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There is now a raging debate about the long-term consequences of the behavioral changes attributable to the virus. Specifically, there is debate about the potential impact on productivity and growth if a large number of people continue to work from home even after the crisis is over. The OECD, which is effectively the club of developed nations, has conducted research on this topic. The economists at the OECD note that, on the one hand, telecommuting “promises to improve work-life balance and may raise worker efficiency and lower costs for office space.” In other words, workers can get more done, in less time, and using fewer physical resources. That sounds like an increase in productivity. On the other hand, the OECD says that the potential impact on productivity remains ambiguous. That is because telecommuting “entails possible adverse effects as it impairs communication, social interactions and may slow down innovation, or may lead to hidden overtime, shifting costs on employees and solitude.” In other words, people need people in order to be innovative. Online technology might not be sufficient to generate the kinds of interactions that engender creativity. Moreover, the OECD says that “the lack of personal interactions can decrease knowledge flows among workers.” It also says that the ability to manage workers is diminished when people are not present.
So, what is the optimal mix of telecommuting and working at an office? The OECD attempts to answer this question by offering guidelines for policymakers. Specifically, it said that, “to minimize the risks of more widespread teleworking harming long-term innovation and decreasing worker well-being, policymakers should assure that teleworking remains a choice and is not ‘overdone’; co-operation among social partners may be key to address concerns.” That said, the OECD also suggested that policymakers can do things to accelerate the productivity gains that come from telecommuting. It said, “To improve the gains from more widespread teleworking for productivity and innovation, policymakers can promote the diffusion of managerial best practices, self-management and ICT skills, investments in home offices, and fast and reliable broadband across the country.”
The OECD notes that, even prior to this crisis, a fairly large number of people were already working remotely. The crisis merely accelerated this trend. It found that, prior to the crisis, the Nordic countries had the highest share of people working remotely, followed by the United States. The countries of southern and central Europe, as well as Germany, were among those least likely to engage in telecommuting. By industry, the highest share of workers engaged in telecommuting were in knowledge-intensive services (such as Deloitte), while the lowest share—not surprisingly—was in manufacturing. Also not surprisingly, those most likely to have engaged in telecommuting were those with the highest level of skill and education. With the virus, however, these patterns have been significantly exacerbated. Surveys indicate that, going forward, many companies expect to keep large numbers of people working remotely even after the crisis ends.
For my part, I was mostly working remotely even before the crisis, not often going to the Deloitte office in Los Angeles. However, I also traveled a lot—clocking roughly 250,000 miles per year in order to meet with colleagues and clients. While telecommuting now enables me to conduct similar meetings, I don’t have the opportunity to chat over coffee or go out for lunch or dinner. It is that informal communication that used to allow me to ask questions, answer questions, engage in banter, and yes, even gossip. Without that, it is more difficult to generate, share, and absorb ideas. It seems to me that, in the future, while telecommuting will surely have a place, in-person interaction will be critically important as well.
Meanwhile, investors are trying to figure out what is happening. The share prices of technology stocks fell sharply last week as some investors took the view that people will soon return to normal behavior as the economy recovers and the virus fades, including more social interaction and less online interaction. Nonetheless, given the uneven recovery of the global economy and the continued suppression of demand for energy, oil prices have fallen sharply on the view that the economy still has some way to go before resumption of normal activity.
The Commodity Futures Trading Commission (CFTC), which is the US government agency responsible for regulating trading of commodities and futures contracts such as derivatives, issued a report that offered a bleak assessment of the future of US finance. The report was prepared by an advisory panel that consisted of major financial institutions that endorsed the report unanimously. Specifically, the CFTC advisory report began by stating the following: “Climate change poses a major risk to the stability of the US financial system and to its ability to sustain the American economy. Climate change is already impacting or is anticipated to impact nearly every facet of the economy, including infrastructure, agriculture, residential and commercial property, as well as human health and labor productivity. Over time, if significant action is not taken to check rising global average temperatures, climate change impacts could impair the productive capacity of the economy and undermine its ability to generate employment, income, and opportunity. Even under optimistic emissions reduction scenarios, the United States, along with countries around the world, will have to continue to cope with some measure of climate change-related impacts.”
