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Jeff Meli Christian Keller

Episode 26

Jeff Meli in conversation with Christian Keller

Navigating the virus economy: How much will COVID-19 change the global economy?

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COVID-19 has wreaked havoc on the global economy over the past several months, drastically disrupting systems and societies. So what will the post-COVID-19 world look like for people, businesses and governments? Some existing trends have been accelerated by the pandemic, while new trends entirely have emerged that could permanently re-shape the “new normal” over the medium to long term.

The latest episode of The Flip Side’s Navigating the virus economy miniseries highlighting the effect of COVID-19 on businesses and markets features Global Head of Research Jeff Meli and Global Head of Economics Research Christian Keller. They debate the longer term, lasting effects of the pandemic on the global economy – from de-globalisation, to mobility and agglomeration and the rising dominance of market power in some industries.

  • Jeff Meli:              Welcome to this episode of The Flip Side. I'm Jeff Meli, the Global Head of Research are Barclays. I'm joined today by Christian Keller, our Global Head of Economics. Thanks for joining me, Christian.

    Christian Keller:   Thanks for having me.

    Jeff Meli:              Today, we're going to conclude our series on the economic and market implications of COVID-19. In prior episodes we focused on short-term issues like the shape of the recovery or the effectiveness of fiscal policy. Today we're going to talk about the potential for long-term, lasting change to the global economy as a result of COVID-19.

    Christian Keller:   Indeed. I think COVID-19 is very likely to cause the deepest global recession since the Second World War, and it's such a tremendous shock really that I think it has a real potential for long-lasting change.

    Jeff Meli:              Well, Christian, it is a large shock, but I also expect it to be a short-lived one. In fact, we're already seeing the beginning of the recovery. For example, we've had two months in a row of strong jobs gains in the U.S., despite resurgence of the virus in parts of the country.

                                  I think that the main economic effects will be to accelerate some preexisting trends. COVID-19 will be like gas on a fire, and specifically I think it's going to accelerate a trend towards de-globalization where production is increasingly onshored in developed markets, and it will accelerate the trend of rising market power where the largest firms in our economy have an increased market share.

    Christian Keller:   I think your predictions may actually not be bold enough. I think it's bigger than that. I think the COVID crisis will do more than just accelerate existing trends. I think if you look at some of the developments in spatial (acceleration), including the growth of megacities and the ever fast and easier frictionless movement of people rather than goods, I think these are trends that survived many shocks in the past, including the global financial crisis and the recent trade tensions, and if true, a change of these could really have major implications for productivity, growth, inequality, et cetera.

    Jeff Meli:              All right, well, let's start with some of the existing trends that I think are going to accelerate, and de-globalizaiton is an obvious one to me. So starting in the early 1990s we had a boom in global trade. Exports as a percent of global GDP rose sharply for two decades and reached historic highs.

                                  Then around the financial crisis, this process seemed to plateau, and some of that was due to economics. Like, for example, the benefit of offshoring activity would have gone down as wages and emerging markets started to go up, just as emerging markets benefited from all of this activity. Second, the cost of producing onshore started to fall as automation improved and domestic manufacturing costs fell.

    Christian Keller:   Yes, the global financial crisis played a role here in two ways. One, it was a massive recession and, therefore, shock to global trade, but it also highlighted the distribution consequences of ever increasing trade and in particular the inclusion of this vast Chinese labor force into the – into the global market.

    Jeff Meli:              Yes, it's true. The theory that trade improves welfare in aggregate probably played out, but it also created winners and losers to a greater extent than economists were anticipating, and I think that led to some skepticism, particularly in developed markets, for policies that encouraged ever greater efficiency through offshoring. And then you couple that with the rise of China, which became a political and at times even a national security issues particularly for the U.S.

    Christian Keller:   So putting it all together, it was an organic slow down in the pace of the globalization, and then we had the dramatic rise in trade tensions with China in part due to the concerns you just mentioned. So terrorism, Chinese goods, and non-tariff barriers went up, and (that we led) to a reduced U.S.-China trade, but also it led to a diversion of trade very much along the lines what you would expect from trade theory. So some of the goods that were previously traded between the U.S. and China and still traded but they're often traded now through other countries and with other countries.

                                  And what we've seen already is that some of the FDI flows actually following the same pattern going to destinations outside of China through other locations emerging Asia where they would not be affected by U.S. trade barriers.

    Jeff Meli:              And now comes along the pandemic, and I think the result of that will be an acceleration towards on shoring where the U.S. and other developed economies bring production back home.

                                  So first of all, the COVID-induced lockdowns caused disruptions with factories and transportation hubs. It showed how vulnerable global supply chains are to production disruptions anywhere along the chain. It also showed how reliant we were on seamless transportation of goods for sort of just-in-time production.

