By Marco Annunziata, Co-Founder, Annunziata + Desai Advisors
The new year has started with high hopes. With vaccination campaigns underway, we might get closer to bringing the COVID-19 pandemic under control. And in the United States, incoming President Joe Biden’s administration has raised great expectations—at least for one half of the country’s electorate.
But the global economy’s prospects for this year and beyond hinge crucially on how we address some momentous uncertainties and question marks brought to the fore by the pandemic. These will likely prove even more consequential than the economic damage inflicted by COVID-19 and the resulting shutdowns. Most of these questions had been simmering in the background for a while, but the pandemic shock has acted as an accelerant.
First: Should governments run up massively higher debt levels?
Even before the pandemic, some prominent economists and many financial-market participants argued that short- and long-term interest rates are set to remain very low for some time and that governments should take the opportunity to run larger budget deficits at virtually no cost. The relatively sober version of these arguments suggested that governments should treat this period of very low funding costs as a window of opportunity to boost much-needed infrastructure spending, which would raise potential growth and, therefore, not only accelerate the rise in living standards but also make it easier to repay the debt eventually.
The pandemic shock has opened the way for a more extreme version of the argument: Governments can safely assume that interest rates will remain very low, perhaps indefinitely, and can, therefore, plan to run large budget deficits for an extended period. Policymakers can also spend generously not just on infrastructure but on a wider range of programs to fuel post-pandemic economic recovery, remedy economic inequality, help fight climate change and advance countless other priorities.
Support for higher public debt has become nearly universal. Years ago, at the International Monetary Fund (IMF), the insider’s joke was that IMF stood for “It’s Mostly Fiscal”, referring to the key role the institution attributed to a sound fiscal position. Most recently, the head of the IMF’s Fiscal Affairs Department, Vitor Gaspar, stated that “circumstances have changed in a way that justifies the rethinking of fiscal rules and fiscal frameworks”, and governments should put concerns about debt sustainability on the backburner.
The temptation to go down this route will be enormous: the US and a number of other countries desperately need to upgrade their infrastructure; climate change and economic inequality have already been marked as urgent priorities; and the pandemic delivered an unprecedented economic shock. The Biden Administration has already proposed a massive additional fiscal-stimulus package and a long list of spending plans.
It’s all too easy to underestimate the risks. Budget constraints help to focus minds and force us to prioritize our spending decisions. If there’s no budget constraint, why worry if we are deploying public resources in the most productive ways? Since the government is rarely a model of wise and efficient spending, even at the best of times, an extended loose fiscal stance will likely leave countries with much higher debt stocks and lower potential growth—undermining living standards and planting future financial-stability landmines.
Second: Should monetary policy be at the service of fiscal policy?
Inflation concerns today have less credibility than UFO abductions. The consensus is that policy efforts should focus on boosting economic growth on a sustained basis and that inflation risks will remain negligible; that fiscal policy should play the leading role because monetary policy has already run into diminishing returns; and that, therefore, monetary policy can be most useful by supporting expansionary fiscal policy.
Major central banks, such as the US Federal Reserve System (the Fed) and the European Central Bank (ECB), are fully committed to maintaining an expansionary monetary stance for an extended period, with policy interest rates at or below zero and balance sheets stationary at record-high levels or even expanding further. Meanwhile, governments have become accustomed (one might say addicted) to historically low funding costs.
This view has de facto undermined the rationale for central bank independence—namely, that the monetary authority should have the institutional autonomy needed to guarantee price stability, even when that means higher debt costs and lower economic growth. Former US President Donald Trump’s inelegant and inappropriate verbal attacks on Fed Chairman Jerome Powell have been rightly criticized, but the true threat to central bank independence comes from the view that the central bank’s raison d’être is to make the Treasury’s life easier.
To be clear, no irreparable damage has been done yet. Central banks’ formal prerogatives have not changed. The Fed has preserved the flexibility to alter its policy stance should economic conditions change. But some major central banks seem now to explicitly accept responsibility for broader and less clearly defined goals, such as fighting climate change. And if inflation picks up while economic growth and employment have not yet fully recovered, it will be much harder for central bankers to shift policy stance proactively.
It’s worth noting that since the pandemic has inflicted serious damage to the supply side of the economy, including supply chains, while the demand side has been supercharged by policy stimulus, the possibility of a faster-than-expected pickup in inflation is not that far-fetched.
Third: What is the future of globalization?
Over the past four years, the prevailing narrative has blamed Trump for single-handedly wrecking the global infrastructure of international relations. He withdrew the US from the Trans-Pacific Partnership (TPP) free trade deal, the Paris climate accord (Paris Agreement) and the World Health Organization (WHO); he threatened to pull out of NATO (North Atlantic Treaty Organization) and routinely criticized trade partners and strategic allies for not paying their fair shares. On his first day in office, Biden rejoined both the Paris accord and the WHO, and many expect that the US will now retake the lead in fostering stronger international cooperation.
