Feature Stories | Nov 20 2020
FNArena’s Life After Covid series wraps with a look at industry trends, geopolitical challenges and problems the Australian economy alone will have to face.
-Shift in industry trends
-Australia’s unique headwinds
-Will life really be different?
By Greg Peel
Part IV of FNArena’s Life After Covid series picked up where Parts I-III left off, further down the track of life under covid, by which time post-covid trends were becoming more evident. (Links to all parts below.)
When the pandemic first hit, and then seemed to be brought under control relatively quickly, the assumption was life would soon return to normal. By the time the second wave hit, it had already become apparent that by 2021, any “normal” we might be able to return to would not be the same as the pre-pandemic “normal”. Things will have inexorably changed.
Post-pandemic, the world is looking at a “new normal”, impacting on industries, workplaces, consumption, geopolitics and more generally, “life”.
What will this look like?
Not in Kansas anymore
The Economist Intelligence Unit, related to The Economist magazine, publishes an outlook for global industries in the year ahead. In publishing its 2021 outlook, the EIU acknowledges its 2020 outlook, published around this time last year, proved to be wrong.
I doubt anyone blames them.
Underlying the political and economic volatility of 2020, industrial trends have either remained consistent with the past or have been amplified by the pandemic, the EUI notes. Trends vary from industry to industry, and to that end, the EUI has highlighted at least four trends that are already reshaping the global economy.
Even before the second wave it was clear a recovery would likely be fitful, and not all companies would be able to take advantage. The consumer goods and retail sector in particular is likely to see a wave of bankruptcies and store closures as more businesses go on line, EIU warns.
The financial sector will have to cope with a sharp rise in non-performing loans that may overwhelm provisions put in place.
Note that in Australia, analysts consider our major banks to be well provisioned, possibly above and beyond, but even as we seem to have nipped the virus in the bud, the winding down of government support is the offset. Some companies simply will not survive, either because of a lack of capacity to hold out until an economic recovery, or because they find they have no place in the post-covid “new normal”.
A “non-performing loan” is one which banks continue to hold on the books despite no repayments being made, before making a decision whether or not to bite the bullet and bankrupt that company, thus crystallising a loss, if it is apparent that company may never recover. As referred to in Part IV of this series, these are the “zombie” companies.
Japanese banks have been carrying non-performing loans since the nineties. Others have been carrying them since the GFC, particularly in Europe.
Covid-driven restructuring will reshape even those industries such as telcos, which have been relatively unscathed, EIU suggests. There will be winners and losers as markets consolidate around surviving companies and opportunities open up for new business models.
Part IV noted that governments around the globe are now awash with debt. How can that debt be repaid? Certainly not by applying austerity measures – that approach failed in post-GFC Europe. And raising taxes would likely kill off a fitful recovery. Biden intends to reverse Trump’s tax cuts, but with the offset being another massive stimulus package.
The only way governments will ever be able to pay down debt is through economic growth. Growth requires investment, and investment needs to be directed towards the industries of the future, not of the past.
The EIU suggests governments will need to focus on protecting jobs by promoting investment, particularly in innovation, and tackling climate change. The energy sector will focus on renewables, coal-fired power will be phased out, and generous incentives will be required to encourage the purchase of EVs.
That said, in countries such as France EV incentives have proved very successful and will soon be wound down. China has led the way on EV take-up, and will now move on to hydrogen-powered vehicles, EIU predicts.
With tremendous foresight, the South Australian government is planning to tax EVs, in order to recover funding lost in existing fuel taxes.
If the pandemic highlighted one economic failure, it is that of the total reliance on offshore manufacturers in the supply chain. This is clearly one aspect of globalisation not being a panacea. As companies try to rebuild, their focus will likely turn inward, EIU believes, with domestic markets and operations becoming a priority.
Trump’s war on China, and goal to Make America Great Again, was the greatest focus of markets over 2018-19. The goal included bringing jobs back to the US and making America more self-sufficient. That war will not end under Biden, and the pandemic will lead to a push by all countries to “re-shore” production and secure supply chains.
This will have implications at the international level too, EIU warns.
