World Economic Update

Wednesday, February 10, 2021
Florence Lo/REUTERS

Partner, McKinsey Global Institute; CFR Member

Global Chief Economist, Citi; CFR Member

President, Peterson Institute for International Economics; CFR Member


Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations; @scmallaby

The World Economic Update highlights the quarter’s most important and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy.

This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies and is dedicated to the life and work of the distinguished economist Martin Feldstein.

MALLABY: Welcome, everyone, to this CFR World Economic Update. The series is dedicated to the life and work of the distinguished economist, Marty Feldstein, who was a friend and teacher to so many of us. We have over six hundred members registered today, and I'm going to get to as many questions as possible in the second half of the meeting. But for now, I have three speakers with me who are known to many of you: Susan Lund, partner at McKinsey Global Institute; Catherine Mann, global chief economist at Citi; and Adam Posen, the president of the Peterson Institute for International Economics. Now, the last time we did one of these World Economic Updates, that was back in October, I began by stating the obvious that clearly no discussion of the world economy can be separated from COVID. That remains true. But nonetheless, since October, some things have changed. We've had better-than-expected results from the vaccines, better than the health experts expected. We've actually had better performance from the economy, better than the economists expected. If you go back and look at the previous IMF global growth assessment, global growth in 2020 was expected to come in at negative 4.4. The update is negative 3.5. It's still the worst peacetime downturn since the Great Depression and nothing to brag about, but nonetheless mildly less bad than it had been. And these two things, better news on the vaccine and better news on growth, explain why a couple of hours ago the FTSE global stock index is at an all-time record. But of course on the negative side of the ledger we do have mutations. So we're going to start with that and I'm going to go to Susan first and ask Susan in this battle between the vaccines and the mutations, when do you think life, and therefore economic activity, can return to normal? And how will that differ across regions?

LUND: That's a great question. For those who want a very detailed answer, there's an article on the McKinsey website called "When the Pandemic Will End." Very subtle. It's a probability distribution as to timing. If we focus on the U.S. the most likely time that we'll see a functional end to the pandemic, meaning that people will start going out more often and spending money, is in the third quarter of this year. So sometime in the summer. The epidemiological end of the virus is when we reach herd immunity, and that's likely to be sometime after that. Europe looks very much the same. I think, though, that it's important to realize it's not a light switch. What we're likely to see is a gradual resumption of people going out, traveling, spending money on services. And indeed, there's talk of revenge spending. So when we are let out of our houses, we may go wild and take a few extra vacations and meals out. But, yes, for the U.S. and Europe, of course, Asia is doing much better. China got through this virus quite rapidly. Many of the emerging markets are not looking as good. I think that there are two factors to watch. One is the vaccine rollout, which has not gone as smoothly as we would have liked in either Europe or the U.S. And the second is the virus mutations. This is the wrinkle in the plan. I think it's widely accepted that COVID and the coronavirus will be with us. This will be an endemic situation but hopefully we'll be getting a vaccine booster once a year and it'll be very much like the flu. But these mutations that might manage to sneak by the current crop of vaccines would actually make the end of the pandemic even further into the future.

MALLABY: Okay, well, the revenge spending idea, just speaking for myself, sounds like sweet revenge. Catherine, as Susan was hinting, if you look across the world at the countries where the loss of economic output versus pre-COVID projections was relatively not so bad, the two countries that have suffered the least are China and the U.S. And we understand that China has done a great job of controlling the pandemic, but the U.S., frankly, has not. Yet economic performance in the U.S. has been relatively resilient. Is that just simply the size of the stimulus? Or would you put something else into that?

