Surviving the World economic crisis

The outbreak of the Covid-19 pandemic precipitated a world economic crisis. Many commentators suggest that the pandemic caused the crisis. In actual fact, several economists, such as Sri Lanka-born Howard Nicholas, have predicted this economic downturn for several years.

The roots of the crisis go much deeper than the Coronavirus. The economies of the world are mired in debt. Because of the hegemony of the financial elite, companies in the advanced industrial nations have not, for years, invested in new plants and machinery but have, instead, used government subsidies to buy back their shares from shareholders. Investors have used this mechanism to increase the apparent value of their assets, enabling them to borrow more from banks.

This is because investors expect to make money, not from the dividends enabled by company profits, but by speculating in company shares. Many of the so-called “unicorn” companies (new, fast growing companies valued at over US$ 1 billion) make no profit, but grow because investors believe they will grow in value.

Economic stagnation

For the same reason, many big companies, such as Apple, Facebook and Google, instead of increasing their own value by investing in production, or research and development, buy other companies. Profitability is increased by reducing staff numbers, or hiring temporary staff at much lower remuneration, often on a “gig” (for-the-job employment) basis. This in turn has an effect on workers’ purchasing power, which affects the growth of markets negatively.

This kind of economic stagnation occurs from time to time. It used to be solved by more “inefficient” companies (that is, companies that do not make a profit, even if they happen to be more efficient by other criteria) going bankrupt, and more profitable companies expanding into the space they create. This has changed now. For example, the old hiring-car-based company Hertz, which made a profit of US$ 168 million in the last quarter of 2019, went bankrupt, while Uber, which made a loss of US$ 1.1 billion in the quarter, is doing famously. Companies able to attract capital prosper, while those seen as not expanding, fail.

The economy recovers from such crises by investing heavily in new technological methods to increase productivity. In the last two decades, however, companies in the West, especially in the USA, have invested in technologies that enable them to extract the greatest profit from “gig” labour, and essentially in sales, delivery and other services, rather than production.

On the other hand, East Asian countries have invested heavily in high-tech manufacturing industries. China, Japan and South Korea, together, account for two thirds of all new industrial robot installations, while Europe and North America only account for 30%. In the context of the current crisis, such countries will probably lead the recovery, with brand new technologies. Other up-and-coming industrial powers, notably Vietnam, Iran and India, will also accelerate their technological capabilities.

The continued economic stagnation, in the USA, has several corollaries. In the first place, as the world’s biggest consumer of imports, the exports of export-based economies will suffer. In the second place, investors are fleeing the US Dollar for gold, the price of which has risen from US$ 48,000 per kg in March to over US$ 65,000 per kg today. The consequent fall in the value of the US dollar (from € 0.94 in March to € 0.85 today) means that exporters will be even more disadvantaged.

The USA is also the world’s biggest consumer of petroleum – using more than the combined consumption of the next two countries, China and India. The price of crude petroleum in Dubai fell from US$ 64 in January to US$ 23 in April. Although the price rose again, to US$ 43 in July, the lower value of the US Dollar means that the real increase is less than this. This means the income of the Middle East and Russia will be affected severely.

Different approaches

How have other countries coped with the economic downturn? The USA, China and Germany represent three different approaches to the problem.

Apparent economic growth, in the USA, before the pandemic, was based on short-term, low wage jobs. Once Covid-19 hit, the country experienced its fastest unemployment growth in history. In reaction, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which budgeted US$ 2 trillion (10% of GDP) to boost the economy. More than half of this went to companies, while less than a quarter went as compensation to poor people losing their jobs or otherwise affected by the crisis.

This stimulus package helped cushion the collapse of the US economy. However, the payments made to the affected poor people often went to pay immediate food and rent needs. Most of the consumer spending due to payments to individuals went to online delivery companies, such as Amazon and Uber, which employ workers on “gig” terms. They did not spend it in shops and supermarkets which employ permanent staff, so unemployment rates remain high.

Unfortunately, even this funding ended at the beginning of August. The government and the opposition (which controls the legislature) argued about a new stimulus package. President Trump wanted to spend only US$ 1 trillion, reducing payments to unemployed people. The opposition Democratic Party wants to spend US$ 3 trillion, mostly on benefits to the affected people and on government programmes, including schools. The two sides could not agree.

