THOUGHT LEADERSHIP

How To Put It BACK TOGETHER AGAIN

Humpty Dumpty sat on a wall, Humpty Dumpty had a great fall. Four-score Men and Four-score more, Could not make Humpty Dumpty where he was before

Samuel Arnold Juveline Amusements, 17971

BY LLEWELLYN VAN WYK, B. ARCH; MSC. (APPLIED), URBAN ANALYST

Humpty Dumpty is a character in an English nursery rhyme, probably originally a riddle and one of the best known in the English-speaking world. He is typically portrayed as an anthropomorphic egg, though he is not explicitly described as such. Its origins are obscure, and several theories have been advanced to suggest original meanings. I thought it particularly appropriate to describe the following article – what are the impacts of Covid on the global economy and how does it recover.

Impact and Response

Many commentators and economists are focusing on how governments go about rebuilding their national and city economies once the world has passed through what Christopher Joye calls the Global Virus Crisis (GVC). 2 According to The Economist, policy response has generally been swift and decisive.3 Globally central banks have cut interest rates since January 2020 and have launched new and substantial quantitative-easing schemes (creating money to buy bonds) while politicians are opening the fiscal taps to support the economy.

In the US, America’s Congress passed a bill that boosts spending by twice as much as President Barack Obama’s package in 2009. Britain, France, and other countries have made credit guarantees worth as much as 15% of GDP, seeking to prevent a cascade of defaults. On the most conservative measure, the global stimulus from government spending this year will exceed 2% of global GDP, a much bigger push than was seen in 2007-09. Even Germany, whose fiscal rectitude is a cultural cliché, is spending more.4

The analysts at The Economist caution though that to focus just on the quantitative changes misses something crucial which is that there are important qualitative changes under way in how policymakers manage the economy – the responsibilities they have assumed for themselves, what is seen as a legitimate action and what is not, and the criteria used to judge policy success or failure. On these measures, the analysts note,

the world is in the early stages of a “revolution in economic policymaking”. Central banks have in effect pledged to print as much money as necessary to keep down government-borrowing costs. The European Central Bank is promising to buy everything that governments might issue thereby reducing the gap in borrowing costs between weaker and stronger euro-zone members, which widened in the early days of the pandemic.

The analysts note that politicians, too, are ripping up the rulebook. In past recessions enterprises could go bankrupt and people too become unemployed. Even in normal economic times, roughly 8% of businesses in OECD countries go under each year, while 10% or so of the workforce lose a job. Now governments hope to stop this from happening entirely. President Emmanuel Macron reflects the view of many when he vows that no firm will “face the risk of bankruptcy” because of the pandemic. Boris Johnson, Britain’s prime minister, contrasts his government’s response with the one during the last financial crisis: “Everybody said we bailed out the banks and we didn’t look after the people who really suffered”. Larry Kudlow, the director of America’s National Economic Council, calls America’s fiscal stimulus “the single largest Main Street assistance programme in the history of the United States”, comparing it favourably with Wall Street bailouts a decade ago.

To that end the analysts note that governments across the rich world are channelling vast sums to firms, providing them with grants and cheap loans to preserve jobs and keep their doors open. In some cases, the government is paying the wages of people who cannot work safely: the EU has embraced this policy, while the British state will pay up to 80% of the wages of furloughed workers. The American package includes loans to small businesses that will be forgiven if workers are not laid off. Households across the rich world are being given temporary relief on mortgages, other debts, rent and utility bills. In America people will also be sent cheques worth up to $1 200.

Most economists support these measures. Nominally they are temporary, designed to hold the economy in an induced coma until the pandemic passes, at which point the world is supposed to revert to the status quo ante. But history suggests that a return to pre-Covid-19 days is unlikely.

Two lessons stand out. The first lesson is that governmental control over the economy takes a large step-up during periods of crisis. The second is that the forces encouraging governments to retain and expand economic control are stronger than the forces encouraging them to relinquish it, meaning that a “temporary” expansion of state power tends to become permanent.5

Road to Recovery

The extent of the economic damage and the time it will take for the economy to recover is subject to a high degree of speculation, and new models have been created to project a recovery trajectory. For example, the recovery can be V-shaped (after the downward fall the recovery will follow a straight line back to the original growth trajectory); U-shaped recovery (like V-shaped but with a longer turnaround period); VU shaped recovery (an initial pop, or sugar hit (the V), which is then superseded by a second, much slower growth phase (the U) due to a huge increase in debt repayment burdens and big creative destruction-induced output gaps (or excess productive capacity) as the virus forces the global economy to effectively rewire itself); Z-shaped (recovery follows the V-shaped trajectory but overshoots the original trajectory due to pent-up demand before falling back to the original trajectory); W-shaped (recovery begins buts fall back before climbing back up again); and L-shaped (growth recovers but ends up lower than that of the pre-C-19 economic growth).

