 Welcome to The Gap, the podcast for enterprise leaders delivering timely insights for today's global economy and tomorrow's competitive advantage. I'm Chris Kane, president of the Center for Global Enterprise, and today we are revisiting a topic we addressed a year ago, global inflation and what decisions CEOs should be making to grow in this economic environment. We are very pleased to have our guests from last year back to provide their perspective on what has happened over the last 12 months and what should CEOs be planning for over the next 12 months. Sam Palmisano, again, will be our guest special host, and he is joined by Kevin Warsh and Michael Spence, both renowned economists and business experts. Governments in central banks have been intensely focused on bringing down inflation over the last year, and progress has seemingly been made. Yet inflation remains higher than policymakers want, and there still is a ways to go to achieve the targets central banks have set around the world. Sam, thank you for piloting today's conversation, and I'll turn it over to you. Chris, well, thank you. And let me also have my welcome to Dr. Spence and Kevin Warsh, a renowned honorary doctorate from many famous schools. I'm actually just teasing you, Kevin, but it's great to have you guys with us this morning. There has been a lot going on, as you mentioned, inflation, but I also think there's been a lot of shifts in the macroeconomic environment. Mike, if you don't mind, would you mind kicking us off from the macroeconomic environment and what you're seeing, and then I'll pass it to Kevin. Perfect. Sam, thank you. It's great to be with you and Kevin and Chris again. So I think the world has changed. The United States now is clearly performing better than any other major economy, with the possible exception of India. The global growth is slowing down, but the magnitude of that slowdown is very different as you move across countries and regions. So US at the top, Europe really struggling, perhaps not surprisingly as the Ukraine war extends itself. And China apparently, although we're a little short of really good data, confronting at least in the short run some pretty major challenges. So I would say until something kicks in, and we'll probably talk about it later, productivity enhancing technologies and so on, I think we're in for a period of certainly for the next 12 months and probably longer than that. There's some pretty difficult macroeconomic conditions. That doesn't mean great companies can't find a way to grow, but this is really a scenario that's on the downside. The good news is, the central banks haven't crashed an economy yet, and the United States economy is producing amazing resilience in response to pretty astonishingly high and rapid rate increases. So maybe that gets a start us in. All right, so thanks. Thank you, Mike. Kevin, want to add to that, please? Sure. So I generally share Mike's views, perhaps a little less sanguine about the state of the US economy, but from a global perspective, the global economy has turned markedly down. I think Mike rightly summarized those that are underperforming and those are outperforming. I'll highlight something which is really more Mike's expertise than mine. If you looked at the changes in global trade over the course of the last nine or 10 months, you would sound much darker about the state of the economy for the next 10 months because we've seen a rapid deterioration in goods that are crossing borders. Much is made of the rivalry between the US and China, but exports, at least if you look in unit terms, if we add prices, the subject of this discussion, get a bit confusing with inflation, but units between and among the largest trading countries in the world are down markedly. And if I were to use any history to judge that, you would say that the turn down in global trade is a very dangerous precursor for what we should expect for a global output over the next year. Thank you for that. And I think I tend to obviously agree with what the data says. I've been reading the trade data as well, Kevin, and I think you're absolutely right. I'd like to just start with Europe. If you guys don't mind, then we'll go to China. I mean, there's a couple ways to think about Europe as I go back through my past. One is as Mike related to, of course, the war in Ukraine doesn't help things and actually probably in the short term just exacerbates it. But I also would comment that I used to refer to Europe as a sclerosis of lack of growth and a lot has to do with the lack of innovation in the economy and their regulatory environment. So I'll just start with you again, Mike. Do you think, because I know you're a scholar in this area and you live in Italy for a long time, do you think that once this war ends that Europe will get to growth or what's going to go back to its usual one or two percent GDP over sustained period of time? No, without substantial structural change, the second is the most likely outcome. You know, if the war ended, we didn't have the headwinds from energy prices. Europe has got a lot of problems. They are competitive when they're competitive in industrial sectors that tend to be carbon intense, right? So they face higher costs. They have a carbon border adjustment tax that protects the domestic markets from their aggressive assault on climate change. They could reverse those policies, but that doesn't help them in the export markets that you and Kevin were just talking about. But beyond that, Europe has retained its decentralized fiscal structure. And Mario Draghi wrote an article, I've actually followed it up with an article that says until they