A Great Realignment awaits us all

Prof Witold Orłowski, chief economic advisor to PwC, talks to Michael Dembinski about the Covid-19 crisis and its effects on the Polish economy – and its long-term implications for global development.

What are the prospects for Poland?

“Poland was partly lucky, partly unlucky when this crisis started. It was lucky because the economy was in relatively good shape from the financial point of view with low debt and low unemployment, which meant the country would suffer less pain, that risks were moderated. But it was unlucky as over the past two years there was a significant deterioration in the fiscal position with the state eating up a lot of the reserves set aside for difficult times. Poland was already slowing down because of supply-side problems and recession in Germany, to which Poland is relative exposed. But overall, Poland was among the rather lucky countries.

“The Polish government decided to implement a radical lockdown at an early stage. As a result, it seems that Poland flattened the curve of the epidemic and significantly reduced the number of infections. But there is a high price to pay for such a radical and early lockdown. For the time being at least, Poland avoided an uncontrollable number of infections, subject to question marks about the intensity of testing and a new wave of the pandemic recurring in the autumn. The government went for this strategy because it was afraid that the healthcare system would be unable to deal with the pandemic; it wanted to avoid a catastrophe like the one that hit Spain or northern Italy. In a sense Poland will pay higher price in the long term because of its lack of an efficient health service. We don’t know what will happen in the autumn – repeating this strategy won’t be possible; by then Poland will have reached the maximum affordable level of lockdown.

“It is difficult to be precise, but the consensus among us economists is that a lockdown costs the economy about 15-20% of GDP per month. So, if this estimate is correct, a three-month lockdown will cost between 3% to 5% of the GDP on an annualised basis. Assuming a return to previous levels of economic activity, we will be below zero at the end of the year; we will be in recession in annual, not just quarterly, terms. But the problem is we will not come back to pre-pandemic activity levels. During the second half of the year we will be facing a demand shock; lower demand for exports and lower domestic investment and consumption. With people losing income, consumers reducing their expenditure, despite extra government expenditure, Poland is likely to face a fall of 5 to 10% of GDP compared to 2019. A global recession will follow lockdown. For Poland, this is something we’ve not seen in 30 years. If it’s any consolidation to us – typical Western economies will also fall by 5-10%. Look at Greece – 15% of GDP is tourism! For economies with advanced technological levels, capable of employing more people online, the negative impact of lockdown might be less.

“We don’t know what will happen in developing countries. The 2008-09 crisis left the developing world almost untouched. All the financial problems were faced exclusively by the developed economies. There is a big probability that recession will prevail in all countries this time. The question is how deep will it be.  There is an assumption that even though it looks less dangerous in tropical countries because of the climate, the virus may mutate towards being more dangerous in warm countries.

“Poland, being deeply connected to the global value chain, is going to pay a price similar to that paid by the other Western economies. The factors which saved Poland in 2008 and 2009 such as a healthy banking sector and being outside the eurozone will not apply. There are no big reasons why Poland can take this crisis in a lighter way than Western economies. Southern Europe will be the worst victims. As I said, I expect Poland to see a significant 5%-10% fall in GDP on the annual level, and unemployment up to double-digit levels. But Spain had 15% unemployment at the outbreak of the crisis! GDP and unemployment are two elements. The third element of the story is debt. The effects of the recession will be reduced greatly reduced by public intervention at the cost of public-sector deficit and debt. Once again, Poland will follow other countries, probably increasing its deficit to 7-10% of GDP. But Poland has a low level of debt, less than 50% of GDP. Spain and Italy both entered this crisis with debt at above 100% of GDP. So again, it’s relatively good in Poland, there’s a smaller risk that this will lead to a financial and banking crisis. But Poland is not in the eurozone – which proved a blessing in 2008-2009; this time the countries inside the euro can count on the support of the European Central Bank. It will, without hesitation, print money to cover the huge increase in public spending; and with that comes higher of inflation.”

That’s the macro economic level, now let’s turn to how businesses will fare.

“There’s the short-term effect – companies that have been eager enough to use advanced technology will do better. Others are desperately trying to catch up. The conservatism of many firms that have preferred face-to-face to virtual meetings will be swept away, there will be a rapid improvement of the tools used, that will have a long-lasting effect. E-commerce is booming, again, as consumers have been forced to use it. The long-term effects? It depends on which sector. Transportation. Air travel will change. After 9/11, people were predicting the end of mass air-travel in the West – actually, what happened next was an explosion in low-cost airlines. This time, we will see new restrictions – a bigger distance between passengers, and that may kill the low-cost model. Airlines will have to take half the passengers off the plane, a killing factor for mass air-travel even if people are become less afraid over time of the medical risk. It seems likely that new regulations in transportation and tourism and the increase of costs may reduce demand at the expense of the low-cost model. It is quite possible that low-cost airlines will go bankrupt. Flag carriers will be helped out by governments – the German government won’t let Lufthansa go bankrupt. But who will save Ryanair?