Yet, the pandemic itself has shown that we have underestimated the risks of globalization. Global trade and tourism facilitated the spread of the virus, and the disruption of complex global supply chains intensified the economic damage of the lockdowns.
Moreover, when it came to the crunch, international cooperation was shoved aside in the interest of national security: countries hoarded medical supplies and pharmaceutical components and imposed uncoordinated unilateral travel bans instead of trying to agree on common standards and safeguards; even the basic exchange of information left a lot to be desired. Suddenly, the idea of safeguarding a reliable local supply of medical equipment and critical industrial components no longer seemed like protectionist nonsense. The recent UK-EU tensions on vaccine supplies are yet another example.
Add to this that creeping protectionism had been on the rise well before Trump got into office; many emerging markets and some developed countries had increasingly deployed local-content requirements and other non-tariff trade barriers. The WTO (World Trade Organization) had long been struggling, and bilateral trade deals had become more prevalent. The adverse repercussions of global trade on specific industries and job categories in the US and other developed countries had already taken a prominent role in policy and academic debates. Indeed, in 2016, Hillary Clinton also ran on a protectionist platform, and Biden has doubled down on Trump’s “Buy American” plan with even stronger protectionist provisions.
Within this context, some new technologies take on especially sensitive strategic importance. Just think of 5G technology: It will be a crucial enabler for autonomous vehicles, smart cities, smart electrical grids and the entire digital-industrial revolution. It will, therefore, also be a vital source of sensitive data and potential entry point for attacks on critical infrastructure. No country can feel comfortable leaving it entirely to the globalized free market—as the contentious debates on China’s 5G technology demonstrate.
In the coming years, these realities will shape global trade much more than the self-assigned globalist/nationalist labels of individual leaders. International trade will be managed more across a wider range of dimensions as governments try to mitigate key economic and geopolitical risks. The challenge will be to do this while safeguarding as much as possible the efficiency gains that have made international trade a powerful engine of global growth. New technologies will help here—manufacturing platforms and 3D printing, for example, already allow companies to operate efficiently at a smaller scale, have greater flexibility in where they locate their facilities, switch production lines more quickly and ensure greater adaptability in their supply chains. But striking the right balance in this area will be crucial to have stronger and more balanced global growth in the decades ahead.
Fourth: Can technological innovation truly be an economic game-changer?
Speaking of technology, 2020 provided a hard reality check on the limits of much-hyped innovations. The robots who were supposedly stealing all the jobs could not prevent a massive recession when workers had to stay home to avoid contagion; artificial intelligence (AI) was supposed to open the age of personalized medicine and cure incurable diseases—but when COVID-19 hit, we were left to shelter in place as we did to combat the plague in the 14th century. Techno-pessimists, such as Northwestern’s economist Robert Gordon, who argue that modern technologies are not as revolutionary and growth-enhancing as those of the original industrial revolution appear to be vindicated. And yet, this humbling reality check could be exactly what we need to launch a new wave of innovation efforts, more focused and more productive.
Companies now have a much greater awareness of their vulnerabilities and the areas where they most urgently need to improve efficiency, adaptability and resilience. They have seen up close where new technologies have been able to deliver and where they have fallen short. With their bottom lines impacted by the recession and great uncertainty over the future speed of demand recovery, they feel a much more pressing need to boost efficiency and improve margins. That’s why across industries, we see corporate leaders much more convinced1 of the need to push ahead with innovation, especially digital-industrial innovations.
Moreover, 2020 also showed us that humans remain crucial and indispensable in the workplace, even as innovation accelerates. At a very basic level, companies have seen what happens when they have to make do without humans: everything stops. Corporate leaders have also become more keenly aware of the need to upgrade the skills of their workforces as new technologies are put into place. And they have been pushed into experimenting with much more flexible work arrangements—which, going forward, could help improve labor-market access to people in a variety of personal situations.
Through all this, 2020 set the stage for what could be a new stage of innovation: more focused and closely aligned to adoption and execution in the economic system, and accompanied by intensified efforts to boost human capital. This innovation boom will be diffused, propelled by the experimentations and collaborations of many companies, big and small. The US has a natural advantage on this front and could spearhead the next generation of digital-industrial technologies and business models.
This kind of innovation unfolds best in a business-friendly, lightly regulated environment with minimal distortions and nudges to the allocation of financial capital. If the Biden Administration rushes enthusiastically into a brave new world of more regulations, higher taxes and more far-reaching government intervention, investment and innovation will suffer, and long-term growth will be lowered. This, in turn, would make the higher debt level more dangerous and slow the improvement in living standards across the income distribution.
Bottom line: 2021 will hopefully bring us close to the defeat of COVID-19 and a return to normal life. But we should already be looking beyond the public-health emergency and focusing on the four hard questions that will shape our economic destiny for a long time to come.
1 Forbes: “The Self-Optimizing Plant Is Within Reach”, January 11, 2021, Marco Annunziata