Why "Living Local" and High Inflation May Not Outlast the Global Pandemic

Institute for International Economics, Adam Posen. And for once I didn't have to ask all the questions because the Council on Foreign Relations Senior Fellow for International Economics, Sebastian Mallaby was in the chair. He started by asking Bill Dudley about the state of the US economy and especially the

surprisingly weak employment growth that we saw in April. You might remember, instead of adding a million more jobs that month, which everybody was expecting, the number was fewer than two hundred and seventy thousand, meaning there are still eight million fewer people in work in the US than they were before COVID. You were one of the first sound a warning about inflation resurgeons. You write a piece in Bloomberg

back in December, Um, how worried about inflation are you? Now? Well, I think the you know, the bubble of inflation that we thought was going to happen has arrived. And it's basically arriving for a couple of reasons. One, base effects were throwing out the very low rings from a year ago. Now, so the year of your numbers are spiking up because

of that. But the most important reason why we're seeing more inflation is there's a lot of friction uh in the economy as you try to reallocate resources back to rapidly increasing demand. Look at the big increase we saw in use card prices, for example, do we really think that's sustainable over time? I think eventually auto production will will pick up as some of these chip shortage disease, and so inflation will will come back down again. That said,

it's certainly more than what we were expecting. I mean, I don't think anybody was expecting to think that the core inflation would already be at three percent. And and it may be we may become more difficult for the Fed to keep talking about this being transitory, as it maybe might last, you know, six or twelve months before

we start to see the other side of this. Yeah, and you you haven't mentioned m the sort of dry powder argument that households, in addition to the fiscal sim houseleves are sitting on a lot of money because the savings rate high. It demands me very strong. I think, you know, there's eight million people that are still unemployed because of the pandemic, and those people have suffered greatly. But for the rest of people in the US, they're coming out of this out of this recession in great

financial shape. I mean, the household savings rates, you know, been running over. A lot of people have used the steamulus money to pay down debt, and monetary fiscal policy are very expansive. So it's really hard not to see a very wrong economic recovery in your ahead, unless something happens with the virus and effectiveness of the vaccines to

throw that all out the window. So I think that you know what's gonna happen is we're gonna we're gonna get back to full employment, I think faster than what people anticipate. And the FEN is going to try to be patient, but their their patients may ultimately be overrun by an economy that does better than what they're currently anticipating. So at searching to fiscal I guess, um, the question

I'm curious about it is you've got this. You know, these these two bills proposed which expensive but at the same time will generate revenues in the sense that lifelong learning and income tax credits, infrastructure, child care provision, all of these things incy increase the productivity of the workforce. UM. How far do you think in the long term these things can be viewed as, you know, not just increasing the share of government and GDP, but the time I

think a lot of it can be segastition. I think the problem is we've heard so many claims through the years about tax cuts paying for themselves that we which they never do are almost never do unless you're marginal. Tax rates are extremely high, that people are skeptical about claims things will pay for themselves. I think many of these aspects you mentioned, particularly things that improve the quality

and the quantity of the workforce. So the pre K education, the community college, the child care helped through taxes and provision to enable women to better balance home and work. Um. More portability on things of insurance and pensions. All of these things are improvements in not just productivity, but even more so their improvements in labor supply. But the thing is, they pay for themselves elves over five, ten, twenty years. They don't pay for themselves over two years, and they

have to be sustained. I don't get caught up in this infrastructure lexicon debate of what you label infrastructure or not. And there are going to be wasteful things. But on balance, if this can be sustained, and if there can be an agreement that this, you know, a few percent of GDP spread over a few years, that will be helpful to this country, in addition to whatever you do to repair bit bridges, trains, power grid which also obviously is necessary, and switching tech a bit to um UH the exchange

for an exchange markets. So there is a view that says, um, you know, we may have an inflation problem coming, but we also have a data problem in the sense that foreign save as being asked to finance this US fiscal expansion at a time when interest rates a negative. Um do you see uh that as being a problem in terms of daughter inflowers and therefore darter weakness and don't in the short term at all. Um, I think and sevesting. You and Stephanie Bill have all been around the block

