Fasten your seatbelt: making sense of a new economic era

There’s a new game in town

We have entered a new economic era; one with rules that are very different to the last.  Things that have been disdained in recent decades are back on the table, including conflict, sanctions, industry policy, tariffs and restrictions on investment and exports.  This is a deep structural change, not a temporary Trump phenomenon — as some would like to think. 

Markets still appear to be underestimating the depth of the change and the likelihood of further shocks.  Much of the market volatility we have seen in 2025 can be traced back to these underlying forces (Chart 1).  The current US-China frictions are a case in point.  China and the US aren’t negotiating a typical trade deal; they are flexing their economic and strategic muscle as part of a contest for long-term supremacy.  

The party is over, back to reality

Geopolitics is the main driver of this new economic era — we have seen a fundamental breakdown of trust between the major countries of the world.  The last economic era was underpinned by a high degree of geopolitical stability and trust between key players.  This stability paved the way for a rapid increase in trade, more integrated supply chains, adoption of just-in-time operations, deregulation and financial liberalisation.

Cross-border capital flows jumped sharply, manufacturing was outsourced to developing countries — boosting services — and countries spent less on defence, freeing up resources for other national priorities (Chart 2).  

The US (and the rest of the G7) controlled the key economic institutions that underpinned the smooth operation of the global economy and financial markets — effectively setting the ‘rules of the game’.

This underwrote a period of strong and stable growth from the mid-1980s through to the GFC, known as ‘The Great Moderation’ (Chart 3).  In 2004, former Fed Chair Ben Bernanke noted “one of the most striking features of the economic landscape over the past 20 years or so has been a substantial decline in macroeconomic volatility (here).

That was the era that most investors and business leaders cut their teeth in.

Today, the world looks very different.  Trust has been eroded.  We face a multipolar world order, with the two largest countries in the world in open strategic competition.  There is war in Europe and a growing threat of conflict in the South China Sea.  Economic institutions have become battlegrounds for influence and trade is being weaponised.

Assumptions that China would continue pursuing economic reform as it became more integrated into the global economy proved naive.  Instead, China has adopted a more assertive posture — seeking to dominate strategic sectors, using economic coercion to achieve its political aims and openly fostering closer ties with Russia, Iran and North Korea (CRINK).

COVID showed that critical supply chains were more fragile than countries had realised.  It also confirmed that when the chips are down, countries look after themselves first (think vaccines).  Russia’s invasion of Ukraine hammered home the point, shifting European attitudes overnight, as their reliance on gas was exposed and the threat of conflict became real.

This contested geopolitical landscape is driving major changes in the global economy.  Globalisation has stalled (Chart 4), a massive defence uplift is underway, and there is a rapid (and costly) push to rebuild sovereign manufacturing capability in advanced countries. 

But that is not the end of the story.  Importantly, this change comes just as the global economy is facing three other historic transitions.

Who wins the race to net zero

The global move towards net zero may have lost some momentum with the election of President Trump, but it is not going away.  A massive investment task still lies ahead to deliver new energy systems and redesign industrial, business and household processes.  According to the IEA (here), clean-energy investment needs to lift to ~US$4.5trn per year by the early 2030s, from ~US$1.8trn in 2023 (Chart 5).

In the long run (i.e. ~ 2050), this should spark new tech innovations and deliver more diverse low-cost energy.  But the transition to this point will be messy.  Most notably, energy security and reliability will be sorely tested, bringing with it the risk of higher power prices for consumers and industry.  This will make it harder to maintain community support for the tough steps needed to drive the transformation at scale.

Net zero has also sparked a classic ‘first mover’ race globally, as countries seek to dominate new green industries and capture the benefits.  There has been a surge in the number of new green subsidies and trade measures.  It is early days, but carbon border adjustment measures will also become far more prevalent, as those taking early and strong action on climate try to prevent laggards from ‘free riding’ and hollowing out their industries.

Riding the AI and technology wave

Another major transition is the wave of new technology sweeping through the global economy, led by AI and machine learning.  This, along with emerging technologies such as quantum computing, robotics, biotech and genomics, is rapidly changing the business landscape. 

