The New Cold War
America, China, and the Echoes of History
On January 20, Joe Biden will walk into the White House as U.S. president facing an economic challenge much like the one he faced when he walked in 12 years ago as vice president. In January 2009, the unemployment rate in the country was 7.8 percent, and as of this writing, it was expected to be similar in January 2021. Then, as now, many small businesses had gone bankrupt, and entire sectors of the economy were severely damaged.
In three important respects, however, the economy will be in a very different position than it was 12 years ago—and it is the differences as much as the similarities that should guide Biden’s response. In 2009, the worst of the recession was still to come: the unemployment rate was rising, the stock market was falling, and the sense of day-to-day crisis was palpable. Today, in contrast, the unemployment rate is falling, the stock market is strong, and the country’s economic problems, although large, don’t have the house-on-fire character that prevailed back then. Biden’s most important and urgent task will still be to stop the COVID-19 pandemic, hasten the recovery, provide relief to households, and foster economic growth through the types of measures that were part of the CARES Act, which Congress passed last March but failed to follow up with new legislation after most of the act’s benefits expired over the summer. But Biden will also have substantial space to craft a relief package that is responsive to the country’s medium-term challenges—what he calls “building back better.” By doing so, he can go beyond merely addressing today’s crisis and establish an enduring legacy that helps the United States better respond to future crises.
Biden will have more economic latitude to undertake this project because of another important difference: the United States will have even more room to maneuver on fiscal policy in 2021 than it did in 2009. This might sound paradoxical, or even wrong, given that the debt in January 2009 was less than 50 percent of GDP but will be around 100 percent of GDP when Biden takes office. The distinction between the two periods is interest rates. In January 2009, the real interest rate on ten-year government debt—the cost of borrowing after accounting for inflation—was roughly two percent. In January 2021, it is likely to be around negative one percent. As a result, even though government debt is higher today, its carrying cost is lower.
The final difference is that the United States was widely blamed for unleashing the 2008 global financial crisis and initially suffered as much as, if not more than, other countries. In the current case, the COVID-19 pandemic did not originate in the United States, and the country has suffered less economic damage than many other comparable countries. China has recovered more completely, but if anything, its efforts to claim global leadership have been counterproductive. Given the global goodwill that will come with the arrival of a new U.S. president, the United States will have a chance to look not just inward but also outward. A Biden administration should take that opportunity to reinvigorate the cooperative system of global economic governance that the United States created and has led ever since the end of World War II. The crises of worldwide collective action that lie ahead—including climate change and future pandemics—endanger everyone and will require all countries to work together.
The onset of the COVID-19 pandemic was a massive shock to the global economy. The synchronized shutdown in the first half of 2020 was the largest, fastest, and most comprehensive reduction in economic activity ever witnessed in the modern world. It affected both supply and demand and was costliest for less advantaged households, whose members were the most likely to lose their jobs.
At the same time, however, countries around the world have mobilized massive policy responses, providing cash transfers and other assistance to individuals and businesses at a scale never before seen in peacetime. Governments also unleashed their central banks, which not only cut rates but also increased credit availability to a wide range of actors. The U.S. response was initially among the largest, with fiscal measures equal to around 13 percent of GDP—comparable to the German response and larger than the reactions of most other countries. U.S. measures have also been highly progressive, disproportionately benefiting the lowest-income households.
One pair of figures captures the massive scale of both the shock and the response: in the second quarter of 2020, the U.S. economy contracted by a record nine percent, but disposable personal income, which includes government transfers such as Social Security payments and unemployment benefits, rose by a record ten percent. For the year as a whole, real disposable personal income per capita is likely to have risen at the fastest rate in over 20 years. Moreover, on average, the lowest incomes have increased even faster—although this average conceals substantial suffering, especially since the additional unemployment benefits created by the CARES Act expired at the end of July 2020. As a result, although the largest employment losses were for low-income workers, the same group appears to have enjoyed the strongest rebound in consumption, helped along by the government support they initially received.
Biden will have substantial space to craft a relief package that is responsive to the country’s medium-term challenges.
