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A growing imbalance between supply and demand

April confirmed the recovery in supply:  industrial production surged (up 3.9% year on year) and China even had the luxury of seeing exports grow (up 3.5% year on year), notably thanks to electronic equipment. It is thus clear that, in this area at least, China has, for the time being, proved wrong those forecasters who had been expecting exports to shrink in April. As regards supply, then, the bet has paid off: after two months of record declines, everything is up and running again thanks to traditional stimulus measures.

One might think the stimulus acted equally on the demand side. For example, in April, total social financing (i.e. private sector financing) once again increased slightly (up 12% year on year, compared with 11.5% in March), buoyed by long-term loans to consumers and businesses and corporate bond issues, reaching its highest level in two years.

In its most recent press release, the People’s Bank of China (PBoC) also hinted that it was getting ready to unleash a fresh round of monetary easing, which might consist not only of further rate cuts (base rates and mandatory reserves) but also of an unprecedented securities purchase programme – something the PBoC had hitherto refused to contemplate.

Yet, as price and activity indicators show, demand is not following. Retail sales were once again well into the red in April (down 7.5% year on year). While purchases of capital goods and cars rose slightly, boosted by public policies implemented in the country’s provinces (vouchers and bonuses to incentivise consumer spending), the services sector (transport, catering, tourism, etc.) continued to languish well short of its usual level.

The same goes for private sector investment, which has still not managed to recover. It is as though this crisis were highlighting the dualism of China’s economy: planned on the supply side, with supply restarted by force if necessary, in the certitude that Say’s law, according to which supply creates its own demand, will once again work its magic; while on the market economy side, embodied by the services sector in large urban areas, the Keynesian view prevails, affirming that the economy cannot recover without demand.

Somewhere between these two slightly dated yet freshly resonant theories lies the issue of confidence: the confidence agents place in their economic system, which determines not only their expectations but also whether they choose to spend or save. This goes to the heart of China’s paradox and problem.

Avoiding the deflation trap at all costs

Industrial production is recovering but producer prices are falling. Exports are picking up but imports are plummeting. Retail sales continue to decline and the only thing keeping inflation positive is food prices, which are highly volatile…
And behind these high-level indicators, the labour market – already deserted by some migrant workers whose precarious service sector jobs have been destroyed – is likely to become more strained. A third of migrant workers have yet to return to their former place of work.

It is as though, this time around, the regime lacked the wherewithal to constrain economic agents’ choices and instil the confidence needed to ensure they choose to spend. Of course, China is calling the world’s bluff. After all, the sharp decline in exports will further boost its surpluses, and thus its currency reserves.At a time when liquidity is increasingly costly, this is an economic advantage not to be sneezed at. And, since these surpluses partly finance US deficits, it is also a driver of geopolitical power.

In reality, however, this supply-demand imbalance masks a hidden danger to the Chinese economy: deflation. In a country where investment continues to play a prominent role (accounting for over 40% of GDP), deflation is dangerous because it destroys capital. Deflation triggers an immediate rise in real interest rates and stalls investment – something that would pose serious problems for the Chinese economy. It is dangerous: as the Japanese economy proves, such liquidity traps are hard to escape from.

To avoid this trap, China may have to set aside some of its instincts as a managed economy and target categories of agents it is not in the habit of helping – in particular, the entire services sector that has grown up outside beyond the confines of planning models. However, the orchestrated communication exercise that has unfolded over the past few days does not suggest any far-reaching change in China’s economic model. The announcements made are completely in keeping with traditional stimulus measures: supporting investment in infrastructure and new technologies through bond issues and pulling out all the stops to get credit flowing again.

Add a hint of political risk, rekindled by renewed demonstrations in Hong Kong, and China looks just like it did five months ago. With just one sizeable difference: the world beyond its borders is changing, becoming more polarised and – as in any crisis – looking for scapegoats. Even under attack, though, China is holding its ground and sticking to its guns, brandishing its figures in its defence. As with the public health crisis, then, so with geopolitical tensions: all over the world, the masks will not be coming off any time soon.   
 