Classic economic questions are being asked about the impact of this new technology on overall productivity and the risk of mass job displacement in established industries.  There is a general consensus that AI will deliver a sizeable productivity uplift.  The OECD (here) suggests this could be in the range of 0.4-0.9 pp/yr, depending on adoption rates. 

Job displacement is harder to measure, and estimates vary wildly.  Most job classes will be affected in some way by AI, but suggestions of mass unemployment appear alarmist.  In our view, evolution is more likely than revolution, but there is still a lot of water to go under the bridge.

The tech revolution is also spilling into the national security realm, impacting other markets such as critical minerals.  The US and China are fighting for tech supremacy, for both economic and military reasons.  This is driving a raft of new tech restrictions (e.g. chips) that could ultimately bifurcate markets for critical hardware and software.  The US ban on the sale of ‘connected vehicles’ that use Chinese components is an example. 

Cyber warfare is also becoming more sophisticated and a growing threat (and cost) for governments and businesses.  We expect this trend to accelerate, especially as quantum computing moves forward.

Preparing for population decline

Finally, we are in the early stages of a major demographic shift as the world ages, and more countries deal with absolute population declines.  This gets less public attention, but the impacts will still be far-reaching. 

According to the UN, ~63 countries have already passed their population peak, including China, Japan, Germany, Italy, Spain, Greece, Russia, and South Korea (Chart 6).  Many more will be in population decline by 2035.  And fertility rates are below replacement in most advanced countries.  In this new economic era, most population growth will be in Africa. 

China faces a particularly acute demographic challenge.  The UN projects that China’s population will shrink by 130 million people by 2050 (Chart 7).  This is one of the reasons why China is so focussed on the application of robotics and automation, to replace its current abundant low-cost labour.

Population decline will continue to drag down long-term potential growth rates across the major economies, put greater pressure on fiscal positions (as dependency rates rise and older households dissave), and drive more intense competition for skilled and unskilled migration. 

Changing demographics will continue to test the compact between young and old (as illustrated by the housing and superannuation debates in Australia) and lift demand for aged, medical and pharmaceutical services. 

A huge wealth transfer is also underway as Baby Boomers pass on their wealth.  In Australia, the Productivity Commission (here) cited research that around $3.5trn in assets will change hands by ~2050, with the annual value of inheritances roughly quadrupling by 2050 in real terms. 

Putting it all together

The new economic era will be shaped by these four structural changes (see Table 1).  Individually, all represent a significant departure from business as usual, but it is the combination of these changes that matters most.

Trying to predict the future a long way out is always fraught, but given these underlying trends, some broad conclusions can safely be drawn.

First, we expect a sustained increase in the level of economic and market volatility, especially when compared with the relative calm of the Great Moderation.  Black Swan (low probability-high consequence) events are more likely now than in the past few decades.  This places a premium on diversification, hedging and other forms of insurance against shocks. 

So far, markets appear to be underestimating the risks.  Even prior to the latest round of US-China trade frictions, we had been flagging the potential for further breakdowns in the relationship, leading to higher tariffs and more market volatility.  This was despite markets taking an optimistic view of the risks since the post-Liberation Day tariff backdown (Chart 8). 

It is true that both countries face major economic costs if events go too far, so they will look for off-ramps where possible.  But investors shouldn’t lose sight of the fact that there is a far bigger game at play here that goes well beyond a standard trade negotiation.  This is a long fight for strategic power; it is not primarily about short-term economics. 

And sitting behind it all is the looming risk of a conflict in the South China Sea.  This is by no means assured, but equally, it should not be ruled out.

Second, globalisation is firmly stuck in reverse gear.  In this new era, we expect more trade and investment restrictions, along with more regulation.  The push for economic security and supply chain resilience is driving much of this, but net zero is also a key factor. 

