Epidemics, trade wars, & small economies
David Skilling
19 February 2020
The Coronavirus (Covid-19) has now killed over 2000 people, with over 75,000 confirmed cases reported, almost all of which are in China. More than 150 million people are in lock-down or face travel restrictions in China, many factories and offices remain shut down, airlines have suspended flights to China, and global supply chains are being disrupted. The Chinese economy may contract in Q1 2020.
And yet equity markets have appeared sanguine, reaching new record levels in the US and Europe over the past week (although some doubts seem to be creeping in over the past few days, and bond markets are pricing in more macro risk). This is also largely the case in small advanced economy equity markets, which function as canaries in the mine of the global economy because of their deep exposure to global economic dynamics.
There are perhaps a few reasons for this. Although the infection rates are higher than SARS, the reported mortality rate is lower (at around 2.5% in mainland China, and lower outside China). And although there are cases in Japan and Singapore, as well as some in North America and Europe, so far Coronavirus remains concentrated in Hubei Province in China. Some are interpreting this as similar to a bad flu season on the other side of the world, rather than a meaningful global macro risk. There is also a view that central banks will ride to the rescue with expansionary monetary policy – and governments with fiscal stimulus.
In this view, Coronavirus will be a temporary, relatively limited shock – and there will be a V-shaped recovery, with a strong snap-back once the virus is brought under control. However, my assessment is that the risks are being mis-priced. Indeed, it is striking that the market reaction to this virus is markedly more muted than the reaction to the trade wars in 2018 and 2019, when markets sold off in response to tweets and tariffs.
This different market treatment is odd, given the potential scale of the impact of Coronavirus on the global economy. There were ways around the tariff barriers, such as trade diversion to economies like Vietnam – as well as reshoring. But there are fewer places to hide from a sudden stop in Chinese economic activity, and a widespread set of restrictions on people flows and systemic disruptions to global supply chains. And there is no way of negotiating a truce to an epidemic, as is possible with trade disputes. If markets were concerned about the trade wars, they should be more concerned about the economic impact of Coronavirus.
There are several reasons that much more caution on the outlook is appropriate. First, the data on reported cases of coronavirus infection and mortality are likely understated. China has a record of smoothing out sensitive data series (like GDP), and the reported infection data do not easily fit the pattern of what is expected of a virus with its apparent properties. The change in methodology that increased the reported number of confirmed cases by around 15,000 last week was a step in the right direction, but is unlikely to have resolved this issue.
The long period (~2 weeks) in which infected people can remain without symptoms complicates the identification process, together with constraints on testing in the public health systems in China and elsewhere. Indonesia, for example, has no confirmed cases. As travel restrictions are lifted in China at the end of the extended New Year holiday, there is a material risk of more widespread infections.
Given the significant uncertainty around the data, I take seriously the behaviour of countries like Singapore that have a best-in-class public health system as well as very good information on Coronavirus. Singapore now has over 80 confirmed cases (no deaths) and has acted aggressively with screening, closing many public activities, and public messaging – as well as a stimulatory budget on Tuesday. This reflects an assessment of a serious challenge.
And the second-round effects, discussed in my last note, are likely to be even more severe. Over the next several months (and beyond), the extended disruption of Asian supply chains will have a significant impact on global economic activity, in addition to the direct impact of reduced tourism flows and retail spending. Governments will not be lifting barriers on people flows until they have high confidence that the virus is controlled. This will have a material negative impact on the global economy, given China’s central role in global growth dynamics.
Even in positive scenarios, in which growth in reported cases weakens over the next month, there will be a long tail of infections – which will drag on economic activity through 2020. And there is a meaningful chance that the contagion continues at pace for some time, and spreads into other countries, leading to additional economic costs. This economic headwinds will interact with existing financial and political stresses, such as high levels of debt, already sluggish growth, and geopolitical tensions.
And longer term, this experience is likely to accelerate the development of a more fragmented global economy – with additional policy frictions and barriers to cross-border flows. Firms are already considering restructuring their global footprint to make them more resilient to shocks. This will have a structural effect on the global economic outlook over the next decade and beyond.
So the likelihood of a rapid V-shaped rebound seems unlikely in China and around the world. GDP growth forecasts are being marked down across Asia (Singapore reduced its official GDP growth forecast for 2020 by 1% this week), commodity prices (oil, copper, iron ore) are down on lower demand, corporates are warning on reduced earnings growth, and so on. Government stimulus measures can offset some of these effects, but this offset will be partial.
My assessment is that the direct and indirect economic effects of Coronavirus are likely to be more substantial than the US/China trade wars over the past two years. Small advanced economies, which were not disproportionately impacted by these trade wars because of their competitive position – and because much of the cost was inflicted on the direct protagonists, are exposed to a generalised slowdown in global economic activity (particularly highly sensitive small economies such as Singapore and Sweden). Small economies will need to work hard and creatively to overcome this drag on growth, but many are well placed to do so.
Dr David Skilling
Director, Landfall Strategy Group