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Supply chains: Volatility keeps ‘businesses from investing,’ professor says

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Raghuram Rajan, professor of finance at Chicago Booth School of Business, joins Yahoo Finance Live to discuss the labor market, Fed policy, the divide between advanced and growing economies, supply chains, and geopolitical tensions.

Video Transcript

AKIKO FUJITA: New data out this morning pointing to a big drop in US job openings. That number falling to the lowest level since September 2021, with 10.7 million vacancies. The latest JOLTS report comes amid growing concerns about a recession. Our next guest says we need to revitalize growth through policies to raise investment and productivity.

Let’s bring in Professor Raghuram Rajan from the University of Chicago Booth School of Business. He, of course, is also the former governor of the Reserve Bank of India and Chief Economist at the IMF. Great to have you on today. Professor, let me just start by getting your broad picture here about where we are in the US economy right now.

RAGHURAM RAJAN: Well, we are in an economy which has a strong labor market. These numbers on vacancies would, I think, gladden the Fed’s heart, because that’s what it’s trying to do. It’s trying to create fewer vacancies while still keeping employment reasonably high. And it hopes by doing that, it will cool the labor market somewhat. It will make it more reasonable for people to stay in their jobs, to not demand higher wages, and, therefore, to not add to the relatively high inflation we already have.

If the Fed, through higher interest rates, can cool the labor market somewhat, it hopes, thereby, it can achieve that proverbial soft landing.

BRIAN CHEUNG: Hey, professor. It’s Brian Cheung here. Great to speak with you again. We were looking at job openings data from this morning– the JOLTS report showing that the number of job openings are falling and that’s a big talking point for the Fed, which has said we can avoid a hard landing where people are experiencing higher layoffs if we just have companies and businesses take down their job postings as opposed to lay people off.

Now, this has sparked a pretty interesting debate from the Fed and then also from the likes of Larry Summers saying, you might not be able to get one without the other. We might have to get layoffs here. Do you think the Fed is going to have to experience a sharp uptick in the unemployment rate to achieve what they’re trying to do here?

RAGHURAM RAJAN: Well, this is one of those areas where you have camps sort of banging on the table as if we know. We really don’t know. We are in a world which is somewhat different from the world we used to be in. So the past data on this don’t necessarily hold up. And this is why we have to be in a wait and see mode.

The Fed certainly is raising interest rates knowing that is what it has to do at this point. But the extent to which it has to raise it in order to get a cooling of the labor market is something that is both their guess and anybody else’s guess. My sense is these data would certainly gladden their hearts. It’s moving in the direction that they want it to move.

And of course, they would like to see, perhaps, some weakening in the labor market also, in the employment numbers. I don’t think they can achieve what they intend without some softening in employment. But they hope that it’s not deep.

BRIAN CHEUNG: Now, as a follow-up there, I mean, what the challenge here is that we’re also trying to make sure the Fed doesn’t tighten to a point where it actually triggers its own recession. You’re already having market pricing, expecting the Fed to, at some point, cut rates. We heard that the Fed chairman said that could indeed be part of the reaction function somewhere down the line. Do you think the concern within the Fed is that, actually, they will at some point have to really hit the brakes and it might have to be hard on this hiking cycle?

RAGHURAM RAJAN: Well, I think at this point, they’re just going to go till they see– first, they are going to go till about 3% and then take a look to see whether it’s moving– everything is moving in the direction that they intend. If that happens, they probably will take a pause. I think they wouldn’t see themselves as cutting at this point unless the economy weakens really significantly.

And given the state of the labor market, I think Chairman Powell has said repeatedly he doesn’t see that happening any time soon. So my sense is they’re going to go with the interest rate increases, probably more moderate than 75 basis points. But they’re going to go up to a point where they feel comfortable they’ve done enough, at least to take a pause and see that the rest of the economy is following in the direction that they want.

They won’t pause if they see no such effect. At this, point I think it’s premature to talk about them cutting. It may happen, but I think we don’t know enough at this point to say that they will.

AKIKO FUJITA: You’ve highlighted many times in the past about this growing divide we’re seeing between advanced economies and developing economies. And you’ve specifically recently kind of honed your criticism on this idea of friend-shoring, something that we have heard a lot from Treasury Secretary Janet Yellen, saying that as we look to emerge, number one, out of this pandemic, but also looking at what played out with Russia and Ukraine, that we need to align ourselves– supply chains– with those who share the same values.

