The business model of global economic actors will change permanently
Countries have dealt with the pandemic and its potential risks differently, each hoping that the economic course will be V-shaped: a sharp decline followed by a quick upswing. But so far this assumption seems unjustified, with forecasts projecting a U-shaped curve with no explicit bottom and recovery not immediately noticeable either. The most pessimistic forecasts show an L-shaped curve, meaning that the recession will stay with us for a long time.
According to the San Francisco Fed’s analysis based on data dating back to the 14th century, real interest rates fell following epidemics, yet moved in a positive direction after wars. The trend is not short-term, but valid for the next few decades after the triggering event. This assumes that the return on assets and general wage level will be lower in the future. Two main reasons are highlighted as causing long-term interest rate decreases: the higher average invested capital per employee due to a reduced workforce, and the higher savings rate resulting from the higher demand for security reserves. Of course, the average working age in the previous thousand years was significantly lower, so epidemics typically decimated the working-age population aged under 60.
Consequently, analysis suggests that this time may be different. However, the potential long-term impact on inflation is unclear. We were in a special situation before the virus, when oversupply of liquidity and low inflation were present at the same time. There is a fierce ongoing debate in the world; whether the risk of deflation or inflation is greater, and what economic phenomenon will follow. After all, the response to the crisis will be money printing, implying the risk of inflation; however, at the same time, internal economic processes project a disinflationary effect.
The consensus among experts on global economic developments is that deflation is expected in the short term, as there is no indication as to what may drive up prices during mass unemployment and diminishing consumption, but the risk of inflation remains. However, others suggest that even large-scale money printing does not necessarily mean inflation in the long run, such as Bernie Sanders, who subscribed to and embraced the Modern Monetary Theory (MMT). In the following period, due to severe disruptions and extreme uncertainties, global value chain management is expected to shift towards crisis management, despite the currently dominating “efficiency first” logic.
This will also mean deteriorating profitability, lower valuations and declining or slowly rising stock market indices. If this really happens, it will go against the business logic of recent decades and potentially launch a process of ‘de-globalization’, which could have a significant impact on countries that are heavily exposed to global trade. If the globalization of value chains reverses, peripheral countries, in which higher value-added production may have been installed, will be damaged - but only temporarily, as these may be the basis for reconstruction. Peripheral countries that have generated lower added value are less likely to be replaced as suppliers - as they can be replaced at any time later. However, if de-globalization becomes significant, they could be seriously damaged in the long run. Of course, transitional or less drastic solutions may be applied, which could even have a positive impact on regions such as the CEE region in Europe:
1. Nearshoring – Meaning the relocation of the value chain within a region, i.e. the relocation from the cheapest and furthest countries, to the nearest but less expensive countries. Central Eastern Europe (CEE) as a region may not be damaged or could even benefit, but at a country level, it may trigger a shift to the north and west.
2. Supplier Diversification – Companies may attempt to increase their existing supplier diversification. As the CEE region is very strong in the service and supporting industries, this can be a positive development at both a regional and country level.
3. Redundant production - Shifting from lean production, i.e. from extreme efficiency to surplus production, may give rise to stockpiling to create reserves for crises. Again, this could also be a positive outcome for the CEE region and countries.
“The white-collar private sector may see positive benefits, with employees capable of being productive even from home. The question arises as to whether these newly introduced solutions will add or destroy value at a company/macro level during the next 1-3 years”
Changes in human behavior – can we even be optimistic at the micro-level?
We also need to consider the extent of changes which may be observed in human behavior comparable to the changes listed above. This crisis is a very personal experience: it affects everyone, regardless of age, gender, denomination or skin color. Some of the key issues we see related to potential changes in human behavior are:
· Will consumption change when life returns to normal? Will we:
a. Consume differently and will weights change in the structure of consumption? How?
b. Consume more ‘normally’ i.e. more durable and/or sustainable products?
c. No longer need certain products and services - and will we have new needs?
• Will our attitude to travel and free time change (thinking about leisure in general, but also how culture, entertainment, hospitality will change)? What will be the ’new norm’ in tourism? Once we rediscover our own close environment during the isolation, will we aspire to travel to distant places again?
• How will our relationship with our environment and nature change? Now that it is becoming a common experience for all of us to see what effect the exploitation of our living environment has; will we have a more forward-looking attitude to the world in which we live? Will we be open to spending on sustaining our environment and not just draining it?
• Our cities and villages are being emptied as a result of the crisis. What will it look like when our common spaces are repopulated? Will there be more cycling, use of public transport, people walking? Or will we take back the roads with our cars, creating traffic jams?
• What will our interactions look like? Education has become digital; postal, banking and public administration have been significantly simplified and many of our interactions have been pushed into the digital space. We have been talking about the need for digitization for years and although we introduced it imperfectly and urgently, it turns out that many systems still work, so what can we keep from this?
• How will commuting and working change? As a result of the virus, workers have begun to revolt against common workspaces and are crying out for more personal space. Who will be able to work permanently from home? How many personal meetings will we have in cyberspace?
Of course, we are under no illusions about the expected outcome arising from the above questions, but we do hope that we will see positive answers to at least some of them during the upcoming years. If that happens, even though it is likely that for many, their lives will become economically more difficult, perhaps at least psychologically, they could be more uplifting.
Adapting to the New “Normal”
So, what can we take away in terms of how the COVID-19 pandemic is changing the world as we know it? We still can’t predict the course of the pandemic, or the full extent to which it will affect us long-term from a business and economic perspective or even in terms of human health for that matter as so much uncertainty remains.
However, it’s clear that we are already seeing the results of the grave effect it has had on the global economy. The sudden shutdown in economic activity across the globe as a result of containment measures mean that the short-term economic effects of COVID-19 look likely to surpass those of previous epidemics.
As events continue to unfold, there is also no doubt that the pandemic will shape our economy for the following decades and the business model of global economic actors will change forever. There will be a new normal, we just don’t know quite what that is yet.
Click here to the pdf article >> Covid -19 and Its Consequences
Click here to read the publication >> IMAP Creating Value - Coronavirus Special Edition