In the case of US-China, as had been predicted last year by the EIU, focus has now turned to technology from tariffs. In telcos, it is the ban on Huawei. The war will also affect other sectors, EIU suggests, including automotive and consumer electronics. The financial sector faces Beijing’s intentions undermining Hong Kong as an international hub.
Another focus, for years ahead of the pandemic, was Brexit. That starts in 2021.
Digitisation will be the trend for almost every sector, EIU notes. The growth of online shopping (extending even as far as automotive) will create new companies and new jobs. On the flipside is the risk of governments introducing new digital taxes to make up for what they lose from old world businesses, which again can raise international tensions.
New digital payment systems were already disrupting traditional financial services before the pandemic began, but they have since exploded, including in Australia. Remember bitcoin? China has introduced its own (government controlled) version.
The pandemic has only served to accelerate the growth of so-called “telehealth”, and that will be here to stay.
The conclusion is that while all industries will ultimately rebound out of the pandemic, the rebound will be unevenly spread. Asian countries, which have managed the pandemic better, will return to 2019 GDP levels in 2021, the EIU forecasts. For major developed economies it will be 2022. Emerging markets (and clearly China is no longer an EM) will have to wait till 2024.
Longer Term Trends
China’s rise as an economic and geopolitical power, and secular disruptor, suggests Pimco’s Global Advisory Board, may be strengthened by its rebound out of the pandemic along with its evolving economic strategy. Having largely recovered from its covid slowdown, China has now introduced the “dual circulation” economic model.
If you hadn’t heard of “dual circulation” before worry not – no one else had either.
The model is an attempt at self-reliance, notes Pimco, but not as far as self-sufficiency. From the inside, Beijing wants to reduce the country’s reliance on exports and foreign technology, strengthen its own supply chains and look to the domestic market as the prime driver of growth.
From the outside, Beijing wants to balance its domestic plans with “international openness”. Pimco questions whether China’s domestic consumer market is big enough to absorb much of the demand.
Australians no doubt are wondering whether “international openness” implies holding up imports with no reason offered.
Given a combination of the virus and US tensions, Pimco suspects Beijing may be prepared for an annual growth rate of 3%, rather than the 6%-plus numbers running before the virus. Supreme eternal leader Xi Jinping is preparing for a long geopolitical struggle but is not seeking to export its model to the rest of the world, suggests Pimco.
You do it your way and let us do it ours.
Be that the case, in an increasingly political global economy of protectionism, populism and nationalism, Pimco does not see just a breakdown in international cooperation but a series of individual initiatives that may lead to China being isolated.
In the US under Biden, Pimco foresees a foreign policy approach of domestic renewal, deterrence and democracy. Like China, Biden wants the US to be more self-sufficient, which was also the goal of his predecessor but with bullying the prime tactic. Pimco notes many believe the US needs greater investment in infrastructure, industry, technology, innovation, education and the green economy, all with social equity in mind.
Deterrence would involve stepping up the pressure on the leaders of China, Russia, Iran and North Korea by raising the cost of aggression or disruptive actions again the US, while looking to its allies for back-up.
Europe, notes Pimco, would be under pressure from both sides (trade, alliance). And as we know all too well, so would Australia. Biden would like to see a coalition of democracies allied against China and Russia. But some of those democracies may not wish to choose sides.
While governments across the globe have delivered a massive fiscal response to the virus (US round two pending), and even EU nations have managed to band together, there has been no actual global coordination, Pimco notes.
In its report, Pimco quotes former Fed chair Ben Bernanke:
“While monetary policy increases demand broadly, fiscal policy can be much more targeted, helping specific sectors or particular income groups”.
And former UK prime minister Gordon Brown:
“Countries will increasingly be judged on their fiscal responses, not least on how much has spent running up what people will call ‘bad debt” and how little on productivity-enhancing ‘good debt’”.
From this we might conclude the use of government debt to prop up obsolete old world industries will lead to a “zombie economy” and an unending debt load, while the use of debt to invest in the industries of the future will lead to economic growth that will pay off that debt.
Of course, none of this is possible without monetary policy support. Central banks around the world have effectively poured in trillions, while pledging to hold rates at zero (or almost zero) for possibly years to come. The risk here is that economies rebound swiftly out of recession once a vaccine is confirmed and distributed, leading to a sudden surge in inflation.