on this with me as well. What would drive down demand for the dollar is also what would mess up the fiscal policy, which is if we have political division in the society and in the particularly in the governance, such that we cannot raise taxes if we need to, such that we cannot sustain useful investments, they get reversed and changed every election. Then people start saying, as they used to do for Italy or Argentina or Greece, Okay, there's there's a lack of fiscal credibility there, and that's

when the dollar starts to fade. And so for me, it's at least ugly contest, and so the US is increasing its ugliness on this fundamental basis, not because of the debt level, but because of the governance, and so that makes things like frankly, the euro look relatively more attractive in my opinion. So it's definitely. Um, a few years ago we might have stopped the presses for that sort of positive comment about Europe. Do you agree broadly that the U Zone and the EU are emerging from

the pandemic looking credible despite the slow vaccine roll. Yeah, I'm not I'm not even sure that Adam was saying that much, but he was certainly being more positive than we might have been even even a few months ago. I think if you, I mean, if you step back a bit, we could probably say that Europe did a slightly better job of predicting, protecting citizens and even cushioning the effect on the economy and the sort of Act

one of the pandemic last year. But if you think a bit seriously botched up at two this sort of crucial period of obtaining and then rolling out the vaccines and that's led to this palpable delay in the recovery is certainly relative to the UK. It's catching up. We're

getting nice. It's a confidence, I would say, and spending is actually probably getting ahead of where countries are in terms of vaccinations, infections um even and quite strict restrictions in many cases still, so you're looking at maybe two thirds of the population being vaccinated by August or September. But I mean, I say that because that's a pretty the difference between that and what you're you're seeing in the UK and the U S which is the beginning

of the summer. Being at that stage, it's pretty crucial if you're particularly one of the southern European countries utterly dependent on tourism. So this this few months delay, if it's if it means losing a summer or or losing a big chunk of your summer trade, that is quite significant, and I think further sort of worsens the credibility of

the of the whole EU effort this year. Even though as you say, people are optimistic, you've listening to the ECB Crest conferences, Christine Legard's upbeat, Um, it could have been a lot better. And if you're in Spain or Portugal or you are really going to be affected by that. And of course it also worse than some of these North South divides that we know have been exacerbated by

the crisis. The key thing, which I'm sure you'll get onto, is whether there's been an institutional shift that's been sort of kick started by COVID last year, and I think there there is some there's optimism in that you now have this next generation to you funding going out. It could help the sort of seal the deal on the recovery. But I worry a bit that though it has this sort of potential and it clearly was enormously significant to have now some sort of serious collective financing for fiscal

policy of some degree in Europe. Um. You know, we're kind of in the opposite situation we were in the Eurozone. I mean, we've all talked. You know, during the Eurozone crisis, we would a key moments you had leadership, whether it was from Mario drug or Chancellor Merkel jumping in and sort of papering over the cracks where there were no institutions to hold the to help the Eurozone response. We now have potentially this institution that could really help it

move forward, and the leadership isn't there. You know, you have the European Commission undermined by the way the rollout was handled. You have Chancellor Merkel on the way out, and and President Macrow, who has probably been the greatest sort of talking most about what Europe could do if it was more unified, what a European identity could be. You know, he's very much distracted with that election coming

up in a year. I see the story that on the one hand, you've got this institutional shift in that there is now this joint joint liability the euro the Eurozone as this union's own Donald the European Union is this uniers own barnd. The question is you're saying a leadership deficit on that the prospect that the Greens might do well in the next general election might portend a greater willingness to do fiscal burden sharing and make the

most of that opening created by the joint bond. Those of us sitting outside Germany always think everything is an opportunity to have a different German fiscal stance. Then it suffers when you actually contact with German politicians involved, and you tend to always find that they're not really very

different from the ones before. And I'm probably not the person to talk about all the permutations of potential coalitions coming out of the next German election, but I think as long as if if the the chances are that the Christian Democrats will be there in some form, and then then it won't actually make necessarily a huge difference

if the Greens have the chancellor itself. Um. But I think you're right to say that green issues and the Green transition economic transition is an area where Europe has clearly got, has made some strides and could show real leadership in the world. Um. I think it's also shown itself um better responding to the competitive and other challenges of big tech and taxing big beginning to do that.