In a survey of 106 economists and real estate experts conducted by Pulsenomics and Zillow, 41% of panellists expect the US recovery to follow a “U” shape, with the recession lasting several quarters before returning to growth.6 This prediction is in line with how the experts expect the US economy to recover overall. Forty-one percent said they think economic recovery will follow a “U” shape, and 33% say it will be a bumpy, multi-year return to trend growth. Both patterns are characterised first by a sharp decline and then match how experts see transaction volume recovering, with the consensus generally being a more gradual journey back to normal.

Whatever the final shape may turn out to be, Eswar Prasad and Ethan Wu, writing for the Brookings Institution, warns, “The world economy is on the precipice of its worst crisis since World War II. As the newly updated Brookings-FT TIGER (Tracking Indexes for the Global Economic Recovery) makes clear, economic activity, financial markets, and private-sector confidence are all cratering. And if international cooperation remains at its current level, a far more severe collapse is yet to come.” 7

A wide variety of economic and survey data suggest that the economy will recover slowly even after the government begins to ease limits on public gatherings and allow certain shuttered restaurants and shops to reopen. Many economists and business owners say there will be no rapid economic rebound until people feel confident that their risks of contracting the coronavirus have fallen, either through widespread testing or a vaccine.8

Prasad and Wu argue that while the current extraordinarily sharp downturn could prove to be relatively brief, with economic activity snapping back to previous levels once the Covid-19 contagion curve is flattened, there is good reason to worry that the world economy is heading into a deep, protracted recession. In their view much will depend on the pandemic’s trajectory and whether policymakers’ responses are sufficient to contain the damage while rebuilding consumer and business confidence. They do not believe that a rapid recovery is likely due to ravaged demand, extensive disruptions to manufacturing supply chains, and a financial crisis already underway.

They, like many other commentators, draw a distinction between the 2008-09 crash, and Covid-19. Unlike the 2008-09 crash, which was triggered by liquidity shortages in financial markets, they point out that the Covid-19 crisis involves fundamental solvency issues for firms and industries well beyond the financial sector. In addition, they note, the current shock is simultaneous and universal. During and immediately following the 2008 crisis, some emerging markets, not least China, and India, continued to register strong growth, pulling the rest of the world economy along. But this time, no economy is immune, and no country will be able to lead an export-driven recovery. Today’s collapse has increased deflationary and financial risks in the advanced economies and struck a significant blow to commodity exporters.

On top of it all, oil prices are plunging even more than they otherwise would, due in large part to Saudi Arabia and Russia flooding the market. In their view all told, the economic and financial carnage wrought by the coronavirus could leave deep, lasting scars on the global economy. While they recognise that central banks are stepping up to the challenge, they point out that central banks cannot offset the fall in consumer demand or stimulate investment by themselves. With both conventional and unconventional monetary-policy tools already stretched to the limit, fiscal policymakers will have to do more.

They suggest that well-targeted fiscal measures can soften the blow to consumers and businesses-especially small and medium-size enterprises, which typically have minimal financial buffers-thereby helping to sustain

employment and demand. In these desperate times, such measures should be fully embraced by all governments that currently benefit from low borrowing costs, even if they already have high levels of public debt.

They also emphasise that low- and middle-income countries who have inadequate health systems will need substantial support from the international community, potentially including concessionary debt relief.

But there is an elephant in the room: unfortunately, the world’s inability so far to forge a common front attest to the erosion of international cooperation, which is further damaging business and consumer confidence. They too, like many other commentators, call for this to change. The world urgently needs honest and transparent informationsharing by national leaders, coupled with aggressive steps to contain the pandemic, extensive stimulus to mitigate the economic fallout, and a carefully calibrated strategy to restart economic activity as soon as it is safe to do so. during times of war (that term again), and that is arguably where the world finds itself now in terms of response.