centralize their fiscal situation to the extent that they can heavily fund transformative investments, including public sector ones, in digital technology and a whole bunch of other things that are the platform on which you build future dynamism, they're not going to be able to do that. They don't have mega platforms. They don't have cloud computing systems that can train generative AI systems. They don't have a lot of things. And the only way they can't do this by having member states shoulder those burdens they're over indebted and they don't have the resources nor the incentives, right? So the proposition is not only in the short run is it going to be tough to get out of this, but I think unless there's a big change in the way they approach sort of economic management at that level, at the fiscal level, it'll be hard for them to reproduce anything like the American performance, notwithstanding the enormous potential sides of the market. And Mike, I would just add to that, you know, compounded building on that thought, I want to pass to Kevin the transition, their labor practices and labor policies don't lend themselves to an innovation economy. I mean, PhDs that you require in multiple double E's and master's and all those things that you require for this innovative based economy, even before generative AI, don't want to be unionized and don't want to be part of one of their various union structures. And I've made this argument to many of their leaders in the past and obviously it fell on deaf ears, but I'll pass this down to Kevin. Kevin, do you have an observation in Europe and then I'm going to jump to China? I can't do better than Mike as normal, but I'll highlight a couple other things as the US and China are separating their economies for better for worse by hooker by crook. Many in Europe thought that they could find a third way they could figure out a way to do business with both. I think that that hypothesis looks harder and harder to manage. But I were to think about how European growth was OK, at least by European standards of the last decade or so. I would say that's because they were relying on three things. They were reliant on Russia for their oil, the US for its security and China for its exports. Well, those three things don't sound too good if we look forward to the next five or 10 years. So if there were a necessary catalyst for reform in the broad conduct of economic policy here, I can think of no better than these shocks and apps in a massive change in productivity. I think that Europe will be problematic. Now, if I were just to highlight one final point, Mike's done more and better work on this subject than anyone, so I hesitate to trot on this ground. But if we were to break the European economy into its product economy and its services economy, something remarkable has happened in the post COVID realm, which is tourism, which was seasonal and cyclical and certainly favored certain parts of Europe better than others. Well, the boom in services is a boom in tourism and travel and almost all members of the European Union have seen a surge in that sector. If by rough measures, Michael correct me, certain countries in Europe were getting 13 or 14% of GDP effectively in tourism broadly defined, and that number were to move up a few percentage points on a sustained and permanent basis. Then there is some sort of new future for Europe. It's not a productivity export oriented future, but it is something and, you know, as one wag said recently, Europe was the home of a great civilization. The question is whether it will now be a museum of a great civilization. Interesting Kevin, you made these points on China, and I like the pivot or build them out a little bit because it really does impact exports as you guys know better than I looking at the data exports from China are way down. And certainly that has to do with the global economy, which we can all understand. But also I think there's also some reaction to policy that policies that have occurred in China that maybe make a lot of their sectors that were very innovative and growing have now been slowed down for whatever sets of reasons. Michael start with you. I know you're also an expert in China, and then we'll go to Kevin. How much of this you think is just the global economy and slowing down? And how much is the fact that the government centralized all economic decision making to the very top? So I think it's more the second salmon. I mean, there's really three things going on. The global environment is inhospitable in general, and particularly in the area of the trade corrections. Second China has a bunch of imbalances that are kind of short to medium run challenges. They're not unmanageable, but they're not easy. The real estate system over indebted real estate sector is big enough that it couldn't really produce major damage in the short run. And there are other factors. But the reason I agree with you on it on the second is that when you look beneath the kind of China is the only country that's in deflationary mode right now, only major economy. And so how did they get there? This takes more words than we have time for here, but it's a loss of confidence. The consumers have lost confidence and they're sort of minding their own business or reducing their mortgages and not spending. And the business sector, especially the so-called private sector, has lost confidence, isn't investing and has decided they're not sure what their place in the sun is. And it's true. The government, meaning mainly the Communist Party, is an increasingly intrusive presence, as you said, Sam, in the private sector. And they're both with respect to these