Paper wealth or wealth based on productivity – what happens next? 

For two decades, the global balance sheet – the sum of all the assets and liabilities in the global economy and therefore probably the best measurement of the global store of value – expanded continuously.

Its rise was far faster than gross domestic product (GDP), and during this period of soaring “wealth on paper”, productivity growth slowed and investment dwindled against a backdrop of low interest rates.

Does this disconnect between wealth and the real economy – stretched to the point of breaking – give cause for concern? Or could there be an opportunity for a new golden age of productivity? It all depends on what happens next.

New McKinsey Global Institute (MGI) research modelled four plausible economic and balance sheet scenarios to 2030. These were: return to past era, higher for longer, balance sheet reset and productivity acceleration.

Only one of the four entails a return to soaring asset prices (and debt). A small minority of executives surveyed by McKinsey put their money on this possibility. Two other alternative scenarios are less attractive and could lead to a shrinking of wealth in real terms for the first time in a long time.

Yet a reasonable slice of opinion believes that it is possible that a productivity acceleration scenario is the most likely. Of the four scenarios, this is the only one that delivers robust GDP growth, rising wealth and a healthier balance sheet.

With interest rates and inflation elevated, and signs of financial stress in many places, there doesn’t seem much to cheer. But if a change is coming, the relationship between wealth and the real economy is restored, and productivity growth quickens, optimism could be justified.

Let’s look back over what were highly unusual decades. Over the past 20 years, asset price inflation created about $160 trillion in wealth on paper. Every $1 of investment generated $1.90 in debt. During this period, growth was sluggish, and inequality rose. Productivity growth in G-7 countries fell from 1.8% a year between 1980 and 2000 to 0.8% from 2000 to 2018.

The 2008 global financial crisis was a sharp reminder that the real economy needs to keep pace with financial expansion. But the financial woes that bubbled to the surface needed to be addressed. More debt was added to the system, propelling asset prices higher – and all to solve a crisis that had emanated from an asset bubble and excessive debt.

During the pandemic – a very different type of crisis – the bifurcation between the financial economy and the real economy widened again. In 2020 and 2021, the intense first two years of the pandemic, global wealth relative to GDP grew faster than in any other two-year period in the past 90 years. The creation of new debt accelerated to $3.40 for each $1.00 in net investment. Commercial and central banks minted $39 trillion in new currency and deposits.

There is a danger that the same record is played on repeat. But there is an alternative. A productivity acceleration scenario would deliver US households alone an extra $11 trillion in real wealth to 2030.

In contrast, our research shows that US households would lose $8 trillion in real terms if monetary and fiscal support allow elevated inflation to persist and eat into their savings; and as much as $31 trillion if, on the other side, too much tightening triggers a reset in the global balance sheet with significant asset corrections and drawn-out deleveraging.

Raising productivity – a goal that has proved elusive in the era of finance – is clearly the path that should be pursued vigorously. That requires, above all, that savings flow into productive investment, and that adoption of digital technologies broadens and accelerates. There may well now be tail winds for both these efforts.

Weak investment and excess saving have prevailed for several decades, underpinning expansion of the global balance sheet. There was a relative paucity of productive options for savers, and the price of existing homes and shares duly rose as debt was used to fund transactions rather than capital formation.

But it is possible that the structural forces behind high savings and weak investment may shift. It is possible that productivity growth could be fuelled by capital deepening – growth in capital stock per worker. Indeed, counterintuitive though it may sound, high inflation and interest rates may be a huge incentive for such deepening.

On savings, ageing populations may lead to a shift from saving for retirement to spending in retirement. If labour markets remain tight, workers’ bargaining power could rise. On investment, in the United States at least decades of underinvestment in infrastructure is starting to be addressed, investment related to the energy transition appears to be gaining momentum, and investment in intangible assets such as digitization and research and development is rising.

Digitization, too, appears to have considerable momentum. We have already seen the pandemic prompt an acceleration in the adoption of digital technologies. A continuation of that acceleration could, MGI research has found, add a full percentage point to both productivity and GDP. Now generative artificial intelligence is gaining momentum and should have a significant impact on productivity.

Current turbulence in financial markets could, and should, be an opportunity to shine the spotlight once again not on rising finance, but on the real economy and the productivity growth that has always underpinned it.