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Bringing the World to a Grinding Halt

Ankita Bahl, CFA

The COVID-19 pandemic is a crisis like no other. Given its complex, global, and uncertain nature, one would think that the pandemic would invite a unified response across the globe, with entities pooling resources and sharing information in a timely manner. What we witnessed instead was political one-upmanship between two economic superpowers (the U.S. and China) and the absence of coordinated containment measures, as the virus wrought havoc on the lives of billions around the globe and brought the world to a grinding halt.

What has been the impact of the coronavirus on the global economy, and what do we know about the effectiveness of the government responses and the path to recovery? And what does this all mean for businesses in a post-pandemic scenario?

Impact on GDP and unemployment

In January, before the global outbreak of COVID-19, the United Nations expected world output to expand at a modest pace of 2.5 percent in 2020. Less than 6 months later, with much of the world still in the grip of the pandemic, the UN revised its forecasts and projected that the world economy will shrink instead, by 3.2 percent this year.1 Under the baseline scenario, developed economies would see their economic output contract by five percent, while that of developing coun¬tries would shrink by 0.7 percent. In June 2020, the International Monetary Fund revised its global growth forecast to an even lower -4.9 percent for the year, almost two percent points below its April 2020 forecast.2 By comparison, the world economy contracted by 1.7 percent during the global financial crisis in 2009.

Canada’s gross domestic product (GDP) dropped at an annualized 8.2 percent in Q1 of 2020. By comparison, real GDP in the U.S. fell five percent. Overall, the service sector was the hardest hit in the months following the outbreak, and industries such as retail trade, leisure, hospitality, recreation, and transportation services in particular, as stronger restrictions were placed increasingly on the movement of people amidst the lockdown. In June 2020, the International Air Transport Association projected an annual decline of 55 percent in the overall passenger demand for the year and is estimating a cash burn of US$61 billion in Q2 of 2020 as a result of declining passenger revenue, accompanied by high fixed and semi-fixed costs.3

Following a record decline of 25 percent in April, retail sales in Canada were up 18.7 percent in May to C$42 billion,4 but still lower than the pre–COVID-19 levels. While online shopping has seen a surge like never before — retail e-commerce sales were up more than 110 percent in May 2020 on a year-over-year basis, and now account for an eight percent share of total retail trade (compared to 3% in May 2019) – they alone may not be able to drive the growth in the retail industry, and it could take years for the industry to bounce back completely.

Unemployment increased sharply as businesses lost revenue, transforming a supply-side shock into a wider demand-side shock for the economy. After reaching a record high in May (13.7%), Canada’s unemployment rate dropped to 12.3 percent in June 2020. While the employment losses resulting from the economic shutdown were unprecedented in their speed and depth, the silver lining is that the initial recovery has been sharper than in the previous downturns, where recovery to pre-downturn employment levels took on an average of 2 to 5 years.5

The U.S. economy lost 20.5 million jobs in April, more than twice the 8.7 million jobs lost during the global financial crisis and erasing the gains of the last decade. At 14.7 percent, the U.S. unemployment rate in April rose by more than 10 percentage points in a single month. In June, the U.S. unemployment numbers fell down to 11.1 percent,6 but it is important to note that: a) the decline was driven primarily by workers returning to work from temporary layoffs while the number of permanent job losers continues to rise, and b) as COVID-19 infections spike across the country, many states have rolled back phased re-openings that brought many jobless workers back into the labour force. In a CFA Institute webinar on COVID-19 market implications presented in April 2020, Nicholas Colas, the co-founder of DataTrek Research, pegged the unemployment rate at 8 to 10 percent for year-end as a base-case scenario.

Government intervention

In response to the escalating health emergency and rapidly deteriorating economic outlook, national authorities and multilateral entities worldwide introduced unprecedented policy measures. Central banks around the world moved aggressively to help stave off the crisis by slashing interest rates, injecting liquidity, and providing emergency funding to firms and households.

In its mid-year report, released in May 2020, the UN noted that fiscal measures worldwide collectively stood at US$9 trillion—more than 10 percent of the 2019 total gross world product. The U.S. government rolled out emergency relief packages worth over US$2.5 trillion: more than double the size of the fiscal stimulus enacted in 2009. European countries also adopted large and multiple fiscal measures, including the temporary suspension of rules that limit the budget deficits of EU member states. In Japan, the government unveiled a stimulus package worth nearly US$1 trillion (equivalent to 20% of its GDP), despite having a public debt to GDP ratio of more than 230 percent (the highest in the world). Most developing countries, on the other hand, with limited fiscal resources for large relief and stimulus measures, implemented fiscal stimuli of between 1 and 2 percent of GDP, and in many cases, even less than 0.5 percent.7

Canada’s response to COVID-19 has resulted in an estimated C$343 billion deficit for the upcoming fiscal year.8 Equivalent to almost 16 percent of Canada’s GDP, the big spike in deficit spending is expected to push the country’s federal debt through the C$1 trillion mark for the first time in its history. Rising deficit concerns and the deterioration of Canada’s public finances led Fitch to downgrade Canada's AAA+ credit rating to AA+ in June, even as the government claims to have a sound debt management plan in place, thanks to the low interest rates.

In March of this year, the Bank of Canada reduced interest rates by 150 bps to 0.25 percent via three separate cuts. Since the outbreak of the crisis, about 60 different monetary authorities have cut their policy rates. The U.S. Federal Reserve Bank lowered its target rate by 100 bps (0.0%–0.25%), while the Bank of England cut interest rates to an all-time low of 0.1 percent. Emerging market central banks, especially in East Asia, western Asia, and Latin America, also implemented rate cuts. In addition, major central banks boosted liquidity in their financial systems and restarted or expanded their asset purchase programs.