important internal stakeholders, consumers, etc., and investors, including companies, they're doing a terrible job of communicating about where they're going, what the endpoint is. So the external investors are scared, even though the size of the market makes it attractive, and the internal investors are holding onto their wallets. And I think the long-term outlook for China, the short-term outlook is just tough, because they've got to solve these problems that we just talked about. But the longer-term outlook, I think, depends entirely on whether they can restore the kind of confidence and optimism and dynamism that drove the economy for so many years. Kevin, you want to add to that? It is easy for Europe to blame their problems on the Russian invasion of Ukraine. It is easy in China to blame this on the growing trade wars with the United States. But Mike and I got involved in economics and policy and thinking about these things for the last several decades, because we think policy matters. These things are not outside the realm of decision-making by economic and political leaders to change the course of the economy of their countries. And the confidence shortfall by decision-makers at the household sector in the business sector in China is the number one debilitating factor in the Chinese economy. Productivity is down, investment is down, and confidence is down because of a loss of confidence that the future will be better than today. That is within the capability of Chinese policy leaders to change that. But once you've lost confidence, it's harder and harder to get it back. And I think in some sense, there are calls from the West, including peers of Mike's in mind. Oh, what the PBOC needs to do now is just cut some interest rates. So what the government needs to do is have a big bang spending plan. But those things don't work unless the recipients of that largesse are prepared to get on their front foot. And so it means that the challenges they have are harder and not so easily fixable. And if Mike and I are right, the broad trajectory and the near term for the global economy is as risky and as filled with risks to the downside, as we said at the outset, then there's a bigger obligation on Chinese policymakers to get the country on the right path. Demographics are no longer their friends. Easy fruits of joining the frontier on productivity have largely already been taken. And so this will require regime change and economic policy. And, you know, most of us in the West are rooting against China's domestic success. But the real question now will be whether the economic weakness has not just economic fallout, but geopolitical fallout. Yeah. Well, guys, thank you. And I'm going to pivot a little bit because as you know, many of our listeners are running global companies and their revenues are distributed around the world. And obviously, if you're mostly in the U.S. and mostly domiciled there, maybe you're a retailer would have you or healthcare. You know, that's one side of our economy. But the other side is really driven by something I know quite well, the tech industry, which is predominantly outside the United States. And you were heavily dependent upon both Europe and Asia for China being the driver of growth to the growth in Asia. Now, India, of course, is stepping up, but that's more recent than in the past. So now if we're running a company that will put the three of us in charge, you guys can be the board members. I'll be the operating partner in this relationship. What would you advise our colleagues to do, given the fact that they're going to be under revenue pressures? That could be for the majority of the revenue streams. If I go to the parallel of an IBM, that was more than 60-some percent of our revenues. And can you offset that with productivity in the next two or three years? So what strategic advice would you all give to our colleagues? So Kevin, we'll switch the order and just start with you, because I know you're on a bunch of boards as is Mike. And I'm wondering what you're saying to those leaderships. You don't have to give us anything that's inside information. Well, good. I appreciate that. And I like going before Mike because he's savvier on these subjects. And this way he can gently correct me for the record and for the time. So I would say for most of U.S. multinationals and large globally integrated companies, for all that Mike and I over the last year or two have talked about the trouble with inflation, the debilitating effect inflation has on household confidence, the harm it does to take home pay. This marked move up in nominal prices has given many companies or living in a nominal world an ability to raise prices at levels they didn't expect and frankly to expand margins if they had an opportunity to do so. And so the surge up in inflation wasn't altogether bad for at least leaders and corporate American around the world. Well, because quite belatedly, the world central banks decided that inflation was a problem and it was something that they could control. We've seen the largest tightening in monetary policy in the U.S. that we'd seen in generations. Much less tightening, but still some tightening overseas and those policies have worked inflation is a choice. The world central banks chose to bring inflation down and it's falling. And while I believe that is absolutely a good thing for the U.S. and the global economy, I think we're entering what I describe as a new period of price instability. The world's companies will not know what the new level of changes in nominal prices will be over the next several years. But they've quickly figured out they do not have the ability