By Colin McLean

Economic shocks are undermining long-held views on forecasting and planning.

The Bank of England and other central banks seem unable to understand and forecast inflation, never mind control it. Government tax and economic policies crucially depend on an assumption of economic equilibrium. Without that, in times of turmoil, it is hard to gauge the harm that new policy initiatives might bring. In a volatile financial world, unintended consequences abound, even with the best of intentions. With demands for resilience and sustainability, our understanding of GDP and the meaning of economic growth is challenged. Can we develop government and central bank intervention that actually works? New thinking is needed.

Economics once had clear boundaries. Now, theory is undergoing a sea change – markets and economics can no longer be viewed as independent of national security. The drive for resilience is being integrated into almost every economic decision, both within organisations and government. At a national level, analysing supply needs more attention, rather than just demand. Supply shocks are now a major theme in business and economic planning, and not always solved by market prices. Decades of relative stability created within government and central banks an illusion of control. Now it is clear there are not enough policy tools to fix big external shocks without a lot of pain.

This drive for resilience may need to step up further. The war in Ukraine has sharply increased the divisions between Western and Eastern geopolitical blocs. Russia has effectively weaponised energy and food exports, while the US dollar has moved from world reserve currency to a political tool. This increasing polarisation of the world economy may accelerate; semiconductor manufacture could become another key shortage, depending on how events in Taiwan unfold. Already, France has announced its intention to make its industry more independent of China. The US Treasury Secretary has talked of “friend-shoring”, a world where more resilient supply chains are created to minimise the potential for geopolitically driven disruption. This views trade as politics as much as economics; something that happens primarily between trusted allies.

This fragmentation of the global economy is not helpful for the UK as an open market economy with a heritage of free trading around the world. Certainly, it has a competitive advantage in many areas such as science and technology. But increasing non-tariff barriers will emerge, with competition becoming more opaque. We must re-examine our comparative advantage. As long as the UK needs to import food, energy and many manufactures, it must export. But the new politics of international trade is another hurdle for exports. Even a likely drop in the value of the pound versus the US dollar may not greatly improve the terms of trade.

Innovative solutions must begin with re-examining whether GDP still represents prosperity and growth. The concept has been around since World War 2, but began in a world of confidence in national planning. The focus of GDP on paid goods and services gives misleading precision, yet it fails to capture a lot of unvalued benefit that takes place in a circular economy. And in a world of growing inequalities, a single measure hides crucial information about the distribution of wealth. In the 21st century, policymakers can do better.

As the world begins to recognise the trade-offs between economic efficiency and national security, it is time to reconsider the metrics that drive policy. There is now better understanding of the interplay between economic, human and natural capital – which means that intervention should be more thoughtful and nuanced. Globalisation is unwinding and Scotland’s economy must adapt.

This year’s turmoil has shaken the foundations of economic and public policy, whilst at the same time undermining faith in central banks. In the face of uncertainty over costs, many businesses are simply giving up, unable to forecast or subsidise losses. Radical review of economic policy is now needed.

Colin McLean is managing director of SVM Asset Management