Economy and markets between two tides: geopolitics and artificial intelligence

The most positive (and surprising) aspect of recent weeks in the economic landscape has been the financial sector’s response to the heightened uncertainty caused by geopolitical instability. There are no precedents for an energy shock of this magnitude without a noticeable tightening of financial conditions. However, on this occasion, the initial risk-off movement moderate, and in some market segments it has been almost completely reversed. Indeed, as the conflict enters its third month, with significant distortions in energy and trade flows, many stock markets are above their pre-conflict levels – in some cases even reaching all-time highs. Moreover, there have been no overreactions in currency markets. Even bond yields are reflecting limited concern about inflation and medium-term fiscal balances, beyond pricing in changes in the monetary policy outlook at the short end of the curve
– something we all would have signed off on 28 February.

This may be the calm before the storm or reflect the difficulty of incorporating geopolitical risk into financial asset valuations. However, this gap between the financial channel and the harsh geoeconomic reality is proving to be an important lever for mitigating the impact of geopolitical risk on the real economy. It could be argued that behind this disconnection lies investors’ excessive confidence in the resilience of the business cycle and in central banks’ ability to keep inflation expectations in check and limit second-round effects on prices, a key factor for financial stability. But perhaps the most important support for this market optimism lies in the beneficial effects that artificial intelligence (AI) could have on productivity and potential medium-term growth, more than offsetting the impact of any negative shock on the supply curve.

In other words, although our attention will remain focused for a while on geopolitics and all its derivatives, the elephant in the room remains the medium-term implications of AI on macroeconomic variables. The risk is of being overly optimistic, but the tip of the iceberg of this megatrend is promising, considering the initial positive effects on US growth and on the earnings of firms in the sector. As a case in point, investment in technology in the US (processing equipment, software and research and development) has been growing at a year-on-year rate of 15% over the past six months, establishing itself as the main driver of growth. Since the emergence of ChatGPT three years ago, the so-called Magnificent Seven have accounted for more than 50% of the earnings growth of the
S&P 500 and 60% of the cumulative rise in its market capitalisation.

In this context, we have dedicated our May Dossier to this new technology, which is becoming a priority in economic competition among the major powers. The strategies adopted vary widely, from the American goal to define the technological frontier, leveraging its competitive advantages in human capital and technological capabilities, to China’s prioritisation of optimising the global industrial value chain and scale, as well as security (see the article: «Differentiated strategies for governing AI: towards cooperation or conflict?»). Meanwhile, Europe, facing the risk of falling behind, has intensified the debate on balancing regulation, competitiveness and scale. At the same time, it is attempting to establish a common governance framework to leverage the strength of its scientific and research base and reduce its high external dependency for semiconductors and foundational models. In other articles we examine the adoption of AI in the Spanish economy and how it could affect productivity growth and the labour market (see the article «Productivity and employment in the face of generative AI: what do we know?»). Our analysis reveals that, although aggregate estimates vary greatly depending on the assumptions used about the proportion of tasks affected by AI (and the average productivity gain in those tasks), in the most reasonable scenario, medium-term productivity improvements of up to 1 pp annually can be expected in the US and around half of that in Europe. This would not be an instant revolution, but it would represent a step change for potential growth. That is precisely what financial markets are anticipating, rightly or wrongly, when they try to look beyond the noise of geopolitics. They are walking the thin line that separates hopes for a new industrial revolution from fears of its effects on inequality and employment.