According to a recent Mckinsey & Company analysis on the COVID-19 crisis, we have two imperatives:
1. To safeguard our lives and
2. To safeguard our livelihoods.
We must solve for the virus and the economy, but it starts with battling the virus and the prevention of the tragic loss of human life.
Interesting that the need to safeguard livelihoods is starting to feature prominently in all analyses of this unprecedented crisis.
The McKinsey analysis predicts that the shock to our livelihoods from the economic impact from the COVID-19 suppression efforts could be the biggest in nearly a century and far greater than that of the 2007 - 2009 financial crisis, known as the Great Recession, which began in December 2007 and ended in June 2009 - the longest recession since World War II.
By now, most analysts agree that we are about to witness a downturn that will dwarf the Great Recession and that a comparison to the 1929 Great Depression may be more appropriate.
It is therefore obvious that if the COVID-19 crisis is going to result in a much more severe economic crisis than the Great Recession, this time, governments are going to have to take much bolder measures. What worked then will clearly not work now and without timely and effective macroeconomic support, the livelihoods of many will be destroyed. This is certainly not a crisis that people and businesses can endure on their own.
The measures that help solve the health crisis can also make the economic crisis worse and the cure may be more deadly than the disease itself. On the other-hand without the right suppression and containment policies, the economic recession will be even more severe. This is the threat to our livelihoods.
So the question is how bad is it likely to be?
· Mckinsey estimate that “a 40% to 50% drop in discretionary spending translates to a roughly 10% reduction in GDP— without considering the second- and third-order effects. That is not only unprecedented in modern history, it has been historically almost unimaginable—until now. The longer a lockdown is in place, the worse the impact on our lives will get.”
· Morgan Stanley and Goldman Sachs Group Inc. economists predict that COVID-19 will inflict greater economic pain than they previously expected as they warned of a record plunge in the US output in the second quarter and a deeper global recession.
· Morgan Stanley’s U.S. economists predict that they now see American gross domestic product falling 30.1% in April-June. That will drive up unemployment to average 12.8% over the period, they said.
· The world economy is expected to contract about 1% this year, which would be a bigger decline than that witnessed in 2009 amid the financial crisis when the world economy contracted by 0.8%.
The news is not good and we have little choice but to brace ourselves for one of the worst crisis since the 1929 Great Depression. Every time a crisis hits us, it exposes how fragile and speculative world economies are. There is no economy that is immune to this crisis but different economies will be impacted to different extents and small economies that are exposed to and depend on external economies are even more vulnerable – the Maltese economy fits into this category.
McKinsey’s state that in the absence of a vaccine, the only solution we have is to find ways to “timebox” this event – to suppress the virus and shorten the duration of the economic recovery. The more we shorten the duration of the economic recovery the less economic damage will be inflicted and more livelihoods will be saved, but we cannot exclude the possibility of a longer-spread of the virus in which case the economic outcomes in 2020 and beyond would be even more severe. Given the sensible and effective strategy Malta is adopting to flatten the infection curve, I would expect our economic recovery to take longer. Flattening the curve of infection and the curve of recession at the same time is a challenge and requires the right economic policy to prevent economic contagion with the first economic priority being to ensure that as many workers as possible remain employed.
Suppression and containment policies buy time and that time must be used well by governments to consider new measures and plan a structured economic recovery. Governments around the world have already committed vast sums to hold up the economy and most of these measures have already returned positive results. Even in Malta, according to a survey carried out by The Malta Chamber of Commerce Enterprise and Industry, the forecasts for redundancies on a national level have reduced from 45,000 two weeks ago to 23,000 workers following the additional measures taken by government.
Notwithstanding the bold economic measures being taken by governments there will no doubt be casualties because governments cannot be everything to everyone and government financial aid is finite and will not reach everyone. President vowed that no firm will “face the risk of bankruptcy” as a result of the pandemic. But we know that this will not happen.
This is not about being negative but about being factual.
People will experience uncertainty and personal financial stress, government debt will rise sharply, government income will reduce, unemployment will rise, businesses will close, shuttered businesses will not reopen, self-employed persons will seek employment, employed persons will take salary cuts, credit default will increase, prices of physical and financial assets will fall, volatility will increase, liquidity will be scarce, certain locally listed securities will become illiquid, corporate bond issues and IPOs will be postponed or aborted, certain issuers of the lower quality listed corporate bonds (and Prospects) will struggle to meet their financial obligations, interest rates will remain low, dividends will be suspended, retirement income will reduce and seed capital for start-ups and innovation will be scarce. These are some of the likely outcomes for the Maltese economy for which we need, not only to be prepared, but also to plan ahead.
We have to understand and accept that some of the damage that this crisis will inflict will be of a permanent nature and that a return to pre-COVID days in unlikely.
There will be some positive outcomes too in certain sectors of the economy. For example, the short-term property market will shrink and most short-term lettings will convert to long-term rents. More properties will come to the market as owners of “buy to let” properties will put up their properties for sale to increase their liquidity, rents are expected to reduce and property prices fall enabling first-time buyers and younger couples to climb up the property ladder faster as residential housing becomes more affordable. Businesses which have not embraced digital transformation, whose operational resilience is low and which were unable to respond to the effects of the crisis need to recreate themselves and reinvent their business model to be able to withstand shocks as this will certainly not be the last crisis. Businesses should have a stronger sense of what makes them more resilient to shocks, more productive, and better able to deliver to customers. We will also witness a dramatic restructuring of the economic and social order in which business and society have traditionally operated. Interestingly, the Economist in its article “Building the Pillars of State” observes that the notion that the government needs to preserve firms, jobs and incomes at practically any cost also means that certain businesses will see little reason why they should change and will merely rely on the expectation of government aid in the next crisis.
With regards to sector damage there is no doubt that the tourism and hospitality sector, and the many sub-sectors that depend on this important pillar of our economy, will be the worst hit. Language schools, restaurants, cruise liners operations will suffer material declines. Other sectors that will be adversely affected are certain non-essential retail trades, manufacturing, traditional real estate agencies, advertising and marketing agencies and anyone operating in the luxury goods and high-end market. Intermediation will decline as there will be less people inclined to pay fees for services rendered. Businesses and individuals who have converted most of their liquidity into less liquid assets such as residential and commercial properties will face liquidity issues as property becomes more difficult to dispose of.
Without losing focus of the remarkable efforts on the part of the health authorities to supress the spread of the virus and to prevent the loss of human life, we need to start planning our economic recovery as early as possible. An economic recovery that is built around an “Economy of Hope” where growth is smarter, more sustainable and more inclusive and where economic and social sustainability is balanced. Deciding which economic activities are more important than others is critical in setting a direction for the economy. We must focus on those economic sectors that will create and add real value to the economy. In shaping our economy recovery, we must focus on quality, value and resilience. We should not just be concerned about the rate of growth of our economy but also about its direction – about less value extraction and more value creation.
I will end by quoting economist Mariana Mazzucato from her book “Making and Taking in the Global Economy” that “the concept of value must once again find its rightful place at the centre of economic thinking and reasoning. If we cannot dream of a better future and try to make it happen, there is no real reason why we should care about value…..The understanding of value, then, is critical to all the other conversations we need to have about where our economy is going and how to change its course.”
1. “Safeguarding our lives and our livelihoods: The imperative of our time” - McKinsey & Company.