Markets & economy

The transition into the post-pandemic world

It is remarkable the extent to which the future is hidden from us. We all conduct our lives largely in terms of our experiences in the recent past, assuming what has been will be. This attitude coloured expectations regarding the return to normality following the initial outbreak of the COVID-19 pandemic early in 2020. Governments, businesses and investors mostly acted on the assumption that, as was the case with the Chinese SARS epidemic of 2002, the health emergency would end within 12 to 18 months and the global economy would then revert to long-established trade patterns which had been disrupted by the pandemic. Few, if any, expected the transition into the post-pandemic world would be as complex and take as long as has proved to be the case. Sandy McGregor discusses the ongoing impact on global economies.

In the two years since COVID-19 was first identified in China, mutations of the virus have caused successive waves of infection. Speaking about a possible pandemic peak in the US at the end of January as the spread of the Omicron variant loses momentum, President Joe Biden’s health adviser, Anthony Fauci, cautioned against placing too much confidence in such forecasts because, “this virus has fooled us before. We thought that with vaccines everything was going to be fine. And along came Delta, which threw a monkey wrench into everything.”

Despite widespread vaccination in richer countries, the health emergency is not over, if only because the pace of vaccination in poorer countries has been very slow. There is also the surprising influence of the anti-vaccination movement, which in certain countries has become an impediment to achieving the vaccination coverage required to bring the pandemic under control. It has become increasingly clear that while vaccination reduces the incidence of serious illness and death, it does not necessarily prevent the spread of new variants.

One of the uncertainties we face is whether the pandemic will now peter out or whether we can expect repeated waves of new variants similar to the annual bout of flu infections. In the latter case the medical knowledge needed to manage future COVID-19 waves exists. Currently research is focused on developing more effective vaccines and on treatments for those infected. Effective treatment would provide an important boost to confidence required for a return to normality.

The limiting factor is not knowledge but resources. Provided the resources are available, the public health issues we currently face can be effectively managed. While developed economies have these resources, many poorer nations do not, creating the prospect of repeated waves of new variants originating in the third world, which then spread globally.

The uncertainty as to when the pandemic will end is an impediment to any return to normality.

South Africa is fortunate in that it can use its medical infrastructure developed to control TB and HIV/AIDS to address these challenges. It is no coincidence that the Omicron variant was first identified in South Africa. However, among developing countries South Africa is an exception, and the global health crisis may be with us for some time to come. The uncertainty as to when the pandemic will end is an impediment to any return to normality.

The disruption of supply chains

Governments responded to the pandemic with programmes aimed at sustaining personal incomes. These have been broadly successful. A lack of mobility shifted the focus of consumer spending away from services to manufactured goods and housing. Working from home promoted spending on home improvements and computers. Online shopping boomed. Travel and eating out collapsed. Personal savings soared as the more affluent ceased making what were previously regarded as normal expenditures. Accordingly, in the major industrial nations there is a lot of spending power which is sustaining the demand side of their economies.

The sudden surge in demand for manufactured goods has disrupted supply chains. There has been a big increase in Chinese exports but there are insufficient ships and containers to get these to their final destination. Port congestion has become commonplace as the surge in traffic exceeds capacity. The increased demand for electronic goods has created a shortage of computer chips which has forced auto manufacturers to curtail production. The production of commodities has been disrupted by the pandemic and with demand exceeding supply, the prices of metals and minerals are elevated.

As is normal, the market is responding to shortages by increasing prices, which incentivises growing the supply of goods to match demand. Also a switch back to greater spending on services, such as travel and restaurants, will reduce purchases of items which are currently in short supply. As is often said, what fixes high prices is high prices. It would be surprising if most of these disruptions last for more than another year. However, there are some shortages which could persist for much longer, notably labour and energy.

The labour shortage

A persistent and widespread complaint of businesses trying to get their operations back to normal is that they cannot find the people they need to achieve this. This is not surprising because in 2019 the developed economies were already enjoying the lowest levels of unemployment since the 1960s. Effectively they had achieved full employment and were dependent on a continual flow of migrants to meet their labour requirements. Partly this was due to demographic trends with static or slowly growing populations not providing sufficient replacements for rising numbers of retirees. Some industries, such as agriculture, had become very dependent on seasonal migrant workers.

the market is responding to shortages by increasing prices, which incentivises growing the supply of goods to match demand

In recent years, rising popular hostility to immigration and tighter border restrictions have worsened the labour shortage. The pandemic has disrupted what was already a very tight labour market. This has been aggravated by people choosing to stop working either temporarily or permanently, and by those seeking employment which offers more attractive working conditions.

