The road(s) ahead: The global economy after corona

4 September 2020 13:13 RaboResearch

The corona crisis has caused major social, economic and political upheaval and has increased uncertainty about the future. We use scenario analysis to shed light on where countries around the world may be headed next.

Down trend financial graph on nCov corona virus microscope image ,concept of economic crisis effect by covid -19 .3d illustration

The coronavirus pandemic has led to global economic and social disruption. The outbreak has plunged the world into the deepest recession since the Great Depression, and has coincided with or exacerbated social and political tensions within and between countries.

The end of the pandemic is not yet in sight. The number of cases is still rising rapidly in Brazil, India and the US, and new outbreaks are being reported in countries that previously appeared to have the virus under control.

But this too shall pass. Many vaccine trials are under way and it seems likely that one or several will eventually be developed, although timelines are highly uncertain at the moment.

Since the beginning of the pandemic, governments, firms and citizens have made major choices and changed behaviors. In response to the economic crisis governments have increased spending and debt issuance. Firms and workers have moved to working from home as much as possible to minimize the risk of infection. Under lockdown, citizens have shifted their consumption toward online purchases.

What life will look like after the pandemic depends on whether these, and other, developments are temporary or permanent. Will governments, firms and citizens return to business as usual, or will the crisis lead to durable changes in institutions and behaviors? Where will the choices that have been made lead us, and what choices are still to be made during the remainder of the pandemic?

Figure 1: Economic policy uncertainty

Source: Macrobond

The future is highly uncertain: a well-known indicator of economic policy uncertainty is currently at its highest recorded level (Baker et al, 2020, Figure 1). Amidst all of this uncertainty, a scenario analysis can help us imagine possible futures. These are not predictions, but do shed light on where certain choices made in the present might lead.

Here we present a scenario analysis that maps these choices and their consequences. We first construct four different scenarios for the future. These scenarios are rough sketches of what society in a particular country might look like after corona. Then we consider, given the most recent economic and political developments, and how they have changed the likelihood of scenarios for the countries that we study, relying on expertise supplied by Rabobank country specialists.

Box: Scenario procedure

To arrive at our scenarios, we used a procedure developed by Baarsma (2018) and applied to the corona crisis by Groenewegen and Hardeman (2020).

Our procedure for scenario analysis consists five steps. First, we asked a group of professionals in business, education, government and health care what corona-related developments and sentiments they have seen and experienced in both their personal and professional lives, as well as in the media. These observations ranged from calls for a universal basic income, to the shift to working from home, to renewed appreciation for people employed in vital occupations. The final list contained more than 250 items.

Second, we clustered these developments and sentiments, as many cover similar topics.[1] Third, we asked a group of ten Rabobank economists to rank these clusters in terms of impact and uncertainty. We picked the most impactful and uncertain two clusters as identified by them. Fourth, we constructed a scenario framework with four quadrants using these clusters as the axes. Finally, we labelled the resulting quadrants to arrive at four different scenarios. While the uncertainties in reality are obviously much more diverse, this process allows one to distill four stylized futures that we consider to be the most relevant at this time.

See footnote here [1].

[1] After a certain threshold (15-30 observations), an increase in sample size in qualitative research change little about results (Marshall et al, 2013)

Figure 2: scenario analysis procedure

Source: Baarsma 2018

Our scenario framework (figure 3) has two main axes: one concerns the balance between government and the marketplace. More specifically, this is about which one is the dominant organizing force in society. The current crisis has moved governments worldwide to interfere on a grand scale in the economy and take extensive public health measures. Meanwhile, there has also been a large counter response by those wary of government interference. Thus far it is still unclear which way this scale will tip after the crisis in different countries. But whichever way it goes, its direction is likely to have a large impact.

The other axis actually concerns the trade-off between robust wellbeing and efficient economic growth. The corona crisis has amplified calls to reconsider how progress and welfare are measured. The argument is that countries should substitute better climate, health and equality outcomes for measures of economic activity. This call for a different measure of wellbeing coincides with a call for shorter, more robust supply chains. A focus on economic growth implies a return to a world of efficient and global supply chains. However, despite these calls, it is extremely uncertain how this trade-off, between robust well-being and efficient growth, will be decided in various countries.