So I think that, I mean, there is a potential there, but we're always saying that, but then the actual innovations are lacking. The innovations are all coming from the US. I am larger with Stephanie. I think the fiscal changes that have been made our precedent setting and exercise the institutions and legitimize future mutual efforts on the fiscal front, but the actual use of the Common Fiscal Policy is going to be very limited. And the German deficits still

ended up being much smaller than they had originally. They're the only country in the world that announces they're going to have much bigger, bigger deficits than actually turns out, which takes a lot of work. Okay, So we we have we have person you know, guardedly more positive on the prospects of the Euro but we also have the Tish, the British voices still the skeptical of Germany as ever, maybe so I'm sorry, I just want to say, I mean, my point is not that the euro and Europe are

doing great. My point is that they have slightly improved in a world where the US is worsening and property rights are no good in China. So in the relative ugliness contest, Europe comes out, I mean, no longer hitting themselves in the head with a giant hammer is definitely

a big, big step forward. Okay, so let's bring another region into this debate, which is the emerging Well, I guess the analogy I have at the back of my mind is that India had a first wave of COVID and people say, wow, that was remarkably mild because well, maybe the Indian population is young, whatever, whatever reason, we don't understand, but the country was hit less badly than

we feared. And then second wave comes and it's truly appalling, and in the same way slightly on economic policy tools. I remember discussing with people at the beginning of the pandemic the sort of inequity that the strong economies that developed economies had policy space, but emerging economies might not. Now, the FED and the other leading central banks loosing so much that there was really policy space for everybody. But

maybe a second wave could be different. So Bill, perhaps, like I could put this to you, do you think that this world in which the US recovers a good deal faster than a lot of emerging markets, it's going

to create complications through the exchange rate channel. I mean it could, but you know, it will be all set by the fact that a strong US recovery that's accompanied by a strong recovery other advanced It probably means commodity prices go go up quite a bit and that so the terms of trade will be you know, will be

beneficial to the emerging markets. And the second thing I think it's really important is the FED is going to be slow regard relative to whatever economic recovery that we get, because they basically told us that they're not gonna tighten Monterrey policy until they're at full employment, they're at two percent inflation, and they're confident inflation is going to go above two percent for some time to come. That's a big change in the Monterrey policy framework. So the FED

is basically communicated that we're going to be late. So that gives time for the emerging markets to sort of catch up in terms of vaccination, in terms of the COVID based recovery. I think, um so, I think that you know, the risk from from the FED is really more that it's not like immediate. I think it's really like two or three years down the road, when all of a sudden the FED has to go from very easy too tight, and that has to happen in you know,

twelve months now. That would be a shock for markets. But I don't think that risk is going to materialize in the near term, Adam. Historians sometimes talk about, you know,

how pandemics have changed political economy in various ways. Either the omnipresence of risk can boost entrepreneurial risk appetite, and you do see more new business formation in the urest and I think also the UK in the last year than the normally or businesses response to health has this by mechanizing production because the labor force has to be distanced or that's sick or whatever, so you get an

acceleration of mechanization. UM you've written a great essay and foreign affairs, perhaps you could talk about how you see, like what is the big political economy effect UM coming out of COVID well Sebastian has many people have been noticing industrial policy of various forms is now back into chic UM. And this has an anti globalization taint to it,

including in the Biden administration and some other places. UM. And it sometimes gets tied to the national security side, to China's doing it, and we can't let China have the technology. And so if we move to an environment where people are more concerned about trust because of health reasons, because of local governance reasons, and because of perhaps overdone

national security fears, then I think there's a cascade of effects. UM. I think we're going to see too much emphasis on manufacturing and too much emphasis on autarchy, which isn't going to go very well either politically or economically. I think we're going to see too much emphasis on local loyalties. UM. I mean we see this in the leveling up debate in Britain, we see this in the discussion of the places falling behind in the US. UM. We see this

throughout the world. But we also see that there are very few policies that level up regions rather than people. UM. So you look at even China, which has the world's largest set of subsidies in the world's best ability to order people to move someplace or to put businesses someplace. And we still see these huge in their latest senses, these huge changes in population of the southeast versus the