On the question of inflationary shock, he expects the deflationary impulse of the GVC via the huge sudden increase in labour supply to overwhelm the inflationary impulse of the crisis over the short-to-medium term (i.e., in the next year or two) noting that the near-term inflation pressures obviously come through supply-chain rigidities as labour is taken temporarily offline.

He does foresee a key consequence of the GVC as compelling much greater internalisation of supply-chains, especially those that service critical infrastructure and security-sensitive goods and services. In terms of changes, it is suggested that the GVC will result in a permanent economic damage akin to a form of creative destruction where the virus kills off weak companies as well as unproductive employees. This he suggests is because many businesses will come back looking different, shedding low quality workers, and closing unprofitable activities/subsidiaries.

Some industries will be permanently changed in both positive and negative ways, for example, entire communities are being forced to get much more comfortable with online shopping and the associated delivery process, reducing at the margin the demand for traditional retailing. The cinema industry will be irreversibly damaged as consumption shifts away from theatres to on-demand digital platforms like Apple and Netflix, which will turn allow these distributors to capture more of the value-chain in the same way Amazon did with bricks and mortar retailing.

The commercial property sector is also likely to feel this change as there is a possibility of a permanent decrease in the demand for both office and retail space. Many companies may conclude they can save overhead by remaining disaggregated (i.e., not renting office space). This will result in a decline in the value of commercial properties, and the risk associated with commercial property debt could increase sharply. Commercial property lenders’ LVRs might suddenly jump because of this. Indeed, he argues that a lot of distress in commercial property debt portfolios can be expected over the next 12 months.

The embedding of Zoom, or cheap video conference technology, may dissipate the value of face-to-face meetings and result in a permanent decrease in the demand for expensive business-related travel and accommodation, adversely impacting airlines and hotels, as companies seek to enhance their operating efficiencies. All this creative destruction could result in unemployment rates not returning any time soon to their pre-GVC levels which will, in turn, place downward pressure on wages. Ultimately, he concludes that this will result in a battle between the shock of the new – a virus that derails life as we knew it – and the opportunities presented by the gigantic stimulus afforded by fiscal and monetary policy.9

The embedding of Zoom, or cheap video conference technology, may dissipate the value of face-to-face meetings and result in a permanent decrease in the demand for expensive business-related travel and accommodation.

Christopher Joye agrees with the sentiments expressed by Prasad and Wu. Joye sees the global economy being burdened by a great deal more public and private debt because of the enormous fiscal policy responses, which will need to be serviced through tax revenue and corporate/ household earnings. This he argues will drag on future global growth after the initial pop in activity as businesses restart and the working-age population gets back into their day-jobs.

On the matter of whether this precipitates a sovereign debt crisis he believes that ultimately the central banks can cauterise this problem by continuing to do what they are currently doing: i.e., funding their domestic treasuries by buying government bonds via quantitative easing (QE). After all, he notes, central banks were originally created to fund governments

As the world tries to deal with the ongoing challenges of Covid-19, it is worth reminding ourselves that infrastructure investment and climate action are both urgently need, and that with the right approach, both goals can be achieved simultaneously. This article provides some indications of what the right approach may be. CLICK HERE TO CONTINUE READING ARTICLE

REFERENCES

1 Opie, J. and Opie, P., ed. (1997) [1951]. The Oxford Dictionary of Nursery Rhymes (2nd ed.). Oxford: Oxford University Press. p. 254. ISBN 978-0-19-860088-6. 2 Joye, C. 2020. “Calling a ‘VU’ shaped recovery: and creative destruction induced by GVC.” Coolabah Capital Investments, 7 April 2020. . 3 Briefing, 2020. “Rich countries try radical economic policies to counter covid-19.” The Economist, Mar 26, 2020. . 4 Briefing, 2020. “Rich countries try radical economic policies to counter covid-19.” The Economist, May 26, 2020. . 5 Briefing, 2020. “Rich countries try radical economic policies to counter COVID-19.” The Economist, March 26, 2020. . 6 Olsen, S. 2020. “Experts: Spring’s missing home sales will be added in coming years. Zillow, June 3, 2020. . 7 Prasad, E. and Wu, E., 2020. “Anatomy of the coronavirus collapse.” The Brookings Institution, Monday, April 13, 2020. . 8 Tankersley, J. 2020. “Economic pain will persist long after lockdowns end.” The New York Times, 13 April 2020. . 9 Joye, C. 2020. “Calling a ‘VU’ shaped recovery and creative destruction induced by GVC.” Coolabah Capital Investments, 7 April 2020. .