The various scenarios describe what societies could look like after corona based on their position on these two axes. We labelled these to clarify what choices and consequences lay ahead. First, in the “insatiable society”, the marketplace is a dominant force, consumer preferences are still relatively materialist, long supply chains enable maximum efficiency and companies continue to offshore production to maximize profits

Second, in the “self-conscious society”, initiatives start bottom-up, consumers prefer locally grown foods and locally produced goods, and firms try to meet this demand by reshoring production and producing sustainably.

Third, in the “determined state”, governments make sustainability a core objective, and taxes negative external effects, such as pollution, accordingly. They also nudge citizens to make more sustainable choices and incentivize firms to reshore production in order to reduce the length and complexity of supply chains

And finally, in the “competitive state”, governments treat maximum economic growth as their main objective, by investing in large-scale infrastructure projects and nurturing and protecting domestic firms.

Figure 3: Scenario set

Source: RaboResearch

Which way?

To get a first impression which outcome is most likely for which country, we survey Rabobank country specialists for the Netherlands, the United States, Australia, Brazil, China, Germany, Italy and the United Kingdom. We asked them to list policies enacted and developments over the past couple of months that might push their country in a particular direction, and also forces in the future that could move their country differently.

Given the uncertainties, all four scenarios are still possible for these countries. The assessment only indicates that recent developments have shifted the balance more in the direction of a particular scenario relative to what was likely before the corona crisis. That assessment is also relative to the current situation in each country and not a comparison with other countries. So to say that two countries are, for example, both heading in the direction of the “determined state” does not mean that they will end up with similar social models. They have different starting points and so a move toward a stronger role for the government and more interest in robust welfare could mean very different outcomes depending on what societies look like now.

Netherlands (Ester Barendregt)

The Netherlands is moving in the direction of the “determined state”. Crisis measures such as support schemes for workers and debt guarantee schemes mean more government involvement in the economy now. And letting public debt rise sharply probably also means more government in the future. This economic support is not unconditional. This means the Netherlands is moving toward a focus on wellbeing as opposed to efficiency, as companies are expected to bring broader value to Dutch society. State support for essential companies also shows that the government is willing to step in to safeguard that knowledge infrastructure is maintained for the Netherlands: this implies a shift towards robustness rather than efficiency.

At the same time, the polder model, i.e. consensus-based decision-making by unions, employers and the government, makes the Netherlands fit the mold of the “self-conscious society”. It is an open question how this governance model fits with more state interference in the economy. International political pressure can also undermine the direction of the Netherlands towards a “determined state”. Also, populist sentiment may lead to more focus on short-term economic interests, rather than on robust wellbeing.

United States (Philip Marey)

The US economy is moving from an “insatiable society” to a “competitive state”. However, reshoring is likely to prevail both in case of a Republican and a Democratic administration. The role of the federal government and the Federal Reserve has increased dramatically during the corona crisis. While some of the measures will be dialed back as the economy recovers, the degree of federal involvement will remain much higher than before, as severe damage has been done to the demand and the supply side of the economy.

At this point in time, it is difficult to see the US economy getting back to the old normal of an “insatiable society” anytime time soon. The fallout from the COVID-crisis is likely to have an impact for years. In the long run, investment in education, R&D and infrastructure could bring the US economy on a growth path that would allow the federal government and the Fed to reduce its footprint in the real economy. This growth scenario is more likely to occur in case of a Democratic president and Democratic majorities in both the House of Representatives and the Senate. However, the Democrats are also less likely to reduce the role of the federal government. So a subsequent Republican administration is more likely to steer the US economy back toward an “insatiable society”.

Australia (Wouter van Eijkelenburg, Mike Every)

Due to the current state of the global economy Australia is “unhappily” and “ unsteadily“ moving towards a “determined state”. The country is now facing its first recession in two decades and also needs to mitigate risks of increased geopolitical tensions between US and China and the territorial disputes in the South Chinese Sea.

In order to achieve this, Australia has to start reshoring and moving up the value chain to keep or even gain jobs to prevent large social welfare gaps and increase local capabilities to improve national security. Diversification of the supply chain is also needed to prevent large dependencies on single countries to both be able to handle crises like the pandemic as well as to counter geopolitical tensions.