“The Democratic Party continues to insist on radical left-wing policies that have nothing to do with the China [sic] virus,” Trump said. On 9 August he signed four “executive actions” regarding payment of reduced unemployment benefit, a moratorium on income tax for poor people, relaxing rules on evicting tenants and action on student loans. Critics say the executive actions may not be workable.

“Six guarantees”

China, the world’s biggest manufacturing nation, the first to suffer from the Covid-19 pandemic, has seen its economy recover. According to “The Economist” magazine’s Intelligence Unit in Beijing, local government investment, in public medical facilities, city infrastructure, old community renovations, transport, power grids and telecommunications, drove construction growth. This, in turn, stimulated production of construction-related machinery and goods, driving up manufacturing output.

The Chinese government has revealed a “six guarantees” recovery plan, based on creating jobs, giving financial support to ensure livelihoods, protecting small and medium enterprises, food and energy security, stability of the industrial supply chain, and facilitating the path from lockdown to a vital social life.

The Standard Chartered Bank says that China’s government is prioritising social goals ahead of GDP growth by creating employment and indicating that fiscal policy will be its preferred way to stimulate the economy. Officials have suggested that they are willing to almost double the budget deficit to support gross domestic product growth, while allowing money supply and credit growth to reach higher levels. There also appears to be a clear shift in China’s strategy; moving from an export focus to paying greater attention to domestic demand, to releasing consumers’ potential, and investing in new and traditional infrastructure projects. It projects a growth rate of 2-3% this year, a surprisingly high outcome for an economy which shrank rapidly in the first quarter of this year.

“Green” recovery

Meanwhile, Germany, the biggest European economy, has put in place a radical “green” recovery plan. The € 130 billion plan consists of fifty measures designed to boost consumption and speed-up economic recovery. The Government of Germany’s actions will be structured on this recovery plan. It is based on three pillars: € 78 billion on short-term economic recovery (about), about €5,000 billion on investment in future-proof and green technologies, and, € 3 billion on European and international solidarity (in addition to the efforts of the European Commission’s recovery plan).

Reducing VAT by 3 percentage points (12 percentage points for the catering and restaurant sector) – to stimulate consumption and revive employment in businesses, particularly in the hard-hit food and beverage sector – will cost the government € 20 billion.

The short-term recovery plan includes a huge green effort: subsidies on consumption of renewable energies, together with a carbon tax, will move use to electricity from other modes. In the transport sector, subsidies for buying electric vehicles are doubled, and support is given to battery and charging infrastructure, modernising commercial vehicles, ships and aircraft, and to public transport and railways. The construction sector has € 2 billion allocated for energy efficient retrofitting to existing buildings.

A key point in the plan is the new green hydrogen (produced by electrolysis from renewable electricity) sector, for which the government is allocating € 3 billion to develop 10 GW of electrolysis units by 2040. Together with the budget for European and international solidarity, this will put Germany firmly in the lead in this technological area.

Lanka’s markets

In the second quarter of this year, the USA’s gross domestic product declined by 35%, and the government recorded 23 million people as unemployed, the highest rate in 80 years. In the European Union the GDP declined by 7%, and unemployment increased to 14 million. In Britain, GDP has declined by 9%, driving unemployment up to 2.5 million. In Russia, GDP dropped 8%, and unemployment rose to 1.7 million. Middle Eastern economies will slow by 5%, affecting migrant labour employment.

These are Sri Lanka’s biggest markets. This shrinkage will adversely affect Sri Lanka’s economy. Both exports, and foreign labour opportunities, will decline. With a collapsed tourism sector, this will allow the country little foreign exchange to buy the things it needs.

In this situation, what can countries like Sri Lanka do? There are a few simple answers to this question. First, reduce imports to match the reduction in foreign exchange sources. Second, find new foreign markets to replace the declining economies. Third, find new products to replace the ones currently being exported. Fourth, develop the domestic market for domestic products, to advance the economy.

Of course, walking the talk will be less simple. How can it be done? The path taken by the USA is the road to ruin, while Sri Lanka does not have the financial resources to emulate China or Germany – although it can emulate many of the measures they have put in place, on a far smaller scale. It remains for the state to create the policy parameters to drive recovery on new paths, using our existing resources, and developing indigenous knowledge. New technology will be a large part of this, but we must use it wisely. We have an educated population which can adapt itself rapidly to new skills. That is our biggest resource in this economic battle.

Vinod Moonesinghe