“You never let a serious crisis go to waste. And what I mean by that it’s an opportunity to do things you think you could not do before.” – Rahm Emanuel
COVID-19 is a worldwide health crisis and the global economy is suffering collateral damage. Thankfully, US policymakers have acted quickly and boldly to stem the effects on each of us individually, and on our country as a whole. Despite social distancing, the crisis has been a unifying force, bringing countries and communities closer together, albeit figuratively at the moment. COVID-19’s tentacles have stretched far and wide, affecting rich and poor, Democrat and Republican; each of us suffering through lockdowns, social distancing and the uncertainty of economic stagnation.
In many respects, COVID-19 is a disease of globalization that emanated from a Chinese province most of its victims had never heard of – until now. Hubei is a mammoth industrial center, a cornerstone of Beijing’s “China 2025” policy. Hubei factories produced 2.42 million vehicles in 2018, accounting for about 10 per cent of China’s total auto output and exceeding the auto outputs of France, the UK and Thailand. General Motors and Honda Motor have joint venture factories there. Wuhan, Hubei’s capital city, was the epicenter of the outbreak and the launchpad for the global pandemic owing to its role as industrial outsourcing destination to the developed world for autos, electronics, materials and pharmaceuticals. The developed world’s reliance on cities like Wuhan exemplifies the fragility of the global supply chain.
America’s superpower status has come under stress in recent weeks as the country struggles to cope with COVID-19. Our nation’s strategic vulnerabilities were exposed, as we learned that many of the critical elements in detecting the disease, treating it and inhibiting its spread were not made in this country, and that our strategic stockpiles were in short supply.
America, like many of her developed-market trading partners, embraced globalization in the early 1980s and benefitted from outsourcing its manufacturing to low-cost countries, like China. The results were transformational: productivity climbed while profits soared against a backdrop of disinflation and lower interest rates. At its manufacturing peak in 1979, America boasted nearly 20 million goods-producing jobs, comprising 21 per cent of the workforce. By the end of 2019, America’s manufacturing workforce had plunged to 12 million, or 8 per cent of total employment. Before the coronavirus pullback, the number of food service workers in the US nearly equaled the total number employed in manufacturing.
We estimate that 28 per cent of today’s workforce, or nearly 43 million people, will be severely affected by the COVID-19 shutdown, including employees in Leisure & Hospitality, Other Services, Construction and Manufacturing. Another 34 per cent, or 51 million employees, including those in Trade, Transportation, Education and Healthcare, will be marginally affected; 57 million Americans in industries like Finance, Professional Business Services and Government will be somewhat insulated.
The exodus of domestic production has left the US reliant on China and other sources of supply for critical medical supplies, like medicines and equipment, in effect making us dependent on the kindness of strangers for the provision of what are, in essence, strategic goods. The US imported $5.1 billion in medical equipment and supplies from China in 2018, according to the Department of Commerce. US imports of pharmaceutical products and other medicinal ingredients totaled $3 billion. Hubei province is one of the main suppliers of medical masks.
Notwithstanding the supply constraints, central governments have stepped up. Global central banks have slashed overnight rates and have collectively launched huge quantitative easing programs to keep liquidity flowing through the financial system. Monetary and fiscal measures have been quickly enacted to combat the blowback of forcing the US economy into a medically induced coma to combat COVID-19’s human toll. The US Congress quickly enacted a $2 trillion income-replacement program. Britain, France and other developed-world governments constructed credit guarantees representing as much as 15 per cent of GDP to help stave off defaults. The massive fiscal and monetary response we are witnessing is much more aggressive than that taken during the 2007-2008 financial crisis. It is estimated that global government spending this year will exceed 2 per cent of global GDP, according to The Economist.
In the developed world, COVID-19 has set the stage for big government, through its response to the outbreak, to take a larger role as policymakers don’t let the crisis go to waste. Since the 1980s, monetary policy has served as a stabilizer to keep economies on an even keel. That strategy has two shortcomings as we face the future. The first shortcoming is leverage. Central banks spur economic activity in the near term by lowering borrowing costs and encouraging debt-induced spending and investment. That has resulted over the years in an unsustainable build up in debt, first among mortgage borrowers in 2007-2008 and now on corporate balance sheets, resulting in credit crises. By mid-2017, non-financial corporate debt climbed to an all-time high of 31 per cent of GDP.