to raise top line growth at the rate of change they've done in the last several years. And while Wall Street, Sam, is enthused at the idea that corporate profits now have somehow bottomed in the second quarter, I'm somewhat more doubtful. I think most companies are going to continue to be under margin pressure and profit pressure certainly over the course of the next several quarters. And so the general advice that guys like Mike and I could give will be different with individual companies, but I think it's going to get tougher and harder to drive the kind of margins. Never mind the top line growth that they brought accustomed. And this is what, where I'll leave it for Mike, this is why a productivity surge, prudent investment in driving productivity over the next several years is more important than figuring out how to make your year end profit goal this year. Mike? No, that's excellent. I've got nothing, certainly nothing by way of disagreement to add to that. Sam on that, on just complimenting what Kevin said, I think it is a tougher environment. I'm a little, maybe a kind of uncertain about how much pricing power companies are going to be heading into, but I definitely think Kevin's caution is right. You know, for companies that are exposed to slowing down economies, is there any place to hide in the sense of a complete, you know, shelter? I don't think so. You know, if you're heavily invested in China and something and they spring one of their negative surprises and shut the yet another sector or something down. There doesn't seem to me any way to protect yourself completely from that. And but I do completely agree with Kevin that focusing on cost containment, on efficiency, on leveraging technology, on productivity is the best possible way to sort of orient oneself strategically for the next few years. No, I completely agree. If I go back to my previous life, I used to say, and maybe some of you people heard me say this because I said it publicly, we could offset Europe or we could offset Asia from an IBM perspective that we're delivering our financial results, but we could not offset both. There was no way that we could have covered downward pressure from both of those large economic environments. And so now we were fortunate because at least in my tenure, we never had to really do that. We always had quite honestly Asia and that would be India and China mostly offsetting the issues we might have had in southern Europe, especially. So fundamentally, that was always in balance, but that would be extremely complex. Getting to the productivity environment, there's incredible excitement around this thing called generative AI and the productivity that that could result them. My question is that as exciting as the technology is, in my experience, most of our colleagues running companies today have very little experience in how to drive productivity through these technologies. So but I could be completely wrong other than there's tons of excitement about the technologies. There's no doubt about it. And clearly, I believe that's going to impact individuals and consumers, but maybe perhaps the lift for enterprise could be a little tougher, but I could be completely wrong. So let me turn it back to our colleagues and see what their view or observations are. Let's go to Kevin first again. So I share your instincts and that the AI revolution is probably overhyped in the near term. But this might sound nuts in light of the abolience. It might be underhyped in terms of what this means to the world a decade from now. There's certain amazing advantages that we get from every surge in technology. And whenever we do, we hear the same story. Well, that's going to put the labor force out of a job. It hasn't proven true to this point, and I will take the make the bet that it won't proven true on this cycle either. The key, of course, as we talked about before is the educational system needs to keep up as technology continues to move forward. So if there was a dismal, dismal forecast here, it says that the emphasis needs to be making sure that workers continue to be trained, especially K through 12 education. They're able to take advantage of this technology. What I find particularly exciting about generative AI is it can make every worker more productive. Most of us had grown up in a time where the greatest baseball player, the best concert pianist, the best trader, extracted huge amounts of gains from the world we were in. What's remarkable about this surge in technology is virtually everybody in the employee stack should be made better. It's not just the top 1% that should be made better by this technology. Let's say you're in the bottom half of the productivity curve in your job sitting around an office or on a factory line. The new technology should make you a lot better, should make your skills that much more productive. And so I tend to be of the view that this can be massively productivity enhancing to consumers. They're already getting some of the benefits of it. As far as I can tell at the business enterprise side, at least writ large, they're signing up for the newest tools. They're asking for the latest co-pilot. But generating massive gains in profitability and productivity at the near term is going to be harder because we're going to have to figure out what to do with this technology. I'll end with a final piece, which again goes back to scholarship Mike had written a couple of decades ago. It's not the advent of the technology which drives the productivity. It's the know-how that comes along with it and then know-how becomes difficult to figure out in the near term, but can fundamentally change