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The Shutdown Decision And Permanent COVID-19 Job Losses

The shutdown decision is a fundamental economic principle. A firm should continue to operate if it can generate sufficient revenue to cover its variable costs. A firm should shut down if it didn’t make at least enough revenue to meet its variable costs. Because of government restrictions put in place to reduce the spread of COVID-19, whole swathes of the economy need to shutdown.

Many politicians are talking about the bridge to the other side. Unfortunately, many businesses have already decided to shut down. Some did not even engage with the possible support avenues because they knew there was no chance the bank would lend them more money or their landlord cut them some slack on their lease obligations.  

The evidence of this is in the enormous unemployment claim numbers around the world. The queues outside social security offices are happening even in countries where a wage subsidy policy now exists because of COVID-19. I don’t think the blame game is helpful at this point, but some empathy with people who are the collateral damage from the public health actions exists.

The public health crisis itself is playing out differently in each country. It’s not clear yet what the real impact of COVID-19 will be – modelling is uncertain, and each country will have its factors that either make their outcomes worse or better. It is silly to think that the only problem here is the health crisis. The social consequences of a 2nd Great Depression due to the sudden stop of economic activity will be just as awful for the world.

A simple thought experiment can help us understand the likely decisions of business owners. If revenue has gone to zero, for an unknown period, there are several ways to pay costs that are still being incurred by the business. It can use its cash reserves, borrow more from the bank, raise more equity from shareholders or use government support packages.

Every business owner will know what their break-even point is. They will also be acutely aware of their ability to support the business. If they have a year’s worth of bills in the business cheque account, this isn’t an issue for them. They will be fine, assuming there is a resumption of regular economic activity on the other side of the bridge.

However, if they are already running a low cash balance or using debt to meet operating expenses, they will not be able to proceed with zero revenue for longer than a month or two. Putting businesses into hibernation doesn’t work because every contractual arrangement they have entered into has to be put into hibernation on reasonable terms at the same time.

The recent drop in asset prices due to uncertainty around COVID-19 impacts and already recognised economic losses such as travel and hospitality shutting down, mean that the fair value of any small business is lower. There are unlikely to be any buyers at present. Incurring too much debt through a crisis impairs the value of the company on the other side.

This reality is affecting large businesses too. Unlike the public sector, a private company can hit “hard limits” of what is possible. Resource constraints exist,  their bank will tell them they can’t borrow more, and the government will restrict their operations. Their employees may choose to quit instead of coming into work and being put at risk. Their landlord will refuse to cut a deal on rent.

This health crisis is a society-wide coordination problem. Without the government imposing a lockdown on all, the decentralised decision-making of many actors leads to businesses putting people at risk because other companies in their industry are still operating, so they feel like they have to as well.  It’s crazy.

One of the issues with specific bailouts is that at this stage of the collapse, it’s likely putting good money after bad. Equity owners and debt owners receive a risk premium to incur risk. If every time a crisis occurs, they get bailed out, with no consequences, the people don’t like it.

The irony is that if people thought the response of populism to the Global Financial Crisis and its fallout was terrible, just wait until the second wave of populism and nationalism arrives after a global pandemic accelerated by the free movement of people and goods across borders.

It will be even worse when banks and large corporations get bailouts when at the same time, many households can’t access welfare. The losses will be borne by those who are unable to negotiate their bailouts with their creditors and landlords because they don’t owe them enough. Because of the uncertainty, many businesses will merely shut down because their balance sheets can’t sustain six months of no revenue.

The government is trying its best under considerable uncertainty. The lesson of this particular crisis so far is that looking to the government for financial support in an emergency is a dangerous path to take. On the other side of the bridge, expect a lot of debt aversion and laser focus on lean operating models where only the critical expenditures to deliver value to customers happen.

The current operating model for many businesses has grown over time to include a lot of unnecessary expenditure. There will be a focus on crucial value streams – what is the bare minimum required to deliver an excellent experience for customers? Product and service catalogues will need to be simplified. Entire categories will disappear because they will seem frivolous in more austere times.

Many firms are already replaying their GFC playbook. This playbook means cancelling projects, standing down staff, offboarding contractors and consultants, and eliminating discretionary spending wherever they can.

Unfortunately, this is the last thing the economy needs. When businesses tighten their belts, the drop in demand from public health restrictions accelerates further. The carnage from further reductions in economic activity will be just as awful as the health crisis happening in the hospitals.

A pandemic of this nature is going to change our way of life for decades to come. The health and economic scarring will be worse than the Great Depression because other than those directly impacted by the GFC, many in the developed countries have not known adversity on this scale their entire lives.

Hopefully, random acts of kindness and humanitarian response from governments to help their people in crisis can prevent a complete collapse of social order. This COVID-19 pandemic is a crisis on many fronts, and the worse the health crisis becomes, the worse everything else becomes. The other side of the bridge mightn’t be one we want to cross in the end.

