Recent global turbulence raises a question: Is the world shifting to a new economic regime for the long run? New McKinsey Global Institute (MGI) research and a recent McKinsey executive survey1 suggest that it might be, but the shape of that future remains uncertain. Business leaders should be aware of potential scenarios so they can adjust and strategize accordingly.
MGI looks at economic health and wealth through a unique lens we refer to as the global balance sheet, a tool we borrowed from the corporate world to sum up all of the world’s assets and liabilities, including net worth. Our view through this lens indicates that the developments of the past 20 years have contributed to today’s economic, financial, and market wobbles.2
Over the past two decades, the global balance sheet grew much faster than GDP—the real economy. Because interest rates were kept low to stimulate economies, asset prices and debt grew. Between 2000 and 2021, $160 trillion was added to paper wealth as asset prices surged on the back of low interest rates. For every $1 in investment, $1.90 of debt was generated. Meanwhile, productivity growth among G-7 economies slowed to a sluggish creep: from 1980 to 2000, productivity grew at 1.8 percent per year, while from 2000 to 2018, it decelerated by more than a factor of two, growing at only 0.8 percent annually.3 Too much savings chased too few productive investments, creating classic secular stagnation.4 This stable and predictable period was kind to wealth accumulation, but it was challenging for growth and it exacerbated inequality.
The majority of executives today have lived most of their professional lives in this environment. But the future could be quite different, and the range of plausible medium-term scenarios today is unusually broad. As a result, the intuition that has served many business leaders well in their careers so far may start to lead them astray. Companies and their leaders may want to prepare for what comes next.
In this article, we will examine the dynamics that led to the expansion of the global balance sheet. We will then propose four scenarios for what might come next, describing in broad strokes the impact each could have on the global economy and identifying which scenario the roughly 1,000 executives and asset managers we surveyed consider the most likely. Finally, we will suggest steps business leaders could consider in order to plan for whichever scenario prevails.
The winning strategies during decades of global balance sheet expansion
Leveraged investors have done well since the start of the millennium. In the United States, for example, the market value of real estate expanded 1.5 times faster than GDP from 1995 to 2021 (Exhibit 1), and in the United Kingdom, 1.8 times faster. The value of equities in the United States grew at triple the rate of GDP.
In this setting, a few strategies proved popular. Since credit was cheap, leveraged strategies and finance prevailed, including leveraged buyouts, leveraged asset strategies, rising corporate debt, and share buybacks. With ultralow discount rates and significant venture capital investment, aggressive growth strategies—including, but not limited to, technology—often beat those focused on early profitability and stable returns.
The low cost of capital fueled a focus on how enterprises would succeed in the long term—say, in 2050—rather than on whether they could reach their potential for the early 2020s. New productive investment struggled to be as compelling as the opportunities awarded by asset price appreciation and transactions. In extreme cases, businesses closed, and corporate sites were redeveloped into residential real estate.
With soft but persistent economic growth, efficiency trumped resilience. Because labor was abundant, recruiting and retention efforts could focus on the highly skilled. Wage—and, even more so, wealth—inequality rose, prompting some sectors to focus on high-net-worth individuals and premium or luxury segments.
Will a new balance of wealth and growth emerge?
What comes next? After a crescendo during the pandemic, when global wealth relative to GDP grew faster than during any other two-year period in the past half century, it appears that a break in the two-decade trend may be coming. But there is disagreement among economists and business leaders about what will change. Will inflation remain high over multiple years? Will asset prices correct and deleveraging occur? Or is the global economy heading for a period of higher productivity and growth?
MGI has developed scenarios based on each of the above three possibilities—and a fourth scenario in which the past era of balance sheet expansion resumes (Exhibit 2). Each of these scenarios is plausible. While structural forces, which may push inflation higher, are in play, central banks’ commitments to curtail inflation could cause corrections and deleveraging. Higher investment, along with the continued spread of digital and AI technologies, might boost productivity and help the world grow out of an outsize balance sheet (see sidebar, “The four scenarios”).
When MGI asked roughly 1,000 executives which scenario they thought most likely, 84 percent of respondents said they expected a scenario different from that of the past era. Their choices of most likely scenario were divided roughly equally between the remaining three options (Exhibit 3). Responses varied by sector and by geography. The financial-services executives who participated in our larger survey, plus a group of about 50 C-suite executives of large asset managers we surveyed separately, thought it was more likely that a “higher for longer” scenario would prevail, where inflation and interest rates stay elevated for much of the coming decade. Respondents in Greater China also favored the “higher for longer” scenario, while a plurality of those in Europe selected “balance sheet reset.” North Americans were divided between these two scenarios.
Why the next era may be different
Few respondents expect a return to the past, which is likely a reflection of the numerous long-term structural shifts that appear to be under way. How these will play out is, of course, uncertain.
The continuous rise of the global balance sheet over the past two decades has essentially been driven by limited investment for productive uses and a glut of savings, which lowered interest rates and fueled debt expansion and asset price growth.
This could change if productive investment picks up. The net-zero transition will require large outlays. Recent stress in supply chains, both as the result of the COVID-19 pandemic and Russia’s invasion of Ukraine, have drawn attention to supply chain resilience; some are being reconfigured, which takes investment. Greater defense spending may also represent an area for investment. In the United States, the Infrastructure Investment and Jobs Act could prompt a boom in large-scale infrastructure investment.
The global savings glut may wane. One factor boosting savings was the fact that inequality rose, and the labor share of income declined, reducing consumption by channeling a disproportionate share of value creation to the wealthy, who tend to save more than the average person. Labor markets are now tight, which may tip the balance toward higher consumption. Aging populations have been saving and have not been spending those savings in retirement, but that, too, might change. A rising dependency ratio means that the share of people spending their retirement money rises while the share of those saving while they work declines (though this is a matter of some debate among economists).