                                  I think COVID also revealed just how central China had become in many of these global supply chains. In many cases, it was the sole supplier of goods including in areas like technology or healthcare which were of preeminent importance. I think that the geopolitical tensions with China are only going to increase from here, and re-shoring production into the developed markets not only makes your supply chain pandemic proof, but it also makes it less exposed to geopolitical risk, and both of those issues are now much more front of mind than they have been at any other point in the past.

    Christian Keller:   I think the re-shoring argument sounds plausible in principle. However, if you look at it in practice a reversal of these global supply chains may really be easier said than done as some of our equity colleagues put it in their recent paper. The cost implications and the related margin losses for companies will really be immense.

                                  So maybe rather than re-shoring what we see more immediately will be attempts to diversify supply chains away from China to other emerging market economics, in particular in Asia. That's a lot easier. It should preserve the benefits of margins that these companies gained over the decades of building these supply chains. And then as technology improves, at that point we could see increased on shoring as a viable alternative. And so, it's something that would probably happen over time, but I don't necessarily see it as an immediate consequence of the COVID experience.

    Jeff Meli:              Costs and margins, those are economic arguments. I think that we're at risk here of underestimating the political forces at play. I think the governments of the big developed markets are acutely aware of the national security and IP risks associated with all of the globalization that has happened and the movement of supply chains over seas.

                                  And you can see their awareness of this issue and attempt to rectify it even in the fiscal policy response to COVID-19. There is a number of government initiatives designed to try to incentivize companies to bring some of this activity back on shore. We've seen that in the U.S., in Japan and Europe. Whether it's tax benefits or procurement policies, I think that there's a political dimension here that we need to be aware of.

    Christian Keller:   That's a fair point. Sure, I think political pressure will play an important role, but I think it will make the difference in specific sectors, those that are very important from an intellectual property perspective, and of course also in the health sector, but again, (inaudible) some of the political concerns.

                                  For example, the U.S. administration is at the moment trying to create networks, commercial networks of trusted partners as they call it, and that seems to be a step into that direction, whereby one tries to establish a more diversified and better controllable supply chain rather than really (fasting forward) directly into reshoring the activity at any cost.

    Jeff Meli:              Now, let's move on to market power. Now, the U.S. has experienced an increase in industrial concentration over the past 20 years. Basically, the largest companies increasingly have a higher and higher market share. Now, in the pandemic, these large companies are the best positioned to withstand the economic shock.

                                  They have the most financial resources. They have the best access to credit so you could look at the record issuance in the U.S. investment grade bond market as proof positive of the biggest company's' ability to access financing even during the most severe disruptions. These companies also have the best access to facilities put in place by central banks.

    Christian Keller:   Yes, I can see why you would say that market power for the largest companies could increase. And if left unaddressed that could be maybe one of the major implications of the pandemic. But I would say that policy makers were quite aware of the issue. And if you see how they responded to COVID, in particular, fiscal policy, they actually made significant efforts to alleviate some of those financial pressures from small and medium businesses.

                                  If you look at the U.S. Paycheck Protection Program, for example, but there are very similar programs also in the U.K. and Europe, they all address really two (words), small and medium businesses. So if they work and they can be sustained long enough, I think at least the financial damage of these parts of corporate can be kept less severe than they otherwise would be.

    Jeff Meli:              I'll admit that policy makers made an effort on this front. I'm just not that convinced that it's going to work. So, let's look at e-commerce as an example. It was growing as a share of overall commerce for many years. But there's been a massive shift forced by COVID-19 where you literally couldn't go into a store; you had to do your shopping online, and that plays directly into the hands of the sort of digital platforms.

                                  They tend to be winner-take-all industrial organizations, meaning that there's one or two big platforms that sort of dominate a space. And as you force people to use those platforms they naturally are aggregating more and more of their activity in a very small number of companies. This increased digitalization plays right into the hands of the biggest tech companies which have been some of the companies that have benefitted the most from increasing market share being aggregated by certain dominant firms.

    Christian Keller:   Again, yes, that sounds sensible. I think as I said it may know the likely policy response. If you think of the large tech firms in particular in the U.S. there has already been a rising skepticism and I think that happened already independent of the pandemic.

                                  And I would say that as a result of COVID-19, it may even grow. And while Europe continues to take steps to (inaudible) power of these companies U.S. has now also become more active. So interestingly concerns are rising from both side of the political aisle on exactly that issue.

    Jeff Meli:              You might be more optimistic than I am, Christian, regarding the effectiveness of regulation. But regardless, what we're talking about here still is the pandemic accelerating existing trends. We haven't talked about anything genuinely new.

    Christian Keller:   Exactly. Let's get to some of the things which I think could be truly new changes as a result of the COVID pandemic. And I think those would be in the area of international movement of people and the space of concentration of people and production.