To support this transformation, a larger role of the government is needed. This also provides the largest uncertainty. How fast and at what costs are Australian policy makers, used to a large trade surplus, willing to support this transition?

If one would ask when Australia would possibly change path and not move toward a “determined state” the following trends breaks need to occur, which is extremely unlikely to happen in our view. Globally there should be: Less protectionism, decreasing geopolitical tensions between US-China, decreasing political tensions between China and other Asian countries and, of course, less global warming. Domestically Australia has to have a V-shaped recovery of the pandemic in order to get unemployment down to prevent welfare gaps and reduce government household support and trimmed down monetary stimulus by the RBA. Only in such a scenario Australia might possibly not move towards a “ determined State”. But, as mentioned, we think it is extremely unlikely such a scenario unfolds and clearly does not represent our house view.

Brazil (Mauricio Une)

Brazil is likely moving towards a hybrid scenario that combines features mostly of a “competitive state”, but also of an “insatiable society” and a “determined state”. Brazil adopted a wide range of fiscal and monetary policies to cement the recovery from the pandemic shock and the gross debt-to-GDP ratio can still grow 20p.p. to around 100% in 2020.

As Brazil’s tax burden is already the second highest in the Americas, the major drive to resume fiscal consolidation would be fostering faster economic growth as in a “competitive state”. But, given the government’s limited ability to invest, such higher growth requires the attraction of private and foreign direct investments by promoting reforms that either lower the amount of the government’s expenditures—whose cap remains an important binding condition for fiscal sustainability—or improve the country’s ease of doing business, more akin to a scenario with efficient growth and a smaller government. Last but not least, Brazil’s faster growth will also keep relying on its global commodity supply and on less income and sanitary access inequality, and hence the need to reinforce the economy’s ESG credentials and increase the well-being of its population as in a “determined state”.

China (Raphie Hayat)

China is moving towards a mix of “a determined state” and “a competitive state”. As the country is very much a state led economy and one that prefers resilience over efficiency it clearly moves towards a large role for government focusing on robustness. However, in terms of economic goals, China is still likely to place jobs and income over other welfare dimensions such as health and societal engagement of its citizens.

The government’s role in China can hardly be overstated. China plans its economic and social developments in so called five year plans. For its upcoming five year plan (starting in 2021) China will likely try to decouple from the US, both in terms of trade and in terms of the US dollar. China’s new economic strategy seems to be one (i) focused on its domestic market instead of relying on exports (called ‘dual circulation’), (ii) using the renminbi as its preferred currency to conduct international trade, (iii) the Chinese stock market to raise capital and even (iv) using China’s own financial infrastructure (such as CIPS instead of SWIFT). This focus on self-reliance is a long term strategy. In China’s view tensions with the US (and internationally) are here to stay. China’s strategy to fight off the US seems to be based on a long time horizon, whereby China gains in economic and political global importance at the detriment of the US.

In a positive tail risk scenario (thus a very unlikely one), trade tensions between the US and China subside rapidly and China’s international trade increases rapidly again after the corona crisis. That would make China become more intertwined with the global economy and even more of a “competitive” state, with a preference for efficiency over robustness.

Germany (Erik-Jan van Harn)

Germany is moving toward a “determined state”, as they have done a 180 when it comes to fiscal prudency. It was Germany and France that initiated the EUR 750bn recovery fund for the EU. This signals a political will to tackle problems, such as climate change and digital innovation, at both a national and a supranational level. A bigger state, with a strong focus on a greener political agenda, was already present pre-COVID, as can be seen from the fact that ‘the Greens’ (a party which advocates for a bigger state) has doubled in the polls since 2016. But this could also been seen from the shift away from fiscal prudence on the more conservative side of the political spectrum (CDU/CSU). In recent years the debt brake came under scrutiny in favor of extra spending on for example social security. The second party, the SPD, moved further to the left side of the political spectrum when it elected its new party leaders.

In the highly unlikely event that the AfD has a tremendous comeback and will govern after next year’s election, these policies could come under fire. But even in that scenario, they are still likely to govern together with the CDU/CSU which have designed these policies and are unlikely to give them up.