But to swiftly respond to rising inflation by lifting rates would be to risk choking off the recovery of a still fragile economy. The Fed, for one, has announced a change in policy tack, such that it will now let inflation and jobs growth overshoot its targets before deciding to act, which is seen as less risky than killing off a recovery trend.
To date the pace of recovery of the US economy has appeared faster than anticipated, but only now are we beginning to see data reflecting the more recent exponential acceleration in virus cases. Third waves aside, the Fed is concerned, Pimco notes, the pandemic-driven recession could morph into a longer term recession due to “scarring mechanisms”.
These include higher precautionary savings (thus not spending) for households, lower investment from businesses, skills obsolescence and damage to supply chains following the loss of thousands of small businesses. To that end the Fed is taking a more “activist” role than simply rate policy or standard QE, Pimco points out, by becoming a “market-maker of last resort”, lending through banks to SMEs, and buying corporate and municipal bonds.
In terms of business sentiment, Pimco has found that most CEOs of US companies have a relatively sober view of how long the recovery will take, but no sense of pessimism about getting there eventually, and no real change in long term risk appetite. What they are anxious about nevertheless, is the loss of smaller companies in the global supply chain that larger companies need to restore their businesses.
And they’re anxious about the unravelling of social cohesion.
Australia’s unique economic headwinds
Not quite by definition unique, but for one, we note Australia is one of few countries running a trade surplus with China. Pimco noted above Europe is in a difficult position with regard its reliance on Chinese trade, and its alliance with the US. Our balance is even more critical.
In a report by Kim Catechis of the Martin Currie Long-Term Investment Institute, Catechis rattles off the long list of things the Australian government has done recently to upset Beijing, from banning Huawei through to legislation to override any state decision on foreign investment, not to mention leading the push for a virus investigation.
He does not rattle off the growing list of Australian export goods Beijing is stifling one way or the other.
Australia has affectively already chosen to stay in the US camp, Catechis notes, so going forward should expect economic ties with China to begin to loosen. The distancing will start with tourism and education, worth $16bn per annum, before spreading to food and other agricultural products, worth another $16bn.
He’s not quite the wrong way around, given a closed border kills tourism anyway and the government recently decided to not let foreign students back just yet, but he’s right about the rest and also recalls Beijing issued a travel advisory against Australia, before the border closed, due to virus-related racism.
Australia’s other unique dilemma is that while it relies on China for trade and the US for security, the US-China “phase one” trade deal signed centuries ago – last January – commits China to buying vastly more US farm produce than it had to date. Clearly the virus has disrupted matters, but were Beijing to actually make good on this commitment it would have to switch import sources to the US from elsewhere.
Hence it may not be China that cripples Australia’s export industry, it may be the US.
Catechis does provide a counter, being Australia’s membership of the Transpacific Partnership free trade bloc that Trump pulled out of, and the benefits it could bring, writing before the recent creation of the Regional Comprehensive Economic Partnership.
The RECP includes Australia, New Zealand, Japan, South Korea and all ten ASEAN members (all of Southeast Asia), as well as, perversely, China. Get your head around that one.
And Catechis was writing ahead of this week’s agreement between Australia and Japan to strengthen military ties, which hasn’t exactly gone down well in Beijing either.
Stand by for promised retaliation.
Where the bloody hell are ya?
It is also not quite unique but unusual among developed countries that Australia has enjoyed brisk population growth over the past decade due to net immigration. While all developed countries are facing the issue of an ageing population, Australia has been able to counter because everyone wants to come here.
Because migration has been such a large driver of growth relative to other countries, the Economist Intelligence Unit is expecting a “very different recovery profile” for Australia. The EIU suggests it will take until the first half of 2022 for Australia’s GDP to return to pre-covid levels, some two to three quarters behind the GDPs of the US, Europe and Japan.
This is despite, EIU notes, those economies suffering a much larger initial virus shock, and in the case of the US and Europe, are experiencing a more substantial second (or third) wave.