Sophie Wieviorka - sophie.wieviorka@credit-agricole-sa.fr

The "no-lockdown" strategy

Sweden has adopted a specific approach to managing the public health crisis, sparking unprecedented curiosity on the part of international media. Even as lockdown became the norm all over the world, including in neighbouring Nordic countries, Sweden opted for a more flexible strategy based on recommendations and controls and underpinned by the principle of trust in citizens' responsibility and discipline. Following initial scepticism and even rejection by some political leaders, on 29 April the World Health Organization acknowledged that the Swedish strategy could serve as a model for other countries.

In an interview with the France 24 news channel on 4 May, Sweden's Minister for Foreign Affairs Ann Linde defended her government's strategy, explaining that it was pursuing the same objectives as every other government, including in particular slowing the spread of the virus, “flattening the curve” of the epidemic and protecting health system capacity while cushioning the impact on businesses and jobs. Its approach consists of a combination of social distancing recommendations (such as encouraging working from home where possible) and legally binding measures in certain specific areas, such as a ban on visiting elderly people (introduced in the fairly early stages of the epidemic). Restaurants, bars, night clubs, school canteens and, more generally, establishments serving food can continue to operate provided they follow social distancing rules (e.g. requiring customers to stay at arm's length from each other, spacing out tables), failing which they must close. Furthermore, schools from kindergarten to primary level, and even some secondary schools, have stayed open, in part to enable parents who work in the healthcare sector to continue to work, whereas higher schools and universities have closed.

The government has also authorised anyone showing symptoms of the disease to stay at home without the need for a doctorcs certificate and while remaining eligible for sick pay from their first day off. The minister emphasised that this is not a “herd immunity” strategy, though Sweden could indeed achieve herd immunity quicker than other countries (26% of the population of Stockholm could now be immune, according to mathematical modelling by the Public Health Agency of Sweden), while also admitting that halting transmission of the disease is not a goal. For the time being, the government is pleased with the success of its strategy: 20% of intensive care beds are reportedly open. Its confidence in the Swedish people also appears justified: for example, the government advised people not to travel to the most popular tourist destinations over the Easter holidays; according to the minister, visitor numbers at such places were down 96% over the period.

As far as travel to and from other countries is concerned, as a European Union (EU) Member State, Sweden is applying the EU's policy prohibiting travel to and from non-EU countries while keeping its borders with other EU countries open. However, as far as tourism goes, the government is recommending no unnecessary travel to or from other countries until 15 June.

How can Sweden get away with adopting a more flexible strategy than other countries?

One oft-touted argument hinges around the country's particular demographic make-up – notably the fact that Sweden has a higher proportion of single-person households than any other European country: over half the country's households (57.3%, the highest percentage in the EU) consist of one adult with no children, compared with an EU average of 34.3%. With fewer people per household, the virus should, in theory, spread less easily than in other countries. According to the authorities, infection rates are highest in neighbourhoods in the north of Stockholm where there are more people on low incomes, and probably living in smaller apartments. Generally speaking, population density in Sweden is among the lowest in Europe (at 25 people per square kilometre, according to Eurostat, with only other Nordic countries showing lower numbers).

Another argument in support of the government's strategy is the idea that Sweden was somehow better prepared for homeworking than other countries. According to Eurostat, the proportion of people who work from home in Sweden is close to the European average (5.9% of jobs, compared with 5.3% for the EU as a whole). However, the structure of the Swedish labour market probably lends itself more readily to homeworking. Sweden ranks second in the world (after Switzerland) for the proportion of jobs in sectors requiring high levels of knowledge, such as new technologies, advanced services and the creative industries (10.2%, according to the Brain Business Jobs: 2020 Index, published by the European Centre for Entrepreneurship and Policy Reform), where homeworking is naturally easier to implement. Moreover, the rate of take-up of digital technology by the Swedish population is very high (with 92% of Swedes using the internet, according to ITU data) and the network is of very high quality: according to the OECD, 69% of broadband internet connections use optical fibre.

Lastly, on the health front, according to the John Hopkins Center for Health Security's Global Health Security Index (2019), Sweden is the seventh best-prepared country in the world to combat the pandemic. Conversely, other sources show that Sweden had relatively few hospital beds per capita on the eve of the pandemic (with 2.2 beds per thousand people in 2017, according to the OECD).

What impact has the epidemic had to date?