North and west and little income convergence between them. We see in West Virginia two senators again ex storting the whole government because this Bobby Bird used to do to bring goodies to West Virginia, and yet West Virginia remains in zero income convergence versus the rest of that country.

So there's a lot of frustration and anger where we're already giving the people, the the prototypical angry white male, the rural white voter, or their equivalent in other countries what they want, which is a retreat from globalization, subsidies, local local boosts, and it doesn't work politically or economically. So this is why the center left and others are flailing about now trying to find something else to do.

And it's hard to convince people if if you have presidents and populists on both sides saying you can have a pony, that convinced them that no, you can't have a pony. You have to get on again on the train and go someplace else. Um. So the final point, sorry I'm rambling. The key point is A I think the political divisions in the democracy's continued to rise for the time being. And B that the world does turn

more into blocks. I mean, again, we've all heard people writing bestsellers every few years about the world turning into economic blocks. I think finally that time is hitting, now that it's going to start happening. It's definitely the same debate plays out a bit in the UK about regional equity. Um, listening to Adam, what's your reaction? Well, I was just smiling because I thought how much that Adam would hate Boris Johnson's new slogan, which is lived, local and prosper,

which you might consider a contradiction in terms. I mean, I think it is a debate that we're seeing in the UK, and it's there is a sort of fundamental um philosophical shift. I don't know if it's going to be matched with a financial shift or let alone an economic shift, but you've certainly you've now got the the government in that sort of lived local and prosper mantra actually saying to small towns you don't you can aspire to more than being the dormitory for some big city

that we put lots of money into. And that of course has been the model of even regional regional development across America and certainly across Britain for for decades. Is you get you maybe don't want it all in London, but you try and get more London's. You try and have cities that can then have the agglomeration effects, and there are towns around that are supporting the economic activity in the city that the city is the central bit

that's delivering the jobs. The Boris Johnson is now saying in terms to people, no, you know, we were not going to force you to go, We're going to take the jobs to you. You don't have to go in the city. You don't even have to get on a train to get them. And I share some of Adam's skepticism about that. I don't think there is any sort of real economic thinking behind that particular thing, but I

would push back a bit. I think even before this, many of us were thinking that there had to be more emphasis on people and places and livability in the vision of globalization that we have, and I think there is I'm not sure I see a fundamental threat to globalization coming out of this. You know, well, at the beginning of the crisis, we sort of thought all supply chains were going to regionalize, everyone was going to pull out of China. It's not what we see on the ground.

We don't see people pulling out of China, and we don't we only see limited regionalization. We have seen massive digitization, and I think that automation has obviously gone done in a few weeks, certainly months, what we might have expected to have happened over five years. And that holds. You know, there's opportunities there in terms of bringing not necessarily bringing jobs right to where people are are, but changing the pattern of jobs. Um, if we if we help prepare

people for it. And again as the big hole, the big the special boris Johnson sized hole, and this is that they're not going to spend any money on any of this, compared to you know, Adams worried that Biden's actually putting some financial weight behind this policy. You don't have to worry about that in the UK because all the sort of extra spending that's gone into the economy is all is all going to dry up next year? Can I just quickly sinned as usual? Stephanie and I

agree about but disagree violently on about or um. The first point is my my concern is not so much the band is going to spend money on this. My concern is more that if we focus on the rural local, and we focus on manufacturing, and we basically ignore of the non college educated people who work in frontline services and who mostly live in cities, and so it's it's partly adjust this argument as well as an efficiency argument. It's not about the waste of money, it's about the