                                  We have seen these trends uninterrupted over the past decades and often actually accelerating over the past decade. If you look at international air travel, tourism, foreign education and migrant labor, in parallel we've seen urbanization most notably the growth of megacities also continuing despite the fact that we had delocalization trends in other areas.

                                  So, if COVID-19 which is obviously a respiratory infectious disease create a fundamental we think of the risk of living together closely, frictionless traveling across continents and living in dense populated areas. That could really reshape how the global economy works and how it's been developed over a long time.

    Jeff Meli:              Yes, I'm skeptical in the middle of a crisis to make predictions that involve such fundamental change. I think we have a risk of assuming permanency of some of the changes that we're experiencing right now even though that extrapolation may end up being inappropriate once we have some semblance of a return to normalcy.

                                  So, I think looking at an example of that around 9/11 where in New York a lot of people thought we wouldn't continue to live and work in big high rise buildings but you look at the Manhattan Skyline now 20 years later and it looks the same, in fact if anything there is even more density and high rises than there were then.

                                  So, I think fast forward six, nine months from now we have some advances on the medical front either in therapeutics or a vaccine or both I think that a lot of what you're talking about travel, city life, moving from city to city will just sort of naturally – maybe slowly but naturally return back to pre-COVID normal.

    Christian Keller:   Well, we'll have to see. I mean, remember after 9/11 we may not have abandoned living in high rises but the security changes on air travel they were permanent. And my impression is that if you have such an extra ordinary experience on such a global scale really unprecedented like the crisis we have now I think it could leave a lasting impression.

                                  And if people from here view that this type of disease or epidemic is a more permanent threat even after we may have a vaccine or any other medical solution to the current COVID strain.

                                  I think they may more permanently value the trade off between living in densely populated urban areas between frequent international air travel and being less mobile and living in less densely populated areas. They will weigh these advantages and disadvantages in a different way.

    Jeff Meli:              I will admit that four months into working from home that the idea of getting on a crowded subway during rush hour comes with a fair bit of anxiety.

    Christian Keller:   Yes. And even relatively small changes in attitude they could have a significant impact on certain sectors on tight economies. For example, travel and tourism has grown over the decades to about 10 percent of global GDP now. In some countries actually for them the share is much higher; they really highly depend on it.

    Jeff Meli:              Yes, it's interesting because a lot of that growth in tourism was from China, so much so that China's current account was neutral despite its large trade balances. That's like a sense of how much money Chinese tourists were spending abroad.

    Christian Keller:   Exactly. That's tourism. And then about 5 percent of the global workforce are migrant workers, who move back and forth between the host and some of the home countries, and they pay – or they submit high remittances. So these remittances are important.

                                  The service sectors in advanced economies become very reliant on frequent international travel for their staff and their clients – financial services, business consulting, high education. So we can clearly see this in the very high share of international flights and cities and countries that have extensive service sectors in this area – London, Hong Kong, Singapore, et cetera.

    Jeff Meli:              You know, Christian, it's exactly because unwinding all of this would be so costly – is why I'm skeptical that it would actually happen. I think it's akin to your supply chain critiques, so the cost of reversing these trends are so high that I think it will prove more difficult than people are forecasting.

                                  So like you said, urbanization, that's a trend that we've been experiencing sort of uninterrupted, you said for decades. I think you could argue it's been happening since the Industrial Revolution. Now, economic theory supports this. We have real benefits from increased agglomeration. You've got knowledge spillover in areas like Silicon Valley, Wall Street, Route 128.

                                  Those concentrated areas of specialization happened for a reason. Agglomeration is a huge stimulate for productivity and with it growth. So I mean as an example, a lot of people have been focusing on income inequality.

                                  You could attribute a large fraction of the increase in inequality in the U.S to regional differences in productivities where the megacities have the highest productivity and the highest wages and they sort of leave the rest of the country behind.

    Christian Keller:   Yes, so economic theory very well explains the reasons for agglomeration, but it always also acknowledge the disadvantages. So congestion, long waiting times, high housing cost, severe pollutions, these tradeoffs always existed. What I'm saying is that a new permanent concern now about health epidemics could now tip the balance.

                                  So the risks we have perceived that we associate with crowding, mass transport, the inability to maintain social distance could become permanently higher. At the same time, we now have the experience of using digital services due to, for example, like remote working during the recent lockdowns.

                                  These services existed before, but we never used them so extensively, and so now we may have perceived the losses of not meeting face to face with people as a lot less. So for example, it is estimated that 30, 40 percent of jobs in the U.S could be done plausibly from home. So far we haven't really tried that out, but we may in the future.

    Jeff Meli:              You know, I remain skeptical regarding the ability to replace face-to-face human connectivity with remote working platforms. So sure many jobs could plausibly be performed from home, but that doesn't mean it's the same thing as doing it really well from an office where you can interact with people.

