Inflation fears and supply-chain disruptions in the wake of COVID-19

Ira: The vaccines are very impactful. The United States and the United Kingdom, among major economies, are the only ones that have so far vaccinated a relatively large share of their populations. Even in those cases, there’s still risk. We’ve seen periodic isolated outbreaks of the virus involving new variants, and that has the potential to be economically disruptive. The situation in India, which is extremely worrisome, is a cautionary tale in that as recently as January, people were saying that India was largely out of the woods and it’s clearly not. Of course, they haven’t vaccinated a significant share of their population, but there was a perception that the virus was under control and clearly that was not the case. So for the United States, we’re in relatively good shape, but we’re not completely out of the woods yet. In Western Europe, the number of vaccinations taking place on a daily basis is now quite high, but in total, the number that has been vaccinated so far is still, as a share of the population, way behind the United States and the United Kingdom. And Eastern Asia is also even farther behind—that would be China, Japan, and other countries where the infection rate remains relatively low, but where the need to be cautious remains high because the vaccination rate is not yet where it needs to be.

Tanya: When we talked back in January, you used the words herd immunity, saying that we were getting closer to herd immunity in the more affluent countries. You weren’t the only one talking about that, but now we’ve got medical experts saying that with the COVID-19 variants and vaccine hesitancy, herd immunity is not likely. How does that change your outlook?

Ira: That’s true. We may not get to herd immunity in the sense that we may not get to the point where such a large share of the population is vaccinated that the virus itself has nowhere to go. And we are running up now against vaccine hesitancy. We’ve reached the point here in the United States where the vaccine is widely available, anyone can get it any time if they want, and yet the number of people getting vaccinated on a daily basis has dropped sharply. So we may not reach the point where a large enough share of the population is vaccinated to fully suppress the virus, which means we may have to live with the virus and we may have to change the way we do things. It doesn’t necessarily mean slower economic growth, but it may affect the demand for some types of services. It may affect the cost of providing some types of services in order to avoid transmission of the virus. In that sense, we may have a slightly different structured economy going forward, assuming that the virus is something we do, in fact, have to learn to live with.

Tanya: You mentioned India, and as we’re recording this interview in the middle of May, India already has more than 260,000 deaths, many of them coming in the last month or so. And hospitals and public services are completely overwhelmed. The human toll obviously is immense. But what are the economic implications of this for India and maybe beyond?

Ira: Clearly, India’s ultimate economic recovery has at the least been postponed. Our own estimate is that the Indian economy actually grew strongly in the first quarter, and then there was this sudden outbreak that has been devastating. Our expectation now is that real GDP will have fallen in the second quarter. There’s a high degree of uncertainty. We don’t know how long it will take to get this outbreak under control. Once it is under control, the economy can resume growth, but then there will still be the risk of further outbreaks and that risk will entail suppressing social interaction in ways that will probably limit the economic recovery. So I believe the Indian economy will grow this year, but probably significantly slower than what I would have expected just a few months ago.

Tanya: Moving beyond India, in general, how’s the structure of the economy changing in response to the pandemic? Is it just a shuffling or is there something bigger going on that we should be thinking about?

Ira: There are a lot of things happening. One thing that happened during the pandemic was nearly complete suppression of a lot of consumer-facing industries. People stopped going to restaurants and bars, stopped getting on airplanes and going to hotels, avoided shopping centers and did more shopping online, and of course, worked at home and avoided going to the office. Now, as we’re starting to come out of this, some behaviors are starting to change. People are starting to go back to restaurants and get on airplanes and go to hotels. That is being reflected in higher prices for those services because companies are not yet ready to meet that increased demand. And that will take time to sort out.

We continue to see very strong growth of spending on durable goods, which don’t involve social interaction. A lot of that extra spending is being driven by the stimulus money provided by governments. That has also led to higher prices and disruption of supply chains. We’ve seen shortages of container ships and freight air service, rising costs of shipping goods and traffic jams at ports. We’ve seen shortages of key commodities and inputs. There’s a global shortage of semiconductors because there’s such a strong demand for online technology and that has spilled over into a shortage of chips for the automotive industry. Some automotive companies have been forced to shut down some factories. There’s a lot of turmoil in the global economy now because of the rapid transitioning out of the pandemic, the response to stimulus, the fact that with the vaccine people are becoming more confident and willing to spend their money. It will take time to sort this out.

Tanya: I want to move away from COVID-19 here for a moment and go to the US jobs prospects. Investors had expected a really strong job report for April. They were anticipating a million new jobs and we got about 266,000. So they were way off the mark. What happened there?

Ira: We don’t know for sure. There are a number of potential explanations. One explanation is that unemployed workers are receiving enhanced unemployment insurance benefits, which were initiated when the December stimulus bill was passed. As a consequence, many unemployed workers are receiving from the government more money than they could get if they went back to work at low-paying jobs in retail or restaurants. Many of them may be reluctant to take jobs that are available. In fact, some states now are planning to cancel the enhanced unemployment insurance in order to encourage people to go back to work.