Italy (Erik-Jan van Harn)

Unlike in other European countries, the governing parties of Italy have not been affected much electorally by the corona crisis: their polls remained relatively stable. Eurosceptic sentiment, which has been a major topic in the Italian political landscape in recent years, has been quelled by the funds promised in the EU recovery fund. Since no major political tensions have arisen since then, the government is relatively stable at the moment. It is therefore likely that the current direction of the “determined state” will be continued, given the fact that the governing parties aim for a larger role of the government. Additionally, their positive euro-sentiment and focus on the environment also point in this direction.

At the same time, given Italy’s precarious public finances EU goodwill and financial support is essential for enabling the investments necessary to move toward a “determined state”.

The position of Lega, still the largest party in the polls, could also play a role. Under its direction, an new government might change direction. Lega is openly advocating for a smaller government, whereas the current coalition is opting for the other direction.

United Kingdom (Stefan Koopman)

The government of the United Kingdom wants to use Brexit as a catalyst for positive change, as the expected disruption creates a platform to force radical changes to the current economic system. As this post-Brexit economy takes shape, the country is likely to make the transition from an “insatiable society” that heavily relies on debt-fuelled consumption to a “competitive state” that focuses on improving the country’s weak productivity record. There is also relatively broad agreement in the UK’s policy circles that the post-Thatcher consensus has only worked for the few, not the many, and that it has effectively passed its expiration date.

The vast impact of Brexit on economic output is expected to come from knock-on effects on productivity. The government therefore needs to take the lead in an investment push that aims to improve the performance of the ‘long tail’ of unproductive companies. Out of the European Union, there is also greater scope to implement selective industrial policies. This should encourage R&D spending, innovation and new technologies and make up for the expected loss in private FDI. It should also help to narrow the country’s persistent current account deficit, which is becoming increasingly difficult to finance in a post-Brexit and post-Covid-19 world and poses a real risk to the economy and the value of its currency.

Destination unknown?

The future state of the global economy is inherently unpredictable. Scenario analysis nevertheless offers us a glimpse of the possible roads ahead. Are economies pivoting towards robust welfare or do they remain focused on efficiently generating income and jobs only? And do governments gain importance in shaping the economy or will we witness a retreat of governments, leaving economic life primarily to the market place?

As with different varieties of capitalism, the resulting scenarios are likely to map out differently across the globe. While some economies are likely to be characterized by a relatively large role for government focusing on overall wellbeing (the Netherlands, Germany, Australia), other economies are much more likely to maintain a singular focus on income and jobs with a relatively limited role played by government (the US). Yet other economies are likely to offer a mix of various scenario’s (Brazil, China). At the moment, China seems likely to develop into a hybrid competitive/determined state, emphasizing robustness but also focusing on income and jobs and not so much on other welfare dimensions.

To what extent and in which direction either markets and/or governments will ultimately shape our future economies is in part a path dependent process. From early medieval Iraq (500-1000 AD) to modern western states (1500 AD onwards), historical examples abound suggesting that major changes in economic pathways do not come about overnight. In that sense, even the current pandemic in itself is not likely to turn our lives upside down. At the same token, however, calls to reconfigure the role of government and the economic goals worth striving for are not new (Mazzucato, 2013). As such, the pandemic might well strengthen developments that started off before the current crisis.

Last but not least, whether particular scenarios will indeed unfold for specific economies is likely to depend upon political developments and stability within these economies. Given the current political developments in some economies (e.g. Brazil, Italy) it seems plausible to assume that the future trajectories of these economies is far less predictable than those of others (e.g. Germany, China). Hence, although the evolution of national political economies follows a path dependent process, there is nothing inherently deterministic about how particular features will eventually play out.

References and footnote

Baker, S. R., Bloom, N., Davis, S. J., & Terry, S. J. (2020). Covid-induced economic uncertainty (No. w26983). National Bureau of Economic Research.

Mazzucato, M. (2013). The Entrepreneurial State: Debunking Public vs. Private Sector Myths. London: Anthem Press.

Van Bavel, B. (2016). The Invisible Hand? How Market Economies have Emerged and Declined since ad 500, Oxford: Oxford University Press