Policy needed for recovery

Macro-economic analysis by Michala Marcussen, Group Chief Economist.

Governments around the world are gradually preparing to lift non-pharmaceutical intervention (NPI) and with that attention is turning to the shape of the recovery.

In the immediate future, gradualism is set to be the keyword, with a new set of health precautions and health-driven behaviours likely to remain in place until an effective treatment or vaccine emerges in the fight against Covid-19. Looking to China, where NPI measures have been largely lifted, consumers remain hesitant when it comes to certain activities, including, for example, travel, restaurants and hotels. Ongoing uncertainty on the broader economic outlook and future jobs security is a further headwind to consumer spending appetite.

Encouragingly, some businesses are managing to turn crisis to opportunity, with some shifting to producing goods and services that have seen increased demand as a result of the pandemic, such as certain pharmaceutical goods, products to make home working more comfortable or new even new technology apps, enhancing the virtual world experience.

Inevitably, however, many businesses will suffer and be forced to cut back on both investment and staff. This is where government policies will make a key difference. To date, much of the policy response has focused on supporting households and corporates impacted by NPI; be it through credit guarantees, income support for workers or ample liquidity supplied by central banks. Policies to support the recovery phase are still largely on the drawing board, but already several ideas are emerging.

Top of the list is the idea of new green deals, promoting investment into renewables and energy efficiency. A focus on upgrading buildings to new energy norms may be particularly interesting as the construction sector typically ranks high for domestic employment. To be a success, governments will need to ensure sufficient labour supply, and here the ability to reskill workers is key. Indeed, history shows that those countries with strong education systems and lifelong learning enjoy far better growth outcomes. Education policies also link closely to the opportunity to support a digitalisation agenda and offer a durable means to lessen inequality.

While it is quite natural for governments to focus policy measures on those sectors that yield the highest impact on domestic growth, a worrying aspect in the current context is the evidence of renewed protectionism, endangering not least the recent agreement reached on trade between the US and China. Such trade wars are costly and could present a significant headwind to global recovery.

One point worth note is that post the 2008-09 crisis, China become a source of demand of last resort for the global economy, with notably a massive infrastructure investment programme, but at the cost of higher debt to the tune of 100% of GDP. It seems unlikely, however, that China today can offer a replay of this situation. For beneficiary economies, such as Germany, this means that growth drivers will have to be sought elsewhere.

Europe offers significant opportunity. The finalisation of the Energy Union, the Banking Union, the Capital Markets Union and some for of Fiscal Union would bring a significant growth boon. Question is whether political agreement can be reached to resolve the Gordian Knot of the risk sharing debate. While we remain positive on European integration in the long term, our concern is that the process will be slow thereby spelling further divergence within the euro area over the coming years, and this with non-negligible political risks.

As such, when it comes to the shape of the global recovery, we expect it to be slow and choppy, but even against this backdrop, entrepreneurs will find opportunity.