You said that’s going to hurt developing economies the most. Can you speak to that a bit– about how you see that affecting the emerging economies more than the advanced economies?

RAGHURAM RAJAN: Well, I think when you start talking about values, typically, you’re talking about democratic values. You’re talking about freedom of the press– a whole bunch of things like that. And clearly, one big difference between developing countries, emerging markets, and industrial countries is many industrial countries have a stronger sense of these things– of democracy, or freedom of press, et cetera.

And so if you start putting a filter based on these issues, then, typically, you’re going to discriminate against the developing countries or emerging markets. There are very few developing countries who would qualify as free functioning democracies. There are some, but very, very few.

So put that filter, and immediately, you tend to discriminate against those countries. Now, you may say they are currently in your camp. But tomorrow, they may be outside your camp if the government changes. So in that sense, it creates a lot of volatility about whether they will be in or out. And volatility does, essentially, keep businesses from investing. So my sense is if you start putting that filter– if the government starts acting on that filter– and I have to say, they haven’t so far– but if that happens, then I think this is going to discourage supply chains from going through emerging markets and developing countries, simply because it will take time for them to reach the standards of democracy and freedom that exist in a number of industrial countries.

AKIKO FUJITA: Well, the counter to that, of course, would be what’s been playing out between the US and China. I mean, there’s so many companies that could point to the fact that while this isn’t necessarily a values play, because of the Zero COVID policy, they haven’t been able to get the sustained recovery. I mean, how do you look at this dialogue that’s playing out between US and China right now, and how much of those tensions, you think, could risk hindering growth globally?

RAGHURAM RAJAN: I think it is a serious issue. I think it turns around the question of Taiwan, of course– and we have the situation of Speaker Pelosi going there and a lot of noise being made about that. But clearly, a lot of corporations are worried, what happens if there is serious action on Taiwan taken by China, and then we get sort of the mother of all disruptions, much bigger than what happened with Russia-Ukraine?

And so I think corporations are taking a number of actions in this regard. They certainly are diversifying their supply chains, trying to make sure they have three or four sources for each part, rather than one source. They are trying to ensure they have greater buffers– inventory buffers. That’s something that they’ve done. They are trying to build more flexibility into their supply chains.

If I have a part that is available, let me make sure I can use that in place of some other part, which is not available. This is especially true of chips, where you can write software around chips, which can make chips inter-replaceable. So companies are doing a bunch of things to make themselves less vulnerable to some kind of disruption. But I think we should leave it at that– let the corporations decide rather than put a government filter on it, because once you put a government filter on it, that will, I think, chill this kind of action even further.

By all means, corporations understand that there may be action on China at some point if China moves on Taiwan. And so they are trying to address that issue.

BRIAN CHEUNG: Professor, when we just kind of zoom out again, the overall picture here is that central banks around the world are raising rates. And I’m wondering if you have any concerns about global financial instability, given that there have been instances in the past where through raising, hiking, cycles, some central banks have caused devaluations in other currencies that have sparked a financial crisis. Is that something you see as a big part of the concern as we continue to see a lot of these kind of moving parts around the world?

RAGHURAM RAJAN: Well, we’ve already seen a few countries under stress, right? We’ve seen Sri Lanka in a fairly desperate situation. Pakistan has reached out to the IMF. So there are a bunch of countries that are already in a certain amount of trouble. But do we see at this point big stresses through the world, a sort of cascade of emerging market defaults and so on? Not at this point, because a number of emerging markets anticipating the Fed action have also raised interest rates.

Yes. A lot of currencies have depreciated against the dollar. There has been outflows of portfolio funds from these countries. But still, nothing to cause a dramatic sequence of crises. Now, if the Fed has to tighten interest rates significantly more than the anticipated 3%, 3.5% by mid of next year, that may cause more disruption, because then you may see a greater outflow from those countries. But so far, with the fact that they have higher reserves– many of them have higher reserves, some of them are commodity producing and have got inflows rather than outflows as a result, and the fact that, so far, things have been manageable, at this point, I would say, yes, there are countries in stress– typically developing countries, typically from the higher price of fuel and food, typically from the fact that their governments don’t have fiscal resources to support their people. But is this a broad brush emerging market crisis of the kind we saw in 1997 in Asia, for example? No, not yet.

AKIKO FUJITA: Professor Raghuram Rajan, really appreciate the time. Hope to have you back on the show again soon– joining us from the University of Chicago Booth School of Business.