The report suggested that climate change could wreak havoc with financial markets by causing “disorderly price adjustment” as well as by disrupting the “proper functioning of the financial system.” Moreover, not only is climate change itself expected to be disruptive, the process of rectifying climate change could also be disruptive. In addition, the report noted that “a major concern for regulators is what we don’t know.” That is, the report noted that we don’t know much about how quickly things will change or what interactions there will be between different types of climate change. It suggested that regulators act decisively to better understand what they face and how to react. It also suggested that financial institutions not only be reactive but proactive. Specifically, it said that “financial innovations, in the form of new financial products, services, and technologies, can help the US economy better manage climate risk and help channel more capital into technologies essential for the transition.” One way to better achieve these goals is to have a robust market for carbon trading in which carbon is priced appropriately. It said that “in the absence of such a price, financial markets will operate sub-optimally, and capital will continue to flow in the wrong direction, rather than toward accelerating the transition to a net-zero emissions economy.”
Finally, the report emphasized the importance of having companies reveal “information on material, climate related financial risks” so that regulators and investors can accurately assess the value of a company’s securities. It also called for other regulatory bodies to incorporate climate risk into their calculus when making regulatory decisions. At a time when the US administration is downplaying and dismissing climate risk, and even attempting to stop pension funds from investing with climate concerns in mind, this report is notable for pushing the US government in a different direction. Interestingly, it reflects a strong consensus among financial institutions, including banks, investment firms, insurance companies, and energy traders, that were part of the advisory panel.
Global investors are evidently optimistic about China. Inbound foreign direct investment was up a strong 18.7% in August versus a year earlier. The government has encouraged this inflow of capital as part of its effort to create a larger and more sophisticated capital base with which to generate future growth. Meanwhile, the government also reported that Chinese banks increased lending by 29% from July to August. Lending to households was up 11% while lending to business was up a stunning 119%. The increasing demand for credit reflects the growing confidence of businesses and households about the state of the Chinese economy. It also reflects the easing of credit conditions by the People’s Bank of China (PBOC), China’s central bank. The PBOC has cut interest rates, reduced bank reserve requirements, and provided direct loans to companies disrupted by the virus. It is likely that the surge in business demand for credit will lead to an acceleration in investment, and possibly an increase in equity and corporate bond issuance. At the same time, the five biggest banks in China report that profits have fallen sharply due to an increase in bad loans.
The surge in credit activity and inbound investment is consistent with measures of real economic activity, which indicate that China is likely in the midst of a V-shaped robust recovery. After falling sharply in the first quarter, real GDP surged in the second quarter and is likely growing at a good pace in the third quarter. However, what is increasingly clear is that much of that growth is driven by government investment in infrastructure and that underlying private sector demand is not commensurately strong. For example, in August, sales of construction excavators were up 51.3% from a year earlier. Sales of heavy trucks, many of which are used for construction, were up 75% versus a year earlier. Meanwhile, some other broader measures were not as impressive. For example, sales of automobiles were up 6%. Also, Premier Li has said in the past that, rather than examine government data on the economy, he prefers such measures as freight rail volume and electricity consumption. Both are doing well, but not stellar. Freight rail volume was up 7.3% in August versus a year earlier, indicating that the economy is operating at a strong pace. Electricity consumption hit a record level in the first days of August. These are good numbers, but not consistent with the numbers that reflect activity in construction. Meanwhile, the government reports that spending at restaurants and hotels remains weak, an indication that the continued fear of the virus is deterring consumers from spending in ways that involve social interaction. Overall, it appears that China is doing better than most other major economies. However, China continues to face risks. These include trade tensions with the United States, weak overseas demand, an increase in the volume of bad debts held by Chinese banks, and weak consumer demand for services.
With the US administration talking about decoupling from China, the risk to China is that its fast-growing technology sector will lose access to critically important inputs, including software and components. Thus, the Chinese government is pushing a strategy known as “dual circulation” that is meant to stimulate the development of domestic technology capabilities. This is seen as a big opportunity for many Chinese companies that hope to participate in the further development of a vertically integrated technology sector for China. Political and business leaders see this as an opportunity to push China to the next level. It is, however, not clear if this shift will enable Chinese technology companies to remain globally competitive if they lack access to foreign technology and research. Rather, it appears that the focus of vertical integration is to be able to serve the massive domestic market should the technology war with the US escalate. Even if Chinese companies can compete globally, this situation could result in two global technology systems that are not necessarily compatible. In recent years, there was a high degree of symbiosis between US and Chinese technology companies. If this link is broken, it could result in a slowdown of the process of innovation. It is reported that Chinese scientists and engineers are worried that a lack of access to Western technology will hold them back, similar to what happened to Soviet scientists during the Cold War.