The second shortcoming is the nominal interest rate. Central banks’ ability to spur borrowing is predicated on ever-lower interest rates. Nearly half of developed-market central banks have zero or negative deposit rates, suggesting their rate-cutting strategy has run its course. We expect governments, through fiscal policy, to have a greater influence on our economy and our lives, beyond the current downturn. Last year, developed-economy government spending accounted for 38 per cent of GDP. Current stimulus programs, combined with a GDP decline in coming months, will push that ratio above 40 per cent, an all-time high, according to a study in The Economist.
Snapping back to a pre-COVID-19 economy is unlikely without ongoing government support, as populations may remain reticent to gather in large groups, dine out and travel. We anticipate governmental authorities will continue to be asserted in society even after the coronavirus is behind us. Using fiscal authority, we expect future policy measures to cover health care, education, manufacturing and the labor markets.
COVID-19 laid bare the economic and heath uncertainties faced by many Americans. Government influence is expected to widen in these arenas, and this could start in our healthcare system. COVID-19 has shown us that healthcare is more than treating individual ailments, and that basic healthcare for all Americans is in our collective best interest. The need for a nationalized approach to our nation’s basic healthcare needs has become more obvious. “Medicare for All” would carry an enormous price tag, but perhaps a scaled-down version could be enacted to protect every American with basic coverage, while private insurance would remain in place for coverage beyond the basics. Such coverage, while not as broad as Medicare, could affect nearly $1 trillion in spending, or about one-quarter of America’s total healthcare expenditure. The business of hospitals, medical providers, drug makers and insurance companies would likely be affected, as a significant segment of healthcare delivery migrates to a single-payer system.
Inadequate paid sick leave also has exposed a systemic vulnerability during the crisis, as workers face a choice between going to work while ill, and possibly contagious, or a loss of income. Under Congress’s coronavirus relief legislation, full-time employees are entitled to 80 hours of paid sick leave and part-time employees are entitled to paid sick leave equal to the amount of their average work hours over a two-week period. Employees are entitled to this paid sick leave if they are subject to a government quarantine order, have been advised to self-quarantine or are experiencing coronavirus symptoms and are seeking medical diagnosis. While the law doesn’t require companies to extend family- and sick-leave benefits to independent contract workers, self-employed workers can seek income tax credits for time off. We expect this legislation to remain in place long after infections subside.
Reshoring – bringing manufacturing capabilities back to the US – dovetails with many of President Trump’s 2016 campaign stances. The domestic manufacture of critical products related to national security, like medical equipment, drugs, microchips and lithium-ion battery components, will be top policy priorities as our economy begins to normalize. For example, the US currently manufactures only about 2 per cent of the world’s supply of lithium-ion batteries. Government incentives will likely expand to cover other, non-essential manufactured industrial and electronic goods. Reshoring of manufacturing will require investment in industrial real estate and warehouses. Construction will likely focus on regional, mid-sized manufacturing facilities that are conducive to automated production, not the mega-factories of yesteryear. Simply put, the secular trends ushered in by globalization will reverse.
Like during the 2007-2008 crisis, many of today’s private expenditures and borrowings will be shifted to the public sector, leaving massive debt levels and gaping deficits. Eventually, taxes will rise to not only help pay them down, but to fund ongoing government expenditures. In the meantime, we expect continued Federal Reserve accommodation. We expect America’s central bank to crank up quantitative easing to monetize (purchase) virtually all of the new debt that will need to be issued.
As this scenario unfolds, we would expect interest rates to gradually increase as inflation pressure builds. Productivity will remain low as decisions over the near term will be guided by national security rather than efficiency. What we’ll be left with is a lower trajectory of economic growth, but one fueled by income, not by private debt. The challenge to policymakers will be to provide the right incentives to germinate industries, investments and, eventually, productivity – the silver bullet that will enable us to improve our collective living standards without inflation. The late 1970s marked the apex in American manufacturing. By 1982, corporate profits relative to worker compensation was at an all-time low. Globalization and deregulation reversed that trend: by 2012, corporate profits were at an all-time high relative to worker compensation. The profit/wage pendulum has swung back a bit since then, and we believe developed-market government policies will continue the trend toward wages.