MANN: So in comparison to comparing, sort of, the three big players in global economy—China, the U.S., and the euro area—we look at how they are projected to perform in a couple of different ways. And I think both of these perspectives are useful. China we had coming back to the pre-COVID level of GDP actually in Q4 of last year. How did it do that? It did it on the basis of supporting production in its form of fiscal policy, as well as being able to export its way to returning to the pre-COVID level of GDP. Consumers not so much a player. For the United States, we are projecting it to get back to the pre-COVID level of GDP by Q2 of this year. And when we think about the role of fiscal policies, of course, the way in which the U.S. is going to get back there is very much, again, asymmetric between goods and services. It's asymmetric in terms of the fiscal policy choices. A lot of effort put forward to give life preservers to people through the form of transfers, both unemployment as well as checks, and people have gone out and spent, not all of it by any means, but a lot of spending it on goods and that has been supportive not only the U.S., but, of course, China as well. Now, the third party here, you know, the euro area, we actually don't see the euro area coming back to the pre-COVID level of GDP until late in 2022. So a big difference there in terms of prospects. It is partly because of the fiscal policy differences, not only the amount, but also the nature. Again, Europe, by and large, has had a much more robust social safety net, which has been supportive of people and their capacity to, you know, to stay with income but they haven't topped up—there's not a lot of stimulus checks, there's not a lot of additional unemployment compensation. So the amount of money being put into the system is not as dramatic. It's also fair to say that there are some big players who said that they were going to do a lot but, in fact, have done relatively little and have done less than they said that they were going to do. Germany the case in point, it's a pattern that we've seen before. Again, the fiscal choices, much more on guarantees, as opposed to, you know, corporate guarantees and that sort of thing, business guarantees, as opposed to actual additional spending is a key area. Now, the one additional way that we think is very useful to kind of distinguish between these three areas is with regard to what our projections say with on standard deviations of growth from historical experience. So for the U.S. going into the first half of 2021, and this was before the most recent fiscal program being, it looks like it's going to be in place, we had a five standard deviation boost to U.S. growth early in this year. The euro area—nothing. No positive standard deviation at all. And actually going into the second part of this year, China is going to have a negative standard deviation from its trend growth. Going into 2022, that's when we get the shift and we get the European Recovery and Resilience Fund. It looks like it's going to actually get paid out but that won't be until 2022.

MALLABY: So, Adam, it sounds like, you know, the Europeans have been slow on stimulus. Has the U.S. perhaps done too much or might it do too much if the Biden proposal is passed in its entirety?

POSEN: I think it's probably too much, Sebastian, but it's not going to matter too much. That's sort of where the debate is now. We have colleagues like Larry Summers and Olivier Blanchard who are pointing out that by the time you add in the package passed in December, the package now, the likely package in the budget coming in March, you end up with something that's several fold and a reasonable estimate of the output gap. Then there's back and forth on a serious level about how uncertain we are about the output gap and how much people will spend. The bottom line is that, going to something that I know you and Catherine and Susan have all written about, is how much inflation do you get out the other end and how bad is it? Because the jump in debt if it turns out people don't spend it and put it into savings, that's not so bad for the U.S. economy. It's just a transfer of whose balance sheet it's off. If people do spend it, presumably, it's mostly because they need it, that they are suffering from the pandemic and the environment around them. And, of course, a large part of the Biden administration package is working the problem directly. It's state and local government, its vaccine provision and so on. So either way, I don't sweat it too much. The question is how much inflation or financial instability even less likely you get at the other end if it is overspending. And that's where it gets interesting. I think the Fed is committed to sitting back and waiting to see what happens. I absolutely happen to think that's right, but that's what they're committed to do. And so I think there is a more realistic possibility now than at any time in the last, I don't know, fifteen or twenty years that the Fed could be behind the curve on a little bit of inflation. I don't think it's for sure we get that because there's so much inertia. It's been so long since we've seen inflation, and you really need wages to go up to get any sort of sustained inflation. So I'm not that worried about it.

Then there is the question, though, how would financial markets react? I'd be interested in what Susan and Catherine have to say, because, I mean, I could imagine at the upper end, you get a three, three-and-a-half percent CPI inflation rate for six, eight, or ten months. Given how much we've undershot inflation in the past, given how sticky things seem to be, I don't think that's the end of the world. On the other hand, since markets are not pricing in anything like that yet, a jump of a hundred basis points in some interest rates is possible or even more if they get freaked. Then what happens? And then finally, the question is how persistent is this? Would the Fed have to do a mini Volcker, really be aggressive to get inflation back down? My guess, and it is only a guess, is that it would be like Napoleon's famous "whiff of grapeshot." One sharp rise in rates would probably be enough to re-anchor. But there are serious people, including my colleague, Jason Furman, who say the Phillips curve is very flat. So you don't want to go through this cycle because if inflation goes up it's going to be costly to bring back down. So there's genuine uncertainty but basically it may well be too much. It's probably as not as much “too much” as Olivier or Larry say and it probably doesn't matter that much.

MALLABY: Just quickly, Adam, one thing that you said almost in passing, is that you don't sweat it too much if the stimulus is too big. If I heard you, right, you said, "Look, if the stimulus checks go to people who don't need them, they'll just save it. So that's fine." So I get the point it's fine from an inflation point of view, but what about from a sort of national debt point of view?

