No Wiggle Room Ahead

December 14, 2021

As in 2021, when the global economic outlook was periodically buffeted by COVID-19 data and shifting political winds, 2022 will bring a mix of hope and uncertainty. Although the pandemic should finally be tamed, many more challenges await, placing a premium on wise decision-making.

NEW YORK – Last year felt like a roller coaster, as hopes rose and fell with pandemic statistics and shifting political winds. The new year looks much the same, except that there will be midterm elections in the United States in November – the stakes of which could not be higher. Given all the uncertainty, it would be foolhardy to make predictions with any confidence. Still, I will offer my best bets. 

For starters, COVID-19 will finally be tamed, though not eradicated. Enough people will have been vaccinated in enough parts of the world as to allow most people in most places to overcome the fear that has gripped us for the past two years. But although this process will unleash a burst of “contained” energy, restarting the global economy will not be as straightforward as shutting much of it down was. 

The price system can offer reliable guidance for marginal decisions – the economy needs a little bit more of this, a little bit less of that – but it is not as good at handling big structural transformations like the shifts from agriculture to manufacturing, manufacturing to services, and peace to war (or vice versa). We are already seeing many hiccups, and there could well be more. We should be prepared for large changes in production and consumption patterns: more Zooming and e-commerce, less in-person shopping in brick-and-mortar retail stores. Demand for commercial real estate may decline, while demand elsewhere in the real-estate sector may rise. 

The labor market has been disrupted like never before, and some of the changes might prove permanent. Many workers are asking whether their jobs are even worth it. Why endure so much stress under such poor conditions for so little pay? Labor scarcities in the US have persisted even after the expiration of enhanced unemployment benefits. Workers are demanding more, and this may finally tilt the balance of power toward labor after four decades of capital taking an ever-larger share of the economic pie. 

The new scarcities will be reflected in prices, and there will be unfortunate asymmetries in these adjustments. Price increases from shortages tend to be disproportionately larger than price reductions from surpluses, which means that inflation is likely, and whoever is in power will be blamed for it. The problem is that while we know how to control inflation when it arises from excess demand, what we are experiencing now is different. In the current context, raising interest rates will increase unemployment more than it will dampen inflation, giving workers one more thing to worry about. 

Equally worrying, the waning effect of earlier fiscal measures enacted around the world to mitigate the pandemic’s economic fallout might lead to a weakening of growth. Much will depend on the fate of the recovery plans that have been proposed in many countries. For example, over the medium term (and possibly even the short term), the supply-side measures embedded in US President Joe Biden’s Build Back Better agenda are likely to help sustain growth. More and better daycare facilities will enable more women to join the labor force; doing more to control the pandemic will reduce fears about working and reopening schools; and investments in better infrastructure will reduce the costs of moving goods and people. 

In any case, a concerted global effort to increase vaccine supply and ensure equal access for the poor would do far more to alleviate inflationary pressures than interest-rate hikes would. We should be celebrating the fact that, well over a decade since the onset of the Great Recession that began in 2008, global aggregate demand is once again robust. One hopes that the economic expansion this time will be used to address real societal needs, including retrofitting the economy for the age of climate change, remedying longstanding infrastructure deficiencies, and investing in people and technology. 

Two Risks

Unfortunately, two dark clouds loom on the horizon. The first is political: the US Republican Party has sold its soul to Donald Trump, abandoning all reason and any commitments it once had to democracy. Republicans have already shown there are few limits to what they would do to gain and then hold on to power. Where once the party engaged in voter suppression clandestinely, now it does so openly and proudly. 

Having abandoned respect for truth, budgets, democratic accountability, and pluralism, the Republican Party represents a clear and present danger to both the US and the rest of the world. Prudence dictates that investors account for the global economic uncertainty generated by this political dynamic. But, as we saw in 2008, markets often do not acknowledge large looming risks until it is too late. Whether they will do so in 2022 is anybody’s guess. It is just as likely that investors will focus more on minutiae like the prospect of the corporate tax rate being increased by a couple percentage points. 

The second dark cloud is geopolitical: China and the US are in an escalating rivalry, and other countries are increasingly finding themselves in the crossfire. To be sure, the conflict today looks markedly different than it did just a year ago, in the Trump era, when anything that benefited China was assumed to be at America’s expense, and when there was little concern about human rights or democracy. Even so, US decision-makers remain fixated on economic competition and national security issues vis-à-vis China. It is noteworthy that the Biden administration still has not removed the Trump-era tariffs. 

The conventional wisdom is that the US and China are too interlinked economically to wage a real twentieth-century-style cold war. But even if that is true, significant decoupling is still possible. The conventional wisdom also holds that a Sino-American rupture would be extraordinarily costly, curtailing opportunities for economies of specialization and comparative advantage. Yet the broader reappraisal of globalization in recent decades has shown that the GDP benefits from these advantages may be smaller, and the distributive costs (and the costs in loss of resilience) may be greater, than previously thought. 

Some commentators have also voiced concerns about the loss of know-how that comes from excessive offshoring to countries like China. But the political calculus in the US is probably not based on fine calculations of economic costs and benefits. Moreover, the dynamic economic consequences are complex. For example, the industrial policies that the US is now adopting in response to what it sees as its new competitive threat may prove to be a spur to growth both in the short run and over the long term. 

The policies we choose now will have consequences for decades to come. We may have brought an end to the pandemic roller-coaster, but in 2022 we must act just as wisely and as quickly to enact strategies that will lead us into a better post-pandemic future.

Project Syndicate