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The holidays are over (regrettably) and now it is time to think about what comes next.
A year ago, very few would have predicted a global recession in 2020. And even after the pandemic caused the global economy to crater in March and April, few would have predicted that most types of businesses would be able to function with most of their employees working remotely. The point is that it was a year in which most assumptions went out the window and most predictions were wrong. Thus, one must start 2021 with humility. That being said, I’m willing to offer a few thoughts on where we stand now and what it might imply for the coming year.
As 2021 begins, the world is faced with promise and peril. On the positive side, the distribution of vaccines is under way, offering the promise that, sometime later in the year, the negative impact of the virus could ultimately abate. On the negative side, the virus continues to threaten economic stability, especially in those parts of the world where the outbreak has not been controlled. This is true in the United States and the United Kingdom and threatens to be a problem elsewhere as the new strains of the virus spread further. The challenge for policymakers will be to stifle the current outbreak, protect those who are disrupted by the outbreak, and speed up distribution of the vaccine.
The US economy clearly weakened toward the end of 2020. Personal income and consumer spending both declined in November and some measures of housing activity weakened after many months of stellar performance. The weakness likely resulted from the impact of the massive surge in the virus. Although the number of new infections began to abate toward the end of December, public health officials worry that the increase in holiday travel in late December will result in yet another surge in infections in early January.
Meanwhile, the US Congress finally passed and the president signed a spending package of about US$900 billion. It includes extended unemployment insurance, cash for households and businesses, and money for education and medical care. It will modestly buttress the economy for a few months, but it is likely that more will be needed unless the vaccine is widely distributed earlier than anticipated. As of this writing, vaccine distribution is far behind initial plans. Once Joe Biden becomes president, he is expected to ask Congress for further funding, especially to implement a much greater level of testing as well as to boost distribution of the vaccine. He also wants more money for households and extra money for distressed state and local governments. His ability to obtain anything from Congress will depend on the outcome of the runoff elections in Georgia schedule for January 5. Those races will determine control of the US Senate.
Eventually, the virus will be defeated. The big uncertainty concerns how quickly this will take place and at what cost. Still, when recovery comes, we can expect that middle- to upper-income households will stop saving such a large share of their income and, instead, spend more on consumer-facing services, such as restaurants and travel. This shift in behavior will go a long way toward boosting the rate of economic growth. Yet even a robust recovery later this year will not likely erase the troubles faced by many former employees of consumer-facing industries who are expected to remain unemployed. This will be especially true for workers in retailing. Disruption of the job market will be a longer-term problem, one whose solution will be debated in Congress. There will likely be plenty of talk about the K‑shaped recovery.
The fourth quarter outbreak of the virus on the European continent quickly abated due to the imposition of economic restrictions as well as reduced consumer mobility. In addition, many governments in the European Union (EU) extended support for the labor market well into 2021, thereby averting further economic distress. The result is likely to be a strong upturn in growth in the first quarter of 2021 after a likely decline in activity in the last quarter of 2020. Moreover, vaccine distribution is under way, thereby setting the stage for a significant acceleration in growth later in the year. Still, as of this writing, distribution is slower than planned. As in the United States, full implementation of the vaccine will likely entail a reduction in household saving and an increase in spending on consumer-facing services. For European governments, an improvement in growth will work wonders for government finances, which have been severely disrupted during the pandemic. The European Central Bank will likely continue to provide support to the market for government debt, especially as long as inflation remains muted.
Having lost the United Kingdom and faced tensions with the outgoing US government, the EU remains determined to extend the realm of trade liberalization. In recent years, it has signed trade deals with Canada and Japan and initiated negotiations elsewhere. By the end of 2020, such efforts bore fruit with a new investment agreement with China. The main goal for the EU was to support the ability of European companies to operate profitably in China. The EU claims that the new agreement creates a level playing field for European companies and ends forced technology transfers. In addition, the EU says that the deal eliminates the requirement that European companies have a local partner in China. Officials of the incoming Biden administration in the United States counseled against the deal on the hope that the United States and EU could take a common stance on issues related to China. The US side evidently worries that the EU-China deal will reduce US leverage in addressing its grievances with China. For China, the deal with the EU could be seen as a way to create space between the United States and the EU. In any event, the EU says that the deal does not remove its ability to address human rights and geopolitical issues in China that are of importance to the United States. Finally, the deal might lead US businesses to pressure their government to negotiate a similar deal with China.