POSEN: Look, you're absolutely right to raise it, Sebastian. We don't want to have a situation where there's ongoing unfunded transfers, especially to people who can make a living in the private sector or have a secure job. No one's going to disagree with that. And the way I said it's fine, and you're right to call me to spell this out, I meant it in two senses. The first sense is as a temporary transfer, if most well-off people, or at least economically secure people, see it as a one-time transfer, they will probably go on a bit of a binge but most of it they’ll put away—they'll save. And national savings combining the private sector and the public sector is first order for what counts for debt sustainability. It was when the U.S. a dozen years ago had an incredibly low household savings rate was when we would get more worried. Because then also if you gave the people money they might spend it all on pizza, or whatever, or home improvement, and I don't think people in the current serious situation are likely to do that more than one celebration before the vaccine comes. The other sense in which is fine, it's just, it's really costly to target things. It's really intrusive of government to target things. So I'm in favor of just some big general rule about what level of income gets it and if a few unneeded people get it that's better than having a lot of government intrusion targeting every single thing. Sorry.

MALLABY: So Catherine, in the last, I don't know how long, a couple of decades of talking to Adam, it's not common for me to hear him say that inflation may be more of a risk than the central bank—well, maybe you didn't quite say that but—

POSEN: But no, but I am switching position. You're right.

MALLABY: So, Catherine, do you also think that inflation is a near and present danger or not?

MANN: Well, you know, it certainly is a question that's been coming up quite a bit, but I think it's important to make a couple of distinctions. My bottom line is no. Inflation is not a clear and present danger with regard to the Federal Reserve needing to tighten. That said, the financial markets may be surprised by some inflation movements, especially in the near term that they have not adequately priced in. So the disconnect that we talked about a lot with regard to the real economy and the financial markets, this is now playing out in prospects for inflation. So let me kind of go into that a little bit more. When we think about, you know, the inflation rate that central banks have to pay attention to—PCE for the Fed, HICP for the ECB—these inflation rates are ones that come from a combination of inflation expectations, commodity prices, and tightness in labor and product markets. We've seen a little bit, you know, a little bit of an increase in inflation expectations in the U.S., but not in the euro area. We could talk about commodity prices being a bit of a boost but not systematically at this point. We're not looking at oil prices, you know, going to $140 a barrel again. I mean, we're kind of talking about $60. And then secondly, let's talk about labor and product markets, those fundamentals, underpinnings, to how the inflation process works in the real economy.

Adam has already noted that the Phillips curve is flat. It was flat when the unemployment rate was at 3.5 percent last January. It probably still is flat when ten million people are unemployed in the United States, and, you know, an equal number are on furlough in the euro area. And we could talk about other countries as well, but it's the same, sort of, story. And in China as well—very weak labor markets, not the foundation for big price increases. But fundamentally, the way you get to inflation that the central banks care about is you have to have firm pricing power. Firms have to believe that they can systematically, in a sustained way and across a broad category of sectors, raise their prices and keep them there. When we talk to companies, they're not thinking in those terms at all. You know, maybe a couple of them. So, you know, lumber prices are higher and maybe used car prices are higher for, you know, as a blip up. But fundamentally, systematically, broad-based, sustained on the real side of the economy, firms do not have pricing power.

We've replaced the China price, which was, you know, the last decade, sort of, issue with the digitalization price where no matter what you're selling, you can go on the internet and find out, in a sense, something cheaper kind of like in thirty seconds. So this is a real constraint on firms' ability to pass through any price increases that they currently are bearing because of some of the issues associated with, for example, supply chains or shortages and so forth. So fundamentally, we don't have the underpinnings of this strong inflationary surge that in a sustained way that some people are concerned about. The markets may not have priced in fully the arithmetic change in these prices that these sort of things care about for Q2 of this year compared to Q2 of last year. They may be a little surprised about that, although I think they're getting with the program here that there's going to be this big arithmetic increase in prices but that's not a sustained increase. And ultimately the central banks have to think about the sustained broad-based increase. And let me just, last point is why do people look at housing? And they're looking at house price increases as sort of this metric that central banks have to pay attention to. House price increases are not in the price indices that are in the central bank indices. They're important for sure. Maybe it's very important for consumers', you know, sense of what inflation is, but it's not in the indexes. So, you know, I don't see inflation being a problem.

MALLABY: Susan, you and your colleagues at MGI have written about a couple of issues I want to get to here. One is, sort of, the, you know, where COVID leaves globalization and supply chains. And I think I'm interested in that, sort of in and of itself, but I'm also interested in the way that it plays into this inflation debate because one of the points that people raised is that deglobalization will reverse one of the secular forces pushing down on global prices.

LUND: Yes, so look, even before COVID broke out in the end of 2019, we started looking at supply chain risk. That's when we thought the U.S.-China trade war was the biggest shock we could imagine to global supply chains. And then in January we added pandemics to the list. So companies have been thinking about this before. We have more climate-related events—typhoons, hurricanes, flooding. We have cyber attacks. We live in a multipolar world with increasing economic complex like you saw between the U.S. and China. Now we live in a world of pandemics. So companies had already been thinking about supply chain resilience as opposed to just cost efficiency. And the research we did suggest that, you know, we may over the next five years actually see some global value chains start to reconfigure. Now, whether you think it's going to be a big amount or small amount depends on where you're starting. So for people who think reshore everything, our estimates said maybe 15 to 25 percent of global goods trade could shift to different countries, which by the way is not the same as reshoring. It just means going to different sets of countries than it is today.

