Tuesday, June 30, 2020

Predictions for a post-COVID world: US economy through 2025

If you've been following these posts, you'll know by now that I am extracting insights and predictions from a post-COVID scenario I drafted.  You can find the entire scenario writeup here (Tip:  hover over the bottom right of the pop-up window and click on the expand box, and you'll see a full screen view where you can also download the document).

I've written a number of blog posts teasing out some of the implications of the scenario and making predictions about the future.  In my last post I wrote about the potential fracturing of Europe into three regions - Northern, Southern and Eastern - and why France is the loser in this scenario, along with a weakening Euro and long standing trade and defense relationships.

I've written a few other blog posts that examine the rise of the Millennials, the likely focus on supply chain resiliency and manufacturing repatriation and other topics.

Today, I want to focus on the US economy through 2025, and what could happen.

The US economy 2020 - 2025

As we stand now, in the middle of 2020, and in the (hopefully) middle of the COVID outbreak, the economic news is grim.  Over 16M people are at least temporarily out of work due to closures and lower consumer demand.  The economy shrunk in the first quarter and is in an official recession.  The big debate now is between types of recovery - V (everyone hopes for), U (a bit worse but we can handle) or an L (not so good).

There are a number of factors that will dictate the health and resiliency of the economy:

  • Consumer spending.  Since consumer spending comprises about 70% of GDP, the money households spend on required and discretionary spending matters a lot.  In a locked down economy, much of our discretionary spending (entertainment, travel, dining out, etc) cannot happen.  This means there will be less spending and with less spending there is less demand.  Fewer goods and services are required, leading to less aggregate demand.
  • Services vs manufacturing - much of the economy is now based on services rather than manufacturing.  Something like 80% of employment in the US is based on services rather than manufacturing, so weak demand for tangible goods impacts a smaller portion of the economy, but weak or no demand for movies, restaurants, tourism, travel and so forth impacts a significant number of jobs
  • Compensation and safety nets in services.  Many of those services jobs are held by people with little savings or safety net.  They need to work to pay bills, and without their services jobs or the gig economy, they cannot afford to pay for even essentials like housing, food, clothing and taxes.  The impact on the economy is profound when lower and middle income families in the services sector struggle to find work.
  • Easy money can't last forever.  While the Fed is promising easy money now, it cannot do so forever without the risk of inflation.  The dollar is already strong relative to other currencies, so our exports are more expensive (leading to less demand for our products overseas) and cheaper imports. Again, more pressure on local jobs and local growth
  • Debt service.  The government now has over $25 Trillion in debt, and that balance is growing rapidly.  We are approaching the point where our debt is larger than our GDP, typically a warning sign for most economies.  At some point, the government will have to start paying a significant amount of its tax intake on debt service, crowding out other spending on important items like Defense and infrastructure.
  • Real Estate sector difficulties. As noted in a previous post, the real estate sector is likely to be hit hard in the aftermath of COVID for at least two reasons.  First, many small retail shops and restaurants will close because of the prolonged impact of the virus, and few entrepreneurs will want to take those spaces until conditions improve, leading to a glut of retail real estate.  Second, if companies are serious about sending people to work from home, there will be a significant amount of corporate real estate coming available in 2021 and 2022, and less demand from corporations.
  • Job creation and destruction. Jobs will return post-COVID, but the type and nature of jobs will change and we may face a capabilities gap.  More and more jobs are being replaced by robotics and automation, but we don't have enough engineers and technicians to do the work to implement and maintain these solutions.  Plus, more data will be available for analysis, yet we lack enough people with data science skills.  Meanwhile, many of the people who held manufacturing and services jobs may see those jobs disappear, and they may lack the skills to take on new roles.  Many college graduates simply don't have the skills to take on new digitally transformed jobs and companies won't be willing to train new employees at the rate they have in the past, when margins are slimmer. 
  • Household savings.  Americans are becoming savers, finally.  Historically, we saved very little but in the face of the economic slow down and COVID, our individual saving patterns have changed.  Now, we are saving more than ever, but this saving works against consumer spending.
Three Drivers of spending

There are three significant drivers of spending - consumers, businesses and the government.  As noted above, most consumers are rapidly becoming savers, and many will not have much discretionary money to spend.  This means 70% of the economy will remain stagnant for some time.  If the dollar grows stronger, businesses will suffer from weak local demand and products will be considered expensive in the export market, meaning many companies will struggle to drive sales in the US or abroad.  The government will act as a spender of last resort but cannot continue to inject trillions of dollars into the economy.  Spending may occur under a new administration, but even in that scenario it will take new legislation for infrastructure or major project spending, and time to roll out the programs.  This means it's unlikely the government can increase spending on roads, bridges and other infrastructure before at least summer 2021.

Winners and losers

The winners in this new economy are the asset-light and asset-less companies that have reasonable scale, low costs and few employees, and create a valuable service, especially those supported by ad sales.  Facebook, Instagram, Google and others are already digital, already relatively profitable and will weather the storm.  Amazon will take even more of the retail market for may of the same reasons.  Companies in the communications and information technology sector, especially those in networking and transmission or digital communications should do well.

Most consumers are likely to become much more value and price conscious, so low cost stores (Walmart as an example) are much more likely to weather the storm than higher end boutique stores.

Basically, the further along any business is in its digital transformation, the better positioned it will be for success in the near future.

Companies that face headwinds in this new world are those that are reliant on exports, since it is likely the dollar will be strong and other countries will experience even slower growth than we do.  Other companies that will struggle are those companies that rely on discretionary spending - travel and entertainment - because we can anticipate that there will be fewer dollars available.

Health and Education as concerns 

Unless we have significant new legislation, I think the health of the average citizen may suffer, because health care costs have increased dramatically and people are likely to postpone healthcare or forego surgeries or medications if money is tight.  For many people who are unemployed and may have lost their healthcare coverage, or those who are in the health insurance markets and finding prices unaffordable, these and others may risk consuming less health care service and may find their health impacted negatively.

People in their late teens and early twenties are likely to see a real impact on their educational and job opportunities as the economy slows.  A college education - already expensive - may seem out of reach if funds are tight.  Those graduating from college may find it difficult to find a job and have to settle for employment that is compensated at far less than their education or anticipation.

Colleges and universities are in for a real shock, I think.  Years of unrivaled cost inflation have placed many colleges out of reach without substantial loan debt.  For many schools, tuition does not cover the cost of attendance.  So we have programs with rapidly escalating prices which don't adequately cover costs, at a time when fewer and fewer people can afford to go to college and the college degree does not convey value as it used to.  Plus, state legislatures are going to take a hard look at the money they spend on colleges and universities.  The next few years will be a real reckoning for small and mid sized colleges, and all colleges and universities will face significant financial challenges.

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posted by Jeffrey Phillips at 8:47 AM


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