How can businesses equip themselves?
The macroeconomic patterns of the past 20 years may be over, but the range of possible economic scenarios between now and 2030 is broad. It makes sense, therefore, for company leaders in any kind of business to lay the groundwork for a potentially different future and to be ready to operate under uncertainty.
Track the right markers
As a first step, businesses should consider identifying a broad set of markers that will help them ascertain which scenario is more likely to occur. Many executives look at the latest inflation numbers but miss more fundamental markers that distinguish between scenarios. Examples of some of the more important ones include the following:
- Central bank trade-offs. Many central banks are independent and have a clear price stability mandate, but they also tend to have a financial stability mandate—two directives that are increasingly in tension.5 What discussions are taking place about the trade-offs?
- Fiscal policy stances. Fiscal tightening could have significant impact on inflationary pressure as interest rate increases face the above financial stability concerns. Where, and to what degree, is tightening likely to happen?
- Business investment. Are commitments, and actual investments, picking up materially—say, by two percentage points of GDP or more? If so, the odds of moving toward accelerated productivity rise, and a return to balance sheet expansion becomes unlikely.
Additional markers also matter, including wage and bargaining-power dynamics, profits, and inequality; the relative shifts in effective retirement ages versus life expectancy; and geopolitics and global flows. Because any one of the four scenarios may occur, it would behoove businesses to track these trend indicators and gather a diversity of economic perspectives rather than simply rely on “consensus” forecasts.
Pressure-test the business for what might come
Businesses, including financial institutions, can consider going beyond the typical sensitivities they test in their risk management and use these four scenarios to pressure-test business models. Firms may also think about beefing up equity buffers, strengthening balance sheets, and/or hedging macro risk, among other considerations.
Understand how strategy would transform depending on the scenario
Some firms may want to bet on one scenario, while others may opt to build optionality and robustness for several. A return to the past era is, essentially, business as usual, with all the risks that this entails. To prepare for the three options that propose significant change, specific actions may be needed:
- Higher for longer. In this scenario, a number of the capabilities necessary to navigate the past couple of years would become the “new normal” of competitive differentiation. Businesses could take a three-pronged approach of pricing, procurement, and productivity to respond to higher input prices and wages. They could also alter the mix of the business portfolio to benefit from growth and high capital expenditure and shield themselves from rising input and labor costs. Scale will matter more to protect margins. In an environment of rising cost and rates, locking in favorable conditions would be attractive, from long-dated maturities in financing to long-term contracts for labor and suppliers. Firms could also strengthen their focus on catering to the affordable end of the market as inequality falls. Investors seeking to protect assets and wealth from inflationary erosion would also find an environment of higher yields. Financial institutions would need to rethink business models hardwired to ever-growing balance sheets. Banks, for instance, could seek to complement net interest income with more fee-based business models and rely less on wealth management for the wealthy.
- Balance sheet reset. A flexible cost base, reduced debt exposure, and “fortress balance sheets” could help businesses build resilience in this scenario. Businesses could also consider how they can ensure that their cost base is flexible in case of a sharp economic slowdown. They may also reduce debt, limit exposure to market prices in equity and real estate, and identify debtors who may struggle to repay in such a scenario. Fortress balance sheets could help weather the storm and enable opportunistic response when distressed M&A opportunities emerge. In a similar vein, investors would seek protection from asset corrections and defaults; holding cash would not be the worst option in this scenario. Financial institutions might live through a situation not unlike the years after the 2008–09 financial crisis. There could be substantial opportunities for consolidation and M&A, including situations of distress, making preparation essential.
- Productivity acceleration. To benefit from growth acceleration, it would make sense to invest in technology, new capacity, and automation to capture market growth ahead of competitors. Companies that are driving the productivity acceleration—for example, through providing new technologies—may capture significant value. Since human capital and materials could be in short supply, businesses should consider how to lock in access to what may well be a highly competitive market for both. As interest rates rise, firms would be wise to secure long-term financing early. Investors could find opportunities in growth equities and face interest rate headwinds in real estate. Financial institutions could engage in ample opportunities for capital project and business finance.
Firms are not passive spectators but rather participants whose collective actions shape which scenario unfolds
In the midst of uncertainty and economic pressure, it can be all too easy for companies to be purely defensive, seeking to mitigate negative impacts on their business and to build resilience. But playing pure defense could turn into a self-fulfilling prophesy of doom and gloom.
If firms plan solely for a slowdown in GDP growth or a recession, they will be less likely to invest and more likely to wait for more benign economic conditions. If they expect persistent inflation, they may proactively raise prices and cause the inflation they fear. If real estate investors expect lower prices, they may delay starting new projects. Banks focused on strengthening their balance sheets could tighten lending standards, reducing the number of loans they offer.
To help catapult the economy into faster productivity growth, it will be critical to play offense, too. Businesses need strategic courage to invest boldly in emerging opportunities and to commit to the human capital needed to power these investments. These opportunities can be found in well-known megatrends like the energy transition and electrification, aging and healthcare, more resilient supply chains, rising defense investments, and new technologies like AI. How firms deal with inflation also matters: the more they manage to raise labor, materials, and energy productivity, the more they can afford to pay higher wages and prices without passing higher costs onto consumers.
Pessimism is rife at the moment, but it is possible for a productivity acceleration scenario to unfold. Indeed, about one-quarter of executives polled in MGI’s survey consider it the most likely one of the four, and many believe that it can happen provided the right actions are taken.
Adjusting to a new era can be difficult and prolonged. It demands revisiting assumptions and modifying planning, strategy, and business models. Few anticipate a return to business as usual. That sense of realism is a useful starting point.