The success of fiscal and monetary stimulus measures, however, is contingent upon the assumption that the economy’s productive capacity remains intact in the medium to long run, given that governments cannot provide aid indefinitely. However, as the threat of a second wave of infection looms large, especially in the U.S., the adverse impact on productive capacity cannot be discounted. The worst hit would be the small businesses, the lifeline of any economy – financially fragile, declaring bankruptcy is a better option for these firms than piling on debt. According to a study by researchers at the University of Illinois, Harvard Business School, Harvard University, and the University of Chicago, more than 100,000 small businesses are expected to have shut down permanently since the pandemic escalated in March, and nearly 2 percent of the small businesses surveyed reported that they were permanently closed because of the pandemic.9

Recovery—the alphabet soup

A question that looms large on everyone’s mind is when, and how, the economy will recover. According to J.P. Morgan, V-shaped patterns have emerged in six of the past seven recessions.10 Recovery from SARS was also V-shaped, though the spread of SARS was limited to fewer places and the virus disappeared more quickly than our present nemesis.

While V-shaped recoveries in individual economies seemed plausible in early March, they now seem like a distant possibility. Even developed countries such as the U.S. and U.K. are grossly underprepared to handle a health crisis of this magnitude, and the lack of a coordinated policy response has not helped the situation. As economies re-open at a measured pace and consumers gradually return to their normal behavior, a U-shaped recovery with a delayed rebound, seems more probable.

According to a survey conducted in June 2020 by McKinsey and Company, 33 percent of the executives believe that the recovery will be slow and bumpy. The general perception about the current economic situation is worsening around the world. Outside of Greater China, a clear majority of respondents (88%–98%) reported declining conditions in their home economies.11 Whilst not highly probable at the time of writing this article, a prolonged W-shaped recovery is also a possibility, if the approaching flu season makes the pandemic worse and policymakers are unable to choose or choose not to renew stimulus measures.

In any case, the need of the hour is for the countries to ensure frequent and free testing on a massive scale, as well as to undertake contact tracing to isolate and manage those who may have been exposed to the virus. The latter has been an effective strategy in limiting the spread of the virus in parts of Asia, such as Singapore and South Korea. A vaccine would be the ultimate weapon against the coronavirus and the best route back to normal life, but even that would take a minimum of 12 to 18 months. If economic activity remains severely depressed for that long, without aggressive but well-targeted government action, the post-pandemic trajectory will look like an L, making the current recession by far the worst since the Great Depression of the 1930s.

The demise of globalization . . . or not

According to the Peterson Institute of International Economics,12 the world is dependent on China for more than 40 percent of the personal protective equipment that is critical in the fight against the coronavirus. Had China’s exports shut down in early 2020, the EU, the U.S., and many other countries dependent on China for critical supplies would be at a very high risk of having their supplies disrupted. Canada too was left scrambling for critical equipment when President Trump invoked the Defense Production Act in early April, halting the export of nearly three million N95 respirators to Ontario. Fortunately, the issue was resolved amicably, but not before exposing the fragility of, and overdependence on, global supply chains.

One would think that a global pandemic would usher in an era of international cooperation in a globalized world, but what it instead triggered was a series of national responses. The pandemic has accelerated the uptick in protectionism that has been on the rise since 2008, and the decoupling pressures that existed between China and the U.S. prior to the outbreak are also expected to intensify as a result of the global outbreak.

While we are not seeing the end of globalization, the pandemic has set us on a path to a new, different, and more limited form of globalization. Instead of being dependent on single sources of supply, economies will diversify supply of key inputs and shift to domestic or regional production, aided by advances in automation and labor-saving manufacturing technologies. Jack Ablin, CFA, chief investment officer and founding partner of Cresset Capital, further believes that “reshoring,” or bringing manufacturing capabilities back in-country, will require investment in industrial real estate and warehouses, and that construction will likely focus on regional, mid-sized manufacturing facilities that are conducive to automated secular trends ushered in by globalization will reverse.

What next?

It is hard to say if it will ever be business as usual. The COVID-19 pandemic has forced business to rethink their strategies, which will now have to be built on the foundations of agility, flexibility, and resilience. Digitization is no longer an option, but a necessity. The coronavirus pandemic has accelerated trends in workplace dynamics that were already underway through automation and artificial intelligence.

To respond, leaders should pursue a broad reskilling agenda that develops employees’ digital expertise and their cognitive, emotional, and adaptability skills. The pandemic is shifting the employment landscapes, and for companies to be resilient in these changing times, it is imperative that they build resilient workforces.

As businesses struggle with the imminent issues of cash management for liquidity and solvency, they will need to reconsider which costs are truly fixed versus variable, as the shutting down of huge swaths of production sheds light on what is ultimately required versus what is nice to have.

Given the high levels of continuing uncertainty, it is imperative that business leaders ensure they are actively tuned into the real-time information from all levels in their organization, plus outside forces, to inform decisions.

Finally, the ability to innovate and execute at scale will be a key determining factor for business survival in the post-pandemic era.

Ankita Bahl, CFA, is a project manager with the Canadian Securities Administrators, with close to 10 years of experience in regtech, financial analysis, data analytics, risk assessment, macro-economic research, and investment strategies. She is passionate about promoting financial literacy in young people and increasing the representation of women at all levels of business.

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