The combination of historic shock and unprecedented policy response has brought the United States close to an economic draw. Early assistance prevented a sustained recession of historic proportions, instead leaving the U.S. economy in what is effectively a moderate to bad recession rather than the depression-scale collapse many feared. The unemployment rate rose extremely high, but only for a short time. In contrast, the country saw longer stretches of high unemployment in the 1970s and in the wake of the 2008 financial crisis. The unemployment rate for 2020 will likely average around eight percent—certainly bad, but not one for the economic history books. When the smoke clears, this will probably be only the third- or fourth-worst of the 12 recessions the country has faced since the end of World War II.
This prognosis is brighter than what most analysts feared in the spring. The recovery, however, is in large part due to the substantial policy response to date, and it remains contingent on similar actions going forward. The U.S. economy is far from out of the woods. Economic growth since the initial sharp contraction last spring was the easy part, a partial bouncing back of activity akin to what happens after a natural disaster. Businesses reopen, workers go back to their old lives, and at least in some sectors, the economy resumes from where it left off.
The natural disaster is not over. The number of new COVID-19 cases remains high and continues to rise. The most important economic policy for a full recovery is to end the disaster itself. This means reducing disease transmission through mask use, social distancing, testing, contact tracing, isolating infected people, improving treatments, and, eventually, the wide distribution of a vaccine. Whatever amount of money the government needs to spend to achieve these objectives would easily pass any form of cost-benefit test. The United States can ill afford not to spend the tens of billions of additional dollars necessary to combat the virus itself.
The economic problems associated with COVID-19 are likely to persist, however, even once the virus itself is under control. In addition to the initial “natural-disaster recession,” which has already begun to taper off, the United States is now suffering a more normal recession linked to high unemployment and reduced purchasing power. The number of unemployed people who were temporarily laid off (which was a result of the natural-disaster recession) has fallen from a high of 18 million in April to nearly three million in October. In contrast, the number of unemployed people who are now permanently laid off (which has to do with the more normal recession) actually rose by almost three million over a similar period.
The good news is that economists and policymakers understand how to treat a normal recession. Yet with the Federal Reserve having done virtually all it can, Biden and Congress need to make another round of fiscal stimulus and family relief their first priority.
One of the lessons that U.S. policymakers learned from the inadequate response in the wake of the Great Recession was that it is critical to do something large. The CARES Act reflected this. It was an impressive and well-timed piece of bipartisan legislation that, in its initial months, provided an astounding 30 percent of GDP in fiscal support. The problem, however, was that the legislation did not reflect the second lesson of the financial crisis: responses to disasters need to be long-lasting. Instead, the act provided extraordinary support for only about four months. After that, most of its provisions expired, leaving a distressed economy without any assistance and a paralyzed Congress and president unable to agree on action. This was predictable. Just as during the financial crisis, it was easier for parties to come together in the beginning of the disaster, when its effects were most acute. After that, differences over how generous social benefits should be, divergent views of the economy’s trajectory and the efficacy of policy, and various political considerations all collided to restore the paralysis that has come to characterize the U.S. political system.
Policymakers must not allow that to happen again. Instead, they should make sure that any future response is both large and long-lasting. No one knows when recessionary conditions might end, so instead of making the policy time dependent, policymakers should make it context dependent; assistance should be a function of the unemployment rate. This means aid would scale up or down automatically with economic conditions and provide hard-hit areas with comparatively more assistance.
The economics of the situation Biden faces will ultimately be the easy part of responding to the COVID-19 crisis.
Within this overall structure, the administration’s biggest priority should be expanding and extending unemployment insurance. About ten million people will likely still be out of work by the time Biden takes office, and the most disadvantaged workers will be disproportionately affected. The constraints on job growth will still be more about the absence of opportunity than any lack of effort on the part of job seekers. Evidence collected by the JPMorgan Chase Institute, moreover, showed that increased unemployment insurance benefits distributed under the CARES Act worked well. They led to increased spending, which in turn created jobs and supported higher incomes. The $600 increase in the weekly benefit the bill created made sense in April and May, but it is too large for the more normal recession the country is likely to experience in the coming year. A new program should propose restoring the extra benefit at $400 per week (or, better yet, at a specific fraction of one’s previous wages), an amount that could be scaled down automatically based on the unemployment rate. As that rate falls, policymakers need to ensure that they are incentivizing workers to look for jobs. In addition, any new program should allow people to continue to receive unemployment insurance for an extended period of time.
