There could be a pretty big global shock, says Nobel laureate & economist Michael Spence

Michael Spence won the Nobel Prize in Economics in 2001 for his influential work in signalling in the job markets, which has since become among the most exported ideas into other fields from economics, with applications in contracts, modern payments systems, tokenisation, public block chains and much else. A long-time observer of emerging economies as the chairman of the World Bank’s Commission on Growth and Development, Spence is currently Philip H Knight professor and dean, emeritus, at Stanford Graduate School of Business. In India to launch the Iron Pillar Initiative in Global Learning at Ashoka University, he spoke to Sruthijith KK about India, China, AI, productivity, signalling, Trump and global economic headwinds. Edited excerpts:

You have observed India and China for a long time. How do you view their evolution?

India is very special, so I come back as often as I can, and I think it’s been pretty frequent in the last 20 years. My interest blossomed when we were doing the (World Bank) growth commission work. I think both India and China are the future economic giants. It’s almost impossible if you’re interested in this general story not to be interested in these two. China got off to a faster start. India started this reform process in the early 90s.


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At this moment, India is a rapidly rising middle-income country. Of the major economies in the world, it’s got by far the highest potential growth rate, and it’s running at pretty close to that potential, as best I can tell. It’s wonderful for the world, and it’s wonderful for Indian citizens.

I come back (and see) things that weren’t there before, being built. The much vaunted infrastructure problem is being solved. The airports are transformed to a rather pleasant place, and so on. I’ve had similar experiences in China. These are very different countries with a fairly important agenda, finding how to live with each other and beside each other.

How do you view the development India has seen, both of physical infrastructure but also digital infrastructure that you’ve spoken and written about?

I would say the physical infrastructure is improving but you have got a long way to go. Everybody knows that. If you spend any time in Bengaluru you know there’s a bit of a traffic problem that needs to be sorted out. On the digital economy side, especially the digital financial thing, India is not only first class, it’s the best in the world.

You have the biometric identification system, so there’s nobody around who’s anonymous anymore, almost nobody. That’s crucial. If you don’t have an identity, it’s hard to own property, it’s hard to have a bank account. The benefits are not totally widely appreciated.

Second, you have the Unified Payments Interface (UPI), which is really a firstclass operation. You’ve got data mobility, which is crucial in leveraging data to accomplish inclusive growth and a variety of things without data monopolies.

I think one of the most impressive things about the architecture here is they essentially solved that problem by giving people control. Telling the people who have the data that when you give your permission to move your data to this entity–because they’re considering giving you a loan–all the people who have data have a legal responsibility to deliver it.

It’s so good, I think it’s going to be imitated by a wide range of emerging economies that need similar infrastructure. And I’m told that they’re already asking for it, and India said, “Yes. We’ll share it with you even up to the source code, so you can implement it yourself.”

This has all been done in the last 10-15 years. This is really important because India is just not running on the Asian growth model. There’s lots of manufacturing here, but it is not, at least up till now, been mainly manufacturing for export.

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There is jubilation over topline economic growth, which was about 7.8% in the last quarter, rare for any major economy. But there is also impatience over per capita income levels of around $2,800. China has leapfrogged to around $14,000. The US is way ahead at $95,000. The East Asian miracle economies saw a strong upgrade in standards of living in the 1990s. When is India going to see that, absent a manufacturing miracle?

You need fairly broad-based employment engines that draw people into the modernising part of the economy. I think pulling all the levers is pretty important if you want to make sure you have inclusive growth patterns because the employment engines are really what generate that. The only qualification is in the development process, you don’t have to make sure everybody benefits in percentage terms the same amount. That very rarely happens.

There are two things you don’t want. You don’t want people who are actually suffering, and you don’t want people who are clearly being left behind. But if the upper end of the distribution is essentially growing in terms of income and wealth at 5% and some other people are growing at 3%, you’ll have widening measured inequality.

An economy that’s running relatively heavily on domestic aggregate demand, which is mainly consumption and investment, is at a pretty good starting point. When you compare this to China, China’s consumption, household consumption, is charitably 40% as opposed to, what, 65% here, 70% in the US.

China’s an outlier. That makes them extremely heavily dependent on investment and foreign demand. And this is not a great environment to be dependent on foreign demand... But they do have an export surge. I mean, this is a country with 30% or so of global manufacturing. Two-thirds of it goes to the domestic market, but the other third is flooding the global system, and that’s going to cause resistance, and that’s not a lever you can keep pulling without getting some pushback. So I think India’s got challenges, but it’s positioned in a pretty good place right now to keep these things going.

You’ve written that for the economic benefits of AI to show up it’s going to take about a decade.

We could start to see these effects if it’s all done right in five years, you know, the end of the decade. That would be on the optimistic end. The AI revolution is so multidimensional that each of the components has different time horizons. Science now—clear. AlphaFold, the DeepMind protein folding thing, has 3.4 million biologists in 190 countries using it every day now. So it doesn’t look like there’s a lot of lag there. In business and economics, there are natural lags because you have to change the business models. You need new skills. You have to figure out how to use it. It’s a bit of experimentation, and all of that is consistent. Doesn’t tell you the exact time array, but it’s consistent with historical experience.

About 20 years ago, India and China were deemed the big emerging powers. China in absolute terms appears to have emerged somewhat more emphatically. We are a robust democracy, China is not–different paths of development. Having said that, on technology, they really today seem to be at the forefront when it comes to AI, electric vehicles, battery technologies, robotics, automation… How does the world view these two powers today?

