The chief executive of Pacific Investment Management Company LLC expects “muted growth” in the next three to five years, in the wake of major changes to the world’s financial system and a shift to greater government regulation.

“[S]ome of the recent abrupt changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years,” said PIMCO Chief executive Mohamed El-Erian in a speech last week, which was posted to the company’s website on Tuesday.

The remarks described his highlights from a recent gathering of company decision makers and independent thinkers at the firm’s annual Secular Forum, where ‘secular’ refers to the extended time period of three to five years.

Shifting conditions

Along with slower global growth, he expects higher unemployment; more government intervention in several sectors; a less cohesive global system core, and the financial sector losing its “pre-eminent role’ in post-industrial economies.

There will be a shift toward higher sovereign risk, growing inflationary expectations and stagflation, he said.

“[T]he world has changed in a manner that is unlikely to be reversed over the next few years. Put another way, markets are recovering from a shock that goes way, way beyond a cyclical flesh wound,” he added.

Beyond a major realignment in the financial system where governments have intervened, there is a shift in balance between the public and private sectors, he said.

Consequences of changes

He also noted “potentially long-lasting consequences of the erosion of trust in such basic parameters of a market system as the sanctity of contracts and property rights, the rule of law and the robustness of the capital structure. Such trust can be lost quickly but takes a long time to restore.”

He saw a prolonged pause or “violent reversal of concepts the market had taken for granted. He referred to the demise of the ‘great age’ of private leverage, asset- and credit based entitlements, self-regulation, policy moderation, and shrinking direct government involvement.

“Not surprisingly given the extent of the gains that were privatized and the losses that are now being socialized, the demise is occurring in the context of popular anger, confusion and what one of our speakers called “a morality play” in parliaments around the world,” he said.

While some factors including productivity gains and entrepreneurs will not disappear, they are not strong enough to return to the high growth and low inflation seen from 2002 to 2007, he said.

“For markets that are highly conditioned by the most recent periods of “normality,” this will feel like a new normal. Indeed, it will be a major shock to those that are trapped by an overly dominant “business-as-usual” mentality,” he said.

He expects the banking system to consolidate and shrink, impacting non-bank financial institutions and the investment management industry.

Risk Factors

Risk factors include U.S. policies that tend toward protectionism, shepherding of other countries’ savings and how the system will drain the current emergency liquidity from the financial system.

Others include restoring “implicit” or social contracts which “are being subjected to major shocks.”

“The longer it takes to restore normalcy, the higher the risk of recurrent financial instability,” he said.

Another factor is how U.S. debt is handled, and how the country deals with in a few years with unfunded entitlements such as Social Security and Medicare.

Weakening of the Federal Reserve and to a lesser extent, the FDIC, “would be terrible news” that would “adversely impact risk premiums across many markets.”

Slower growth projections also postulate robust growth by same major emerging economies such as Brazil, China and India.

Inflation