Despite additional benefits, many households have suffered from hunger and have struggled to pay their rent and other bills. This deprivation has been concentrated among people who have not been receiving unemployment benefits, either because they are not aware of them or because they are not eligible based on their work history or immigration status. To reach such households, the president and Congress should increase available funding for nutritional assistance through the Supplemental Nutrition Assistance Program. As with unemployment insurance, the level of extra assistance should taper off if the unemployment rate falls. Policymakers should also consider another round of direct payments to lower-income households, similar to the $1,200 checks provided by the CARES Act. As with expanded unemployment benefits, such measures would have a disproportionately positive impact on the overall economy because they would go to households with a high marginal propensity to consume, that is, a far greater likelihood to spend the money rather than save or invest it.
The next priority should be assistance for state and local governments. Inadequate state and local assistance in the wake of the 2008 financial crisis sliced 0.6 percentage points off the GDP growth rate during the five years that followed. And according to the economist Gabriel Chodorow-Reich, the economic benefit of a stimulus from state and local spending is stronger than any other fiscal measure—with more than $1.70 added in GDP for every $1 transferred to states and localities. Moreover, this kind of funding also prevents damaging cuts to education and other programs and would help local leaders address shortfalls in their revenue, pay for emergency measures to better virus-proof their communities and schools, and provide additional assistance to low-income households and small businesses.
Although states entered the pandemic with less debt and larger rainy-day funds than at the onset of the last recession, nothing prepared them for the magnitude of the current crisis. Balanced-budget requirements also make it impossible for many states to spread costs out over several years, so federal assistance is essential.
States have already gotten $212 billion in assistance, just enough for many of them to cover the last fiscal year. For most states, however, the current fiscal year began in July 2020, and without additional federal help, they will face a combined shortfall of more than $200 billion in revenue—a number that does not include emergency costs for the next two years. To fill this gap, the Biden administration and Congress should link the level of federal contributions directed to state Medicaid programs to state unemployment rates. This would allow aid to automatically rise in hard times and fall in good.
This agenda would provide immediate relief to households in need and help states and localities avoid otherwise damaging cutbacks. It would also be an effective fiscal stimulus that could add several percentage points to the growth rate in 2021, bringing the unemployment rate down much more quickly than it would come down without help.
Making such steps permanent would help with the current recession and reduce the severity of future recessions, as well: in good times, aid measures would automatically go away, but in bad times, they would return without the need to wait for Congress to act. This is especially important in the United States, which, by virtue of having a smaller and less progressive fiscal system than other advanced economies, has tended to have relatively small automatic increases to federal spending and more limited tax reductions in response to recessions. This was not a big problem when interest rates were higher; the Federal Reserve could simply cut rates to make up for the absence of fiscal support. But with rates likely to be difficult to cut much further in the foreseeable future, it will be important to improve automatic stabilizers tied to economic conditions.
Unemployment insurance, nutritional assistance, and state aid are all proven ways to bolster demand quickly and efficiently. On their own, however, they will likely not be enough. Higher demand is good at getting people back to their old jobs and causing businesses to reopen as they get more customers, but it is less effective at helping people find jobs in new industries and occupations. Finding a long-term solution for this problem—known as “labor reallocation”—will be important in the aftermath of a crisis that could permanently alter many sectors of the economy. The travel industry, for instance, may suffer for years to come. Some activities that have mostly ceased during the pandemic, such as business trips and conferences, may be permanently scaled back in favor of videoconferencing. Many firms have realized that they can make do with fewer employees and will either not bring everyone back or will slowly pare down their existing workforces. Some brick-and-mortar stores may permanently give way to online retail. The disruption to the labor market has been massive: all told, some economists estimate that last April, labor reallocation was more than twice as high as it was in the four years before the pandemic.
This aspect of the pandemic is especially concerning because the U.S. economy never fully recovered from the last crisis. At the beginning of 2019, the economy was 22 percent larger than it was at the onset of the Great Recession, and the unemployment rate was down to a mere 3.5 percent. Even with these impressive numbers, however, the percentage of men aged 25 to 54 who were employed at the end of 2019 was only 86.6—below the 87.2 percent at the start of the financial crisis. The U.S. economy has had a long-standing problem connecting unemployed workers to jobs, and there has been a 50-year slide in the employment rate for men.
Countries around the world have largely turned inward to focus on solving their own problems.