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The Industry Composition Changes From COVID-19 Fallout

The industry composition changes from the COVID-19 fallout will be enormous. The firms with the most robust operating models that deliver value without people needing to leave their homes will emerge in a dominant position. The firms that rely on in-person service delivery will struggle to rebuild their revenue once social distancing becomes a new way of life. The impact on households will be dark as many stores closing now will never reopen.

The rapid spread of COVID-19 and the accompanying public health restrictions have caused millions of job losses globally. The speed of the economic collapse of the entire industry sectors of tourism, air travel, retail, hospitality and personal services is unprecedented. Different countries have responded with varying policy responses to slow the spread of the virus.

Some have focused on the banks and business. Others have focused on jobs and wage subsidies. Some have tried to balance a mixture of support across the economy. This human tragedy is a real-time policy experiment across countries where everyone can see the different outcomes of different ideological belief systems.

We are dealing with both a health and an economic crisis. It is juvenile to ignore that there are tradeoffs governments are making, whether we agree with them or not. There is some modelling behind their decisions to move from one level of restrictions to a higher level. One of the things politicians are responsible for is making the calls based on the advice they receive. That’s part of what modern Westminister democracy entails – outsourcing political judgment to politicians, supported by the public service.

One concerning aspect of the policy response so far is that the crisis has highlighted the weaknesses of many existing business models. Typically, a recession would lead to those businesses closing down as part of the normal business cycle of creative destruction. In this case, a rapid collapse in economic activity in some cases because of government decisions means that many businesses are closing well ahead of where they would have failed in the next economic downturn.

The rational response of many boards and senior executives has been to lobby the government to secure an industry-specific support or bailout package. Small businesses don’t have that option. The support offered to banks to extend lending terms or provide low-interest bridging finance for an indeterminate period looks good at first blush but doesn’t pass the real-world test.

The reason why many businesses won’t take on additional debt in a time of high uncertainty is that if their revenue has gone to zero, they are still incurring fixed costs. They will try and reduce as many of those fixed costs as possible, and may not have the cash to be able to top up wages for a wage subsidy or even let people take annual leave or sick leave for a month.

Hence, many layoffs and redundancies have happened already irrespective of whatever policy response the government has deployed. The likely announcement of a wage subsidy in Australia today is too late for all the people already lining up at Centrelink. In New Zealand, every second day, MBIE announces little tweaks to the wage subsidy in perhaps the best example of iterative policy implementation in the country’s history.

When it comes to identifying industry composition changes from COVID-19, strong balance sheets are a crucial factor. In the hospitality sector, a clearout of small businesses is likely, leaving many countries with national chains and franchises the last ones standing on the other side of the bridge. Unless retail landlords give rent holidays, lots of cafes, bars and restaurants will have no choice but to close down. Given that very few own their premises, the prospects for independently owned hospitality operators is bleak.

Because of the uncertainty of the COVID-19 pandemic, it’s unlikely many small business owners will take on more debt other than out of pure desperation. If you trace back the impact of zero revenue and work backwards to who loses, generally it is property owners and the banks. Their tenants may default, and their borrowers may default. This reality is how a health crisis becomes a financial crisis.

There are now three crises – health, economic, financial. All three are interlinked, but the primary focus of many governments has been the economic and financial crisis. The health crisis has had far less government money directed to it. There will be real-world consequences from this approach.

For example, the purchase of residential mortgage-backed securities by the central bank is a significant change in the expected behaviour of a central bank. If the central bank is becoming the entity holding the credit risk hot potato, what is the point of the banking sector? What was the justification of the enormous investment in higher regulatory standards since the Global Financial Crisis if a stress event of 1 month changes everything?

The US Federal Reserve mainly spent a decade doing and then trying to rewind quantitative easing. Now it is going full speed on quantitative easing again. How can you price risk responsibly in such an environment? There are enormous problems that will stem from the panicked responses to this crisis. Those who most need a bailout don’t have a hope of getting nearly as much as they may require through no fault of their own.

The impact of COVID-19 on the retail sector is another one to watch. With physical retail stores closed, and staff stood down, how likely is it that firms will reopen them on the other side of the bridge? Already, retail in Australia was struggling. Many firms will use this crisis as an opportunity to accelerate plans to reduce store numbers and increase online shopping share of their revenue.

Some will use the crisis to close underperforming brands or chains and exit onerous lease obligations wherever they can. The face of retail will never be the same again. The impact on major landlords such as shopping centres will be grave. In the USA, commercial mortgage-backed securities could be in deep trouble. How many rent payments will they receive on April 1? Many retail chains there have told their landlords they would not pay the rent for the duration of this crisis.