the productive capacity of the economy. And so I'll just summarize this before turning to Mike with it's easy to be pessimistic about the U.S. and the global economy over the next year. And I frankly share much of that pessimism. I hardly think it's the right policy for the U.S. to try to adopt command and control structures and industrial policy which are failing in most of the rest of the world, but we seem to do it. So it's easy to be troubled there, but I do think that what looked like darkness in 1980 and 81 turned out to be a productivity miracle that came through during the Reagan and Clinton administrations that established a higher productivity, higher efficiency for the economies in the U.S. that were then mirrored around the world. We could be in the early innings of a massive expansion of the supply side of the global economy, which will bring fruits to workers in the U.S. and everywhere. But I'd say it's the very earlier innings and I would be surprised if we weren't subject to a very tough global recession between the moment we're in now and that optimistic future sometime from. Right, Mike is very well said, you know, I think Kevin's absolutely right. First of all, to sort of get straight on the time horizon. So we're in the early innings. You know, there's going to be lots of exploration and experimentation, but it's not going to show at least my version of Kevin's 10 years from now is the second half of this decade will start to really see it on the general proposition. Does it have the potential to produce this productivity surge where you define productivity broadly, scientific research, biomedical research, quality of health care, properly measured, etc. I think the answer is clearly yes. Generative AI is at least two characteristics that distinguish it from everything that's come before it. One is it domain switches. You can talk to it about anything. You can use it as a platform to build highly specialized valuable use cases. And the other one is you don't need technical training to use it. You may need a little tutoring to know how to sort of formulate queries or prompts. But it's just when I look at it, it looks to me like its potential is literally covers the entire economy. So I think we're going to see the powerful digital assistant model. We'll have a bit of a bias in terms of the full automation model that we need to resist if we're not going to tip in the direction of replacing people as opposed to enhancing their productivity. And I think we can do that. I have one other thing I want to add to this, but I think the potential is just enormous. Does anybody have a complete map of it at this point? No. I mean, it's going to take hundreds of thousands of smart people and companies figuring it out over time. We both discussed this. It's not just people. It's all systems. Generative AI looks like it's going to increase the transparency and efficiency of global supply chains. Something we'll probably talk about in Dubai and so on. So we tend to think of it in terms of people and jobs and stuff like that, but it's much better than that. Some of the AI people call this ambient intelligence. It's basically you take systems that are opaque and equip them with this incredibly powerful ability to understand and dissect a system and then deliver back actionable stuff for the managers and the people who are operating in it. I want to say one final word about the policy agenda. There's two aspects of the regulatory agenda. One is limiting downside risks and damage, and it's a perfectly legitimate part. The other part is we need programs and supporting activity to make sure that this gets diffused as widely as possible. McKinsey Global Institute has documented in previous rounds of digitalization, the tech sector and finance and a few others ran ahead and a whole bunch of others stayed behind. This applies to sectors and companies and if we're going to get the full productivity potential, we don't want to repeat that kind of pattern of dispersion. And so I think that the right way to sort of think about this is rebalance the regulatory agenda sure with the risk mitigation and preventing the negative stuff as prominent, but not the exclusion of worrying about how are the small, medium-sized businesses, et cetera, going to play in this game, not tomorrow, but over time. Well, Mike, I completely agree with you and I'll just build on that point. I think we've learned over time if you take the European model, which is heavily regulated, and therefore you look at the impact of the economy from a productivity perspective or from a CEO's perspective, the growth opportunity. It's obviously a lot less than the environments like the U.S. where you had frameworks and you had flexible structures and policy. Now, of course, that wasn't always perfect, but it allowed innovation to occur and accelerated deployment. And I totally agree with you that the guys who gained in the past got the digitalization of the internet were primarily in the financial and the tech sector. And I do think that, and I would make the point to our colleagues in Washington, they need to broaden the people that they're working with because they're limiting those meetings to predominantly tech and a little bit of finance and they're leaving out the rest of the economy, but not that they'll ever listen to me, but it's a suggestion I think we all should make. Now, having said that, I'm going to try to put you guys on the spot by asking you for a forecast. Given the environment of the economy slowing globally and interest rates staying high, if we look at another year from now we got together, where do you think inflation will