One solution to this problem is to create new jobs in new industries. The most effective tool the federal government can use for that task is a substantial increase in infrastructure investment. The Biden administration should propose spending more than $1 trillion on traditional projects such as roads and bridges and on a green strategy to increase energy efficiency; expand clean energy, including both nuclear energy and renewables; and harden the economy against natural disasters. Such spending was warranted even before the COVID-19 crisis, but the pandemic has made it even more important. Although it is easy to mock claims about so-called shovel-ready jobs, 52 percent of the funds earmarked for highways in the 2009 Recovery Act were spent within two years, and 81 percent were spent within three years—well ahead of projections. And even if infrastructure investment is unlikely to do much immediate good, the economy and the labor market will need support for many years.
A focus on infrastructure building was, however, better suited to replace the construction jobs lost in 2008 and 2009 than it will be to replace the jobs lost this time around, which were disproportionately face-to-face service-sector positions. Although economists know less than they would like to about the value of programs for training displaced workers and helping them find new jobs, they do know that community colleges have been very successful and that general funds to help dislocated workers pursue their own training can be effective, as well. Additional funding for these kinds of programs, alongside job-search assistance, would all be worthwhile.
Finally, policymakers should take the long-overdue step of complementing unemployment insurance with a new system of wage insurance. Unemployment insurance insures workers against not being able to find any job; wage insurance insures them against being able to find only a job that pays less than their last one. Such insurance should be available primarily to older workers, who are often unable to get retrained for new jobs. Ideally, it would cover roughly half of one’s lost wages for a period of about five years. Such insurance would help motivate unemployed Americans to get back into the job market and would also protect Americans from the dislocations that have come with increased globalization and free trade.
To truly seize the moment, Biden must go beyond merely seeking to address the pandemic’s immediate economic fallout. After all, his slogan “Build Back Better” suggests fixing structural problems that predate the COVID-19 shock and shoring up systemic weaknesses that the crisis has highlighted. Among these are serious inadequacies in the United States’ social safety net. The Affordable Care Act made health insurance accessible to millions of Americans whose employer-provided coverage ended when they lost their jobs during the pandemic. But it was not enough: millions of people were unable to get insurance either because they lived in states that had failed to expand Medicaid or because the program’s subsidies were not large enough to cover unaffordably high costs. Although Democrats and Republicans have very different views on health care, the Biden administration needs to find a way to extend coverage, perhaps through a compromise that includes a substantial role for private health insurance companies. Unemployment insurance also played a vital part in protecting households and the economy, but long delays, outdated computer systems, and confusing eligibility determinations exposed long-standing problems that were exacerbated by chronic underfunding. Although temporary patches have helped many Americans get benefits, policymakers need to undertake a full reform of the system. This means more administrative funding, better coverage, and possibly a unified federal program.
The United States went into the pandemic as the only advanced economy in the world without nationwide paid sick leave. In March, policymakers were forced to invent a plan for paid sick leave on the fly, a task that proved difficult amid a pandemic. A new system with mandatory sick days covered by employers and a publicly funded option for longer leave is essential not just during crises but also for the everyday needs of U.S. workers. It would help foster a more flexible workforce.
Finally, the United States also acted quickly to invent brand-new taxpayer-funded programs, such as the Paycheck Protection Program to help small businesses keep workers on the payroll. Although this succeeded in the short term, a better system would rely more on job-sharing (whereby employers temporarily reduce workers’ hours instead of laying them off) and on business-
interruption insurance that is paid for in good times by firms themselves. Going forward, the government should study ways to help ensure that the private sector offers such policies, and perhaps it should offer a federally backed version, as well.
An ambitious agenda of this sort will cost a lot of money. When it comes to immediate and temporary relief, however, economists broadly agree that such programs need not be paid for now. And limiting support due to concerns about debt would directly hurt individuals and families while causing lasting damage to the economy. Even those who normally advocate fiscal rectitude, including the International Monetary Fund and economists such as Carmen Reinhart and Kenneth Rogoff, have urged governments to take a less restrained approach. In the long run, new social insurance programs such as wage insurance, paid leave, and business-interruption insurance should be paid for without increasing the national debt above and beyond its current trajectory. Actively reducing the debt, however, should not be a priority right now—or even necessarily a concern.
