Road to Economic Recovery and Obstacles Ahead

It’s a year and a half since Covid-19 made its appearance in China and went on to ravage the world with amazing speed and virulence. China managed to control it effectively since they locked down Wuhan completely and prevented the spread of the virus while the infected were being treated. Other countries managed to control its spread with varying degrees of efficiency. While some countries – predominantly East Asian – managed to control it effectively in the early days through widespread testing, others in the West, especially US and UK proved the most efficient in vaccinating their people at a good pace, partly also because they had pre-ordered them in huge quantities, about which I have written before.

In India as well as in Europe, the vaccination phase was poorly managed for a variety of reasons, not least in India, where the government seemed to have underestimated the magnitude of the problem and left it to the states. Vaccine supplies too have yet to pick up. At the end of 18 months, the world is therefore recovering at varying speeds and rates.

We are now at an inflection point, where vaccination and reopening economies ought to be the focus. However, the new Delta variant, first found in India, and Delta Plus are already spreading fast both within India and overseas and that could certainly hamper progress in reopening. New variants can always pose problems and we have to remain vigilant as well continue to follow mask and social distancing rules for many more months until a large part of the population is vaccinated. Health authorities as well as vaccine developers also need to be constantly testing the vaccines’ efficacy against new variants, as well as continuing to research better vaccines and testing those too.

On the economic front, it has been a case of economies firing on only one engine, while the others are down. Almost everywhere, manufacturing has rebounded and essential supplies have been kept going. Services, especially travel, retail, dining and entertainment have been hit hard, and trade has seen a decline, even though trade in manufactured goods recovered from the lows. Trade is now being hit by supply shortages, huge spikes in shipping and container prices and other issues to do with the sudden spurt in demand and supply not being able to keep up. Not to mention Brexit-related issues which affect Britain, Europe and Ireland.

That is pretty much the story of consumption in most economies as well. With more people vaccinated, thanks to generous relief checks and furlough schemes in the developed world, pent-up demand is now making its presence felt. In fact, there are fears of high inflation now in the US – the highest it’s been in decades – and there are some arguing for a pull back in the Federal Reserve’s and the government’s stimulus packages. Consumer price inflation in the US for April, May and June 2021 over the same period last year were at 4.2%, 5% and 5.4% respectively, with core inflation (excluding food and energy) at 3%, 3.8% and 4.5% for the same months. I agree with the camp that believes the current bout of inflation in the US is mainly due to supply shortages (chips, copper, lumber, etc) and is further skewed by the rise in prices of used cars and trucks in the US. Wages have risen moderately, but millions are still unemployed/underemployed and so there is still some slack in the system.

Rising consumer price inflation in the US; Graph: St Louis Federal Reserve website

It is in India, that inflation ought to be a real scare. Consumer price inflation has been on the rise for well over a year and core inflation for May and June 2021 were 6.56% and 6.2% respectively. Inflation in food and fuel were high, but even excluding these, transportation costs accounted for the biggest increase. Any wonder, when fuel prices have been raised so often for the past six to seven years, thanks to higher excise duties imposed by the central government? It had to reflect in broader inflation increases across the board at some point, and is now posing the biggest threat to growth and economic recovery, because it is certain to crimp demand for a lot of discretionary goods and services.

This will be felt most among the middle consuming classes and in rural India; growth in rural consumption demand has been the mainstay of our economic growth for the past many years. And as I wrote in a recent blog post on the Indian economy, private consumption has been in decline all of 2020 and only registered a growth of 2.66% in the Jan-March 2021 quarter. April-June 2021 is not likely to be any better due to lockdowns, albeit localized, fear of the second wave of Covid-19 and reports of a slowdown in demand.

If we look at the next possible obstacle, besides new variants of the virus, and rising inflation, it has to be the state of employment around the world and how households are doing. In India, unemployment is once again on the rise, after an improvement during the latter part of 2020. Urban unemployment is said to be faring worse, at 10.07% for June 2021, while rural unemployment is also high at 8.75% for the same month, according to CMIE (Centre for Monitoring Indian Economy). We must remember, of course, that unemployment in India was already at elevated levels pre-pandemic at above 7%.

In the US unemployment has fallen sharply from its pandemic high levels of 14.5%, but there are still an estimated 9.5 million people without work. In the UK and Europe, unemployment levels are relatively unchanged because of their job protection and furlough programmes, intended to keep people employed in short-time work. To that extent, the unemployment numbers might not give a very accurate picture of the current work scenario. That said, countries in southern Europe still suffer from high unemployment levels from well before the pandemic and youth unemployment levels are as worse as before.

In fact, it has been widely reported that women and the youth were the worst affected among those who lost their jobs or were furloughed during the pandemic. In the US, UK and Europe we have the added complication of unfilled vacancies – reported to be 9.3 million in the US alone – and there is growing demand from some quarters for the relief packages to be withdrawn or curtailed. These people believe that the relief packages are working to disincentivize people from seeking employment. One could also argue that labour seems to be enjoying greater bargaining power – waiting for a better job to arrive – something not seen in decades. Of course, one shouldn’t overestimate the bargaining position of labour, since the pandemic has also accelerated digitization of the economy, some of which is likely to replace jobs even as it creates new ones.

