As the global economy emerges into a ‘new normal’ as well as a likely deep recession, Sofia Karadima looks at the factors businesses and countries will have to adapt to, as well as the opportunities still on show.

The Covid-19 pandemic has brought with it shocks to both supply chains and consumer demands, which are set to negatively impact cross-border investments. The UN Conference on Trade and Development (Unctad) has forecast that in 2020 global foreign direct investment (FDI) will be below $1trn for the first time since 2005.

“In terms of FDI, our base case is that we will see credit constraints on home supply markets, which will reduce the levels of capital expenditure and the number of projects, forcing investors to become more selective in their international ventures,” says Andres Abadia, senior international economist at research consultancy Pantheon Macroeconomics.

“But the overall trend is to expect a sharp deterioration in FDI this year and in early 2021 due to the supply and demand shock. The Covid-19 crisis will likely hit FDI through its impact on country budgets, and/or through international financial constraints. And many countries are rethinking their capital expenditure projects to reduce their vulnerabilities to global shocks due to the sharp GDP contraction,” he adds.

Indeed, there has been a sharp fall in GDP in 2020 in many countries, with the Organisation for Economic Co-operation and Development’s (OECD’s) latest economic outlook report predicting a global drop of 6% for the year, while forecasting that the unemployment rate will rise to 9.2% among OECD countries, up from 5.4% in 2019. These figures are based upon there being only one wave of infections during 2020.

However, the report states that “if a second outbreak occurs, triggering a return to lockdowns, world economic output is forecast to plummet by 7.6% in 2020, before climbing back 2.8% in 2021. At its peak, unemployment in the OECD economies would be more than double the rate prior to the outbreaks, with little recovery next year.”

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Beyond the bargaining power

High unemployment rates along with a stagnant economy mean that labour forces will have less bargaining power, according to Rob Carnell, head of research and chief economist at ING Bank’s Singapore branch.

“The chances of arguing up wages year after year is relatively small, which is set to have an impact on purchasing power and real incomes,” he says. “Even if there was a one-off spike in inflation in response to supply disruption, it will probably drop back again, ending lower than it started.

“I think stagflation as a prospect would be great in some ways, as there would be some nominal wage increases, and this would mean that households would benefit by seeing improved income to debt service ratios. Governments would also benefit as inflation would ‘deflate’ the stock of their debt relative to GDP. However, it is not feasible because we lack the mechanisms that generate a price shock into an enduring wage cost price spiral, and without that it is not possible to get stagflation.”

As and when unemployment rates rise, the supply of workers will outstrip demand – leading to reduced wage bargaining power, according to chief economist at NS Media Group Glenn Barklie. “Many of the worst-affected sectors – such as tourism and airlines – have many lower paid and lower skilled workers. For such people to regain employment, they require these industries to bounce back as they have less transferable skills [to move into more resilient sectors],” he adds.

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Chief economist at Pictet Asset Management Patrick Zweifel says that big increases in minimum wages by law would be needed to actually translate into a sustained period of stagflation.  He explains that higher minimum wages mean higher costs of production that a firm will pass along to consumers in the form of higher prices, but in the absence of strong growth, higher minimum wages mean higher unemployment as it may prevent people who would have been willing to work at a lower wage to join the labour market.

However, Zweifel adds that the risk of stagflation is rather limited, except in countries with populist governments.

“Compared with more traditional governments, the populist agenda tends to favour four economic policies, which are short-term, and where long-term [repercussions] are generally [disregarded]. [These policies are] increasing spending, cutting taxes, limiting immigration and… creating trade barriers.”

Pressure on prices

Governments are providing economic stimulus packages to assist individuals and companies as a response to the pandemic, moves that many believe could trigger inflation.

However, Abadia argues that downside forces, driven by the severity of a recession, will likely offset upside pressures from the boost of the stimulus packages and the recovery in global commodity prices.

While prices are set to increase for businesses such as restaurants, airlines and gyms, to protect margins or ensure the viability of the businesses, the drop in demand that these areas are likely to experience should keep price pressures under control.

However, the relocation of production facilities can also bring with it an upward pressure on prices, because such a move can bolster production costs, which in turn leads to higher prices. A number of investors are looking to walk away from China and reshore facilities closer to the source of FDI, either in central and eastern Europe for European investors, or in Canada and Mexico for those based in the US.

“Many companies want to reduce their vulnerabilities in terms of their own supply chain and are ready to increase their cost of production in order to insure themselves against future pandemic risk,” says Zweifel. “However, there are companies that are ready to take on the risk of having a future pandemic, as they will have a competitive edge, by keeping a low-cost approach and maximising their profits. An acceleration of deglobalisation is therefore not a foregone conclusion.”

Indeed, the pandemic has stimulated an unwinding of globalisation with regards to goods, but it has accelerated globalisation in digital services, with online communications, remote learning and e-commerce rising in popularity. Businesses operating in these areas look to be good bets for attracting further investments in the years to come. Although the headline figures regarding FDI are worrying – with Unctad forecasting that flows will decrease by 40% in 2020 – every crisis presents an opportunity, and for investors looking to diversify their portfolios, digital services offer a prime example of a profitable industry amid the despair.