Economic impact of coronavirus: Last year we published the first issue of our megatrend report, which examines the central interactions between the megatrends of globalization, digitalization, and demographic change and their effects on people’s employment and income opportunities. In the second issue, we discuss the impact we expect the Corona pandemic to have on the medium and long-term development of digitalization and globalization.

Effects of the Covid-19 pandemic on digitalization and globalization

The Covid-19 pandemic is far from over, and it will probably take years before all the economic and social damage is more or less repaired. However, given the severity of the economic crisis and the enormous efforts being made to overcome it, it should already be clear by now: This far-reaching event will bring about long-term changes in our economic life.

From an international division of labor perspective, two developments play a central role: the acceleration of digitalization and the slowing pace of globalization.

The Covid-19 pandemic as a catalyst for the digitalization of the economy

The impact on the global economy of the Covid-19 pandemic can serve as an additional incentive for companies to make greater use of digital technologies. This may not reduce susceptibility to crises in all areas if another epidemic or pandemic occurs, but at least in many cases, it could.

The pandemic-related reduction of demand may be battled by a shift to online trading, at least in some segments. Digital solutions can also counteract the health-related absences of workers to mitigate the supply crisis. Remote work will be intensely used in this context.

Another response to the experience of the Covid-19 pandemic with a target for the medium-term is increasing use of machines, robots, and other digital technologies in production processes. By replacing human labor, automation reduces dependence on it.

This trend is already in full swing since digital technologies increase productivity considerably and reduce costs. Using such technologies to increase resilience against crises that affect production acts as an additional incentive. However, not all industries and companies have the same opportunities to use digital technologies to reduce their vulnerability to crises.

The Covid-19 pandemic as a brake on globalization

The Covid-19 pandemic has caused great disruption in the trade and production networks. Lockdown measures have led to short-term production and demand issues in many countries. Companies are looking for ways to render their production chains less susceptible to crises to promote resilience, i.e., the ability to survive an acute crisis well and recover quickly. The pandemic will probably end up acting as a catalyst for the reorganization of global production networks.

We are entirely used to a world of border-crossing value chains. From an economic perspective, such a clear division of production steps is sensible to make production particularly efficient. “Just in Time” has long been the slogan of modern production. Stocking production inputs was considered an unnecessary cost factor, and production was optimized for the greatest efficiency.

The Covid-19 crisis now makes the weaknesses of this system visible. One likely consequence of this is that companies will focus less on maximizing efficiency and more on securing resilience by implementing some kind of “buffer.” This could take the form of production overcapacity, stockpiling, diversification, reduction of supply chains, and modernization. “Just in Case” is going to replace “Just in Time.”

Economic impact of coronavirus: Three central challenges for the international division of labor

The combination of accelerated digitalization and slowing economic globalization has three important implications for the future of the international division of labor and international competitiveness.

#1 International division of labor is increasingly under pressure

Efficiency and cost minimization used to be essential aspects of the design of the international division of labor. Since the reliability of supply will likely still be a relevant issue in the future, we expect a tendency towards further diversification of value-creation chains and increased inventory-building.

However, efficiency loss is the price to be paid for reducing reliance on supplies from the rest of the world. The partial renationalization of production processes could also trigger a renewed protectionism race.

Another problem is that companies procure certain input products from overseas either because the corresponding local products are uncompetitive or because specific resources are not locally available. This means that purchasers will continue to opt for currently available, more cost-efficient overseas goods and services even outside of times of crisis when such products are no longer imported unless and until the underlying economic outlook is altered. Therefore, the re-localization of the production of certain goods, which would be needed to minimize risks, will hardly be possible without some form of state support.

#2 The relevance of vertical industry policy is increasing

China, the USA, and other nations support key industries with a promising future such as electromobility, robot technology, or biomedicine with targeted support for selective sectors or technologies (vertical industry policy). If Germany and Europe have no desire to fall behind in these areas or become dependent on imports, they will have to step up the pace in vertical industry policy as well.

This is not about copying the Chinese or US approach but rather about developing a dedicated industrial policy approach true to the values and societal targets of a social market economy.

#3 Innovation capability becomes a core resilience factor

Industrial policy will emerge as especially relevant in the area of innovation. The intensifying hegemonic conflict between China and the USA reinforces the innovation competition between these two states. Dedicated technology spheres of influence are growing where either Chinese or US standards apply and where technology developments from one of these countries dominate.

The Covid-19 crisis further accelerates this trend. It reflects just how quickly states can be cut off from foreign innovations and shows how valuable domestic innovation capacity is in times of crisis. When it comes to increasing digitalization, domestic capabilities in technologies such as artificial intelligence, 5G, or blockchain will gain in importance.

Measured by particularly relevant, “world-class” patents, the USA is the global leader in many future technologies, and in particular in digitalization. China has boosted its power of innovation with rapid growth in the last few years.

These and other developments have led to a substantial structural change in the economy and society – and require citizens to adapt. The already elevated demand for facilitating these adaptations through social and educational policies is further increasing. Nevertheless, policies must be put in place.

Perhaps the greatest insight from the Covid-19 crisis is that changes happen faster than expected. Which ever country or individual adapts faster to these changes has a competitive advantage. Policies that improve adaptability and the embracing of change are therefore even more essential than before. Countries which are stuck in path dependency and adapt too slow will not excel in a post-Covid world.

Reading recommendations: The full report is available in German only. An English summary can be found in this MegatrendBrief.

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