How should the economy be reshaped? Global recession this quarter will give way to a pick-up in activity but some sectors may be unrecognisable. Not just with a legacy of debt but operating with new business models and driven by a changed social agenda. Big companies bailed-out today may be called to account politically for their failure to build-in sustainability and resilience.
Whatever the wish to unwind the effective nationalisation of parts of the economy, there is no case for going back to the previous economic structure. National resilience will demand bigger roles for health, contingency planning and other preparedness but also greater use of tax and legislation to encourage effective business structures. UK corporate governance has simply not been fit for purpose, if that goal is to create sustainable growing businesses. Too many company boards have presided over excessive dividends, share buy-backs, and unreasonable executive rewards – leading to over-borrowed businesses with no buffers for bad times.
Reshaping western economies is too important to be left to stockmarkets. Certainly, they will help with refinancing distressed listed companies and banks will feed finance to badly-hit small and medium sized businesses in the broader economy. But investment analysts work best at assessing individual business prospects in a steady economy. The job of incentivising sustainable business structures is a political one. There will soon be opportunity to make change.
Heavily borrowed company structures – much loved by private equity – should be the first to go. High debt creates a one-way option; great if the economy goes well, disastrous in a downturn. Restaurant chain Carluccio’s and many high street retail chains are testimony to this.
Urgently needed, too, is an acceleration on the pace at which companies are implementing environmental, social and governance issues. Responsible investing must play a greater role, taking to task boards that incentivise bad behaviour and companies that have behaved badly during the crisis. Regrettably, some businesses have been much too quick to dump employees onto state support, when other adjustments might have been made. The UK may need to move nearer to a German system of employee rights to set out a basis on which pay reduction for a period might be negotiated. Mixed economies with a different public/private balance have proved more resilient than very market-driven ones in downturns. In the aftermath of the great financial crisis, European job retention mechanisms and other welfare stabilisers proved just as effective in engineering early recovery as the US tax stimulus.
What are the themes that investors should note - apart from debt, share buy-backs and bad executive incentives? Companies structured to pay little tax will be one area of risk, often combined with an apparent statelessness. Tax havens can be a virtual home for cruise companies, tech businesses and some private equity, but do not have the resource for bail-outs. Should other governments step in? Employment may be at risk, but with little in tax receipts to pay for that. A re-set of tax on a global basis seems likely.
Despite all the money being pumped into economies by governments around the world, even lower inflation and interest rates are now likely. This disinflation trend has been in place for more than a decade, but the loss of wealth will cut consumer confidence until that capital safety-net is rebuilt. Unemployment will constrain wage growth despite a move to shorter supply chains. Low inflation and dividend cuts have a big impact on pension fund liabilities and the balance sheets of many big companies.
At the same time, credit is stressed much as it was after the financial crisis. Many smaller and medium sized companies will suffer higher borrowing costs. As in 2008, junk bonds – low quality borrowing - are again a problem. This time central banks may hesitate to bail out questionable financial structures. Much of the distressed borrowing is related to energy, hit by the oil price collapse.
Understandably, politicians are currently focused on the crisis. But this experience should drive fresh thinking on the economy of the future.
A version of this article was published in The Herald on 09/04/2020.