Post Covid Scenario - 2021

Digital
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Article
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Economics & Society
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Who Will Win — and
Lose — in the Post- yo
Covid Economy?
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by Philipp Carlsson-Szlezak, Paul Swartz, and Martin Reeves
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HBR / Digital Article / Who Will Win — and Lose — in the Post-Covid Economy?
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Who Will Win — and Lose — in
the Post-Covid Economy?
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by Philipp Carlsson-Szlezak, Paul Swartz, and Martin Reeves
Published on HBR.org / June 01, 2021 / Reprint H06DQN
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HBR Staff/NoDerog/Getty Images
As an extraordinary recovery is underway, it won’t be long before

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business leaders face a perennial political economy question: With wages

rising and workers’ claim on economic output growing, will firms’ profits
come under pressure?
With tight economic conditions all but guaranteed, there are multiple
scenarios of how output will be shared between workers and firms in the
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post-Covid expansion. The policymakers who have placed the big stimulus
bet also will have to negotiate the path ahead.
Copyright © 2021 Harvard Business School Publishing Corporation. All rights reserved. 1
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We’ve identified a small number of plausible scenarios that sketch the
interaction of wage growth, productivity growth, and policy management.
While workers and policymakers can live with several of the scenarios,
only one will be truly appealing for firms.
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The Ongoing Stimulus Bet
Fiscal stimulus was both enormous and necessary when the Covid crisis
hit last year, and it successfully prevented the structural damage that
weighs down recoveries. But even as the economy was on a better-than-
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expected rebound, the Biden administration and Congress opted for an
additional stimulus package, in the hope of delivering a booming economy
that will boost workers’ fortunes in the post-Covid economy. The
downside to this stimulus bet is the risk of imbalances, such as inflation or
asset bubbles, as the economy “overshoots.”
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In the below exhibit, we summarize four ways in which this bet may play
out — and who wins and loses. Let’s look at each of these scenarios, before
asking which one is most likely and what that means for business leaders.
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1. Win-win: Wage gains are paid for by firm productivity growth.
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The Goldilocks scenario is where workers, firms, and policy makers all win
in the post-Covid cycle. Firms don’t lose out from higher wages if they’re
paid for by productivity growth. And policy makers prefer this dynamic
because there are no current or latent inflationary pressures as the
potential of the economy expands.
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However, this combination of wage and productivity growth is not a given.

The period that most resembles this scenario was the late 1990s. U.S. wage
growth was very strong, but so was productivity growth, which muted the
impact on corporate margins. Companies were happy to ride the wave of
strong economic growth, itself driven by strong wage growth in a virtuous
cycle.
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In the post-Covid world there is a credible expectation of some higher
productivity growth but whether it can be enough to meaningfully offset
wage pressures remains to be seen.
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2. Win-lose: Workers gain at the expense of firms — reversing a
longstanding trend.
If productivity growth falls behind wage growth in the post-Covid world,
firms will be faced with cost pressures. If they’re unable to pass them on to
consumers (see Scenario 3), their margins will be compressed and
workers’ share of economic output would grow at firms’ expense,
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reversing a multi-decade trend.
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Across recent business cycles we have seen strong wage growth when the
labor market is tight and firms’ margins fall.
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Keep in mind that firms’ profits may continue to grow in this scenario, as
the strong economy drives top-line growth that can offset margin
pressures. But it’s a less attractive scenario than the first one because we
don’t see as much overall economic growth.
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Policy makers would approve of this scenario, not only because of their
policy objective to raise wages but also because firms’ absorbing wage
pressures in margins means less inflationary pressure. However, their
approval would be qualified, as rising wages cannot be sustainably
absorbed in firm margins indefinitely, eventually leading to inflation.
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3. Lose-lose: Inflation threatens the cycle as policy makers deal with a
losing bet.
If wage pressures are not offset by productivity growth, and firms have the
pricing power to pass them on to consumers, then inflation will result.
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If this occurs at a modest pace (say 2%) policy makers may be satisfied. But
if it drives inflation sharply higher for some time, policy makers will have
lost their stimulus bet. Faced with too much inflation, they would have to
raise interest rates and risk a recession — a lose-lose all around.
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Such a “policy error” occurs when the Fed has to move faster and stronger
than anticipated to catch up with realized inflation. While an error, it
remains the desirable course of action, because ignoring emerging
pressures has the potential to deliver far worse than a cyclical downturn.
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4. Lose, then lose again: Policy makers double down on a losing bet,
leading to disaster.
The disastrous scenario is that monetary policy makers don’t raise interest
rates even when prices are rising faster, and lawmakers push for even
more fiscal stimulus in a quest to extend the cycle.
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The ugliness in this scenario is that cyclical pressures can break the
structural foundations of the inflation regime when pressure is high and
sustained. Such a “regime break” is a higher bar and takes more time than
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just a few quarters or even years. But it can happen, and it has happened
before — last time in the late 1960s, leading to a period known as “the
Great Inflation.”
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If this scenario happens, the outlook wouldn’t just be a single short
recession, but more frequent recessions, low asset valuations, higher rates,
and a painful process of re-anchoring inflation expectations.
Which Scenario Is Most Likely?
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While scenarios are a necessarily stylized version of the future (not the
messy reality), there are reasons to be optimistic.
With wage pressures almost certainly building, the good news is that
productivity growth is likely to absorb some of it — as the Covid crisis has
facilitated new business learnings — but not all, so margins will be
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pressured to absorb some of it. If there is enough of these two outcomes,
monetary policy makers can raise interest rates slowly without killing the
cycle — a relatively good outcome for workers, firms, and policy makers.
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If price pressures are passed through and too-high inflation does result on
a sustained basis — which we view as less likely — policy makers stand a
chance to avoid a recession, even though that window could be quite
narrow. An early and well-balanced policy intervention can deliver a “soft
landing,” where the economy cools down just enough, but not enough to
push it into recession.
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Only if inflation starts a fire that needs to be put out rapidly and policy
makers deliver a recession is it a clear lose-lose bet. (Although conditions
could change, we view this as unlikely.) Yet, this remains preferable to the
structural inflation break (very unlikely in the near term) where policy
doubles down on a losing bet and undermines the inflation regime.
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What It Means for Firms — and What They Can Do
Stakeholders in the macro economy have different interests in the

