In 1920 the world faced a horrific crisis of a deadly disease that decimated economic growth during its span of 2 years. Exactly a century later we are faced with a similar crisis, the magnitude and span of which is clearly unknown as it ravages through booming economies causing a standstill to the overall economic outlook. Through the series we try to understand the economics of the pandemic. In the later part of the series, we will try to understand the outlook for the markets and opportunities that it presents to the investors.
An important concept to grasp straight away is the systemic impact that uncertainty and nervousness can create in the overall economic activity. Doubts about the short and medium term future can have a chilling effect on decision making and consumer choices. Further the dramatic rise in joblessness can trigger what Prof Surico calls “cashflow spiral”.
Cash Flow Spiral:
A cash flow spiral starts with the general uncertainty that increases at times like this. Due to uncertainty the households reduce their spending and consumption. This fall in demand leads to many small and medium sized firms closing down which adds to the job losses and deepens the spiral. We are already seeing the beginning of the spiral as is evident from the consumer spending data. As uncertainty rose in March, consumption rose in anticipation of lockdown phase- the stockpiling moment. Then there was a large decline in spending from everywhere-retail, transport, groceries etc. Households became extremely cautious with March spending less than half of the amount spent in January indicating massive contraction of aggregate demand.
The huge job losses in US and UK reflect the scale of damage done to the employment levels. The effect is felt in India as well as the MSME’s cut jobs across the sectors to sustain in the future. Unlike other recessions, the crisis is having an uneven impact across sectors. While the confidence index of banking companies looks strong with 60% of the companies confident about post-crisis survival, the hospitality sector suffers from a massive wave of pessimism with only 15% owners confident of post-crisis survival.
Here, the degree of hardship faced by people varies according to the cost of housing. People with low mortgages are much better placed to face this crisis rather than people with mortgages and debt. Also the rental sector already had little savings and are now dependent on credit card debt to manage their day to day livings which can create huge debt problems in due course.
Supply and Demand:
What initially looked to economists as a supply shock, due to disruption in China and supply, followed by social distancing and quarantine in reducing the number of hours worked has translated into a demand shock as well due to uncertainty among consumers and an apparent lack in spending. This dangerous phenomena can turn a recession into a depression.
Destruction of Economic Surplus and Equality
An initial estimate shows that in lieu with the current drop in output, the economy would face almost a 10% annual drop in USA. Similar drop is expected in India which was already going through a downturn before the pandemic. The drop is humungous as compared to previous recessions by the way of contrast as the overall loss in 2008-2009 was 4.5% which is still being recovered economically.
Economic inequality is likely to increase as well due to the skewness in the jobs available. Jobs in technology sector are likely to increase due to instant connectivity and the benefits that technology provides. Hence people with technology backgrounds will have a better chance at employment which will create skewness in employability. This would most likely further widen the income gap in the society. Healthcare sector is likely to see a boom as well, as finally the governments of the world understand the complacency they have placed in health infrastructure and the need to make it robust and sound.
The economic challenges arising from pandemic are huge. Certain macroeconomic interventions like increasing disposable income of the people and tax rebates to the industry should be the immediate concern of the government to spur growth and unleash animal spirits. Debt should not scare the government as growth will systematically restore public finances. It needs to be noted that during this pandemic deflation is the problem, not inflation.
Coming up Next: If the economics are so poor, why is the market sentiment extremely positive? The next part will look at then market aspect of the pandemic and opportunities it provides to investors.
By- Akshay Vyas