We try to take a first glimpse at the world after the corona crisis. What will be the impact of the pandemic from an economic, social and political point of view? Julius Baer's report 'The world after the corona crisis' finds brief answers to big questions.
Economics: Entering a new normal?
Footing the bill of fighting the crisis
In order to foot the bill of the corona crisis bailout, policymakers have three options at their disposal: increasing taxation, renewed borrowing from the private sector and monetisation. Higher taxation corresponds to financial repression in the shorter term for those concerned, but borrowing could also bring financial repression, if governments cap public borrowing costs, in an effort to service high debt burdens. Monetisation of debt, on the other hand, raises the risk of inflation in the medium to longer term, eventually creating financially repressive effects for everybody. However, the last decade has impressively shown that debt monetisation, with a central bank buying public debt, does not have to be necessarily inflationary, as it depends crucially on the incentives to use the newly created central bank money in the economy. The inflation outlook therefore depends on the readiness to reduce well-received state support and balance public budgets, once the emergency that triggered the fiscal stimuli is over. Reluctance to stop the expansion of public debt, with the aim of not endangering swift economic growth and prosperity, would foster inflation with some form of supply bottlenecks, and insufficient private investment and de-globalisation could eventually become catalysts for sharply rising inflation. On the other hand, aggressive austerity, caution in the use of the newly created central bank money, as well as pressure on the private sector to shrink its financial liabilities, all keep the deflationary risks, that emerged during the economic slowdown, alive, even when the economy recovers. This has happened in many advanced economies in the last decade, against a backdrop of secular deflationary pressure from widespread globalisation.
Central banks to lose their independence
Central banks responded decisively to the financial market and economic fallout of the containment measures against Covid-19 and pulled their weight to prevent a total systemic collapse. In order to avoid such a collapse, following the sudden cessation of activity in large parts of the economy, central banks provided financial markets with liquidity at an unprecedented speed and scale, slashed interest rates and also reactivated extended quantitative policy tools. The failure of central banks to prevent a persistent undershooting of inflation below their targets in the past decade, had already weakened their claim to independence. The dominating fear in financial markets, that the corona crisis fallout will be long-term deflationary, undermines central banks’ independence further and promotes the idea of coordinated monetary and fiscal policies under the name of ‘Modern Monetary Theory’ (MMT). MMT vindicates the monetising of public debt in order to achieve full employment, and claims that the risk that monetisation would result in hyperinflation or a sharp currency devaluation is low. In addition, MMT justifies capping the level of sovereign bond yields, in order to disentangle fiscal spending from the whims of financial markets. This permissive attitude towards inflation, which policymakers had already started to adopt prior to the corona crisis, is currently receiving an extra boost, as the sharp economic slowdown and the collapse of the crude oil price have further sensitised policymakers to deflation risks.
The state reborn ‘as protector of last resort’
The corona crisis has forced the state into the role of ‘protector of last resort’. The risk that governments bail out ‘zombie’ companies, i.e. companies without an economic future, is on the rise. In addition, the pandemic could change people’s perception of globalisation. There is growing acceptance of the notion that governments and public bodies deserve a more active and protective role in shaping a country’s economic and social future, instead of focusing conservatively on the ideals of a more restrained role characterised by financial austerity. Many sectors of the population also welcome a reduction of globalisation and an increase in self-sufficiency (reshoring, nationalisation of key supply chains), due to the disruptive effects of the pandemic and in light of the ongoing trade disputes. However, a state-dominated economy, combined with less globalisation, will tend to reduce overall economic productivity and wealth creation potential for its citizens.
Politics: Shifting to a more authoritarian world?
Aside from the spread of the virus around the world, the corona crisis is the result of the politics and measures undertaken to safeguard public health. Over the past decade, the multipolar world has been subject to endless debates, primarily originating from the rise of China to superpower status, a political system that differs in many ways from those seen in the Western World. Confronted with the outbreak in its origin, China took drastic measures, dismissing what the West sees as civil rights, and showed strong leadership to fight the pandemic. Geopolitical analysts and commentators soon launched into a debate on whether authoritarian rather than libertarian approaches were potentially more effective in fighting a pandemic, or whether strong leadership is a prerequisite to protecting citizen health. Of course, pondering these questions in all their dimensions could fill many books. Instead, we focus on some early, noteworthy observations.
- Effectiveness of the measures. Strong leadership and an established security apparatus aligns society swiftly with political will. The evidence from Europe and North America, however, reveals that the libertarian approach proves effective too. Compliance with promoted health measures was very high in most countries and soon curbed infection trends. Citizens saw themselves as part of society, less as an individual, which nourished the intrinsic motivation to follow the policies.
- Flexibility of the systems. The Western World’s libertarian systems in fact showed great flexibility in enabling an effective response. Politics nudged some existential civil rights in order to make fast decisions and enact burdensome measures. Such emergency mechanisms are part of any libertarian constitution. That said, some raised concerns about constitutional breaches.
- Success of the measures. While infection rates and speculation on deaths from Covid-19 filled the news, it is the overall mortality rate that is the most appropriate data by which to measure the success of fighting the pandemic. This data is not biased by selected testing or differing definitions of causes of death. Relying on this data, mortality seems to vary wildly across countries, independent from political systems.
Globalisation: The start of reshoring?
Borders closed, flights cancelled, exports restricted, supply chains disrupted: Covid-19 brought the functioning of our globalised and interconnected world to an abrupt halt. Of course, this extreme situation will not last. Borders will be reopened, people will start travelling again, trade flows will resume. However, the outbreak of Covid-19 has revealed the fragility of international relations, the risks of international interdependence and the vulnerability of global supply chains. This experience adds pressure on governments and businesses to rethink their global dependencies.
Although the benefits of globalisation are widely recognised, the focus has increasingly shifted towards the risks and downsides of an over-globalised world. This debate has been most prominently led by nationalist politics and has been fuelled over the years by the failure of governments to adequately support the economic losers of the global integration process in their home countries. Brexit, debates over border walls, the trade conflicts between the United States and China as well as the European Union, are just a few examples. The corona crisis has put even greater emphasis on reducing dependencies on other countries, especially when it comes to critical supplies. Self-sufficiency and reshoring of manufacturing are thus likely to make their way back to the political agenda.
Independent of the political agenda, the corona crisis forces companies to reassess the risks of their supply chain systems, especially for those that are dependent on single sources of supply and just-in-time production. The recent supply chain disruptions are prompting reconsiderations about efficiency, robustness and costliness. For some companies, the reshoring of production might be the optimal response to a higher risk of supply chain disruptions, but for many international companies this is unlikely to be the case. For the latter, greater robustness means diversifying production across geographies rather than concentrating it on one location only, relying on a broader range of suppliers or holding larger inventories. Either way, greater robustness comes at cost. The shift to more robust supply chains would not only increase costs for companies but eventually also for consumers.
The world after the corona crisis
The Julius Baer 'The world after the corona crisis' report provides brief answers to big questions in the areas economics, politics, globalisation, society, inequality, healthcare, ethics, digitalisation and investing.
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