scenarios we laid out above. Workers are fine with scenario 1 or 2, and
some politicians might even prefer scenario 2 where labor’s share most
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clearly rises. Policy makers would prefer scenario 1, but they would be
satisfied with scenario 2 as well. They may also be willing to push the cycle
if that scenario develops.
Firms, on the other hand, will strongly prefer scenario 1 and that means
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they have to deliver higher productivity growth in the post-Covid cycle.
It’s difficult to overstate the importance of productivity growth to firms.

Passing on wage pressures to protect margins is only a winning strategy if
other firms can’t do the same. If all firms can and do so, the inflationary
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outcome will drive up interest rates and thus be a headwind to growth. In
aggregate, therefore, for firms to win they must deliver on productivity
growth.
So, what are firms to do? Productivity growth, in essence, is about

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producing more with existing inputs, or producing the same with fewer
inputs. That almost always is easier said than done, particularly when the
pandemic has already put enormous strain on the workforce, but here are
some key levers to do so sustainably:
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• Seize on the specific learnings from the crisis. Covid has forced
many firms to survive and adapt to new realities, often by exploring
new, digital, and often more efficient processes and channels.
• Institutionalize the learning process from the crisis. Covid also
forced firms to try things they wouldn’t have otherwise tried, often at
surprisingly little cost. Now is the time to build processes that generate
these learnings in more normal environments.
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• Understand that the old playbook of plugging gaps by hiring the

next worker will be hard. Thus focus must shift to improving existing
worker productivity through new technologies. In particular, the
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ongoing “digital transformation” of incumbent businesses has at worst
the potential to increase the cost of doing business, and at best could
drive both growth and productivity. In this respect, the biggest gains
will be if business models are reimagined in the context of new needs
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and new possibilities, rather than merely incrementally enhanced.
• Yet don’t ignore existing technologies. Often their use can be
deepened today since previously the tradeoff between incremental labor
or capital investment was less favorable.
• And lead effectively. Leadership that gets everyone pushing in the same
direction (ranging from the operational to the inspirational type) can
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unlock productivity gains as well.
Avoiding paying higher wages in the post-Covid cycle will be a losing

strategy. Instead, making your firm more productive so that workers’
additional value creation pays for their higher remuneration is how firms
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can turn the post-Covid cycle into a win-win scenario.
Philipp Carlsson-Szlezak is a partner and managing director in BCG’s

PC New York office and global chief economist of BCG. He can be reached
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at: [email protected].
Paul Swartz is a director and senior economist in the BCG Henderson

PS Institute, based in BCG’s New York office.
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Martin Reeves is the chairman of Boston Consulting Group’s BCG

Henderson Institute in San Francisco and a coauthor of The Imagination
Machine (Harvard Business Review Press, 2021).
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HBR Staff/NoDerog/Getty Images

As an extraordinary recovery is underway, it won’t be long before

business leaders face a perennial political economy question: With wages

However, this combination of wage and productivity growth is not a given.

Which Scenario Is Most Likely?

Stakeholders in the macro economy have different interests in the

It’s difficult to overstate the importance of productivity growth to firms.

So, what are firms to do? Productivity growth, in essence, is about

• Understand that the old playbook of plugging gaps by hiring the

Avoiding paying higher wages in the post-Covid cycle will be a losing

Philipp Carlsson-Szlezak is a partner and managing director in BCG’s

Paul Swartz is a director and senior economist in the BCG Henderson

Martin Reeves is the chairman of Boston Consulting Group’s BCG

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