In April, both the stock and bond markets remained calm and stable at the index level. The MSCI World index, measured in euros, went up 0.1% during the month. While the stock markets of Europe and North America experienced marginal gains, the stock markets of developing countries recorded negative performance.
Despite the rising interest rates, companies have managed to withstand the environment surprisingly well, with their turnovers and profits even experiencing nominal growth. Larger companies, leveraging their market power, have successfully increased the prices of their products and services, effectively transferring the impact of rising input costs and labour expenses to consumers. However, the situation is more complicated for small companies.
I am somewhat surprised that several central bankers (Christine Lagarde among others) have accused entrepreneurs of greed, instead of admitting their own past mistakes. Central bankers need to acknowledge that the prolonged policy of ultra-low interest rates was a regrettable mistake, with consequences that are just beginning to surface, including mounting debt burdens, rapid price inflation, and an ensuing unstable economic environment.
Many politicians still refuse to admit the problem
While some central banks have started to curb the inflationary pressures resulting from their previous monetary policies (with the Bank of Japan being one of the few exceptions), a significant number of politicians remain oblivious to the gravity of the problems at hand.
In the autumn of 2022, the international spotlight fell on the previous British government’s populist experiment of overlooking the mounting deficit in the national budget. Fortunately, this experiment remained purely theoretical as, following the British government’s proposal to reduce taxes and resort to borrowing to compensate for diminished budget revenues, government borrowing rates soared to such an extent that Liz Truss’s government deemed it wiser to step down after just 44 days in power. Politicians solely engrossed in domestic political manoeuvres and those who lack an inclination for economic policy likely remained oblivious to this failed attempt.
The mounting problems with public finances are not just a problem for Britain. In the event that Democrats and Republicans in the US Congress fail to reach a consensus on the budget for the upcoming fiscal year, there is a possibility that the nation with the world’s largest and most significant economy could find itself indebted to its creditors.
I have a suspicion that inflation will persist until politicians successfully achieve a balance in national budgets. This is not an easy or quick goal to achieve. Over the past decade, as interest rates remained low and even negative, politicians undertook new borrowing obligations on behalf of their constituents. Now, these loans must be serviced with increasingly higher interest rates. In addition, the increasingly tense geopolitical environment requires higher national defence spending.
Tax increases are becoming inevitable
Despite potential reductions in government spending, taxes are likely to rise globally. Broadly speaking, the options are either to swiftly increase taxes now to achieve budgetary balance or to allow the debt to accumulate and face the prospect of significantly higher taxes later on, potentially leading to a deep recession.
Getting a state’s finances back on the path of long-term sustainability should take priority over a single annual budget. In mid-April, the French government passed a law that raised the retirement age from 62 to 64. It was a difficult and unpopular decision, sparking protest that continues to this day. And yet, considering the long-term perspective, it was unavoidable.
While cuts and tax hikes are never easy or popular, the unsustainable accumulation of the debt burden on future generations cannot continue indefinitely. It is likely wiser to accept the bitter pill now rather than letting problems pile up until creditors compel you to take a triple or quadruple dose in the future.
Fortunately, the budgetary challenges of the Estonian state are much smaller than those of many other countries. But this also poses a danger: by implementing minor tax increases and making some changes, we may inadvertently overlook long-term trends and delay the necessary discussions that society needs to have.
I trust that the need for a long-term budget balance is evident. But why not explore diverse ideas on how fiscal policy could encourage innovation, enhance societal productivity, and optimise the use of existing resources?
To minimise risks, it could be agreed before the discussion that, regardless of the suggested changes, the government’s share in the redistribution of the gross domestic product should not increase. Why not explore the possibility of introducing property taxation as a means to potentially lower income tax?
Furthermore, it would be intriguing to witness a debate on how much a corporate income tax could potentially lower the social tax. What impact would it have on the business environment, and would it foster innovation?
While these are not rhetorical questions, I do not have the answers. No question or idea should be dismissed as foolish. If these inquiries stem from a genuine desire to enhance the efficiency of the organisation of the state and drive societal progress, they deserve at least some deliberation. However, I believe that the slogan “No playing with taxes,” which has been effective for 30 years, has become outdated and is now impeding the progress of the Estonian state. This slogan effectively shielded us from the risk that the state would cover arbitrary expenses with money taken from politically convenient sources. However, over time, the Estonian economy has experienced significant growth and undergone structural changes. The world around us has also changed.
AI as a possible springboard for the economy
Machine learning and artificial intelligence have been topics of discussion for decades, but the launch of ChatGPT for free public testing on 30 November last year has garnered tremendous attention. In just the first week, the programme attracted over a million users.
By now, artificial intelligence has become a compelling investment topic. The sector is expected to experience an average annual growth of about 40% in the coming years, with the global AI market anticipated to reach approximately 1.6 trillion dollars by 2030.
The growth of artificial intelligence has made a significant impact on the US stock markets this year, with the S&P 500 index experiencing a 9% increase since the start of the year. The main driver behind this is an increase in the value of Microsoft, Alphabet, Nvidia, Apple and Meta. If we combine this with the rise in value of approximately 20 smaller companies focused on artificial intelligence, it can be argued that, were it not for the AI boom, the S&P 500 would be in negative territory compared to the beginning of this year.
In my previous monthly newsletters, I have repeatedly expressed my belief that the world economy is unlikely to overcome the continuously escalating debt burden without a significant shock. A favourable scenario could involve a substantial technological upheaval, similar to the industrial revolution of the 18th century, which resulted in an unparalleled boost in labour productivity but also led to extensive and challenging transformations in the social fabric.
Artificial intelligence possesses immense potential to become a transformative technology that will greatly accelerate economic progress and aid in resolving the critical challenges confronting humanity. Most likely, it is merely a matter of time before this emerging technology will reach a level of sophistication capable of accomplishing that.
I am an optimist in the long term and believe in human ingenuity. Nevertheless, I am forced to admit that despite the accumulation of challenges over the past decade, asset prices have continued to rise. In the upcoming years, I believe the emphasis should primarily be on safeguarding capital, while keeping in mind that innovation is what drives life forward.