                                  So as an example, it's relatively easy to collaborate over a short or medium term digitally with people you've worked together in person with for many years. I think it's a totally different thing to say I'm going to establish new relationships and trust through these remote communication channels.

                                  I'd also point out you can't schedule serendipity, so random meetings at cafés or in bars or at the cafeteria at work where you have discussions that spark new ideas or new ways of thinking about things, you can't Zoom schedule that kind of interaction.

    Christian Keller:   Yes, but we may not need a radical shift or a complete reversal of past trends. Small shifts could already have significant implications. For example, rather than fully undoing decades of urbanization, which is very unlikely, we could see a shift towards smaller, less-densely populated second-tier cities, more urban sprawl.

                                  If you look at most recent search behavior from some property website, state agents, et cetera, they show some evidence of people no longer looking for city centers but for the outskirts. And this is against projections that megacities, on most of those projections, are going to increase in number over the next decades, and that may not happen.

    Jeff Meli:              Yes.

    Christian Keller:   I also think we'll have less travel and less interpersonal interaction and more digital interaction.

    Jeff Meli:              You know, that's definitely the case that the suburbs in New York City have gotten a boost as a result of the COVID experience, and maybe the tradeoff that you're talking about Christian is inevitable. Maybe workers will demand it even if companies don't necessarily see the benefits of dispersed employees. It could be that their employees will force the issue, but I still think it comes at a cost to productivity and with it I think a decline in potential growth.

                                  I'd also say there are some distributional issues that we have to consider. So big megacities have high paid knowledge jobs like Silicon Valley and Wall Street, but they also support a lot of service's jobs, so your consumption pattern's living in a big city are a lot different and might throw off a lot more economic activity.

                                  So when you live in a big city, you eat out more. You use ride hailing or taxi services more. You consume more culture and more arts, and I'd worry really that the scenario you're painting is actually kind of a bleak one for a lot of residents of the cities who aren't lucky enough to work in the jobs that are quote, unquote "plausible to do from home."

    Christian Keller:   That's a concern I share. These new special economics could be accompanied not only by working from home arrangements, which nicely suit high-skilled workers, but they also could bring further automation efforts especially in areas where usually lower-skilled people are deployed in the – employed in the service sector.

                                  And over the past few years, we already saw that hotels and catering industries have started to outsource some of the human duties to so-called collaborative service robots. But so far, this has been driven mainly by cost efficiency considerations.

                                  Now if you move into a world where we have more concern about hygiene, social distance, automation in that part of the service industry could be really – receive a big boost and obviously with the related pressure on low skilled jobs.

    Jeff Meli:              Yes, so that new trend that you're talking about could just be another factor that drives widening gaps between labor and capital, higher and lower-skilled workers, benefits the winner-take-all companies over the rest of the companies in the economy, and probably actually benefits advanced developed markets over emerging markets.

                                  All of that would be good topics for future episodes of the Flip Side. Thanks for joining me, Christian. Clients of Barclay's can read about our analysis of the long-term implications of COVID-19 for the global economy in the 65th Edition of the Equity Gilt Study available now on Barclays Live.

     

Authorised clients of Barclays Investment Bank can log in to access related reports on Barclays Live:

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Research

NEWS

2020 Equity Gilt Study: Putting the post-COVID world in context 

Now available for clients of Barclays Investment Bank, the 2020 Equity Gilt Study explores how the global economy’s status quo is shifting when it comes to five macroeconomic trends.

The Flip Side

Episode 23: Navigating the virus economy: Will the global recovery be a quick bounce or slow grind? 

Jeff Meli and Christian Keller debate about how long it may take for government interventions to be effective in restarting the global economic engine.

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About the analysts

Jeff Meli is Global Head of Research within the Investment Bank at Barclays. Jeff joined Barclays in 2005 as Head of US Credit Strategy Research. He later became Head of Credit Research. He was most recently Co-Head of FICC Research and Co-Head of Research before being named Global Head of Research. Previously, he worked at Deutsche Bank and JP Morgan, with a focus on structured credit. Jeff has a PhD in Finance from the University of Chicago and an AB in Mathematics from Princeton.

 

Christian Keller is Global Head of Economics Research at Barclays, leading a team covering both developed and emerging markets. Christian is based in London and joined Barclays in 2007 from the International Monetary Fund (IMF), where he had worked since 1999. Based at the IMF headquarters in Washington DC, Christian worked on IMF programs with emerging market economies in Europe, Latin America, and Asia and served as the IMF’s Resident Representative in Turkey from 2005 to 2007. Christian graduated with a PhD in Economics from University of Köln, Germany, and holds a joined-MA in Economics and Finance from University of Köln and HEC, Paris.

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