The fastest-growing labour force age cohort has been those over 60, many of whom had chosen to continue working beyond their normal retirement age. While the number in this group continues to grow, during the pandemic there has been an acceleration of retirements as many have responded to new complexities by deciding to call it a day. According to The Washington Post, in the United States 1.5 million more were retired in November 2021 than would have been expected from pre-pandemic trends. In many cases buoyant financial markets have elevated the value of retirement assets, making the decision to stop working easier.

Lockdowns and closures of schools have had a big impact on families with children. Schools are not only places of learning, they are also daycare facilities which provide parents and in particular women time needed to do a paying job. When schools closed, parents had to take on the additional task of supervising their children’s distance-learning education. It is a social reality that this burden falls largely on women. Consequently, a significant number of women withdrew from the job market to spend time caring for their children.

a major reason why our economy remains trapped in stagnation is a shortage of skills. South Africa has a propensity to lose skills through emigration

While the reopening of schools should theoretically reverse this trend, the shortage of labour has made daycare very expensive, and many find that once this cost is considered, it does not make sense to go back to work. There are certain professions in which women predominate, notably health and education, where a decrease in the participation rate of women in the labour force can have a significant adverse impact.

One sector which is finding it difficult to return to where it was before 2020 is the restaurant trade. Many of its previous employees have got jobs elsewhere with more appealing working hours. For example, in France, where food is the backbone of civilisation, restaurants are finding it very difficult to recruit those they need.

These are but three examples of a complex phenomenon. The simple truth is that skills are hard to find and this problem is not going to go away soon. The market response has been to increase wages. There is pressure to do this both from employees, who are already experiencing an increased cost of living, and to meet business imperatives. There is a generation of business managers whose experience has been formed in a world of stable wages. Many are unprepared to operate a business in an environment of spiralling wage costs. They will seek to protect margins by passing on this cost to customers. For most businesses, wages are the largest single cost. A wage cost spiral constitutes the greatest threat to price stability. This risk is most pronounced in the United States but is also growing in Europe.

An energy crisis

The last quarter of 2021 was plagued by high energy prices. These were not caused by the pandemic; rather they are the result of specific industry issues. However, coming coincidently with COVID-19 supply chain shocks, they have significantly aggravated inflationary pressures.

The current energy shortage has its origins in the decarbonisation project. Companies producing oil, gas and coal have come under huge pressure to cut back on any investment which would boost production. A Dutch court has ruled that Shell must comply with Dutch decarbonisation targets. The world’s largest asset manager, BlackRock, has launched a crusade against the carbon molecule and is putting huge pressure on managements to comply with its agendas. Pension fund trustees have joined the battle. Banks are being pressured to follow suit. The fallacy in this response to climate change is that it ignores that decarbonisation will require a lot of carbon. The oil and gas companies have reduced investment to completing projects already underway and harvesting other assets by allowing production to decline through normal resource depletion.

The agendas of those preventing the oil industry from meeting energy demand over the next decade are setting the world up for damagingly high energy prices, which will have serious adverse consequences on living standards and economic growth. The present price surge is an example of what we can expect in future years.

The oil production caps agreed by the Organization of the Petroleum Exporting Countries (OPEC) and Russia continue to work effectively. The Brent oil price peaked at US$86 per barrel in October and then retreated. However, this cartel has proved it can manage supply to keep prices at current elevated levels. As the post-pandemic recovery proceeds, they will gradually increase production until demand exceeds 100 million barrels per day. The spare capacity in the system will then be fully utilised, after which a totally new pricing environment will emerge. On present trends this should happen in 2023.

The focus of attention has been on natural gas. Gas is the best transition fuel to facilitate the creation of a totally electric economy. Gas-fired power generation can be used to stabilise an electricity distribution system dependent on intrinsically unstable wind and solar energy. Gas demand in Asia has grown strongly and most US gas exports are now into the Asian market. This has left Europe very dependent on the Russian producer Gazprom. Europe did not take up Gazprom’s offer of long-term contracts, believing that it should increase sales through the spot market. This does not suit Gazprom’s agendas and it has declined to comply with Europe’s wishes. Shortages have pushed European gas prices to record levels, which has severe social consequences as the cost of heating homes in winter has soared. High energy prices are becoming a severe impediment to Europe’s competitiveness in global markets.