The issue of technology decoupling has emerged because the United States has sought to limit the ability of Chinese technology companies to participate in the US market. Moreover, it has sought to limit the ability of Chinese companies to gain access to US technology. The Chinese authorities are reported to be considering a so-called nuclear option to deal with this. That is, they are considering restricting US access to Chinese-made pharmaceuticals. US imports of pharma products from China are substantial, with US-based pharma companies having engaged in massive offshoring to China over the past two decades. China is the world’s largest maker of active pharmaceutical ingredients. If it were to restrict such exports to the United States, it could be hugely disruptive to the US health care industry. The idea is that this would only be done if the United States does something to hugely disrupt China’s technology industry.
Meanwhile, both President Trump and his opponent Joe Biden have talked about reducing US dependence on China’s pharma industry, although accomplishing this would likely take a long time. If China undertakes the “nuclear option,” it could spur the United States to take strong steps meant to develop pharmaceutical independence, and it could lead the United States to engage in retaliatory action on other fronts. Thus, there is potential for an even more disruptive trade conflict between the two countries, one in which there might not be any winners. Meanwhile, a lot of pharmaceutical imports to the United States come from India, which relies heavily on China for inputs. If China pulled the plug on supplying India (in order to hurt the United States), there would be a negative impact on India’s large pharmaceutical industry as well.
The value of the US dollar has fallen sharply since the start of the pandemic. Why is this and what are the likely consequences?
First, let’s consider what fuels movements in currency values. All other things being equal, a currency will fall if the country’s interest rates decline relative to those of other countries. That is because lower rates make the currency a less attractive vehicle for holding assets and generating income. In the case of the Unites States, the exceptionally easy monetary policy of the Unites States likely contributed to the drop in the value of the dollar because it implies a prolonged period of exceptionally low borrowing costs. In addition, a currency will fall if a country’s inflation rate is expected to be higher than that of other countries. That is because inflation erodes the value of assets. Again, in the case of the United States, the easy policy by the Fed implies higher future inflation rates. In addition, a currency will generally decline if economic growth is expected to be weaker than in other countries. This is because slower economic growth implies a lower return on assets such as equities. Lower growth also hurts overall investor confidence. In the case of the United States, most economists expect weaker economic growth in the coming year than in Europe, in large part because of the failure to fully suppress the virus. Finally, a currency will often decline in value if investors expect the country to have an unsustainable external deficit. That is, investors expect that a large net deficit will require stronger exports and weaker imports in order to revert to a sustainable level. In the case of the United States, the fraught trading relations with its principal trading partners bodes poorly for a boost to exports. Investor uncertainty about the future of US trading relations has likely suppressed the dollar.
What has been, or will be, the impact of a weaker US dollar? For the trading partners of the United States, a weaker dollar implies a stronger domestic currency. This will be disinflationary, providing central banks more wiggle room to ease monetary policy without generating more inflation. In addition, a stronger currency will mean less competitive exports and more impetus to import goods and services. A stronger currency will mean that overseas assets will be cheaper, possibly generating more outbound investment. A stronger currency also means that commodities priced in dollars, such as oil, will be cheaper. Finally, a stronger euro could boost the global trading role of the euro, thereby hurting the dominant role of the dollar. For the United States, the cheaper dollar will mean stronger exports, weaker import growth, somewhat higher inflation (which is a stated goal of the Federal Reserve), and more inbound investment.
Interestingly, the US dollar has fallen principally against the currencies of other developed countries, such as Japan, the Eurozone, and the United Kingdom. Against major emerging economies, the dollar has increased in value. These include Brazil, Mexico, India, and Russia. Thus, these countries have not benefitted from a falling dollar.
