By Ángel Ubide, Managing Director at Citadel.
This article was originally published in Aspenia review n. 94 (Italian Edition).
Bidenomics has been hailed by some as revolutionary, because of its strong and explicit focus on fiscal policy, income inequality and industrial policy, and its reduced concern for incentives and debt levels in the design of policies. But this isn’t a revolution. It is a natural evolution from the success of the economic policies of previous decades, which have created the conditions for a more active fiscal policy and protective role for the state. The aftermath of the financial crisis and the response to the Covid shock have been the catalysts. In this piece, we discuss how the starting point for Bidenomics differs from the recessions of the past 30 years, how these differences have helped crystallize the principles of Bidenomics, and the substance, risks, and opportunities of Bidenomics.
A different starting point: the success of the Washington Consensus
The economy in late 2019, the starting point of the Covid recession, was very different from the 1990s-2000s, in three fundamental ways.
Firstly, the policies of the Washington Consensus had succeeded and its menu of recommendations had been mostly exhausted. In the 1990s, the global economy was very far from the production possibilities frontier: fixed exchange rates were prevalent in emerging markets, trade openness was very limited, labor market institutions were rigid and plagued by indexation, inflation was high and volatile, and fiscal and monetary policy frameworks were weak and lacked discipline and credibility. The Washington Consensus was the recipe to improve the global macro fundamentals and it was successful where it was applied well: opening up economies, optimizing incentive structures, disciplining budget management with credible fiscal frameworks, stabilizing inflation with independent and credible monetary policy. By 2019, a very large share of the global economy had already implemented those policies. And perhaps with excess zeal in some areas: maybe inflation was too low, fiscal policy too focused on debt reduction, global trade too open without due care for those displaced by it. With the macro objectives mostly achieved, it became possible to start investing some of the credibility capital achieved with the Washington Consensus and putting more emphasis on other priorities, such as income distribution, gender and race inequality, or climate change.
Secondly, global equilibrium interest rates had declined, due to a variety of factors including population aging, slower productivity growth, excess savings and weak investment, and the reduction in risk premia driven by the success of the Washington Consensus. Lower equilibrium rates had a series of implications: (1) the room for expansionary austerity had vanished, as the gains from lower interest rates and risk premia were minimal; (2) countries that had adopted credible economic policy strategies had gained significant fiscal space; and (3) monetary policy had very limited room to manage the business cycle.
Thirdly, the strength of China, the resilience of the main emerging economies, and the weakness of the eurozone, had created a more balanced global equilibrium of economic and geostrategic forces. Combined with the Covid crisis, and the climate emergency, it led to the realization that, even in the US, there was a need to strengthen the domestic economy to increase resilience and remain influential in the global sphere.
The principles of Bidenomics: from macro to micro
This new economic and geostrategic context naturally led to a deeper focus on the micro aspects of the economy, conditional of course on the stability of the macro outlook. It is a rebalancing of efficiency and resilience, of market mechanisms and the protective role of the state. We identify three main principles in Bidenomics, intended to build a more resilient economy, the “building” part of the “building and blunting” strategy against China advocated by Rush Doshi, the Director for China at the National Security Council (see Doshi (2021))
Firstly, an active use of fiscal policy as a policy tool. In this economic context, sound fiscal policy is not always a synonym for deficit and debt reduction. In an environment of zero interest rates, fiscal policy must be the main instrument to manage demand, taking advantage that, after decades of underinvestment, the return on public investment is high (see Ubide (2020) for a detailed discussion). And the need to address income inequality and poverty, for which fiscal policy is better suited than monetary policy, became even more acute after the 2008 financial crisis and the increase in global political polarization.
Secondly, a strong emphasis on the labor market, on achieving maximum employment, and on supporting incomes. It is notable that most of the economists in Biden’s Council of Economic Advisors are experts in labor economics, instead of the more traditional macro roles of past administrations. Differently from the policies implemented in prior recessions, which focused mostly on conditional support and strengthening incentives, a large share of the fiscal support during the Covid crisis has been unconditional (or with much relaxed conditionality) cash transfers, such as direct payments or enhanced unemployment benefits, with a clear focus on reducing poverty and inequality.
Thirdly, a renaissance of industrial policy, with concepts such as “Build Back Better” and “Made in America”, and three objectives: protecting American workers from the costs of globalization, reinforcing domestic supply chains in critical industries, and winning the technological competition with China. There is a clear shift of emphasis away from more multilateralism and globalization, which is perceived as already enough, and towards more inclusive and robust growth at home, which is perceived as insufficient.
Bidenomics in practice: resilience over efficiency.
These three principles underpin the main economic measures taken by the Biden administration: the large fiscal packages – the USD 1.9tr package adopted in early 2021, and the infrastructure packages likely to be adopted by end 2021 – the new focus of the anti-trust policy, and the maintenance of export controls and tariffs. The overall objective is to improve the microeconomic resilience of the US economy.
The infrastructure packages include both traditional, physical infrastructure, and social infrastructure – anything related to human capital that lifts potential growth, including, education and poverty reduction. The “US Innovation and Competition Act”, which passed the Senate in June, complements these packages, with large allocations of spending in semiconductors research and applied sciences to improve US competitiveness – including funding to return to the Moon.
Anti-trust policies are being redirected beyond the long standing Bork doctrine of maximizing consumer welfare towards protecting consumers from excessive price increases and workers from excessively low wages. To this end, Biden signed an executive order to address over-concentration, monopolization and unfair competition, and created a new competition council.