Two years ago, Lawrence Summers and I argued in these pages that Washington had been overly concerned about debt and that, with lower interest rates, the debt was much less costly than previously assumed. If anything, U.S. government debt issuance has had some beneficial effects. It increases the scope for monetary policy and provides support for an economy with chronically low demand. Since we wrote that article, our case has only gotten stronger. Even before the pandemic hit, interest rates were negative in real terms, meaning that the government could pay back debt at a lower cost in the future. As a result, the United States and other countries have had no problem borrowing to respond to the crisis. Even in the extreme case of Japan, which has nearly twice the debt-to-GDP ratio of the United States, high debt has not increased interest rates—removing the conventional reason to be worried. Indeed, the biggest threat the economy faces over the next several years is not the debt itself but political concern—sincere or opportunistic—about the debt.
Even if Americans had been immune to COVID-19, the effects on other economies around the world would still have been severe enough to cause a recession in the United States. Now, similarly, the country cannot enjoy a strong recovery without much of the rest of the world doing the same, and economic growth has been hit even harder in Europe and Latin America than in the United States. Luckily, however, the pandemic has not turned into a financial crisis, and some of the worst fears about its impact on emerging markets have not materialized. Nevertheless, the global economy still faces the continuing effects of COVID-19, the likelihood of further financial and political instability, and the possibility of even worse crises in the future.
The world sorely needs U.S. economic leadership. Although Washington has been mostly absent from the global economic stage during the COVID-19 crisis, now is the time for it to reassert itself. In the past, the United States has helped solve systemic crises to its own benefit, including the Asian financial crisis in the late 1990s. U.S. engagement (without direct American resources) was also crucial to addressing the 2010 eurozone crisis, which strengthened the United States’ post-recession recovery.
The most important step is also the easiest: reasserting the U.S. commitment to global governance and institutions. To date, there has been little international coordination on the economic response to COVID-19. Countries around the world, and not just the United States, have largely turned inward to focus on solving their own problems. Instead of coordinating, advanced economies have undertaken so-called correlated actions: they faced a similar menace at a similar time and thus behaved comparably. Although correlated actions have worked relatively well for advanced economies facing similar problems, a full recovery will require additional coordination on fiscal and monetary commitments.
Correlated actions, for example, are completely inadequate when it comes to addressing the debt and capital flow issues plaguing many emerging markets. Their interests and positions are different from those of more developed economies. Coordination, including debt-service suspensions, debt relief, and, if needed, resources for the International Monetary Fund, will be necessary to help prevent another financial crisis, sustained increases in poverty, and hardship in some developing economies.
Finally, countries will have to solve the tricky issues of global vaccine distribution and the fallout from trade wars over personal protective equipment and medical supplies. Here, Biden should step back from his “Buy American” policies, which are at best ineffective and at worst damaging, since they will raise the costs of U.S. government procurement and weaken the market for American exports to foreign governments. Biden should also move to immediately join COVAX, the global vaccine development, production, and distribution effort in which almost every country in the world is now participating, including every major country except Russia and the United States. Joining would set a tone of moral leadership, one the United States will need to adopt if it hopes to make any progress on other thorny issues, such as international taxation, climate change, and cyberwarfare.
The economics of the situation Biden faces will ultimately be the easy part of responding to the COVID-19 crisis. The hard part will be the political challenge of a potentially Republican Senate. In some areas, both sides will have similar goals, and Biden should do everything he can to seize those opportunities. Responding to the immediate economic emergency and infrastructure investment are two items that Republicans have already expressed interest in. On other issues, Biden may need to compromise more in order to make progress, something he has substantial experience with both as a senator and as vice president. On a host of other topics, however, he will likely need to build a long-term case for policy change.
The biggest difference between Biden’s experience today and the experience of the administration he helped lead in 2009 might be the trajectory of the recovery and its associated political implications. The fiscal, monetary, and financial measures Washington undertook during the last crisis prevented a second Great Depression. But it was hard to make that case when the actual unemployment rate did not fall below 7.8 percent until the end of President Barack Obama’s first term.
Biden’s timing is likely to be better. If he implements anything like the policies he has campaigned on, the recovery will speed up. The natural business cycle and (one hopes) a vaccine will help, as well. This combination should allow Biden to convincingly and correctly argue that his efforts were successful, putting him in a position to build political support for the structural changes he seeks to make. Good timing alone, however, will not be enough. A successful presidency has to start with a good plan.
The Global Economy Will Never Be the Same