A lot depends, of course, on when Australia can reopen its border. Writing before Pfizer’s vaccine announcement, the EIU predicted mid-2021. It will no doubt come down to a trade-off between exponential case growth offshore and the speed of vaccine distribution.
On that assumption, the EIU forecasts Australian population growth to slow to 0.4% in 2021 and recover modestly to 0.7% in 2022. Net migration inflows will remain very weak in FY22 before gradually recovering through to 2024.
Note that population growth is the net of births/deaths and migration inflows/outflows. The border closure also means no Australians moving to other countries, but this number has always been smaller than the number of incomers. It also means no one departing our shores for Christmas holidays, which is one reason why retail analysts are expecting a bumper Christmas and holiday period this summer domestically.
The EIU’s population growth forecasts are largely driven by the net of foreign students departing after having completed their studies, to be replaced by the next incoming cohort. But while some students will decide to remain in relatively virus-safe Australia rather than return home to hotspots of pestilence, this year there will be no replacements.
Nor will there be the usual influx of seasonal workers, with many (such as backpackers) long having returned home. The heartache for farmers is that after long years of drought, this year’s bumper harvests may be stuck on trees.
How important is population growth? It’s a one for one impact on GDP, the EIU notes.
The EIU forecasts all of the US, Europe, UK, Japan and Korea will have returned to their pre-covid GDP forecast trajectories within five years. Australia, say the analysts, is a “clear exception”. GDP is expected to be -5% below the pre-covid forecast in 2025, and remain lower in the long run.
This comes despite Australia’s relatively successful response to the covid-19 pandemic, and in most cases a smaller hit to GDP in 2020. The permanent loss of population caused by the pandemic explains this high degree of economic ‘scarring’”.
Nostalgia just isn’t what it used to be
Part IV of this series proposed that life will not return to normal post-covid, rather a “new normal” will be established, and examined this thesis on an economic basis.
But what about actual “life”. Part I of Life After Covid, written in the middle of the first wave, questioned whether our livelihoods and attitudes would really change inexorably, as some were predicting.
At the end of October, National Bank economists surveyed 2000 Australians across a diversity of state, gender, age and other key demographics. The survey found many Australians continue to expect significant change.
Apart from our personal hygiene, Australians expect the biggest lasting changes in behaviour will be fewer overseas holidays, travelling less on planes and public transport, saving more, spending less time in major shopping centres, eating out less and shopping more on-line. But the survey also enquired as to what extent we really want our old lives back?
“Some aspects of life have changed for the positive, so it can be extremely difficult to go back to something viewed as less desirable,” says Dean Pearson, NAB’s head of Behavioural Economics. “While most Australians continue to say they do not want their lives to completely return as they were before the virus, the lure of our old lives is growing.”
“People are creatures of habit and there is growing reason to believe that as life starts up again, some old habits will return,” Pearson suggests.
My view is that the two fundamental changes to our lives will be flexible workplaces and online commerce. The latter is of course not new, just forever accelerated by lockdowns. The former is not exactly an innovation either, but recent technological innovation has proven work-from-home works, for both businesses and employees.
As for fewer overseas holidays, saving more, less time in major shopping centres and eating out less, sure, it will be a while before these all go back to normal.
But I bet it will be faster than most anticipate.
As for travelling less on planes and public transport, I’d say true for the former with regard overseas business that can be conducted via video-link, but not for holidays. A flexible workplace, offering a mix of office attendance and work-form-home, should both reduce the twice-daily commute and spread out commuter times more evenly.
We now supposedly have two vaccines, with potentially more to come. We still have to reach mass distribution and there will be much heartache in the meantime for many. But, and this assumes any vaccine actually does work, I believe it won’t be long before the annus horribilis that was 2020 will fade into distant memory.
Fingers crossed this too shall pass.
Life After Covid Part I (https://www.fnarena.com/index.php/2020/06/02/life-after-covid-part-i/)
Life After Covid Part II (https://www.fnarena.com/index.php/2020/06/10/life-after-covid-part-ii/)
Life After Covid Part III (https://www.fnarena.com/index.php/2020/07/10/life-after-covid-part-iii/)
Life After Covid Part IV (https://www.fnarena.com/index.php/2020/11/16/life-after-covid-part-iv/)
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