diversion of attention. But secondly, and the thing I wanted to pick up on is Stephanie's absolutely right about supply chains, and her and or Bloomberg colleagues have done a great job of reporting and tracking on this, But I think trade is a very actually small part of the story. Um. Look, it's the corrosion of globalization that we're seeing is much more about flows of people, flows of technology, flows of ideas,

and even in the digital realm. While I agree there is this potential for allowing small businesses individual workers to sort of get more flexible from where there there happen to be located. I think there's also divisions going up in the world around the Internet, around platforms, around standards. There are fewer students going back and forth across borders. There are fewer people. The immigration is being cut back in a lot of places now. The US is doing

more of this cutback than most places. And that's one of the things I tried to put out my article, and we have charts at pia dot com about this, that he got much worse under Trump. But it really all started twenty years ago, and it wasn't just trade. It was investment, it was immigration, it was making trade deals or not making trade deals while others make them.

So I just want to say that I'm not sanguine about globalization in general, and particularly from the US, even though I agree with Stephanie's characterization of trade and supplych We were trading messages before we went knife here. And I think Bill, you said to me that your choice for the political economy shift coming out of the pandemic

would have to do with inequality. I think that the thing that strikes me about the pandemic is how unfair it has been through a small section of the population you know, the people who worked in leisure and hospitality, the people that had the list incomes, so that burden had fallen very disproportionately on a small segment of the population, you know, the eight point two million people that are

still without jobs. And I think that really colors ethnoic policy going forward is like because it really underscores to the Adams point, how unfair and unequal A lot of aspects of the US regime are in terms of the taxation regime, the inheritance taxes, I mean, things that allow generations to pass on money to to the to their to their children, their grandchilda. And I think that's really

going to be the lasting impact of COVID. I think in the United States it's really gonna it's the illustrated so clearly the inequities in the society, and I'm sort of hoping that that as a consequence of that will actually see lasting um set of policies to address them. Do you want to comment on this stuff? And it well, I think it's when it clearly is something that we've has been most evident in the in what's happened in

the response to the to the crisis. But I think of it as being I think Robert McFarland talks about unburial in a book he's written, the British author and that he's talking about things that get unburied close to the Arctic Circle, things that were buried undreds were expected to stay under the surface, but because of global warming, a sort of just coming out of the earth. And it feels a bit like that inequalities that we knew were there have just become much more evident and have

been been unburied. I guess I'm just a little bit skeptics of I mean, there has been quite a deep understanding of inequality for some time, and a lack of in most countries, a lack of practical political will, particularly when it comes to capital taxation. You know, people way down the income scale want to pass on wealth even when they don't have any. They really care about the

ability to pass on wealth. It's just been a been a persistent issue trying to even begin to address that, and you end up with these very inefficient property taxes. As a result of taxes, particular in the UK, you tax the transaction, you don't really tax anything to do with the value of the house itself. On an annual basis.

So I would like to think of all the things that Bill is talking about, but actually this long overdue shift to thinking more in terms of capital taxation and not only in terms of income tax when you're thinking about any kind of redistribution um will start to happen in the US and other places as a result of

the crisis. But I'm just given how much the crisis has itself exacerbated inequality, I guess I sort of feel like you have to have quite a lot of political will just to offset what's happened in the last two years,

let alone start to turn some tide. The one thing I wanted to add, which is no place where I want to give credit to the by administration, is they're very clear openness stated by Secretary Allen that they're going to engage in the international discussions over a minimum corporate tax globally and against profit shifting by large companies and particularly dig job companies. And that's not going to solve

every problem. But unless you make sure that countries are getting revenue and that that revenue is seen as fairly gotten. That's it for this special episode of Stephonomics. I'll be back next week. With a lot more from around the world, but if you need to, you can always get more news and analysis from Bloomberg Economics by following at Economics

on Twitter. This episode was produced by Magnus Hendrickson, with special thanks to Sebastian Mallaby, Bill Dudley, Adam Pose and all at the Council on Foreign Relations in New York. The new executive producer of Stephonomics is Mike Sasso, and the head of Bloomberg Podcast is Francesca Levy.