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.