be? So, since Kevin's the markets guy and he likes going first, I think maybe we'll start with him, right, Mike? This is the one I didn't want to go to first. I wanted to hear Mike's view and I want to improvise simply from that. I think that the global economy is in bad shape. I think the idea that somehow the US would be in Alan Greenspan's famous words a couple of decades ago, an oasis of prosperity when the rest of the world was falling fast is hard for me to believe. More broadly, I see a household in a business sector that are increasingly cautious, but GDP looks good because not only do we have massive government spending, but we have business investment, which is largely subsidized by the federal government itself. When in terms of inflation forecast, I think the World Central Bank should take credit. They have raised the policy rate in the US to a level higher than the inflation rate, and lo and behold, inflation has fallen. I worry, however, that they think in the US that it really was just transitory, that it just took a while for the supply chains to work themselves out, and I worry that there are serious intellectual errors in the conduct of monetary policy that's really responsible for inflation. Even though the rate of inflation in the US has come down, the cumulative price increase in the basket of goods that American citizens would have bought now versus a few years ago are up about 20%, and I think that partly describes why they are so dour about the state of the economy and their own individual prospects. Kevin, thank you. Mike, you want to give us maybe a little rosier perspective on inflation? A slightly different view, maybe less skeptical view on the government investment. There's no question that we're stretching things fiscally. I completely agree with that. If these investments, whether they're done through subsidies or whatever, do not produce longer-term benefits in terms of innovation, productivity, and growth, then they will have been wasted and will be in the soup. Apropos our previous discussion, that's where we hope to go with the American economy and the lead. I think complimentary comments. I think Kevin's right. I just talked to innumerable people that live in his world, mainly, who sort of thought, gee, we've got a tough inflation fight. They weren't really sure why we had it, but when we won it, we'd go back to the world we were living in before. I think the chances of that are zero. This is a fundamentally differently configured world in terms of the supply side. What I think that means is that until that changes, whether it's a productivity surge or something else, and as long as spending and investment holds up reasonably well, there'll always be an inflation threat of a type that we didn't have for 30 years, because the supply side was so elastic. I think when I look out a year, I think they'll continue to get inflation under control, hopefully with a relatively soft glide path for at least the American economy. But I think for the well past next year, when we look at it, we'll find inflation's a little better. The costs of capital are going to be higher for longer and probably persistently higher, and that's a major change in the environment that we're operating in. Higher costs of capital mean something. For businesses, they also mean something for the federal government and a whole lot of other sectors. So I guess where I am is I'm not worried about inflation now that they're on that, even as they arrived late on the game. But what I keep trying to emphasize is we're not going back to where we were. There's just too many things from aging, the labor market behavior, to geopolitical tensions, to expensive diversification that have fundamentally changed the supply side. And I just can't imagine that's the right thing. So higher costs of capital is what I would add, Kevin. Let me put on my corporate hat again, and my CEO, and just kind of summarize if I was, and I agree with everything you guys were saying quite honestly. But basically, what I would be thinking, you'd have to be ampidectors, as I used to say, which means you have to tighten the belt as tight as you can in this environment. But at the same time, you have to reallocate the capital, assuming a higher hurdle rate for the future productivity initiatives. Now, there's a challenge in that because of the cycle time associated with the learning that's required to deploy these wonderful technologies. I mean, it's called pilots and use cases if you use the layman's terms, but you have to learn and experiment. But at the same time as you're investing, your hurdle rate has gone up. So I think the ability to buy your way out of this, if you have the balance sheet and the cash flow to do acquisitions, it's going to be a little complicated if you actually put on your shareholder hat. So I guess the net of it is tighten as much as you can. I completely agree. Give yourself financial flexibility. But think about organic before you get to acquisitive. So thank you guys. I mean, I think it's been a wonderful discussion. And with that, I'll pass it back to our president, Chris Kane. Thank you, Sam, Kevin and Mike for returning to us today to talk about this really important critical topic for CEOs. We really appreciate you giving us your insights once again. I would encourage our listeners to replay get episode number eight. So as to have the full context for today's discussion, it was the discussion we had 12 months ago. You've been listening to the get sponsored by the Center for Global Enterprise, celebrating 10 years of convening global enterprise leaders around the most important business transformation issues.