Although the coronavirus was, by far, the biggest event of this year, the result of the US presidential election in November is likely to have a significant impact on the global economy, business environment, and geopolitics in general. The world view of the two candidates could hardly be more different. President Trump espouses a policy of “America First.” Recall that this phrase was the basis of a movement in 1940 to keep the US out of World War Two. The adherents believed that the United States, buffered by two oceans, had no business being involved in the outside world. It opposed alliances, especially those involving military action, and supported restrictions on trade and immigration. This world view ended with the war and a more globalist view informed US policy for the last 75 years, supported by both major parties. Trump has turned the table, endorsing restrictions on trade and immigration, dismissing alliances and treaties, and focusing on a mostly domestic agenda. Biden, in contrast, spent half a century in politics supporting the post-war bipartisan consensus. If Trump is reelected, he will likely continue to see trade as a zero-sum game, will restrict investment from China, will dismiss alliances such as the North Atlantic Treaty Organization and organizations such as the World Trade Organization, and will continue to restrict immigration. This implies more isolation and protectionism for the United States and, potentially, a vacuum in geopolitics that could be filled by other powers, such as China.
If Biden is elected, it is likely that the United States will, in part, return to the old consensus. This will mean a renewal of the Atlantic alliance and a bias toward freer trade, migration, and cross-border investment. It will also likely mean a return of the United States to the World Health Organization, the Trans-Pacific Partnership, the Paris Accords, and the Iran nuclear deal. However, on trade Biden will face obstacles and will have to navigate differences within his own party. In a recent interview, Biden was asked about Trump’s tariffs on China. He replied that he would “re-evaluate the tariffs upon taking office.” His staff then attempted to clarify his statement, evidently fearful that he would not be seen as sufficiently tough on China. Being hard on China is currently popular in the United States, because of both a perception that China’s trade policy has hurt the United States and concerns about human rights issues. Moreover, within the Democratic Party, there is a strong protectionist sentiment among many, especially in the labor union movement as well as among the far left who see freer trade as mainly benefitting big business. Thus, Biden, who’s instinct is likely globalist based on his Senate experience, must avoid being seen as too globalist within his party.
This situation is quite different from the past. Over the past half century, almost every US president was inclined toward freer trade and stronger alliances. Often, they or their parties faced opponents who complained that these policies were damaging to the country. Yet those opponents, upon taking office, usually reverted to globalist policies. For example, Bill Clinton ran against the first President Bush on a relatively protectionist platform, only to push for freer trade once in office. Likewise, Barack Obama ran in 2008 complaining that the second President Bush was too inclined toward free trade, only to push for more free trade himself. This time, a Democrat is running against a decidedly, and historically anomalous, protectionist Republican. He faces an electorate that, according to polls, is strongly suspicious of China but is still supportive of the benefits of trade. Navigating this will be tricky not only during the campaign, but even after becoming president should he win.
Industrial production bounced back strongly in July, rising 8.0% from June, the highest rate of monthly growth on record. Still, output remained 16.1% below a year earlier. The strong monthly increase was driven in large part by the automotive sector that saw output rise 38.5% from June. Other areas of manufacturing were up 9.0%. Clearly, the industrial side of Japan’s economy is recovering, but still has a long way to go to catch up to the pre-crisis level. Meanwhile, retail sales fell 3.3% from June to July after having increased strongly in the previous month. July sales were 2.8% below the level from a year earlier. The monthly decline varied by sector, with sales down 5.2% for general merchandise stores, down 20.9% for apparel stores, and down 2.6% for food and beverage stores. Nonetheless, sales were up 7.8% for motor vehicles.
The overall weakness of retail spending suggests that Japan’s consumer sector is failing to recover, boding poorly for overall economic growth in the current quarter. This follows a very sharp decline in GDP in the previous quarter. An index of consumer confidence fell slightly in August and remains well below the pre-crisis level. Evidently, the consumer economy in Japan is stalling. With Prime Minister Abe retiring, the new prime minister will likely have to focus on stimulating domestic demand.
Retail sales in the Eurozone started to falter in July after having grown in each of the last three months. The European Union (EU) reports that, in July, real (inflation-adjusted) retail sales fell 1.3% from June after having risen 5.3% in the previous month. In addition, real retail sales were up 0.4% from a year earlier. The good news is that the volume of retail spending has returned to the level prior to the crisis. The bad news is that spending stopped growing in the summer. The monthly decline was most pronounced in three categories: clothing stores (down 10.6%), internet shopping (down 7.7%), and computer equipment (down 6.7%). Only a strong increase in spending on automotive fuel prevented a much sharper monthly decline in spending. Real retail sales fell in Germany but increased in Spain and France.