But clearly, that’s not the only reason for the slow job growth. There are other reasons. One reason is that some consumers remain wary of the virus and are wary of taking on jobs that involve social interaction. Some unemployed workers are reluctant to go back to work because they have children who have not gone back to school full time, and it’s difficult for them to go to work or take care of children who [would] otherwise [be] in school. Another reason is that we’ve seen disruption in the supply chains of many industries, which has reduced their ability to produce at the level they would like to produce. Their demand for labor has been suppressed because of the shortages of commodities and inputs and transport services that they face. So there are a wide range of reasons why we did see weak job growth in April. My expectation is that for the remainder of the year we’ll see reasonably strong job growth and the economy will move back toward full employment, maybe at a slower pace than we might have expected a few months ago.

Tanya: You mentioned some people not going back to work because even if their job is there, their children are at home or they don’t have child care or whatever. Certainly there are some men in that situation, but that is largely affecting women. There are a lot of women, record numbers, dropping out of the labor force right now. Where does that leave you thinking about their prospects, and also, what happens in the labor force if we have all of these women leaving?

Ira: Well, this is a very important issue and it goes beyond the experience of the pandemic. Over the past 15 years, we’ve actually seen in the United States a decline in female labor force participation. The United States is unique among developed countries in seeing this happen. In every other major advanced economy—Canada, United Kingdom, France, Germany, Japan—we’ve seen, over the past 15 years, increasing female participation. So why is the United States different? Well, one thing that distinguishes the United States is that uniquely, we don’t have a government program to subsidize child care, and child care can often be so expensive that for many women the choice to work is not economically feasible. Which is why the current administration has proposed subsidies for child care as a way to encourage more women to return to the labor force. Then, of course, certainly during the pandemic, we did see well-paid women who were working from home decide to quit their jobs because it was not feasible to do that work from home when their children, who would normally be in school, were home. The hope is that when the schools can fully reopen, those women will go back to work.

Tanya: One of the challenges, I would imagine, for some of those women, maybe many of those women, is they might have been out of work for over a year or more. That reentry process can be a little bit challenging.

Ira: That’s true. I mean, evidence suggests that the longer people are out of work, the more difficult it is to find work and to make the transition back to work. So long-term unemployment has a more scarring effect on the economy than midterm unemployment. That’s also one of the reasons we’ve seen both this and the past administration committed to very substantial stimulus in order to push the economy back on track very rapidly.

Tanya: Are we going to see people continuing to work remotely? Do you think we have a full-sail embrace by enough employers that it makes a difference and there’s going to be a lot more remote work?

Ira: We will see more of it, based anecdotally on the conversations I’ve had and also based on some surveys that I’ve seen. It appears likely that once the pandemic is truly over, we will have a situation where a large share of office workers will a significant share of their time [be] working from home. A recent survey that I saw indicated that prior to the pandemic, 5% of the labor force overall was working from home. It increased at the peak of the pandemic to about 60%. And based on their survey of both workers and employers, their view was that postpandemic [that] will go up to 20%, up from 5%, which is a significant difference. That will mean less traffic on the road, less demand for energy, and therefore lower oil prices. It will mean less demand for office space, which could have a disruptive effect on those parts of the financial markets that backup mortgages for office buildings, and it could have an impact on productivity. On the positive side, people spending less time commuting and using more online technology could mean an enhancement to productivity. On the other hand, if people never get together in person and don’t share ideas in ways that generate innovation, that could have a negative impact on productivity. So there’s some uncertainty now.

Tanya: We’re starting to think about possibly inflation. What should we anticipate?

Ira: There is a big debate about this. We did see here in the United States, for example, a very large fiscal stimulus where the amount of additional money spent by the government exceeds the estimated gap between capacity and output. That led some analysts to suggest that we’re overheating the economy and that that will lead to ruinous inflation. The counter argument is that a large part of that stimulus will be saved and some of it will drain out of the economy in the form of higher imports, and therefore we won’t overstimulate the economy, we’ll just get the economy simply back on track, and we needn’t worry about inflation. In the midst of that debate came word recently that in April there was a very sharp surge in inflation here in the United States. Prices rose on an annual basis of 4.2%, which is the highest it’s been in many years. That led people to be concerned that we’re now entering a new era of much higher inflation.

However, what is clear is that within that inflation report, there were some very large one-off increases in prices in key categories that were unrelated to underlying inflationary trends. Rather, they were related to supply-demand disruption. For example, there was a very big increase in the price of renting a car, and that’s because there’s a shortage of rental cars. That’s because during the pandemic, rental car companies sold off much of their fleet and they’re now struggling to purchase a new fleet. There was a very large increase in the price of airline tickets, and that’s because the airlines had reduced capacity during the pandemic. Now, suddenly, in the midst of mass vaccination, people are deciding to fly again in bigger numbers than were anticipated. So these types of disruptions don’t signal the underlying inflation that you get from a wage-price spiral from rapid money-supply growth. Rather, they suggest a one-off temporary or transitory increase in inflation that will ultimately disappear once all the supply-chain disruptions and the changes to demand patterns are resolved. My view is, yes, we’re going to get higher inflation this year and next, but it will ultimately return back to a normal level and that we needn’t be extremely fearful of inflation at this point in time.