Coal prices also reached record levels following a Chinese decision to restrict production to meet environmental goals. However, the Chinese government could and did reverse its policy following severe power shortages and coal prices have since retreated. The coal industry’s economics are similar to those of oil and gas. Significant demand and little investment in new collieries are a formula for long-term shortages and high prices.

many problems experienced in 2021 will persist into 2022 so the risk of persistently high inflation is very real

China’s economic growth slows

While China led the world in being the first nation to get its economy back to where it was at the end of 2019 and has enjoyed a record trade surplus as the demand for its exports of manufactured goods soared, its economy has now run into severe headwinds. The key driver of Chinese growth has been the property sector. Serious problems in its housing market are now emerging, with prices unaffordably high, overbuilding and developers in financial distress. As a result, the prospects for Chinese economic growth are far less favourable than they were. Whereas for the past decade China has been the largest single contributor to global growth, its role in the post-pandemic world, while still very important, will be more muted.

The response of central banks and governments to surging inflation

Inflation has far exceeded expectations. In December 2021 consumer price inflation reached 7% in the United States and 5% in Europe.

The party line of the US Federal Reserve (the Fed), European Central Bank (ECB) and Bank of England (BoE) in the first half of 2021 was that inflationary pressures would prove transitory and did not justify higher interest rates or an ending of large-scale asset purchases funded by printing money. As month-by-month inflation continued to increase totally contrary to their expectations, doubts started to develop. In September the Fed announced it would start tapering asset purchases then running at US$120bn per month with the aim to end them in June 2022. In December this schedule was accelerated so that they will cease in March. Fed Chairman Jerome Powell has conceded that with US inflation at 7%, the word “transitory” is inappropriate.

The ECB is also cutting back on asset purchases and the BoE has implemented its first interest rate hike. The simple truth is these central banks have totally misjudged the inflationary outlook. If they had responded promptly to rising inflation by suspending asset purchases and increasing interest rates from zero to between 2% and 3%, inflationary pressures would have naturally abated, but this opportunity has been lost. The leading central banks are now way behind the curve and there is a real threat that self-reinforcing upward spirals in the cost of wages and housing will get out of control and that a higher rate of inflation will prove persistent.

Governments’ pandemic spending sprees resulted in a huge expansion of fiscal deficits, facilitated by central bank purchases of government debt. There has long been growing pressure on governments to run larger deficits and to spend more. The most notable supporters of bigger deficits are the proponents of Modern Monetary Theory (MMT), who argue deficits do not matter. For a while the initial success of the stimulus programmes suggested that MMT had arrived and would play a determining role in the post-pandemic world. Surging inflation has changed all that. With central banks ending asset purchases, governments will no longer be able to fund deficits at zero cost. Given massive government indebtedness following the pandemic, even a small increase in cost of borrowing has significant adverse fiscal consequences.

Political resistance to taking on more public debt is growing. In the United States, where the scale of the response to the pandemic exceeded that of any other country, President Biden’s US$3tn additional spending programme has run into strong resistance in the Senate and it now increasingly seems that in 2022, US government spending will revert to pre-pandemic trends. In Germany, a new Socialist-led coalition is also committed to continued balanced budgets. An inflationary world imposes fiscal prudence.

we are on a journey without a clear vision as to our destination

2022 as a transitional year

This year should see the world making significant progress in returning to the new normal, whatever that will be. While contracting fiscal deficits and a slowdown in China will have an adverse impact on global growth, business activity will be sustained by continued spending of pent-up savings and the recovery of the hospitality sector. Increasing numbers of vaccine shots are being made available to poorer countries, which hopefully will bring the worst of the pandemic to an end.

Perhaps the biggest risk is inflation. The market economy adjusts to disruptions by adjusting prices. As discussed earlier, many problems experienced in 2021 will persist into 2022 so the risk of persistently high inflation is very real. This would then force central banks to raise interest rates far higher than they currently expect, which in turn would have adverse consequences for the prices of equities and property. The problem is that we still do not know what the post-pandemic world is going to look like, and we are on a journey without a clear vision as to our destination.

With buoyant agricultural and mining exports, South Africa’s economy should be well placed to resume its normal growth path. However, a major reason why our economy remains trapped in stagnation is a shortage of skills. South Africa has a propensity to lose skills through emigration. A global shortage of skills will make it easier for those who wish to relocate to find jobs. Over the past two years travel bans have prevented large-scale emigration. As travel normalises, the pace of emigration will increase. The opening up of borders poses a significant threat to our economy.

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