Are the increasingly upbeat economic forecasts for 2021 warranted?
As the new year begins, the U.S. is facing a dark winter characterized by high levels of coronavirus infections and related deaths and growing concerns regarding a new and more infectious COVID-19 variant. The sharp economic rebound observed in the third quarter of 2020 is starting to wane amid renewed virus fears and reimposition of some restrictions. Consumer spending is cooling, consumer confidence is down and the labor market recovery is losing steam. Yet, financial markets and economic commentators appear increasingly bullish about the economic prospects for 2021.
The key thesis underlying hopes for a surge in economic activity in the second half of 2021 is tied to expectations of a relatively rapid roll-out of vaccination programs during the first half of the year and a subsequent reopening of nearly all sectors of the economy that unleashes enormous pent-up demand from frustrated consumers who have been stuck at home for a prolonged period. Many argue that record levels of fiscal support, along with the ultra-accommodative stance of monetary authorities, have primed the U.S. economy for a strong surge in consumer spending later this year. Expectations for a strong second half economic performance appear to be already baked into the stock market as reflected in the recent record highs set by major indices.
The U.S. economy is consumer driven (personal consumption expenditure accounts for more than two-thirds of aggregate expenditure), and, consequently, any evaluation of growth prospects must take into account the underlying strength of the American consumer. During the pandemic, government largesse has managed to offset income declines at the aggregate level. Though millions of low-income households suffered job losses and continue to face severe hardships, massive fiscal transfers have helped shore up overall household disposable income. The U.S. personal saving rate entering 2021 is at nearly double the pre-COVID levels. Furthermore, U.S. household net worth is at record high levels (helped by a spike in asset values that were driven by surging home prices and equity markets). High saving rate and strong household balance sheets certainly augur well for consumer spending this year.
There are, however, distributional concerns and sector differences that may affect the overall pace and direction of consumer spending in 2021. Much of the gains in asset values have accrued primarily to upper-middle class and high-income households, whose marginal propensity to consume is typically less than that of lower-income households. Past behavior suggests that asset-driven wealth gains do not typically result in sharp spikes in consumption.
From a sectoral standpoint, much of the reduced demand during 2020 was experienced in the service sector, especially in contact-intensive industries. Meanwhile, demand for durable goods was strong as the pandemic led to the work-from-home trend and a shift to remote learning. Stuck-at-home consumers also engaged in purchases of exercise equipment, electronics and home furnishings. These spending patterns created an interesting dichotomy — male-dominated sectors such as manufacturing and construction saw a relatively robust recovery from the initial pandemic shock while female and minority-dominated contact-intensive service sectors continued to struggle.
Durable goods purchases are often one-time purchases, and we may have pulled forward demand for such items. Consequently, the pace of demand growth for durable goods is likely to be more muted in 2021 compared to 2020. The pace of service sector recovery will therefore be a critical factor in determining the strength of GDP growth in the second half of this year.
Assuming widespread vaccination, service sector recovery hinges on the answers to the following questions: How quickly will consumers return in large numbers to restaurants, movie theaters, stadiums and other social arenas? Will local and international students return to U.S. campuses this fall? Will domestic and international travel rebound quickly? Will patients return to dental and medical offices for routine and elective procedures?
Even from an international trade perspective, it is worth noting that while the U.S. runs a persistent trade deficit involving merchandize goods trade, it runs a trade surplus in services trade. Recovery in both domestic and international demand for services is crucial for sustaining growth in a service-oriented economy like the U.S.
Besides consumer spending, business fixed investment and new residential construction also matter for the 2021 economic outlook. Improving fundamentals and reduced political uncertainty may lead to a rebound in equipment (especially as oil prices stabilize) and software investment. The shift to remote/hybrid work arrangements and the growing preference for online shopping is, however, likely to crimp corporate investment in new structures. Meanwhile, new residential investment has been a source of surprising strength in recent quarters as record low mortgage rates, expanding teleworking options and a shift in preference for single-family housing outside of crowded cities has led to a surge in new construction as supply struggles to keep pace with rising demand.
Premature withdrawal of fiscal or monetary support is unlikely this year, which lends further credence to the widespread belief that the economy will perform rather well in 2021. Low probability but potentially dangerous downside risks do, however, exist. If new virus mutations emerge that make currently approved vaccines less efficacious, and/or, if there is a slower than expected rollout of vaccines, then a delay in the time frame for a return to normalcy is inevitable. On the economic front, financial turbulence may ensue if there is a severe asset market correction, or if the expected gradual weakening of the U.S. dollar gives way to an abrupt rout and/or if there is an unexpectedly large and persistent spike in inflation.
Vivekanand Jayakumar is an associate professor of economics at the University of Tampa.
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