So there could be material movement and then the question is raised and often comes up does this mean we're going to pay higher prices for goods? If companies are nearshoring or reshoring, does that mean their inputs are more costly? And actually what we're finding on the ground is no. And the simple reason for that to be true you'd have to believe that current global supply chains are perfectly efficient, that they are at the frontier of productivity and efficiency. In fact, for many companies it's more like barnacles on a boat, right? These things were set up incrementally, piecemeal a decade ago, fifteen years ago, when wages were different and technology was different and transportation costs were different. And so they persist out of inertia, right? And so when companies actually go to assess what could be shifted where, they actually find they can improve resilience by diversifying their set of suppliers, get to market faster, and improve cost efficiency as well. So right now I guess the answer is, there's lots of what we call low-hanging fruit and being able to be more resilient and not see cost increases. So when we come back to inflation, I don't think that that would be a significant upward pressure on prices.

MALLABY: Thank you. I want to get actually one question in before we go to members who are scattered around watching screens all over the place. So one last question, which is going to be for Adam, which is that I'd like to hear a bit about how you see Europe right now. You've got Mario Draghi who might have a chance to save European unity not once but twice having done it at the ECB as the president of ECB with his "whatever it takes" statement. He's now been asked to form the next Italian government, which has a chance to spend this large amount of, sort of, reconstruction assistance from Brussels. And on that question of whether Italy can disperse the funds in a productive way that gets its trend growth rate up on that may depend the resilience of European economic integration or at least that's the line. I wonder if you agree with the line and I wonder what your sense is of Draghi's chances of pulling a double?

POSEN: Thank you, Sebastian. And as Catherine already said, Europe is behind on having the resurgence of growth as well as on vaccines despite the fact the U.S. and UK and others are messing up each in their own way. And so this question of how the common funds get spent is incredibly important. I think that soon-to-be or if not already Prime Minister Draghi is going to know what are the right things to do and put those as a priority in a way that few previous Italian prime ministers have wanted to. We have had technocratic governments where they've wanted to do that. Many people we all know and friends have served either as ministers, even prime ministers, in those governments. But they sort of had their eye also on the next political chance. Because of Draghi's accomplishments, and more importantly, frankly, because of the common European funds disbursement that you pointed to, which is a breakthrough for European fiscal policy, Draghi has a mandate in a way that none of those technocratic predecessors had let alone not having something to offer the way of authorities have. And they're starting in a good political place. This isn't my expertise but we know that former Prime Minister Renzi provoked this crisis of the previous coalition because he knew Draghi would come in. So I am hopeful. I think the most important point to make, Sebastian, though, is it is possible—there are two points—it is possible to improve growth in Italy. So you look at Japan and it used to be Japan and Italy would be often compared—very grim demographics, a lot of accumulated wealth, a lot of elderly people, very low taxes in Japan, not as much for evasion reasons as in Italy but some evasion too, just low collection of taxes, and all these reasons that were given up for why they should have low-trend growth. Japan has actually improved this trend growth significantly in the last ten years and is now towards the top of the G7. And a key part of that was what Abe they called "Womenomics," which is making better use of the female labor force. And there are all kinds of ways to make better use of young people and women in particular in Italy that could make a very major difference to debt sustainability and growth. And I think Draghi knows that. And I think that that's one direction to go. I think the other main point is that Italy does get a bum rap as many people point out but very few people seem to retain. And I know both Susan and Catherine have thought about this. You know, Italy actually on the macro side has been running primary surpluses. It's been a net contributor to the EU budget. It isn't this huge spendthrift, you know, image that it had. So there is capacity there. There is capacity there and going back to Susan and her colleagues' very good image of the supply chains as being sort of historical accumulations not perfectly optimal planned, which I think it's absolutely right, Italy is critical to a number of European supply chains. Northern Italy is very functional. So I think another aspect Draghi can bring to bear with the European imprimatur is that Italy is a more vital, more viable economy than people give it credit for. They still need reform, but hell we all need reform.

MALLABY: Good. Okay, at this time, I'd like to bring in members with questions. I think the operator might be able to help us here.

STAFF: [Gives queuing instructions] We will take our first question from Tara Hariharan.

Q: Hi, everyone. Thank you so much. I'm Tara Hariharan from NWI, a New York-based hedge fund. My question is how do the panelists see China's economy faring this year after it was a world beater last year. Because pandemic-related export demand may start to fade this year and also it seems that China's planning tighter monetary and fiscal policy. Furthermore, are of you expecting any sort of easing up near term in the U.S.-China investment and trade relationship? Thank you.