The year 2021 begins with Britain finally separated from the EU, with an eleventh-hour deal having been signed at, well, the eleventh hour. The deal allows trade in goods between the United Kingdom and the EU to take place without tariffs or quotas. However, trade will now involve bureaucracy and border controls, adding costs and reducing speed. Service trade, however, remains subject to potentially restrictive rules. Meanwhile, the United Kingdom has exited the single market and the customs union. The single market, which encompasses the EU as well as Norway and Iceland, means free movement of not only goods and services but also people and capital. It also means common rules applied to certain industries and activities. The customs union means barrier free trade and a common external tariff with respect to other countries. The United Kingdom chose to exit both agreements in order to restrict and control migration, implement its own internal regulations, and make trade agreements with non-EU countries, such as Japan and the United States. The passage of a deal is a relief to many observers who worried that a no-deal Brexit would have been catastrophic. Still, the British government’s own Office of Budget Responsibility (OBR) says that in the long run, the current deal will reduce real GDP by 4% versus if the United Kingdom had stayed in the EU. The OBR said that a no-deal Brexit would have reduced real GDP by 6%. Meanwhile, the latest spread of COVID-19 is already disrupting trade. This will make it difficult to discern the true impact of Brexit.
China’s economic growth continues at a healthy pace. Consumer spending has been boosted by confidence that the virus is under control. Fixed asset investment has been helped by substantial funding for state-owned enterprises as well as regional governments. And exports have performed well, in part owing to China’s global competitiveness in technologies for which demand has accelerated during the pandemic. This includes personal protective equipment (PPE) and technologies used for remote interaction.
Yet the strength of China’s economy has come with a cost in terms of rising debt. Moreover, the government is evidently keen to avoid the kinds of financial pitfalls that often emerge when credit creation is excessive. For example, the government has recently shut down so-called P2P lending organizations that raise funds from consumers, promising high returns, in order to provide loans to small businesses that are often excluded from formal credit channels. There was concern that the P2P channels involved poor loan management and even possibly Ponzi schemes. Yet the collapse of the industry has caused millions of investors to lose their life savings. Meanwhile the government is allowing bad corporate debtors to default on loans and bonds rather than encouraging lenders to roll over loans. This suggests that the government wants to create a sounder financial base for the coming decade. Indeed, China’s president recently said that “financial stability is the basis of national stability. Deleveraging state-owned enterprises is top of the top priorities.” Although a system of credit that punishes failure will eventually generate more productive investment and faster growth, in the short term, it will likely create disruption.
While the economic outlook for China in 2021 appears positive, one big unknown is the future of the relationship between China and the United States. With a new US administration, there is clearly potential for change. Yet the Biden team has downplayed the possibility of a swift change in US policy toward China. They prefer to first focus on domestic issues as well as solidifying political support before taking potentially unpopular actions with respect to China. In addition, any action related to trading relations with China is likely to be undertaken after negotiations between the two sides. It is likely that, if there is a modest rapprochement between the two sides involving a reduction of trade barriers, businesses on both sides of the Pacific will take this as evidence of a more stable and predictable environment. Still, the current US administration has recently imposed rules that limit the ability of Chinese companies to raise funds in US capital markets. It will be interesting to see if the new administration leaves these rules unchanged.
Emerging markets have experienced a range of economic outcomes during the pandemic, but the common denominator has been a sudden temporary collapse in economic activity followed by a rise in debt. Although many emerging countries are now growing rapidly, the ability to fully recover from this situation will depend on many factors, not the least of which will be the speed at which vaccines are distributed in poorer countries. Even in the best of circumstances, many countries will remain laden with debts that could stymie growth and create financial vulnerabilities. The ability to service and pay down debts will depend on the path of global commodity prices, the volume of remittances from expats living in affluent countries, the value of the US dollar (in which many external debts are denominated), the ultimate return of the massive tourism industry, and the health of global trade in manufactures. All these factors are, in some degree, dependent on whether or not the world succeeds in suppressing the virus.
Meanwhile, global food prices have risen sharply in recent months, potentially creating economic and social stress. The prices of wheat and soybeans are now the highest they have been since 2014. In the past, sharp swings in food prices often led to politically destabilizing mass protests or a sharp rise in unsustainable government debt when governments attempt to subsidize food costs for consumers. The recent increase in prices is due to several factors, including stockpiling of grain by China, expectations of higher energy prices, expectations that the global hospitality industry will soon recover, and higher freight transportation costs. The rise in food prices and the high level of debts accumulated by many poor countries are factors that might potentially unsettle the emerging world, not only economically but also geopolitically.
The Deloitte Global Economist Network is a diverse group of economists that produce relevant, interesting and thought-provoking content for external and internal audiences. The Network’s industry and economics expertise allows us to bring sophisticated analysis to complex industry-based questions. Publications range from in-depth reports and thought leadership examining critical issues to executive briefs aimed at keeping Deloitte’s top management and partners abreast of topical issues.
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