Looking at the change in spending over the past year, it is possible to discern significant trends. For example, real internet spending in July was up 16.0% from a year earlier while real spending at clothing stores fell 25.8% from a year earlier. Thus, it is evident that European shoppers have made a sharp turn toward remote shopping, a trend that was already under way prior to the crisis and has accelerated during the crisis. Also, from a year earlier, spending is up in Germany, the Netherlands, and France but down in Spain, Portugal, and Greece. Thus, it appears that retail spending in northern Europe has recovered more quickly than in southern Europe. This could reflect the fact that the southern European countries suffered more draconian lockdowns early in the crisis. Thus, they have farther to go in order to return to normalcy.
Regarding Spain, it is currently experiencing a surge in the virus which, according to high-frequency data, is suppressing mobility. Thus, it seems likely that retail sales will not have grown in August. Thus, Spain may be hard pressed to have retail sales return to pre-crisis levels. The same could be true of other countries that experience a surge in the virus. The only other European country that is currently seeing a significant surge is France. Another factor that could stymie spending in the months ahead is the expiration of government-funded furlough subsidies for employers. Expiration could lead to a significant increase in unemployment and a decline in personal income.
In the Eurozone, inflation turned to deflation in August as energy prices continued to fall sharply. Specifically, consumer prices were down 0.2% in August versus a year earlier. When volatile food and energy prices are excluded, core prices were up 0.4% from a year earlier, the lowest level of underlying inflation on record. This means that the weakness of the economy is overwhelming the impact of a large increase in the money supply. Personal and business savings have increased, suppressing demand. Moreover, even though reported unemployment remains low, the reality is that many people are not actually working but are being supported by government furlough schemes that are about to expire. Hence, the decision to save heavily makes sense. Meanwhile, the European Union reports that the reported unemployment rate in the Eurozone is increasing rapidly, hitting 7.9% in July. This is the highest rate since late 2018. This means that, despite the various furlough schemes that have provided income to temporarily dismissed workers, many employers are permanently eliminating positions. In some cases, this reflects business failures. When furlough schemes do expire, the unemployment rate could increase quickly. In any event, the weakening of the job market and the weakness of demand have both contributed to historically low inflation.
The US government released the latest data on job growth for August. The report was surprisingly good, with relatively strong job growth and a sharp decline in the unemployment rate. The reason it was a surprise was that, with the expiration of enhanced unemployment insurance at the end of July, there had been an expectation that personal income would decline in August, leading to a decline in spending and weakness in employment. However, job growth continued nonetheless, perhaps reflecting the lag between changes in demand and changes in hiring patterns. That said, job growth decelerated from the previous month, suggesting the possibility that the expiration of stimulus funding began to have an impact in August. The government releases two reports: one based on a survey of establishments; the other based on a survey of households. Let’s consider both.
The establishment survey indicated that there were 1.371 million new jobs created in August, down from 1.734 million new jobs in July and 4.791 million new jobs in June. Moreover, 238,000 new jobs were temporary Census Bureau jobs that will disappear next month. Without those jobs, there were 1.133 million new jobs created in August. Meanwhile, the total level of employment was 316,000 above a year earlier; a small increase and not enough to compensate for population growth. Still, it is notable.
The increase in employment for the month included 249,000 jobs in retailing, 197,000 jobs in professional and business services of which 107,000 were in temporary services, 75,000 in healthcare, and 134,000 jobs in restaurants and bars. The latter figure was down from 525,000 in the previous month. Thus, job growth in a key consumer-facing industry decelerated sharply in August and overall employment in the industry remained 192,000 jobs below the level from a year earlier.
The separate survey of households found that a large number of people returned to the labor force, which means that they chose to work or look for work. Thus, the share of the adult population participating in the labor force increased from July to August. And many of the new participants found work, thereby pushing the unemployment rate down from 10.2% in July to 8.4% in August, the lowest level since the crisis began—but far above the pre-crisis level of 3.5% in February. Moreover, the number of people out of work for a short time fell sharply. This meant that many people who were dismissed early in the crisis returned to work. However, many large companies have lately announced significant permanent elimination of jobs. This has been especially true of the airline industry. Moreover, although participation increased in August, it remained far below the level from a year earlier. Specifically, the size of the labor force declined from 163.9 million people in August 2019 to 160.8 million in August 2020. The participation rate fell from 63.2% of the working age population a year ago to 61.7% today. Meanwhile, the number of working-age people not in the labor force increased from 95.5 million a year ago to 99.7 million now. Thus, despite the improvement in August, there is a long way to go.