Tanya: So that’s you looking at that, but people who are just average consumers and they’re seeing prices go up tend to get a little freaked out. We just saw people rushing to gas stations to fill up because of the pipeline problems over this past week. So what’s the lag time between when consumers freakout and stop spending? Like, how does that work?

Ira: This is the danger. And indeed, the University of Michigan reported its consumer confidence down in May, in part because consumers were increasingly fearful of inflation, having seen some large price increases in some major categories. Perception matters. Expectations matter. If consumers believe that they’re going to face higher inflation, then they will be more amenable to price increases and will seek higher wage increases. If businesses believe there will be higher inflation, they’ll be more willing to seek to raise their prices. If workers believe there will be higher inflation, they will seek higher wages. So expectations matter and can create an inflationary spiral. So that’s the danger now. As I said, I don’t think the price increases we’ve seen signal a sustained increase in inflation. But if they do change the way people behave, then we could get higher inflation as a result of those perceptions. That might compel the Federal Reserve to tighten monetary policy sooner than would otherwise have been the case. That, in turn, could lead to slower economic growth than we might otherwise have expected. So there’s some danger here that comes from this change in perception.

Tanya: I want to also touch on China. There are some really interesting demographic shifts that are happening somewhat, maybe because of COVID-19 and other things recently, but actually much larger trends as well in marriages and birth rates. First of all, give us the lay of the land on that. What’s happening in China?

Ira: The Chinese government recently reported their decennial census and it showed that in the past decade, population growth was the slowest that’s been in the postwar era. That was a bit of a surprise because earlier in the past decade, the Chinese government had ended its policy of allowing only one child per urban family. The hope was that people would have more children. The birth rate would go up and population would accelerate. The reason the government felt it was important to do this was because with slow population growth and with the likelihood that the working-age population will decline, there was concern about the potential for slower economic growth and also the potential for a decline in the ratio of workers to retirees, therefore making it more difficult to serve the needs of an aging population. But evidently, even though they changed the rule about one child, people continued to have fewer children. So the birth rate didn’t go up. Population growth remains slow, and that does not bode well going forward for China. Now, China, of course, has become a much richer country. It’s still growing at a pretty good pace. But they’re concerned enough that they’re making some policy changes. They are talking about raising the retirement age. They are looking at providing greater subsidies to families for child care, for example, as a way to encourage people to have more children. We don’t know if these changes in policy will be effective and what the nature of those changes will be. But it’s likely that in the coming decade, China will face slower economic growth than it did in the past. Given that they may face a bit of a labor shortage, there’ll be more investment in labor-saving technology, which will mean a further acceleration in productivity growth.

Tanya: Labor-saving technology would include things like artificial intelligence and other types of things like that, which China has declared it wants to be the world leader by 2025.

Ira: Right.

Tanya: So those two trends are feeding each other. The conversation around the demographic shift in China has me thinking of Japan, which also has seen historic declines in birth rates and marriages and real issues with employment, even though there are more women in the workforce now than there used to be. Is it fair to compare those to or is Japan completely on a different plane than China?

Ira: No, that’s a very fair comparison. When Japan went through a substantial change in demographic patterns about 30 years ago, that, not surprisingly, coincided with the period when Japan’s economic growth slowed considerably. That’s a cautionary tale for China, and I’m sure the leaders in China are aware of that comparison. What’s interesting about Japan is that even though its population is declining and the economy has not grown very rapidly, it’s already a relatively affluent country and it has moved toward higher productivity of workers through offshoring of low-value-added processes and improving the ability of its workforce to do higher-value-added processes. That’s something that will happen in China and may already be happening. I mean, we’ve seen a lot of low-value-added processes in China either moved from the coast to the interior or moved offshore to other countries like Vietnam or India. That process will continue as China moves up the value chain.

Tanya: Ira, thank you so much. Appreciate it.

Ira: My pleasure. Always look forward to the next one.

Tanya: OK, let’s do it soon.

Tanya: Ira Kalish is Deloitte’s chief global economist. He puts out a weekly global economic update that you can find at Deloitte.com/insights. While you’re there, check out our conversation about how COVID-19 may reshape the workforce.

Carol Fishman Cohen: At the peak, if you look at the numbers, 2.3 million women and 1.8 million men left the labor force. We’re starting to see companies that offer return-to-work programs think about whether to lower their minimum years of career break for eligibility to apply for the program, from two years or one-and-a-half years to one year. And I’ve seen that Deloitte’s encore program itself in the United States has even made it shorter to six months.

Kristi Lamar: The idea around that is we want to make sure that people feel like there is opportunity. Everyone’s break is different. It’s the idea of saying, let’s use this as a chance to retool, do something different, and change the trajectory.

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I’m Tanya Ott. Thanks for listening and have a great day.

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