“The retail sector. People and regulations – change of minds, change of regulations, shopping malls are seeing numbers of visitors reduced, accelerating the long-term push towards e-commerce. Once people have adjusted to shopping online for several months they may stay there. Places where people shop and meet, come for entertainment, may suffer a collapse in profits. The lower demand for retail malls, coupled with lower demand for physical office space will hit the entire real-estate sector which will have to readjust.

“Industrial production – manufacturing. If there have been two lesson from lockdown, it’s been to invest in robotisation, and to move production closer to the hub, not dispersed all over the world as has been the trend over the last 30 years. Value chains have become stretched out all over the world – they will be brought under much closer control. This may be good for Poland, assuming everything else is OK in the EU; it is relatively close, it is relatively cheaper. This may create a boost for robotisation; Industry 4.0 will be certainly be accelerated.

“We don’t know how the reindustrialisation of the West will look. Before the crisis, it was happening anyway – Industry 4.0 was accelerating. It may hamper many developing countries – the usual route of development has been via the shift of production from high-cost economies. China has already been intensively seeking for the past ten years to upgrade its technology. Countries that can catch up with technology will do best, ones locked into outdated technologies using cheap labour will fall behind.

“The automotive industry was already under intense pressure before the pandemic. There’s a big question mark about how eager young people will be to have their own cars, especially in developed countries, where having a car is a problem not only a pleasure. Autonomous car services will eventually become available on a broad scale. The automotive sector will suffer a series of blows, firstly because of lockdown, then a temporary recession, then a rebalancing towards the car as a service. Developing countries will still strive towards car ownership, however, in developed economies, there will be fewer cars – but smarter cars. This will be environmentally and economically better for consumers.

How will consumers’ behaviour change?

“People will probably see a clear link between health problems and environmental problems – life will not just be about how much they earn and how many goods they buy, but an acceptance of having to deal with other global challenges. This crisis is showing that risk really is a risk. Warnings about pandemics have been shown to be correct, despite politicians neglecting them. This pandemic might make people much more serious about climate change as well.

Will the state end up playing a bigger role in the economy?

“The pandemic will lead to a rebalancing between the state and the private sector. The private sector is about creating value and profit; that may be in conflict with future costs that are not covered today. Therefore, the policies introduced to protect public health are against short-term profits but they are protecting a sustainable society – consumers – for the future. The pandemic will force the private sector to look more to the long term.

“The tendency towards increased inequality will focus the debate around taxation, in particular looking at capital flight and the tax that’s not collected from rich people. I don’t know whether this crisis is going to change income distribution – much depends on how the money spent fighting the effects of Covid-19 will be paid back – all those increased debts, and who will pay them. If you increase VAT, the poor will pay. If it’s more effective taxation of wealth and income, the rich will pay. If it’s paid for by inflation reducing the value of the debt, it will be the middle classes and pensioners.

“The pension system will have big problem is everywhere. Deteriorating long-term economic development prospects will have a double negative effect on pension systems, which before the pandemic were unsustainable in any case. If the rate of return on assets falls and risk of the excessive indebtedness of the state rises, then pension systems will be punished doubly.

“The tendency to see more state in the economy is normal in any crisis, as the state takes up the shortcomings of the private-sector economy. Some companies may be nationalised to be saved; a most likely scenario is that governments will take shares in many companies in exchange for a massive financial support – it may still seem impossible to many to imagine that companies will be renationalised and brought into the public sector. But this is the second-best strategy in times where the private sector can’t do it itself.

“What to do next? People give the example of the Scandinavian banking sector in 2009 – the state partly nationalises the sector, then the state sells back the shares to private investors when the crisis is over. The ultimate role of the state not to run businesses, but to recover money for the state and let private business operate. Now, other governments might like to retain under control companies that have become state-owned after their shares have been taken over in an emergency situation – we shall see what the final result of state activity will be, but the political economy is the number one factor right now. The state still has two ways out ultimately – to keep those shares of the companies it has nationalised or partly nationalised, or to sell them back. Both of these ways seem to be plausible in different countries.

Is the crisis likely to change the way countries are led?

“Dictatorships vs. democracies – I would not be so pessimistic. I tend to believe that autocracies’ support is based on their claim that they can defend the people against their fears better than democracies can do. Dictators took power in the 1930s because democracies couldn’t protect their people from the effects of the Great Depression. If democracies are unable to protect the people and a dictator can show that he does it better, he retains power. But a dictator that can’t fulfil his promise will lose his position. Authoritarian rulers who, rather than fight the pandemic in an efficient way, simply pretend it isn’t there, will face problems.  Personally, I believe in democracies.