The Long Haul Starts Now: COVID19 Policy Implications from Here

Tomorrow, Heads of State and Government for the Group of Seven nations will meet by teleconference. As of this writing, two of the seven have already implemented nationwide mobility restrictions. All seven are seeing major corporations and individuals preparing to cease activity and shelter in place until the true extent of infection rates, transmission mechanisms and mortality data are known.

When Supply Shocks and Demand Shocks Coincide With Global Illness

Analytically, we have moved beyond the supply shock associated with China’s shuttered factors in January and February. A temporary disruption in global supply chains can be remedied with aggressive, targeted fiscal stimulus. A temporary disruption in local supply chains (due to widespread illness or worse) can be similarly addressed through aggressive, targeted fiscal stimulus.

Supply chain disruptions due to natural disasters or terrorist attacks provide the playbook. However, all modern supply chain shocks have been largely localized, regional events. Even the supply chain shocks associated with the grounding of airplanes in the weeks after September 11 did not trigger lasting shifts in supply/sourcing behavior. This time will be different, and not in a good way.

Demand shocks are a different story. Demand shocks generate far deeper economic damage that lasts longer. Even after the worst of a demand shock has been remedied (a process that can take at least a year or more, depending on the severity of the situation), serious demand shocks have a way of permanently shifting sourcing and purchasing behavior.

The demand shock currently underway is unprecedented in its impact on services, which constitute the largest part of advanced economies. While it is true that information workers (who can work at home with a good internet connection) provide the largest marginal contribution to economic growth in advanced economies, moving towards a distributed model for work and productivity does not eliminate the need for those workers to have access to basic items.

Widespread illness – and understandable public health efforts to curtail transmission processes – will disrupt local supply chains in the near term at least as intensely as the global supply chains. The most severe impact will be seen in services sectors that depend on purchases from knowledge workers and for which the deliver of the service is person-to-person. Often, these are workers least able to absorb sudden shocks to their personal revenue.

This includes retail businesses (large and small), restaurants, health clubs, spas, tourism, transportation, travel and all businesses that require large audiences of people (sporting events, arts events, etc.). Healthcare and pharmaceutical companies face their own parallel shock due to an imbalance between high demand and limited supply, the consequences of which are literally fatal among at-risk individuals.

The Financial & Economic Policy Landscape Today: Just Getting Started

The political (as opposed to policy) implications are impossible to anticipate right now. But they will likely be significant when the dust settles and they will be directly correlated to the scale and distribution of the societal disruption. The simultaneous occurrence of a dramatic (labor) supply shock paired with a global supply chain shock is already generating a significant demand shock for the personal services sector.

The chain reaction from here in terms of personal and business closures will require policymakers to intensify fiscal and monetary policy efforts to mitigate the impact as anticipated in our post HERE last week. Our post regarding likely financial regulation policy options HERE accurately anticipated a range of activities taken in the United States and Europe last week. These won't be the last actions policymakers will take, so you might want to keep the inforgraphics handy. THEY ARE FREE TO DOWNLOAD FROM THE RELEVANT BLOGPOSTS. They will be updated as the situation warrants.

Calls for international policy coordination can be expected to multiply in the coming days. But in a situation in which deadly infection is transmitted person-to-person through the air (see this AP story for the details), governments have a responsibility to protect their populations.

When freedom of movement clashes with public health protocols, even treaties must be suspended in order to protect the health and safety of individuals.

There is little that the G7 can do beyond rapid increases in scientific cooperation to share solutions and vaccine development priorities..

The reality is that this crisis will hit each economy differently. Highly indebted weak economies (large and small, advanced and emerging) that went into the crisis with anemic or faltering growth rates will face a larger challenge than robust economies. Meeting that challenge will become harder in the coming days as headlines regarding transmission and fatality rates increase.

In this context, it can be no surprise that our platform has collected a record number of monthly observations regarding the coronavirus response function in the official sector.

The scale on the left tells you everything you need to know about the level of concern and activity.

In the year we have been collecting data, we have never seen this scale of activity on any individual issue.

Moreover, since the impact on the economic and financial system will lag the health crisis, we expect action from financial, trade and economic policymakers to increase dramatically in the coming weeks.

The early data provide a hint as to the economic hit we will all have to absorb in the coming months.

Last week, the World Trade Organization (WTO) released its regular data regarding services trade through January 2020. As a reminder, at the end of January the COVID crisis had not yet peaked in China and it certainly had not created cause for concern in other economies. The data is seasonally adjusted, so typical drops in January activity associated with new year celebrations around the world have already been factored in:

These drop offs will only intensify in future data periods (adding to the negative headlines) just as the United States experiences the brunt of the pandemic impact.

Looking Ahead

The long haul starts now. It is likely safe to say that cross-border supply chains will never be the same again for both goods and services. Companies large and small will not want to replicate their exposure to short-term supply disruptions. Localizing sourcing priorities will likely increase costs since the least cost supplier may no longer be the most attractive business partner. Knowledge workers operating through remote, distributed communication channels and their employers will think twice before organizing meetings at least until a vaccine has been safely disseminated through the population.

The ripple effects will obviously be significant for both the supply function and the demand function whose interaction governs pricing. Leading economists are already sounding the alarm about the adverse impact that responsible public health policies will create for the economy. The same is true for the rest of the world.

As testing increases, headlines regarding rising infection rates can easily be expected to dominate attention and continue to unsettle capital markets for the coming weeks. Fatality rates and intensive care needs as a percentage of the infected population will shift and will provide the best early indicators of how long initial isolation measures will last. Fear will only intensify the downdrafts regarding demand even as widespread illness intensifies short-term supply chain challenges.

The best policymakers can offer each other at this point at least is a standstill on complaints regarding derogations from existing international standards. Increased vigilance regarding phyto-sanitary and other non-tariff barriers to trade can be expected, as can major relaxations of a broad range of Basel III regulatory capital requirements. Maastricht Treaty requirements regarding budgetary ratios will need to be relaxed (particularly in Italy) on a par with the derogations already proliferating regarding the Schengen Treaty.

Export bans regarding pharmaceuticals and medical equipment are understandable but regrettable. They are understandable because governments owe a duty of care to their citizens and other living inside their borders. Regarding ventilators, since the latest research indicates that some respirators can actually help accelerate disease propagation, caution is warranted in order to avoid amplifying an already dreadful situation.

Decisions made today by policymakers regarding trade policy, fiscal policy, monetary policy, and financial regulation policy will have a material impact on how we navigate this virus crisis. Those decisions will forge a new set of standards and a new reality for how local and global economies function.


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