It can be hard to divert public attention away from the current political turmoil to policy debates concerning the scale of economic risks posed by the outbreak of Covid-19. Following the World Health Organization’s (WHO) escalation of its risk assessment of the pandemic to “very high”, the Organisation for Economic Co-operation and Development (OECD) has warned that the ongoing disruption to supply chains could halve the already slow global growth to just 1.5% this year.
Covid-19, which has claimed more lives than SARS in 2003, spooked investors further following the unexpected jump in deaths in Italy and South Korea, sending global stock markets tumbling, with the Dow Jones and S&P 500 dropping into a correction. In response, governments and central banks around the world have taken steps to stimulate their economies, joined more recently by the US Federal Reserve’s largest emergency rate cut since the global financial crisis.
Bank Negara Malaysia too slashed the overnight policy rate to its lowest level in a decade, citing tighter financial conditions and downside risks to global growth outlook. The second rate reduction this year came just days after the unveiling of the government’s RM20 billion stimulus package that aims to stimulate the tourism sector and increase household disposable income. Consumer confidence is expected to be boosted while fewer employers will roll back spending.
Yet, a consumption-driven growth model may not be sustainable over the longer term as it continues to mask the actual impact of slow investments in both public and private sectors on expanding the economy’s output potential. Malaysia’s household debt is one of the region’s highest and it is not clear if private consumption can be resilient enough to absorb further risks to supply chains, which have led to falling factory orders and may potentially create mass layoffs.
What needs more emphasis in the domestic policy debate is recognition of the supply shock to the global production ecosystem, which seems very likely to be prolonged due to the rapid spread of the coronavirus. The shutting down of manufacturing operations, not just in China but also in Europe and East Asia, can create worldwide shortages in supply, compelling factories to draw down on inventories at a faster pace. Domestic lockdowns and travel restrictions for foreign workers will also create temporary shortages in labour supply. This means that business cost should rise as more producers chase after shrinking resources.
A supply shock brings back memories of the oil crises of the 1970s when prices accelerated even as unemployment was high and the economy producing at below its full capacity. Aggressive growth boosting by the government gave way to constrictive monetary policy by the central bank. But so far, the current supply shock has not been accompanied by higher inflation and policymakers can afford to provide stimulus without worsening an ongoing problem with prices. Rather, muted prices reflect broader concerns of falling demand and a general sense of pessimism, which may prove to be much harder to address than simply stoking spending.
Much still needs to be done to boost resilience in supply chains globally. Multinationals who depended perhaps too heavily on the Chinese supply chain ecosystem have taken steps to reroute its production from the country to new locations, particularly in Asean. Japanese construction equipment maker Komatsu and air conditioning manufacturer Daikin Industries are considering shifting production of components parts to Vietnam and Malaysia respectively.
This rerouting is the second wave of trade diversion following the escalation of US-China tariff disputes. Company managers have also learnt to strike a balance between production cost efficiency and supply chain resilience. This means that recipient countries of these new foreign investments will likely see deepening industrial relationships with domestic workers and suppliers, which form the foundation for technology transfer and value chain upgrading.
Malaysia is home to some global manufacturing titans and it is poised to take further advantage of the trade rerouting. However, the government’s policy to unleash the animal spirits in the domestic industry has been marred by the ongoing political uncertainties. Foreign investors are also closely watching the political developments and may turn away if institutional reforms are being reversed or more protectionist measures created.
The argument for liberalising the economy and promoting competition is well understood. But the reality is that the reform agenda to promote inclusivity and economic growth continues to be perceived by segments of the population as a zero-sum game. While it may take longer to rebuild trust between the people and the country’s institutions, it is still incumbent upon the new administration to try to do so or risk a divisive alternative that will disrupt our growth trajectory far more permanently than the shocks to global supply chains.
Lau Zheng Zhou is research manager for the Economics and Business Unit at the Institute for Democracy and Economic Affairs (IDEAS)