Some of these restrictions are warranted, given the new risk environment and the need to take out insurance against coercion or shocks.  The critical minerals market is clearly too concentrated, and a heavy-handed market intervention will be necessary to break China’s stranglehold.  Every time China threatens to restrict access, it just accelerates this process.  At the same time, a lot of the new regulation is just old-fashioned protectionism, hiding behind the banner of economic security or net zero.

We can also expect to see more ‘blurring of the lines’ between the public and private sector across Western countries, with tighter state-business coordination.  Governments are already being drawn more into energy, technology and green industries, including through direct investment.  The use of ‘national champions’ to exert strategic influence will also increase, akin to the model long used across East-Asia (e.g. ‘Japan Inc’).

Whatever the form or the justification, more trade barriers and regulation is a net negative for growth — putting more ‘sand in the gears’ of the global economy.  Put another way, the economic benefits that flowed from globalisation will be significantly reduced in this new era.  This means less efficiency, higher prices and lower real incomes.

Third, these structural drivers should see a significant lift in the overall level of investment over coming decades.  This, along with more pressure on government budgets (see below), will shift the savings/investment balance and put upward pressure on the neutral interest rate (R*), reversing the trend over recent decades (Chart 9).  Trend Saunders and Harry Ottley recently reviewed our estimates of neutral here.

As outlined above, the net zero transition requires a huge up-lift in physical investment.  AI also requires major new investments in data centres and supporting energy infrastructure.  In addition, the heightened risk of conflict is driving more  defence investment.  NATO commitments to increase spending to 5% of GDP are a game-changer, even if the roll-out of this spending will be slower than planned (Chart 10).

There is also a broad push to rebuild domestic manufacturing capability across Western countries, as they lose trust in supply chains and fight for emerging green industries.  Much of this will fall away over time as new trusted supply chains form up, but we could still see some reversal in the long-term decline in manufacturing (Chart 11).

Fourth, public debt levels will face growing structural pressure.  An older age profile will drive higher levels of public spending on health and aged care.  Smaller working age populations and higher dependency ratios will also mean the tax burden falls on an ever-smaller group (Chart 12).

The investment into net zero and defence will heavily impact public balance sheets.  The NATO defence commitment alone implies an increase in structural spending of 2-3% of GDP for most affected countries.

It is hard to see governments building a consensus around difficult budget repair measures, given the backdrop of rising community expectations, a more polarised society, and increased pressure on the intergenerational compact.  Governments are more likely to dodge the problem until forced to take tougher measures by bond markets.

The combination of lower productivity, more protectionism, growing fiscal pressure and the switch in the savings/investment balance all points in the direction of greater structural inflation pressures and more volatility.  This means that term premiums in the bond market (and eventually equity markets) will likely rise over time (Chart 13).

A silver lining to this rain cloud?

The above paints a gloomy picture.  It suggests this new economic era will be more dangerous, more uncertain, with lower productivity and economic growth, and higher interest rates, relative to the last few decades.

However, there are also clear positives.  The combination of AI and other new technologies, along with the move towards net zero, has the capacity to generate a major boost to global productivity.  If this does come to fruition, it will help to offset many of the negatives outlined above. 

Higher productivity can offset the drag from increased trade barriers and regulation and materially boost government revenue.  New technology has the potential to dramatically cut the cost of the net zero transition for governments, businesses and consumers.  And, as in China, robotics and automation can help to solve many of the challenges thrown up by an ageing population and smaller working age populations.

What technology can’t solve, is the breakdown in trust in the global economy, so geopolitical tension and volatility will remain high.

Future notes will dive into different aspects of these four major transitions in more detail.

Note

This report is not investment research and nor does it purport to make any recommendations. Rather, it is for informational purposes only and is not to be relied upon for any investment purposes.

This report has been prepared without taking into account your objectives, financial situation (including your capacity to bear loss), knowledge, experience or needs. It is not to be construed as an act of solicitation, or an offer to buy or sell any financial products, or as a recommendation and/or investment advice. You should not act on the information contained in this report. To the extent that you choose to make any investment decision after reading this report you should not rely on it but consider its appropriateness and suitability to your own objectives, financial situation and needs, and, if appropriate, seek professional or independent financial advice, including tax and legal advice.