

17:47And it's one that economists like a lot. As to what time horizon, it depends on so many other trade-offs. You have to view the budget in its whole. If you start picking little bits, Robert, and I know it's frustrating, nobody will be happy. But the point I'm making is the OBR actually cannot assess the public finances unless it at least is given some guidance about, you know. So in the old days, Gordon Brown used to talk about getting balance over the course of the economic cycle, which was a slightly nebulous approach. But then, you know, essentially you could make an assessment of where we were in the cycle.

18:26Previous government talked about a different kind of balance over five years. She's not actually made a decision about whether it's the cycle or whether it's five years. I'm just really wondering which approach you favor. So I would favor the cycle and I would favor the other thing that Gordon Brown said and is not repeated often enough. Prudence with a purpose. Prudence with a purpose is really important. Yes, we want to be fiscal prudent, but be fiscal prudent in the context of a growth mission. And I think that's important. I think if you go back to 1997, when Gordon Brown came into the Treasury, there's a lot to learn.

19:04And I wish that more of what they did then was done now, including not delaying the budget for a very long time, including having a number of policy announcements ready to go that go beyond simply what they've announced. But it is what it is. The good news is that the government can play catch up at this stage. The big difference though, between then and now, and I've heard you talk about this, Mohamed, is that we don't have the external engine we once had. Brexit means that we don't have the same trade powers. So that's a problem, isn't it? And how do we get that back? Yes, you're absolutely right.

19:42We've lost a very important external engine and our internal engines are exhausted. They're literally exhausted. So what do you do? First, you work very hard to use the prime minister's words to release the brakes on your existing engines. But the second step, which I suspect we're going to hear a lot about, and the investment summit recently focused on it, is you create new engines. And the UK is lagging the US in particular. It's ahead of the rest of Europe, but it's lagging the US in particular in focusing on the engines of tomorrow. And these are really important. And so on that, I mean, Steph and I talk an enormous amount about the potential of artificial intelligence and the industrial revolution we are living through.

20:28I do think both within the public and the private sector, this offers obviously risks, but enormous opportunities to improve productivity. And as an extension of that, therefore, wages and living standards. How can government show the kind of leadership in the rollout of AI through an economy like cows and prevent something that frankly happened with the last digital industrial revolution, which is that almost all the benefits were taken by owners and investors. And actually, it led to widening inequality rather than the kind of productivity-fueled wage growth that we would have wanted. Yeah, you're absolutely right.

21:08That's an issue. I call it the 80-20 problem. AI is 80 % good, 20 % bad. So like anything else, you have to embrace the 80 and the 20 and not just focus on one. So I'll give you an example. The previous revolution, as you called it, everybody focused on the 80. The people leading the revolution believed that they were changing the world and had no idea that what they were doing was systemically important and could be misused, election interference being an example. Governments didn't pay attention to regulation at all. They also fell in love only with the 80. Europe was completely different. Europe got obsessed by the 20, try to over-regulate the 20 and lost sight of the 80.

21:51So the right thing to do, Robert, is as you say, embrace 80-20. So you unleash the 80 and you risk mitigate the 20. And the two elements of the 20 are, one, as you said, you cannot assume that good distributional effects will happen. You actually have to manage that. And second, you have to limit the misuse of these transformational innovations. There is much better appreciation today, not just in governments, but among the companies. They've looked at what happened to Facebook. They've looked at what happened to Google. And they've understood that if you're systemically important, and AI is systemically important, you need to take some responsibility.

22:33And if you look at what DeepMind, this revolution is being led by two companies, OpenAI and DeepMind. DeepMind in particular has been really, really careful. So for example, the thing they were recognized for in the recent Nobel Prize in chemistry is for the helping to decode protein. The engines for doing so is available to everybody at no cost. That's one way of trying to make sure that we don't repeat the mistakes of the past. Isn't part of the problem though that it's the people who understand this the most, the people who know the pros and cons of new technology and AI are not the people in the public sector.

23:16They're not in government. These are all skills in the private sector and there isn't enough. There isn't the skill set there in government to understand this enough. Yeah. I mean, that is an issue, but the answer is not leave it to industry. I heard that argument in 2006 and 2007 when the financial sector was innovating with all these derivatives and the argument was, wow, they're so smart, they can self-regulate. We should have, quote, light touch regulation, light touch regulation, because they're so smart. And it turns out that even smart people can do really stupid things, especially when the motivation is profit.

23:54And the result was a financial crisis that could have led to a multi-year depression. So yes, the public sector is lagging, but there's a need to educate the public sector, because you cannot leave this to the private sector on its own. But just on, therefore, the 20 % of bads that flow from this, and there's one aspect of it that I am obsessed with, which is the extent to which, A, you might lead to quite significant job losses as super powerful AI simply replaces people, or you simply employ relatively unskilled people, give them AI tools, and then pay them minimum wage, simply because even without skills, you give them a bit of training in the use of AI.

24:45They're going to be as good as currently people who've got really quite high levels of skills. How do you make sure if you're a government that AI doesn't lead to massive wage compression and unemployment without doing the kind of interference in the private sector that actually deters the kind of necessary investment that we need in the UK to see rollout. So how do you balance sensible intervention or how do you get sensible intervention that doesn't deter the kind of investment we need? Yeah. And this is a longstanding problem. It's not just an AI problem. Think of the controversy over P &O ferries that has nothing to do with AI, that has to do with working conditions?

25:28And do you try to reset working conditions? Do you not try to reset working conditions? Look, those of us who are looking at AI in terms of the impact of the economy identify two influences on labor. One is labor substitution. You just talked about it. And the other one is labor augmentation, that labor can do even better things with AI on that. And my own assessment, and remember this thing is moving really quickly, but my own assessment is the labor augmentation side far exceeds the labor substitution side. We will have to absolutely keep an eye on those who are adversely impacted. They have to be protected.

26:09But as you say, it's really important not to inadvertently also frustrate the labor augmentation because at the end of the day, if we don't get higher productivity and higher growth, our problems are going to be much worse than what they are now. Still loads more to get through, but let's have a quick break.

26:31We've talked quite a bit about fiscal policy. Can I ask you about monetary policy? Because I've heard you say before that you think we're too reliant on it. And my biggest beef, when I've said this quite a few times on the podcast, when we've been talking to people from the Bank of England and so on, is that how can you control inflation domestically when so many of the inputs to our prices now are international and it's not things you can control by putting up interest rates to stop people having as much disposable income to spend and therefore that brings prices down. But what do you think? So the good news is we're getting out of this phase where monetary policy was, quote, the only game in town.

27:13And I wrote a book called the only game in town back in 2016, worried about what you just said. The reason why we got into the situation, if you go back to the global financial crisis, is that central banks, after they intervened to fix broken financial markets, they looked around and who did they hand off the next task of ensuring high growth? And governments didn't step up. So central banks started being a bridge and they believed they were a bridge to somewhere good. And it ended up, particularly in the United States, where they ended up not being able to hand off to anybody. So they took on more and more responsibilities with very imperfect tools.