ECONOMIC SHOCK AND IMPLICATIONS
Pandemic is exposing deeper flaws in our economy
By Lily Fang, AXA Chair in Financial Market Risk
There is no doubt that COVID-19 represents a very severe shock for the global economy, more severe than the last financial crisis. All three of the world’s economic engines – the US, China and the EU – have been hit at the same time. Even in the financial crisis, that didn’t happen. The good news is that this is an external shock. There is nothing fundamentally wrong with the economy. In fact, prior to COVID-19, we were in the midst of the longest expansion in history in the US and Europe. The policy response to the COVID crisis has been effective. In Europe and the US, central banks have provided massive liquidity support – a lesson learnt from the financial crisis and the Great Depression, that you need to inject liquidity to prevent the markets collapsing. China has been more reticent – it’s not providing as much stimulus. That’s because, in the past, whenever the economy slowed, China stimulated through borrowing, and by investing in infrastructure that often had no real economic purpose. In a sense, China’s economy is suffering from stimulus fatigue. But this is positive: we know that China cannot continue to grow indefinitely through debt. Globally, we need to ensure that this extra liquidity is used productively. In the 2008-2009 financial crisis, a lot went into unproductive areas, such as stock market speculation, financial investments or real estate. Investing in infrastructure would be one option – the US, for example, has a lot of out-of-date infrastructure in need of updating. This sort of Keynesianism had fallen out of favor, but it’s now being examined again more closely.
“Right now, we are in the worst economic recession – there will be businesses that are permanently shut. For some sectors, the recovery will be long and painful. We will need some labor adjustments. We will need more people in healthcare and nursing. Naturally, you can’t achieve that overnight – in many cases, we will need to train people for new roles.”
We might see a very quick rebound, but it’s really little more than a sugar high. Every day, it seems, the stock market is up – it’s moving further and further away from the real economy. The recovery is already priced in – so is a resolution of the trade tensions we’ve seen, particularly between the US and China. That leaves the markets vulnerable to any bad news, including a second wave of the infection. Markets are also likely to be more volatile, particularly in the run-up to the US elections in November. The real economy, though, will take longer to recover. Right now, we are in the worst economic recession – there will be businesses that are permanently shut. For some sectors, the recovery will be long and painful. We will need some labor adjustments. We will need more people in healthcare and nursing. Naturally, you can’t achieve that overnight – in many cases, we will need to train people for new roles. More importantly, the crisis will expose fault-lines in the economy that had been masked previously. Take supply chains. They have been globalized, but they are not diverse. For many basic products, you have one producer and that producer supplies 90%. It’s often China – it’s never good to put all your eggs in one basket, either from a health or a national security point of view. We tend to look for the cheapest supplier for the sake of profit. There is something to be said now for diversifying our production base. Diversification would support local business and help mitigate risk. Also, cheap prices don’t always reflect the true costs. What about the cost to the environment? Do we price in the carbon footprint of these products? If you look at this through an environmental lens, China becomes a less efficient producer because it still relies on coal for much of its energy. That still isn’t priced in. Ultimately, this is a failure of the market – the market just doesn’t recognize these externalities. If we include these external costs, it would certainly help reduce the price gap between different producers.
“It’s not just about equal rights – it’s much more fundamental than that. It’s about having the economic opportunities to develop, so we don’t waste so much human capital. In that respect, education reform is very important – we need to make the rules fair and open up economic opportunities to more people.”
For companies, tech firms are continuing to gain ground. They’ve been helped by the crisis – they’re grabbing even more market share in retail. Investors are switching money into these tech stocks, and out of sectors like aviation and utilities – more cyclical sectors that have suffered during the lockdown. We’re worsening inequalities in the economy – salaries are incredibly high for coders, for example, but not for the basic work we need to keep the economy going. During a crisis like COVID-19, skilled workers keep their jobs by working from home. And, if you don’t have those skills, you’re out of luck – that’s mainly people who are poor, uneducated, most in need, and most likely in the minority. The economy grows, productivity increases – but inequality gets worse. This inequality cuts along socio-economic lines, often racial lines – as we have witnessed with the recent riots in the US and elsewhere. George Floyd’s story is a story of hopelessness and economic devastation. It’s not just about equal rights – it’s much more fundamental than that. It’s about having the economic opportunities to develop, so we don’t waste so much human capital. In that respect, education reform is very important – we need to make the rules fair and open up economic opportunities to more people.
Readers also read
- Green investment to kick-start economies, by Gilles Moëc
- COVID-19 is leaving Europe’s low-skill workers worse-off, by Professor Luigi Guiso
Professor Lily Fang is Professor of Finance at INSEAD in France, having previously spent twelve years at INSEAD’s Asian campus in Singapore. Professor Fang’s primary research interest is financial market information and investment strategies. She has published numerous papers on the performance, behavior, and incentives of financial analysts, fund managers, and financial institutions in top academic journals.