MALLABY: Maybe we'll put that to Catherine.

MANN: Yes, thanks very much for the question. It certainly is a very important one not, of course, only for China, but for the neighborhood as well as for the global economy. So, you know, because China was into the pandemic first, it's also in some sense the first to exit. And so we are looking for a policy set, both fiscal and monetary, that is less robust than the U.S. for sure and then going into 2022 for the euro area. So there is a question about how much China can be a contributor to global growth versus one that's actually sort of on the backfoot. Again, when we look at the standard deviation of China's growth relative to its historical experience, when we use that metric as a way to evaluate the forecast, China is one standard deviation below its mean in terms of its forecast. You know, granted, its historical experience has been very, very fast growth, but I think that what we have seen over and over again is that there's a big challenge that China faces in making the transition to a lower sustainable growth rate. We've seen it, you know, over and over again the challenge of moving away from investment-led, real estate-led, export-led growth to one that is more consumer and services based. Sometimes the transition is sort of partway down the road and then the shocks hit and they go back to a more standardized playbook. So the issues and the vulnerabilities that China has had, you know, other times, particularly financial market vulnerabilities, these continue to be issues. This time around you've got some of the foreign flows coming in perhaps taking a little bit of a brunt off of the potential shocks to any kind of financial markets that, you know, you kind of export some of that volatility because you've got foreign ownership of a variety of assets at this point. So that's, you know, that's one way of defusing some of the domestic concerns. But then another transition that's been underway has been a consolidation away from private sector towards state owned and that has some vulnerabilities of its own with regard to how much can really be done in a directed way on the innovation side of things, which, again, is a very important ingredient of the, you know, making 2025 objective. So if, you know, if we had to put on a scale, you know, a balancing act of China versus the rest of the world in terms of its projections and possibilities going forward, I come back to the way of thinking about it in terms of standard deviations away from historical growth rate and it's the one area that big of the big three where it's performance is below, by current projections, its historical norm and I think that presents a lot of challenges.

MALLABY: Okay. Carrie, next question, please.

STAFF: We'll take our next question from Nancy Walker. Please accept the "unmute now" button. We will move on and take our next question from Dan Rosen.

Q: Hi, good to see everyone. Thank you very much. Question—how would any of you judge the action that any of the major governments we've talked about have taken to make some headway against the massive outlays required for climate mitigation adaptation at the same time they're looking for holes to dig and holes to fill in and the classic stimulative steps they've taken in the past twelve months? Thank you.

MALLABY: So how green is the policy response? Susan, do you want a crack at that?

LUND: I will. So look, the policy response has been more replacing lost income to businesses and individuals. I think on the business side, though, when all of this began a year ago now, I thought there was a real chance that companies may take their environmental and societal goals or ESG agenda and quietly set it aside. And actually that really has not happened at all. If anything there is renewed interest in a sustainable recovery, in doubling down on climate commitments and emissions commitments, as well as thinking more about the "S" in that ESG about companies societal impact and responsibilities. So I would say that, you know, and now with the U.S. change in administrations, I think we're going to see different actions. But so far I can't really speak to the policy response being so green. But I can say the corporate response and the investor community response has been continued to focus very much on those goals.

MANN: Could I intervene just quickly on that and make two points? One is in terms of achieving the objectives on the climate side you need to have both policy initiatives and private sector response. And the private sector response has to be the main driver of achieving the climate goals. There's no amount of government money that can get you there. But the two of them obviously you would like them to be synergistic. On the policy side I would put forward that the, you know, there was a big splash with the European Recovery and Resilience Fund. It was a pan-European fiscal effort. Very important that it was pan-European and that it was financed by a European instrument. Now it's taken a while to kind of get the money out the door although it was always the case that the money was going to be back loaded. That's part of the reason why we have 2022 looking more robust for Europe in terms of standard deviations away from the mean as opposed to for the U.S.. On the U.S. side, though, I think in a very, very critical question is whether or not the second package is going to come through. I'm not sure how many times we can go back to the well, given the political climate even with the current configuration. I'm not sure we can go back to the well again even to get an infrastructure/climate package that would put the U.S. on a coherent path along with Europe to achieve some climate objectives. But the two of them do have an alignment on some carbon border adjustments that probably could create more incentives for the private sector to respond. The other policy area that I think is important and where there is increasing initiative is on the central bank and regulatory side through the total climate finance disclosure. In other words because climate risk is a financial risk, it's a financial stability risk. Financial institutions have to evaluate that risk on their portfolios. The Bank of England is already, sort of, moving in the direction of incorporating it into stress tests. That isn't there yet and other central banks aren't there yet either, but they're moving in that direction. And then, of course, also, as Susan said, the private sector investment community is increasingly viewing the carbon footprint as a place to discipline the capital allocation of the private sector and make money at the same time, which of course they liked.