Compared with those European countries hit hardest by the pandemic, such as Italy, Spain, France and the United Kingdom, numbers of COVID-19 cases and related deaths have been far lower in Sweden. On the other hand, comparing Sweden with its Scandinavian neighbours, which have implemented much stricter lockdowns, portrays the country in a much less flattering light. Based on the number of new cases, the epidemic appears to have peaked much later in Sweden, somewhere around 25 April, compared with 8 April in Denmark and 28 March in Norway. But the contrast is most striking when you consider population size. As at 6 May, Sweden, the largest of the Nordic countries with a population of 10.3 million, had recorded 23,216 cases of COVID-19 and 2,854 deaths since the onset of the pandemic, translating into a death rate of 27.6 per 100,000 people. Norway, with around half the population (approximately 5.4 million), had recorded 7,903 cases and 209 deaths, giving a death rate of 3.9 per 100,000 people. Meanwhile, France, with a population of around 67 million, had recorded 25,531 deaths, equating to 38.1 deaths per 100,000 people.

Will the Swedish exception pay off, economically speaking?

The contraction in Swedish GDP in the first quarter, down 0.3% quarter on quarter, was much more limited than in eurozone countries according to preliminary figures from Statistics Sweden, which notes that exports increased, while lower investment and changes in inventories adversely affected growth. However, available leading indicators for the second quarter suggest that Sweden will not be able to escape a significant recession in the first half of the year as well as a rise in unemployment, notwithstanding the lack of a strict lockdown and despite generous government support measures (including a support package for the healthcare system and the labour market worth over 100 billion Swedish krona, equating to 2% of GDP). The National Institute of Economic Research's Economic Tendency Indicator, which aggregates responses from consumers and businesses, fell 34 points from 92.5 in March to 58.6 in April, 8 points below its lowest level in the 2008 financial crisis. As a small, open economy (exports of goods and services account for 45% of GDP), Sweden will be affected by the contraction in global – and particularly European – demand. Manufacturing orders plummeted 9.6% in March, mainly pulled down by capital goods orders (down 21% in the month). Investment, which had already contracted 1.1% in 2019 as a result of uncertainty over future demand, is set to fall even more steeply. The sharpest drop, though, will probably be in household consumption: even though non-essential businesses have not been forced to close, the shock to confidence and, more fundamentally, higher unemployment and lower income are likely to trigger a decline in consumer spending.  

All in all, GDP is set to fall by around 10% in the second quarter, according to forecasts by Sweden's central bank, the Riksbank. In its two alternative economic outlook scenarios, which differ according to the length of the public health crisis, the measures implemented to contain it and the strength of the global economic recovery, the Riksbank expects GDP to fall by 7% and 10% respectively in 2020 (before bouncing back by 4.6% and 1.7% in 2021). Meanwhile, the two scenarios put the increase in unemployment at almost 10% and 11% respectively.

What are the short-to-medium-term risks?

The crisis will undeniably aggravate Sweden's long-term imbalances. The upward trend in inequalities, which had eased over the past few years thanks to improved labour market conditions, is likely to resume. It will be harder to integrate immigrants – and notably refugees – into the labour market, which in turn entails risks to political stability and will no doubt boost the popularity of the far-right Sweden Democrats party. Furthermore, household debt – the Achilles' heel of the Nordic countries, particularly in Sweden, where it equates to over 160% of disposable income (compared with a eurozone average of around 94%, according to Eurostat) – is likely to start rising again. A significant correction in the already severely overvalued Swedish housing market is therefore to be expected.

What the shutdown has already changed

By becoming a pandemic, and above all with this idea of other potential setbacks, the virus has ushered in a permanent state of emergency. This is a huge shift in political perception – what Walter Benjamin called the “catastrophe-world”[2], when the exception merges with the rule.

The first thing to point out is that this catastrophe-world is endangering freedoms. In Hungary, Viktor Orbán has assumed absolute power. In Poland and some US states, anti-abortion legislation is flourishing under lockdown. And there is widespread concern about apps, bracelets, drones and other ways of keeping tabs on people.

The second thing to note is that in this catastrophe-world, politics has regained the ascendancy, re-empowering decision-makers and placing renewed value on decisions. This is big news because it means the virus is attacking one of the root causes of the political crisis we’ve been enduring for the past thirty years: the endless rhetoric about governments all being the same and economy being more important than politics. In fact, faced with COVID-19, governments have not all made the same choices: the gap between Merkel and Bolsonaro has widened… Meanwhile, the seemingly unshakeable primacy of politics over economics has briefly been reversed; so it was possible after all, and this will not be forgotten. This is another major shift in perception. 