Trade policies have adopted a more multilateral process and language, but the actions have been a continuation of the status quo. Notably, the Biden administration has kept the export controls that the Trump administration put in place to blunt China’s advantage in critical technologies. And, despite strong economic arguments against them, trade tariffs have remained in place, even against allies like the EU. De facto, Biden seems to have embraced Trump’s strategy of using tariffs as leverage for the achievement of non trade objectives.
Risks and opportunities: inflation, protectionism and, eventually, a higher neutral interest rate.
This shift in policy priorities has raised several concerns, but it also creates opportunities.
The main criticism has been that the fiscal stimulus is either excessive or badly designed, or both. It may be excessive because, under some assumptions about fiscal multipliers and potential growth, the fiscal packages may push the US economy well above potential growth (see Edelberg and Sheiner (2021)) and excessively raise inflation. It may be badly designed because the prominent focus on cash transfers and demand support reduces the space for spending on infrastructure that may lift potential growth. The modest rise in interest rates during the early part of 2021 and the subsequent surge in inflation have been hailed as supporting these criticisms.
However, there are also powerful counterarguments to these criticisms. The estimates of fiscal multipliers and output gaps are notoriously uncertain – it is quite possible that the US economy had some amount of slack when Covid19 hit – and the recent increase in inflation is driven mostly by the severe dislocations created by the reopening of the economy, which has led to a sudden surge in global goods consumption the global economy is not well suited for. To wit, US used car prices have increased almost 50% in 12 months, as a result of the global shortage of semiconductors that has reduced the supply of new cars. These dislocations are, by definition, transitory, although they may be somewhat persistent and last several quarters. For as long as this temporary increase in prices doesn’t affect inflation expectations, the impact on underlying trend inflation should be muted.
In addition, a robust fiscal stimulus is likely to help avoid excessive inflation in the medium term. A stylized fact of recent recessions has been the presence of hysteresis, the apparent reduction of potential growth as a result of a recession. This has likely been the result of insufficient support to growth during the recovery, as fiscal policy turned to austerity too soon while monetary policy was limited by the zero lower bound. Deficient demand lengthens the duration of unemployment, damages labor supply and reduces potential growth. These fiscal packages are, de facto, a strategy of running the economy hot to avoid hysteresis which, if successful, will preserve potential growth.
Finally, the combination of less hysteresis, a reduction of inequality, and a boost to public investment, are all likely to contribute to an increase in neutral interest rates, creating a more balanced and effective policy mix and making monetary policy more powerful.
If inflation does accelerate to excessive levels, the Fed knows how to manage it. Whether the Fed should target slightly higher inflation, a discussion that may appear at the time of the next framework review in 2025, when maximum employment will likely have been achieved, is a different issue. In any event, considering the potential benefits of this economic policy strategy, a limited period of somewhat higher inflation is a risk worth running. As I argued in Ubide (2017), there are moments when excessively conservative economic policies can increase the fragility of the economy – it is the Paradox of Risk.
A more serious risk of Bidenomics is the entrenchment of the trend towards protectionism started with the Trump administration, under the principle of a “trade policy for the middle class” (see Posen (2021) for a lucid discussion). There is no need to apply tariffs or redirect production to American firms to improve the conditions of workers. In fact, it is counterproductive, as these measures reduce productivity and increase costs that are borne mostly by the middle class. A policy mix that generates a hot labor market to attract discouraged workers back into the labor force and puts in place the conditions and programs for less unequal outcomes are better instruments. This might have to be balanced against the view that this more expansive and active fiscal policy may have to be accompanied by more targeted immigration policies, to overcome the so called “paradox of diversity” (see, i.e. Putnam (2000)) whereby the support for provision of public services falls if people think the recipients of those services are very different from them.
Overall, Bidenomics is an important evolution in the economic policy mindset, reducing the stigma of deploying expansionary fiscal policy to manage the business cycle and increasing the protective role of the state. It is possible that, over the course of the last decades, too much risk had been transferred to the individual and, that, at times of elevated uncertainty, the state may be better place to manage risk. There is an optimal level of protection that is necessary for political stability, which achieves the right balance between competition and social cohesion, between effectiveness and resilience, and allows the state to reconnect with citizens and show that it can solve problems. However, the protectionist instincts inherent in this policy mix must be kept firmly in check.
The critical test of this new economic policy strategy, which will outlast the Biden administration, will be climate change. Most of the strategies to reduce emissions involve increasing the cost of dirtier energies to incentivize the switch to cleaner energies. This higher cost of dirtier energies will have a regressive macroeconomic impact, affecting more those at the lower end of the income ladder. To preserve political support, and avoid a backlash similar to that against globalization, governments will need to deploy enough fiscal resources to offset this regressive impact.
References
Edelberg, Wendy, and Louise Sheiner (2021), “The Macroeconomic Implications of Biden’s 1.9tr fiscal package”, The Brookings Institution
Doshi, Rush, (2021), The Long Game: China’s Grand Strategy to Displace American Order, Oxford University Press
Posen, Adam (2021), “The Price of Nostalgia”, Foreign Affairs May/June
Putnam, Robert (2000), Bowling Alone, Simon Schuster
Ubide, Angel (2017), The Paradox of Risk, Peterson Institute for International Economics.
Ubide, Angel (2020), “Fiscal Policy when Interest Rates are Zero”, in The Euro in 2020, Fundación ICO.
This article was originally published in Aspenia n. 94 (Italian Edition).
The views or opinions expressed in this article are solely those of the author and do not reflect the views, policies, or positions of the author’s employer, Citadel.