You’re right about China. Not only is it very advanced, it’s one of the two places doing frontier AI. Whatever gap there was between China and the US is essentially closed, according to the AI Index Report. My view of China and India is they, with obvious differences in terms of the specifics, are on the same path.

India can’t afford this massive amount of infrastructure required to play in that game. But 10 years from now, when the per capita income is $10,000-plus, which is where I think it’ll be at these growth rates, you will be able to afford it. And then India will be the next major player in this. Then I think there’s a question mark about Europe because Europe has the scale but not the organisation to get it done. They can’t make the investment decisions. The capital markets aren’t big enough or integrated enough, etc. So I would say, the crude summary is India and China are on the same track, but China’s about 10-15 years ahead but they’re slowing down. You know, if you’re at $14,000 or $15,000 (per capita income), it’s very hard to grow at 8%, right?

That’s why India’s potential growth is way higher. The actual growth rates are way higher too. So you catch up quickly. Why was India a bit slower behind? It was a slower ramp-up. China started slightly earlier, but in the early 90s, there were a lot of things to sort through and a lot of legacy systems that needed to be marginalised in India… It’s been done by successive governments… I think it’s unstoppable now. Indians have figured it out now.

How should firms and countries plan in the era of Permacrisis? Should we be becoming more self-sufficient and look to delink from external linkages, which is the opposite of what we’ve spent the last 50 years doing. Do we optimise for more resilience, more self-sufficiency?

I think you optimise for more resistance, resilience. So businesses will do that in this shock point. When we wrote that book (Permacrisis), we thought: “We better say this is a world of both shocks and structural change that are pushing us into a new environment.” Much more attention to resilience, more costly, a more inflationary environment, more national security overrides in the formulation of economic policy.

Where we’re going to go, best guess, is not what game theorists would call a Nash equilibrium. Everybody goes their own way. It’s a non-cooperative game. Not full interdependence because it’s not practical and fit. I think it’s going to look like the Indian strategy of collaborating on specific things when it’s in your interest. It’s what Mark Carney has started to call variable geometry. You have kind of fluid different groupings, depending on what issue you’re trying to deal with.

I do worry about the low-income countries because this variable geometry and all the negotiation that goes with it will tend to occur among players who have some significant impact on each other. And there’s a lot of countries that don’t have a significant impact on anybody, and the question is, is some collection of countries going to take responsibility for making sure that the whole system’s inclusive with respect to them?

That’s an open question and a legitimate area of concern.

I think about your ideas on signalling sometimes when I watch President Trump conduct his own unique brand of diplomacy. There’s something in game theory about the benefits you can have in appearing to be unpredictable. When you look at some of his tactics, do you reckon that some of it is signalling, or is there real potential for damage?

The technical term is nuts (laughs). (Thomas) Schelling wrote about this. He was one of my thesis advisers. Yes, there are game theory incentive structures where being incredibly convincing that you’re crazy means that you are willing to do something that is somewhat self-destructive that will affect the choices that other people make in a way that’s beneficial to you.

That’s the underlying argument, and it’s real. There’s an element of that in Trump. I think it’s impossible to know unless you can climb inside his mind whether he does it on purpose or it’s a kind of spillover benefit of the way he does business.

There’s a lot of things that are puzzling about Trump. It’s very transactional. It’s anti-multilateral for sure, so it’s bilateral and negotiation-based. It’s very puzzling that his primary aggressive moves are directed at what you would think of as traditional allies and friends and trading partners—Canada, Europe, etc —and it’s hard to know where that comes from.

But that’s who he is and I think he has demonstrated the ability to do things that people thought you wouldn’t see an American president do, and that gives him a degree of freedom with respect to what happens in terms of the responses. And so some responses are that we have to negotiate with this guy, even if he’s sort of rude. Other responses are more like the Carney response now, which is we have to, you know, band together as middle powers.

When you look at the world today, with these multiple flashpoints and potential bubbles around the investments into AI, what are the areas that concern you the most? Do you think there is a risk of a catastrophic economic moment? What worries you when you look around the world?

I don’t think there’s (going to be) a catastrophic collapse, but there could be a pretty big shock. We have very high debt levels. We’re building a ton of this infrastructure using debt instead of equity. We have a huge investment programme, the returns on which are completely dependent on people being willing to buy these tokens and then get results. So it’s partly diffusion and whether it works… Then we have the markets, where the valuations are elevated, the concentration in the major indices is high.

If there’s a big change in sentiment, regardless of where it comes from…this isn’t working very well, you have a huge change in valuations and all that much debt, I can see a whole lot of chaos emanating from the financial system.

It could cause a recession in the US, and if it’s big enough, it’ll spread. That would be the main thing. I mean, other than just an open, flat-out, widespread war. I think it’s a tough environment for lots of emerging economies because the US central bank is going to raise interest rates. They (the Federal Reserve) have already started. I don’t think the President can cut them off because they were unanimous. That I did not expect.

This causes the dollar to strengthen. That causes other currencies to depreciate, which is inflationary. And then it’s a double whammy because oil and gas prices are priced in dollars. So I’m a little worried. A lot of countries, maybe even ones with weak growth dynamics unlike India, are going to be forced to raise interest rates as a defensive measure.