Europe has set aside funds to help retrain workers and some of their furlough schemes are conditional on retraining, which is a growing call according to this FT article. What is encouraging, meanwhile, is that from a high of 23 million furloughed at the start of the pandemic, it is now down to 6 million. In recent months number of short-time workers has spiked due to the third wave of Covid and lockdowns. Nevertheless, governments in different European countries have taken different measures to tackle unemployment. Netherlands, France, Germany and Italy are providing fully-funded training courses, and Germany has also shifted the focus of furlough to industries worst affected.

While Britain has extended its furlough scheme till end of September 2021, in Spain and Italy they expired in the spring of 2021. France, having earlier announced its furlough till mid-2023, has increased employers’ contribution to a smaller furlough salary. In India, we neither have unemployment benefits, nor a furlough scheme to keep people in their jobs. The government did announce some schemes last year to provide income support to the rural poor and migrant workers as well as offer emergency credit to small businesses backed by a government guarantee of 50%. This when the typical pandemic loan to small businesses in European countries has 80-90% government guarantee. However, as I had written in a previous blog post, it is time for the Indian government to announce another relief package, especially for the poor as rural India battles the coronavirus.

Finally, so much of employment is dependent on business investment, which in turn depends on consumer demand and existing capacity. One hopes that the pent-up demand on reopening of economies will settle to a more stable demand and that companies will increase their investment, at least in brownfield projects, if not in greenfield ones. Capital investment tends to be volatile, and although gross fixed capital formation in India contracted by -10.78% in FY2021, it appears that the last quarter saw growth at 10.85%.

In Britain, business investment in Q1 2021 fell by 18.1% over the same period in the previous year according to the Office for National Statistics. The fall was led by transport equipment investment contracting by -47% compared to Q4 of 2019 and by intellectual property, which is due to an increase in intellectual property investment of 1.3% in 2020. However, gross fixed capital formation, a better indicator for employment prospects, fell by 3.7% in Q1 2021 over the same period in 2020.

OECD Chart: Investment (GFCF), Total, Quarterly growth rate (%), Quarterly, Q2 2020 – Q1 2021

OECD Chart: Investment forecast, Total, Annual growth rate (%), Quarterly, Q4 2022

OECD Chart: Domestic demand forecast, Total, Annual growth rate (%), Quarterly, Q1 2020 – Q4 2022

For most countries, however, as the first OECD table shows, gross fixed capital investment seems to have contracted in a couple of quarters in 2020 before recovering in the remaining quarters of the year. Some Eastern European countries, such as Estonia and Lithuania seem to have seen significant growth in gross fixed capital investment. How much of capital and business investment is sustained is yet to be seen and depends on how well we keep the coronavirus under check. It is also dependent on consumer demand and we need to see more people back in full-time work.

Investment in infrastructure projects could be another way of putting people back to work, though there is always a long gestation period in these. India, for example, had laid emphasis on a capex increase in infrastructure this year in the annual budget, but not much has been reported on it, since. The US is likely to approve massive infrastructure investment of around US $ 1.2 trillion which would help to create new jobs. What is critical is what it is being spent on, and over what time period.

New Chinese city under construction in 2013; Image: Clay Gilliland CC by SA 2.0 on Wikimedia Commons

Speaking of infrastructure, no country has built more of it in the past couple of decades than China. And when talking of the global economic recovery, one realizes that a lot of it is dependent on China, its domestic economy and its international trade. Not only did China escape a technical recession last year, it has been growing almost on all parameters. In Q1 of 2021, private consumption measured through retail sales grew 33.9% year on year and 1.86% over the previous quarter. Factory output grew at an average rate of almost 16.4%, while fixed asset investment grew by 25.6% during Q1 2021. China’s Q2 GDP just announced a few days ago is 7.9%, much slower than the previous quarter’s 18.3%, but that is owng to a base effect, and it continues to be a healthy growth rate.

During President Biden’s recent meeting with EU leaders on his tour of Europe, it was reported that they had settled their trade war over the Boeing-Airbus dispute and tariffs were reset at their earlier levels. I believe that some of the inflationary pressure in the US can be eased by a calling off of the US-China trade war and resetting the raised tariffs on both sides to their earlier levels. I always thought that it should have been high on the Biden regime’s economic agenda, on assuming office and I think there is a need to separate tariff-related issues from the rest, including the treatment of Uyghurs, Hong Kong and intellectual property disputes.

If we do not resolve trade issues with China, it could become the next biggest obstacle to global economic recovery and it will be a self-imposed one.

Perhaps we need to reset tariffs and allow trade and investment with China to continue, and find other ways to engage with the country. Making China a more responsible power internationally ought to be the objective, and that approach could lead to new ways of dealing with the country’s rise. To my mind this approach calls for including China in international matters, and not isolating them.

The road to economic recovery has many bumps ahead, but some are clearly more avoidable than others.  

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