MALLABY: Adam, do you want to weigh in?

POSEN: I think Catherine's point about the border adjustment is important. I don't think the alignment is actually that great because Europe is far ahead of us. I know Katherine is aware of this and Dan Rosen certainly knows this stuff, but just to say that I think the Biden administration is going to say in principle they agree with border adjustment and try and whack maybe Brazil or India with worries about their coal or even China but then be quite snippy when the Europeans say, "Well, we've got a much higher carbon price and real carbon price than you do." So I think there's going to be a frictional aspect there. The second thing, going back again to Catherine on the bites of the apple question, you know, I think one of the concerns raised about Biden's large stimulus package is about how much room does this leave not just debt terms, but in political terms to fulfill some of their commitments on green spending. And it would be a shame when you ask what does it matter, Sebastian, and I seem not to worry about overspending, I do worry about the political economy aspect that this spending might in some senators’ minds, in some Congress people's minds, preclude the kind of investment we need in green energy. And I hope that's not the case. Also, colleagues of mine at Peterson Institute are very aware that any kind of seeming bad outcome from the U.S. spending will be used in the internal European debate as an argument against fiscal activism. So while I agree with Catherine that it's a great step forward that Europe did do this common approach, we don't want them to go into reverse. That doesn't mean that the U.S. shouldn't do it, but it means we should be aware that some northern Europeans are deficit hawks and are going to try to use the U.S. move to excuse their fiscal inaction in the coming years.

MALLABY: One interesting thing, which is sort of, you know, as a fundamental way of coming at it is that COVID has led to an experiment in sort of government-backed scientific procurement. And in fact the British vaccine procurement, which has been out in front was run in a way, not surprisingly, by a venture capitalist. And she, for a living, what she did was, you know, she would assess technologies and figure out which was the smart one to bet on. And it worked in terms of UK vaccine procurement. Not much else has worked in the UK but that has. And I just wonder whether that lesson could be carried over into climate tech procurement where by itself venture capital has not been always successful in generating climate technologies but with the government providing a market might be. So just one other idea to throw in there. Carrie, next question.

STAFF: We'll take the next question from Barbara Slavin.

Q: Hi, thank you very much. I wanted to ask about the Middle East and your forecasts for countries like Saudi Arabia. In particular, what you think the price of oil will be? Will anyone invest in Saudi Arabia given Mohammed bin Salman’s record? And so and I see the Saudis are trying now apparently to put through some sort of legal reforms and they've let go Loujain al-Hathloul, the woman activist. Thank you.

MALLABY: Barbara, sounds slightly as they used to be telling us what to expect in Saudi Arabia. Let's see if any of my colleagues puts their hand up and says they want to talk about this [inaudible] outlook.

MANN: I can just take a crack at it. I mean, of course, Ed Morris, my colleague, head of commodities, is really the encyclopedic knowledge of the Middle East. And we have actually expanded our footprint in the Middle East with a couple of new people there, so it's an area that obviously we're very interested in. On the oil price, you know, we're not, I already mentioned it, we're not at looking at $140 but there is a bit of a more robust oil price that looks to be solid above the forwards by the way. We're in the, you know, early top sixty plus, but not seventy, you know, even in the bull case. So, you know, it's range bound because of technology not particularly—and also it's range bound because our understanding is that, you know, Saudi has been doing a pretty good job of managing OPEC-plus in terms of keeping everybody in line. On the investment story, you're alluding to investors being concerned about maybe ESG considerations. And I think there are a lot of investors for whom that is not necessarily the driver. And in terms of diversification of economies and moving away from fossil fuel-based, there is a sense in which maybe Saudi is making more progress than some others. And so those who are looking for investments that are non-fossil fuel-based may well find a receptive place for those kinds of investments.

MALLABY: Carrie, next question, please.

STAFF: We'll take the next question from Teresa Barger.

Q: Hello, thank you very much for having this. My question is if we were to see even a hundred basis points rise in U.S. interest rates sometime next year, that would presumably have a big effect on the U.S. dollar. And the investment thesis for a lot of the inflows we're seeing in the emerging markets now have to do with the presumption of either stable or falling the U.S. dollar. Would that be a monkey wrench in the works?