The most challenging impact so far is the people who have already lost work because of this crisis. Recessions are particularly brutal because a proportion of people who become unemployed in downturns never work again.

Many parts of the economy will “bounce back” from this crisis. However, lots of people will lose their lives due to COVID-19 complications, and many will have ongoing issues like lung scarring and respiratory problems. The human cost will be enormous, and the overall human tragedy will be higher if the economic situation keeps accelerating towards a global Great Depression.

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We Will Judge Businesses – ESG Risk And COVID-19

The rapidly escalating COVID-19 global pandemic is causing enormous pain for people affected by its spread. The rising death toll and number of cases around the world is growing exponentially, just as experts predicted it would earlier in the year. The different response of many countries is a real-time experiment with people’s lives. There couldn’t be a more tragic way for 2020 to have turned out so far.

We will judge businesses and their response to COVID-19. The good ones are doing what they can to do right by their customers, their employees, their suppliers and their communities. The not-so-good ones are using a public health crisis as a lobbying opportunity for industry-specific bailouts and carveouts that protect executive compensation in a time of mass layoffs. Many boards and senior executives still haven’t learned the lessons from the Global Financial Crisis – your social license to operate can be revoked at any time in this new political climate if you act up.

One of the lessons of the past few weeks is that many well-managed businesses have been able to deal with this crisis as good corporate citizens. They had strong balance sheets, clear business continuity plans invoked, and the right attitude towards their stakeholders. These businesses operated in industries where their margins enable them to invest in preparedness and do the type of work where they can send their staff to work from home with no issue.

Small businesses are in a completely different situation. Already, non-compliance with regulation and community norms is an issue for small businesses. They are likely to be under-capitalised, trading on modest margins in highly competitive industries and aren’t going to have the balance sheet to “get to the other side of the bridge”.

Many small business owners will have looked at proposed support from their bank and wondered how on earth that helps them make lease payments and pay trade creditors. Many will have realised they can’t even last a month without revenue, and the rational course of action is to layoff their staff and close the business down.

Larger businesses not big enough to land a bailout will have moved fast to plan and execute redundancies and stand-downs. This fast decision making is because their cash flow pressures mean they can’t even wait a week because of how fragile their business model is to adverse external shocks.

There is a real-time example in New Zealand: Air New Zealand was able to secure a government loan with associated conditions, still stood down most of its people. Virgin Australia was not able to obtain any support, so is now consulting on closing its entire New Zealand operation.

There are many arguments from both sides – letting businesses close down isn’t the end of the world as long as there are strong social security supports for the people impacted. Because of the speed at which this crisis has developed, the welfare system in many countries is being overwhelmed. Lots of business owners have realised the uncertainty ahead and just pulled the trigger, likely without advice or engaging with any potential support avenues.

We will judge businesses by how they respond to this crisis. Already, some major corporations have shown their true colours and gone back on all of the ESG statements and claims they have made over the past few years. By re-running previous crisis playbooks, they are unlikely to have the goodwill of their stakeholders on the other side of the bridge. It’s already a difficult enough time for the world – doing the right thing is seemingly too hard for many. It’s great to see some businesses stepping up responsibly, they’re the ones who’ll survive.

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The COVID-19 Economic Depression

The pace at which the COVID-19 pandemic is spreading is exponential. This crisis is the greatest challenge faced since the end of World War 1. It is bigger than the Great Depression and the Global Financial Crisis. It is the COVID-19 economic depression.

The difference between a recession and a depression is that a recession is part of the business cycle. It will last a couple of months, perhaps even a year, but there is a view to the other side, and through belt-tightening and some restructuring here and there, most firms can make it to the other side.

An economic depression because of COVID-19 is very different. The scale of the shock to both the demand and supply side of the economy is enormous. There is a massive labour supply shock to the downside as well. The entire economy is facing considerable changes in demand and supply chain reliability in an unprecedented fashion.

When the public health advice and evidence so far is that reducing the growth rate of infection requires complete lockdown, the cost/benefit analysis becomes apparent at a high-level. If the number of those infections is in the millions and the potential death rate is in the hundreds of thousands, then spending tens of billions to avoid that outcome is worth it.

In Australia today, the queues around Centrelink offices show how rapidly the private sector has responded to the uncertainty. It doesn’t matter what support the government offered up to businesses – many made rational decisions when faced with zero revenue for an indeterminate period and laid people off immediately. Most of those business owners will be ruined financially within weeks just the same as their laid-off workers.

Because of the increase of casualisation and part-time work, many who have lost their job had no opportunity to build up an emergency fund. They are unlikely to have a cash cushion to survive this uncertainty because they never had enough hours of work in the first place.

The situation of anyone on a temporary visa is particularly dark. This fact will slowly become a humanitarian crisis for governments around the world – how do you respond when many can’t return home given travel bans and extortionate airfares? The response will be telling. This situation could break globalisation and free movement of people across borders for a generation.

