The financial and economic crisis we find ourselves in today is unlike any other we have experienced in our recent history. It was brought on by a health pandemic, that quickly turned into a steep and nasty recession as economies around the world were forced to come to a grinding halt. The short, and long-term effects of this crisis, however, may amplify many of the trends that have been in place for several decades.
Kenneth Rogoff, Harvard professor, former chief economist at the International Monetary Fund, and internationally respected expert on recessions, says this downturn doesn't fit neatly into any prior models. His 2009 best-selling and widely cited book with Carmen Reinhart, This Time is Different: Eight Centuries of Financial Folly , examines the booms and busts that helped shape today's global economy. The coronavirus pandemic and ensuing recession have profoundly amplified trends that were already at work in the global economy, but how it evolves from here is the great unknown.
This time is certainly different.
As we attempt to begin what is likely to be a long and winding recovery, I interviewed Rogoff via video conference to see how he envisions the long-term effects of this crisis and how it will shape the dynamics of the global economy five to ten years from now. Here is an edited version of our recent conversation.
Income Inequality and De-globalization
Silver: What will be the most important economic impacts of this pandemic and recession when we look back 10 years from now?
Rogoff: The political ramifications will be just massive. There were trends already in place, such as de-globalization and populism, and my guess is those trends will be reinforced—and not just in the United States. Obviously, the concern about inequality just blows up in this situation with 20% unemployment. People who don't have adequate space and adequate resources are suffering inordinately.
Silver: So let's talk about globalization. There was a trend away from it. Even though really it has defined the last several decades. Do you see that becoming more extreme, and do you see this rise of nationalism and re-shoring continuing?
Rogoff: We've had periods of de-globalization before. The most radical episode started in the 1920s and accelerated into the 1930s, ending with World War II. Before that, there had been a golden age of globalization from roughly 1870 until the outset of World War I in 1914. We seem to be heading into the downside of the cycle now. We were already seeing a sharp slowdown in the growth of trade after the global financial crisis. But it has really taken off with the rise of anti-trade populism during the 2016 election. It is not just a Trump phenomenon. Bernie Sanders is staunchly in favor of heavy trade restrictions and has had a big influence on young people, especially.
On top of the economic issues, there are long-term geopolitical and strategic questions. The rise of China has created tensions between Europe and the United States over how to deal with it. The Trump doctrine, if there is one, seems to be that trade with China has created long-term risks for the United States if China remains authoritarian. On the left, progressives in favor of stronger labor unions want to reduce imports from China—and trade in general—in order to shelter American workers from competition.
COVID is a big boost to anti-globalization. There could be be restrictions on travel and that in turn will reduce cross-border investment. On top of that, there is surely going to be a big push towards on-shoring industries where events have revealed legitimate security concerns, such as the production of antibiotics, masks, and ventilators. Of course, before COVID, a populist like Trump was prepared to argue that reliance on Canadian steel posed a national security threat, though this is ridiculous.
The question is where things will stop. How much of a de-globalization overshoot is there going to be? We're speaking by Zoom right now, and our connections rely on semiconductors and a lot of others materials that are not made in the United States. The next virus could easily be a computer virus, whether due to malicious hackers or a hostile state. Finance will not be spared from de-globalization because finance is theoretically and practically a reflection of what's going on in global trade and travel.
How We Should Measure Economic Progress
Silver: How will our notions of GDP, productivity, and economic growth change because of all of this? Should our economy be measured on the same metrics we have traditionally used, or do we need a new way of measuring economic progress?
Rogoff: As services become a larger and larger share of the economy, it was becoming more and more difficult to measure output even before COVID-19, and now the challenges are so much greater. Measuring prices and inflation is equally a challenge during a period of lightening-fast change, such as this. How do we measure inflation when a lot of goods suddenly become unavailable? In classic price measurement theory, new goods can have huge value, so I suppose losing existing ones should be thought of as effectively very inflationary. I suspect there'll be economic historians arguing about this in 10 or 15 years.
A lot of the trends in the last 40 years have been due to globalization, and especially the rise of China. Trends such as declining interest rates, very low inflation and deflation, and rising standards of living, very much owe to globalization. What will happen when it goes into reverse?
True, there are legitimate complaints about inequality within rich countries. The best remedy would be to tax the rich more, and provide more transfers and services to lower-income people. But make no mistake, if we look at the world as a whole—and treat every citizen of the Earth equally—globalization has been the best thing that ever happened to equality. If the United States leads a generalized pullback in globalization, it risks putting hundreds of millions of people back into poverty.
The rich countries will certainly lose some future growth, but if de-globalization goes too far, growth could easily be negative for a sustained period. True, the United States may not suffer nearly as badly from de-globalization as many other countries; the United States can do a lot of things by itself. It is a very diversified economy, with huge natural resources. On the other hand, for small countries, de-globalization will be a disaster.
Maybe New Zealand will do OK because it exports milk and mutton, final consumer goods. But for small countries that have become part of a global supply chain, this is a disaster. It is also a disaster for small island countries that depend on tourism, as do many large countries such as Italy, Spain and Greece. I find it odd that anyone talks about a V-shaped recovery because this isn't a classical demand shock. It's not just a health shock. It's also a political shock.
The Dangers of Skyrocketing Debt
Silver: How does the stratospheric rise in government spending to combat the economic impacts of the pandemic play out in the next five to 10 years? What are the dangers of our debt rising so dramatically?