POSEN: So I think where I'd start is the fact that emerging markets, at least the higher income or in globally-integrated emerging markets, have actually done surprisingly well this cycle. We were very worried in March and April. There was an enormously rapid outflow of money from emerging markets back into the U.S. and safe havens and that flow almost completely reversed shortly thereafter. And we've seen a number of major emerging markets actually have policy space. Places like Brazil, places like India, markets have given them space to run looser monetary policies, even fiscal policies, I think, constructively. And so as the cycles go we've seen actually in some ways more at least financial macro resilience in terms of this lack of space and of these emerging markets. So what does that portend for the future if there is a U.S. interest rate rise as you rightly ask? My hope would be that that tells you that the world is more diversified and that these countries are perceived as rightly more resilient but the problem is this is somewhat a self-fulfilling prophecy. If the markets decide in their infinite lack of wisdom that these countries suddenly are no longer resilient, then they will become no longer resilient. So I regret to say I don't think there's much to change there. What I would say is why it's more than a hope that I think the response of emerging markets to a hundred basis point rise for the U.S. will be less bad than usual is three reasons. First, for obvious reasons, but different reasons, the U.S., Europe, China are all are less attractive than they used to be. The relative value proposition of going to places that either can't get their act together on fiscal policy or can't get their act together on public health policy or intrude horribly on private property rights is not good. So at the margin, I think, the relative attractiveness of [inaudible] is up. The second reason is, going back to the discussion of four of us just had, if one thinks one's getting growth in the U.S. without much in the way of inflation, which is the main market forecast and Susan gave some reasons why my worries about inflation may be overdone and my worries are not that big to be honest, that's a positive EM scenario. Because it's not a scenario for huge amount of ongoing U.S. tightening or very rapid U.S. tightening. It will be a market-driven tightening rather than a Fed tightening. And the third reason I would suggest that, I hope, but I also expect it wouldn't be so bad in terms of outflows is because, frankly, a number of these countries as horrible as what's going on in human terms, have surprisingly outperformed in terms of management of the disease. And while that doesn't take anything away from the need for debt restructuring and SDR release and funding for the poorest countries, that doesn't take anything away from what Sebastian's colleague, Tom Bollyky, and my colleague, Chad Bown, have argued against vaccine nationalism and I know Susan and MGI have worked on this. You know, all that said, from an investment point of view, the functionality of a lot of these countries has surprised on the upside and I think that's going to show up in some resilience and demand for their assets.

LUND: Let me add one thing, which is back to the globalization of trade. You can already see some of the better-performing emerging markets, higher income, are picking up trade from China. So you can see consumer electronics moving. India's making a big play, it's attracted Samsung and some other players. Mexico has got announcements of more foreign investment in the consumer electronics space. Textiles are moving. So there's also an opportunity there for some emerging markets.

POSEN: I just want completely second Susan. Colleagues of mine, including Mary Lovely, Penny Goldberg, Sherman Robinson at Peterson, as well as colleagues at MGI, have been emphasizing this. I don't know what the scale is. But in this talk pursuit of resilience and in the concerns over U.S.-China reshoring as we discussed, there's going to be redundancies built in supply chains and that will benefit third party well-positioned emerging markets. I completely agree with Susan. That's a fact I can support.

MALLABY: Great. Carrie, another question.

STAFF: Our next question from Paul Maidment.

Q: Thank you. Paul Maidment, Oxford Analytica. Thank you very much for a very helpful discussion. I'd like to drill down a bit more into this potential on debt stress in emerging markets. They have less scope for fiscal stimulus. They'll be slow to get vaccines at scale. They're often exposed to slow-recovering sectors like tourism. So growing out of debt will be difficult for many of them. So which of the economies that you see most at risk from debt stress? And how great is the possibility of some sort of regional spillover?

MALLABY: Do you want to weigh in Catherine?

MANN: So you know, this is of course a big investment question as well as, you know, a real side question is I think the point that you have put forward, which is emerging markets are a very diverse group. And so in order to understand who is potentially vulnerable, you have to start by looking at who still is vulnerable to the COVID trade shock. And that is tourism; it's not technology. I mean, that has been positive. Technology shock and the COVID trade shock has been positive on the technology side. And the second thing is you have to kind of look at the economies that have commodities because as it turns out commodities have been doing pretty well as the overall global economy has been bouncing. Looks good now, maybe not so much in 2022 as things apparently go back to trend. So, you know, get your get your growth in now. So a lot of very, very diverse lot of emerging markets across the sectoral exposure. The second area that we think is important to evaluate is what is the currency composition and that varies dramatically. And you need to make a distinction between the euro and the dollar because those two, you know, then you're making both a country play as well as an exchange rate play in terms of your exposures. And then the final point that we think is important when evaluating the emerging markets is a lot of them did issue a lot of additional debt, but it was long term. And so looking at the term structure of the debt is quite important. So we actually don't have, other than there are certain countries that, you know, we all know the name of it that are going to be in trouble, I think Adam alluded to them as well, that that we're not looking at a systematic, you know, cliff that face emerging markets as a whole.