The behaviour of many people over the past few weeks with their hoarding behaviour may be rational at an individual level but has caused new panic and hysteria that means strict law and order enforcement is the only path forward.

The Anglo countries, in particular, have many cultural traits that mean responding correctly to this sort of crisis is very difficult. In essence, the Bondi Beach crowds on the weekend mindlessly going about their weekend business without a care in the world about social distancing are a prime example of this individualist streak.

In regular times, these traits are a strength. When a pandemic with no vaccine is growing exponentially, they are deadly. There’s no surprise that Spring Break crowds in Miami were behaving similarly to Britons going out to pubs and Australians just going to the beach as usual. It’s the common law vs civil law difference.

The COVID-19 economic depression is moving so fast that following the public health guidelines and practising self-isolation for you and your family right now is the most practical and rational thing you could do. This suggestion applies even if your particular government hasn’t moved to a lockdown yet.

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The Economic Impact of COVID-19 On Australia And New Zealand

The economic impact of the COVID-19 pandemic on Australia and New Zealand is going to be enormous. The governments of both countries have already announced substantial support packages, the central banks are easing monetary policy on a vast scale, and the private sector has begun to make enormous changes in how they do business.

The scale of the impact from a public health perspective is enormous. Everyone apart from essential workers self-isolating is going to happen within weeks. Many experts suggest it should already be in place, and some businesses able to offer working from home have already embraced it. For businesses, this is a massive health and safety issue. Your people should not come into the office unless they have to.

For frontline workers, enormous focus on deep cleaning and provision of appropriate safety equipment is the bare minimum you should be providing. If a business is making no revenue, it needs to cut its costs. It no longer matters if there are contracts involved. Fixed expenses will go down.

The advice from public health officials is always changing. However, the impact of social distancing and self-isolation means that the hospitality and tourism sectors are now over. For the duration of these restrictions industries in deep trouble include aviation, most non-essential retail, and any discretionary or entertainment spending.

What this crisis and the response is highlighting is the fragility of the current economic order. Casual workers, households and small businesses are now the unprepared shock absorbers of risk in the system. The rapid deterioration in asset prices around the world represents a rational reaction to uncertainty over what the present value of those future cash flows is under these economic circumstances.

However, asset prices going up or down doesn’t help households paying bills. The inflexibility of many contracts entered into by businesses or families will accelerate the economic fire we are experiencing. The relevant public health requirement of social distancing flies in the face of economic reality for many households. They simply cannot afford not to work, and their small business cannot afford to operate with $0 in revenue.

There are many ESG risks for firms here. How do they treat their employees? How do they treat their customers? How do they treat their suppliers? Doing the right thing is more important than ever. The behaviour of firms throughout this process will be under the microscope, and any poor decisions will be franchise destroying. All of the goodwill built up inside a brand or reputation can be damaged by making silly decisions like making people come into the office when they can work remotely.

The operating model impacts will be severe. Because of the fragility of many value chains, the reliance on outsourcing, and lack of investment in technology over many years, the inability of some firms to deliver on their contractual commitments after they implement their business continuity plans will become glaringly obvious.

Some companies are doing the right thing: everyone who can work from home already is, flexibility with customers and suppliers, and customers treated properly with credits or waivers offered due to radically changed circumstances.

Some companies are not doing the right thing: lobbying for taxpayer money when there are higher priorities, worrying about their particular industry when this is a societal issue, or treating the parties they have contractual relationships with inflexibly.

Boards and senior executives will need to think very carefully about the impact of their decisions on their communities. Their customers and employees aren’t silly – they know the implications are likely to be negative.

If there are six months of drastically lower economic activity, protecting essential capabilities ability to deliver key value streams on the other side of the slow down is an important consideration. For example, airlines need to preserve some ability to operate domestic flights and cargo freight.

The overall economic impact will be much higher than 10% of GDP. Unemployment will be more than 10% in Australia and New Zealand within months. Underemployment will be even worse because of the number of casuals now out of work and part-time workers who will never get more hours under these circumstances and could also have to take leave without pay to keep their jobs.

The unfortunate economic response from governments so far has been very much about business. This focus underestimates the economic impact of this crisis. The real issue is people being able to pay their bills. If hundreds of thousands of companies go to the wall, asset owners and lenders should be taking a hit. This reality means commercial landlords being flexible with their tenants and banks bending over backwards for their business and institutional customers will be necessary.

The pace of this economic slowdown is so fast that attempts to use fiscal and monetary stimulus during the midst of a public health crisis simply won’t be fast enough. The impact on people’s wellbeing will be devastating.

If you thought that the Great Depression-era generation had unusual attitudes about many things, the scars from the economic side of this crisis alone would last decades. Let alone the enormous changes in societal behaviour that will be required to flatten the curve.