Will the COVID-19 recession trigger a new era of structural change?

Healthcare, pharmaceuticals and technology are in the spotlight as the world adjusts to rapid structural change brought on by the COVID-19 recession, says AICD chief economist Mark Thirlwell.

Although often contested by economists, the most cited definition of a recession is two consecutive quarters of falling real GDP. On that basis, Australia’s economy resumed recession-free growth in September 1991 and kept going for a record-breaking 114 consecutive quarters of uninterrupted economic expansion. Granted, there was the occasional negative quarter: in the last three months of 2000, then again in the final quarter of 2008 during the global financial crisis (GFC), and once more in the weather-disrupted first quarter of 2001. But there were no consecutive quarterly declines — until now.

COVID-19 means that unprecedented run is almost certainly over. Real GDP shrank by 0.3 per cent over the first quarter of this year, dragged down by a combination of the summer’s bushfires and the first economic shockwaves emanating from the coronavirus. And while the Australian Bureau of Statistics (ABS) won’t publish an official result for Q2 GDP until early September, a range of partial indicators already signals a sharp contraction in the June quarter.

Moreover, that downturn is expected to dwarf previous quarterly drops in GDP. The consensus prediction at time of writing is for a 7.1 per cent decline, and although that represents a slight upward revision to the previous median forecast of an eight per cent contraction for Q2, it still leaves the anticipated result deep in negative territory.

The prolonged period of almost three decades of recession-free growth now behind us spans some dramatic events in the world economy — including the dissolution of the Soviet Union, the Asian financial crisis, the birth of the euro, China’s WTO accession, the dot-com boom and boost, the World Trade Centre attacks and subsequent “War on Terror”, the “Great Moderation” and its subsequent immoderate culmination in the GFC, the Eurozone crisis and the onset of trade and technology wars between Washington and Beijing.

Services sector

The period has also seen substantial changes in the structure of the Australian economy. In FY1992, for example, manufacturing was still our largest sector, accounting for more than 13 per cent of gross value added (GVA). As of FY2019, manufacturing’s share had fallen to about six per cent of GVA. The overall pattern of structural change has been a combination of a rise in the relative role of services alongside a resurgence in the importance of mining and a decline in the relative share of manufacturing and agriculture. Within services, the strongest growth has been in business services (finance and insurance; professional and technical; rental, hiring and real estate; and administrative and support services) and healthcare services. Services associated with goods production have not fared as well. Note, however, that the nominal fall in the share of information, media and telecommunications services — part of business services — reflects weak relative price growth. Measured in real (inflation-adjusted) terms, this sector has seen a dramatic expansion.

Several trends helped power these structural shifts. Rising household incomes meant the share of consumer spending devoted to services including health, education, and financial services enjoyed a sustained, decades-long rise. Government policies, including those involving finance (deregulation) and insurance (compulsory superannuation), also spurred the growth of some sectors. Technological change has also transformed a range of goods and services-producing industries. Strong population growth, the Australian love affair with real estate and a mining investment boom all boosted construction.

Developments in the broader global economy have also played a major role. The rapid industrialisation and urbanisation of East Asia in general, and China in particular, alongside the expansion of globalisation and trade liberalisation, delivered an increase in competitive pressures on manufacturing and a commodity supercycle that transformed the fortunes of the resource sector. Technology and globalisation have also interacted, as innovation in information and communications technology encouraged offshoring, outsourcing and the expansion of global supply chains.

Will the COVID-19 recession be followed by a new period of structural change? An early — and therefore possibly misleading — guide to the future is the immediate sectoral fallout from COVID-19, where the degree of damage has differed significantly by industry. For example, based on a recent ABS survey of Australian businesses, about one in five of all firms has suffered a loss of revenue of 50 per cent or greater due to the coronavirus. But the distribution of that loss varies widely, ranging from more than half of all businesses in the accommodation and food services industry; more than 40 per cent of all businesses in arts and recreation, and information, media and telecommunication; more than a third of education and training businesses; and more than a quarter of administration and support services businesses; down to less than 10 per cent of mining businesses and less than five per cent of finance and insurance businesses.

Although this and other metrics such as employment losses tell us a lot about the immediate impact of lockdowns and changes in public behaviour, they don’t take into account second-round effects or the potential consequences of longer-lasting changes in consumer behaviour and preferences, future shifts in government policy and regulatory settings, and other transformations in the operating environment.

Winners and losers

So which sectors will be the longer-term winners in a post-pandemic world? It’s almost certainly too soon to tell for sure, but business planners and investors typically don’t have the luxury of “wait and see”, and the pressure is already on to imagine the features of a post-virus economy. Early candidates for potential winners tend to start with the obvious — healthcare, pharmaceuticals and technology.

After the wrenching experience of COVID-19, it seems likely governments will place a new priority on building national resilience through an increased focus on public health. And the virus is already driving accelerated technological change and adoption in remote working, and in the delivery and consumption of goods and services.

Likewise, it’s widely assumed that early losers — substantial segments of traditional retail, international tourism, and international education — will continue to face significant adjustment challenges. But other shifts are more speculative. Will a new focus on the vulnerability of international supply chains and a deteriorating policy framework for international trade spark a resurgence in domestic manufacturing, for example? Or will the recent and widespread demonstration of the viability of remote working spur an acceleration in offshoring and outsourcing across a range of jobs where old assumptions about the necessity of face-to-face interaction are no longer quite so compelling?

Will COVID-19 release a new wave of public infrastructure investment, or will fears about ballooning debts and deficits overcome the lure of stimulus and cheap financing? While the details remain to be settled, a new era of structural change is upon us.