MALLABY: Paul, are you there? Paul's gone. Carrie, another question, please.

STAFF: We'll take the next question from Harold Schmitz.

Q: Excuse me, hi, thank you. I'm Harold Schmitz with the March Fund and University of California, Davis, and really appreciate the session. My question is given the environment you guys see and given the relevance of science and technology competitiveness, especially between the U.S. and China, but globally, what are your thoughts on the conditions going forward for S&T investment in a, you know, in a general way and the depth of that and how at risk it might be in fundamental versus applied? Thank you.

MALLABY: Susan, do you want to have a crack at that?

LUND: Well, you know, COVID has shown this recovery is digital. I mean, the technology sector is done the best—hardware and software. We see increased pickup of all sorts of technologies by companies in part to reduce density in the workplace and to cope with demand surges in things like e-commerce warehouses. So I think that overall, if anything, the pandemic has spurred adoption. Now, when you get to investment, especially in the basic science R&D, I will also quote Catherine's "you don't get a second bite of the apple." So a lot of the stimulus that, you know, increased R&D is not on the radar. So long term that could be an issue. But certainly from the private demand side, it's definitely there and companies are investing quite heavily in realizing that, you know, the pandemic really shook up, it was the giant nudge, so to speak, from behavioral economics, right? It shook up ways of operating and behaving. And no companies are really thinking about going back to quote "the way things were before." They're thinking about what is my company look like in the new normal and technology is just a huge part of that.

MALLABY: And MGI has done work, I believe, on sort of the future of work. And this relates to the question as whether the market for further digitization of remote work or improvement of remote work remains robust post-COVID. What was your take on that?

LUND: So our take is that some form of partial work-from-home and remote work is going to likely be the standard option for office space work. And let's just remember that the majority of workers in the economy don't have the option as we're all doing of working from home on a computer. But for office space work most companies are thinking about some type of partial work from home and it varies. But that, I think, raises interesting questions not only for, well, demand for lunches out, and retail, and transportation, and oil and gas, but also more broadly. Some companies are thinking more boldly. When they say remote work they didn't mean from your home, they mean from Detroit or Lexington, Kentucky. And by setting up homes in different cities across the country, not just the high price cities on the coast, they're also hitting goals like recruiting a more diverse workforce, sometimes hitting environmental goals. So all of it seems to be coming together and I think it's too soon to say whether this will persist. But I think there's a chance that we may actually see more economic activity migrate out to other parts of the country.

MALLABY: So software will continue to eat the world. Let's go get one last question, please, Carrie.

STAFF: We'll take our last question from Sonia [inaudible].

Q: Hi, Sonia [inaudible] with the Aurelius Americas. I would like to bring back the discussion to Latin America actually. And I would like to know what is your take: is the region part of the problem or part of the solution considering it's a major commodity and raw materials it provides? And also the increasingly percent of China in Latin America? Thank you.

MALLABY: Adam, how do you see Latin America coming out to the pandemic?

POSEN: I had the privilege yesterday, thanks to some colleagues, to speak to a large group of Latin American business executives. And, you know, it's the usual combination that you can focus on a micro level and see a lot of very good entrepreneurship going along. And it's not all commodities and it's not all China. And my colleagues, Simeon Djankov and Eva Zhang, have a piece coming out shortly on countries where entrepreneurship has boomed during COVID. And Chile is one of the few Latin American countries we have good data on and it's up there with the top performers on that. At the same time, heavily influenced by my colleagues, Monica de Bolle and Jose de Gregorio, we are well below consensus on our top-down macro forecasts for Mexico and Brazil. They are messing up their pandemics in ways that are out in the lower tier. The human toll is very big. And the governance issues are very big. And so you're sort of caught betwixt in between. I do want to stress, the reason I started with the positive and the sort of micro is because I don't think we should look at Latin America solely as commodity or solely as an agent of Chinese influence. Latin America does have its own destiny, each of the countries largely under their own control. I mentioned Chile's entrepreneurship burst despite the protests on inequality last year. The act of the Colombian government to extend and legalize the long-term stay of refugees from Venezuela was an act of heroism, and will, frankly, be stabilizing and probably growth friendly for Colombia. I mean, so there's a lot going on there. I just want to back off having any sort of general tendencies, but I do regrettably believe that the two major economies in size—Brazil and Mexico—will continue to underperform because of their government's behavior.

MALLABY: Well, on that solemn note, I want to note that the video and transcript of today's discussion will be posted on the CFR website. Thank you very much to Catherine Mann, Susan Lund, and Adam Posen. And from me, Sebastian Mallaby, all of you have a good day. Thank you.


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