The second death of Ronald Reagan

The third thing to point out is that the criteria on which governments’ legitimacy is based have changed. Efficiency and safety now rule. This will affect every election, and authoritarian regimes will not be immune either. In South Korea, the government has regained popularity by handling the public health crisis well. In the United States, after forty years of criticism of the welfare state, the “Big State” is once again becoming the prerequisite for efficient government. While some Republicans are worried, the game has changed: unlike in 2008, Democrats and Republicans alike agree that massive – and perhaps even long-term – state intervention is needed. And people are remembering that 1929 resulted in a (thin) safety net and an infrastructure network in the United States, while the Second World War bequeathed a unified Department of Defense. In short, Ronald Reagan, who said at his inauguration that government is not the solution but the problem, is dying a second death. A third major change of political perception. 

The dollar is (still) king…

In the post-crisis world, geopolitics will be queen, but this is nothing new. Who will be king is harder to predict, because the crisis is redistributing power. With control over data now even more strategic than before, power is shifting first of all to the Big Four tech firms: we are now hearing of “surveillance capitalism”. Power will also shift towards those countries that emerge from the crisis earliest and in the best shape. As things currently stand, China is likely be the only great power to experience growth. While the Russian government is managing the crisis with a view to protecting strategic sectors, it is running a major risk in terms of domestic policy and is weakened by the energy crisis.

Meanwhile, the US situation is complex: the economy and the energy sector are losing power; there are significant domestic policy risks (unemployment and the threat of institutional fragmentation, with growing hostility between the federal government and states); and monetary policy is increasingly dominant (in case we’d forgotten this, the crisis has reminded us), as is the military (with the US accounting for 38% of global military expenditure). However, Donald Trump aside, it’s precisely this cocktail of power and decline that makes the country dangerous: political scientists[3] have long described the behaviour of a hegemonic power backed into a corner, destroying not only its rivals but also those international institutions that no longer operate to its advantage. Trump slamming the door on the WHO is a case in point.

Lastly, with populations traumatised, the post-crisis world will be marked by an escalating war of words: COVID-19 has given soft power a boost. China launched the assault by rolling out a “mask road”, though its success has been somewhat hit and miss (with shipments not arriving in Chile and some African countries but alliances with Pakistan and Central Europe strengthened). The United States responded by seeking to play the blame game. Things have since been moving quickly. Too quickly, in fact, undoubtedly signalling an upping of the geopolitical stakes.

America’s recent and ongoing accusations sketch out the contours of a bipartisan cold war in which Europe would have to pick sides, while Russia, having failed to enforce its demands that sanctions be lifted, would fall into line with China. Moscow has also denounced US activism over Arctic resources, while in Asia, COVID-19 has intensified tensions between China and Taiwan.

All of this is troubling not only to major powers. Everywhere you look, politicians are attempting to deny responsibility for the public health situation, both domestically and internationally. Everywhere you look, the Other is to blame: the crisis has unleashed the full power of the scapegoat mechanism[4]. Meanwhile, Recep Tayyip Erdoğan has spoken of the crisis as of a godsend: “For the first time since World War II, Turkey has the opportunity to take centre stage in a period of restructuring on a global scale.” He is not wrong: there will be a geopolitical reshuffling of the deck that will open up an array of possibilities to second-tier powers (Saudi Arabia, India, etc.).

Everywhere you look, citizens are also becoming more and more nervous as the sabre-rattling ramps up. In the United States, anti-China sentiment is at its highest since 2005, when 35% of Americans had an unfavourable view of China; today, the figure is 66%. In short, if politics were to open up new possibilities, that would be good news; but if geopolitics were to further divide an exhausted world, that would be very bad news indeed.

(1) Olivier J. Blanchard and Lawrence H. Summers, Hysteresis and the European Unemployment Problem, 1986.
(2) On the theories of Walter Benjamin, see Governance, Sovereignty and Profane Hope in a Globalised Catastrophe-World, Francisco Naishtat, Presses Universitaires de France, Diogène 2009, issue 228.
(3) Robert Gilpin, War and Change in World Politics, 1981.
(4) René Girard, Violence and the Sacred, 1972.

 Tania Sollogoub - tania.sollogoub@credit-agricole-sa.fr