Rogoff: There will be tremendous pressure to just keep borrowing for as long as possible, even after the recession passes. If there's a Democratic sweep in the November elections, they surely will (and should) raise taxes on the 1%. But will they raise them on the 50%? With huge ambitious expenditures programs, they will need to avoid having debt levels go up exponentially. Right now, that seems like the main idea. But it could prove very costly.
"I promise you over the next 10 years, we’ll get hit by another shock that didn't occur to us and no matter how much we borrow this time, we will want to be able to borrow even more—if the market will let us."
I promise you over the next 10 years, we’ll get hit by another shock that didn't occur to us and no matter how much we borrow this time, we will want to be able to borrow even more—if the market will let us. The United States is fortunate in that the dollar rules supreme, but it's worth bearing in mind that marketable U.S. government debt already vastly exceeds the combined debts of the eurozone countries (even though Europe’s economy is easily as large as the U.S.); and even if one throws in other OECD countries, U.S. government debt is almost as large as the government debts of all the other rich countries combined. I believe we are doing the right thing today by borrowing to make it through this tragic crisis, but make no mistake: It is not a free lunch, and it is not without its risks. Many advanced countries are already likely to experience strains to help their populations, especially given the likely coming wave of corporate debt problems, and the need to protect banks.
Do you raise taxes on the rich and increase transfers to the poor and government services, which I think is sustainable long run—or do you just avoid the political battles and keep borrowing? There's a danger that we do the latter, and then we run into a shock that we weren't counting on and having debt much higher than we had before, this next time it might turn out to be much harder to borrow.
Income Inequality and Taxes on the Rich
Silver: The investing class and the wealthy have done well in this recent recovery. We’re also seeing protests around racial injustice and police brutality, which is bringing up issues of income inequality. Do you think, no matter who wins the next election that there will be a broader acceptance of increasing taxes on the wealthy and raising the corporate tax rate back up again to pay for social services?
Rogoff: I certainly think that's the direction of travel in the long run—raising taxes on capital income. On the other hand, some of these ideas about a wealth tax are pretty naive. If one looks at how hard it is to calculate the value of the estates, and then think we have to do that across the whole economy, I think that's really stupefyingly naive. But we could have higher taxes on capital, and I think that's coming.
Is it coming in November no matter who wins? Of course it does but, regardless, it is eventually going to happen.
Inequality is growing. We live in a democracy; in the long run, there have to be more taxes and transfers, as well as spending on health and education. The danger is that politics leads instead to heavy-handed interventions that stifle growth, ultimately will making it harder to match the rise of China.
Has the Fed Done the Right Thing?
Silver: The Federal Reserve has enacted monetary policy measures beyond quantitative easing that maybe we couldn't have imagined in the past, as it tries to stem the crisis. It is going into the corporate bond market, small-business lending, and various other measures to try to provide liquidity. What are some of the unintended consequences of some of these actions?
Rogoff: In short, the Fed has been a hero in this pandemic. It has been very creative. It has learned and implemented lessons from 2008. The good news is that the policies that have been put in place are going to work marvelously if there turns out to be a pretty rapid recovery, and most importantly a solution to COVID-19 in the form of a vaccine and/or highly effective antiviral treatments. That optimistic view seems to be underpinning the stock market at this exact moment. But this rosy view fails to incorporate the possibility of second and third waves of the pandemic hitting both regionally and globally. If that happens, there is still a long, arduous road ahead to recovery. Absent a very rapid recovery, the Fed’s policy of virtually guaranteeing every credit in the economy is just not going to be sustainable, and other tools will be needed. I believe that the only tool left to support independent monetary policy is deep negative interest rate policy (my 2016 book explains how this could be done effectively). But right now, there is no appetite for it.
What about more fiscal deficits? For sure, that should be tried, but it is not going to be sustainable if COVID-19 drags on. I would prefer to see stimulus though a tax and transfer system that reduced inequality, I believe that can give a large amount of stimulus with much less risk.
The Biggest Surprise in This Crisis
Silver: What has been the biggest surprise through this crisis? What did you not expect?
Rogoff: The number-one surprise really has been Germany's willingness to start talking about a fiscal union in Europe. The euro, as currently designed, is not resilient; it is not possible to share a common currency indefinitely without greater fiscal and monetary union. I have been arguing in favor of a tighter union for a long time, but until recently no one seemed to want to hear it. When speaking in France in 2012 about fiscal union, someone commented that I must be drinking wine and beer at the same time. Until recently, the Germans have always said they wanted a fiscal union, but in practice that meant only under German rules. So recent progress towards what can only be described as massive transfers to struggling Italy, Spain, and Greece is potentially historic. I wouldn't have predicted it. If it happens, it will be a huge step in the future of Europe and in overall global stability.
Which Economic Term Encapsulates this Moment?
Silver: Which economic term best encapsulates what we're going through right now?
Rogoff: We are going through an epic recession that could be the worst in 150 years. It doesn't fit neatly into the kind of recessions that Carmen Reinhart and I studied in our 2009 book. It really looks most like the 1918 Spanish flu, but the world wasn't rich enough back then to be able to shut down the way it has now. Back then, the growth effects were pretty temporary and mild compared to what I think we are seeing and going to see here.