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Legg Mason Perspectives: COVID-19: Social And Economic Consequences

By J. Patrick Bradley, Senior Vice President, Investment Research

The pandemic has created a fertile environment for social unrest, with much depending how well governments address the crisis and the subsistence needs of their citizens.

There’s nothing prophetic about saying the coronavirus will change the way we live and conduct business. Unemployment will rise, and some of that increase will create permanent joblessness. Some businesses will fail, despite the efforts of monetary authorities and governments to replace the income lost and to stem the spread of the virus. We have to wonder whether or not governments will come under pressure from citizens straining under the lockdown, who have lost jobs, and have found it increasingly difficult to feed their families.

No Conclusion Is Too Far-Fetched
Many parts of the world have been under mandated lockdowns and the services sector has been especially hard hit, like restaurants and tourism. Only essential services have been permitted to operate. This has led to protests across the globe…Tensions are rising.

Chart 1: Stringency Index
chart 1

Source: Oxford COVID-19 Government Response Tracker. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

In most developed countries, the strength of their institutions will allow a peaceful resolution to the lockdown dissents. However, the same peaceful resolution of conflict in emerging markets (EMs) may be different, where the strength and stability of institutions and government responses to the virus crisis might prevent a resolution of protests or civil disorder. Chart 1 shows the stringency index, a measure of governmental responses to the crisis, including school closings, fiscal stimulus, and healthcare. Arguably, a higher stringency score would be an indication of aggressive country measures to stem the spread of the virus. In this chart, Peru shows the most aggressive policies, while New Zealand has the lowest—the latter has begun to slowly exit its lockdown. Aggressive policies, particularly in EMs, could contribute to social unrest and growing protests, which could exert a negative impact on a country’s economy.

Protests have arisen as a response to government policies that locked down their economies. India and Iran are just two countries where citizens have reacted. In India, migrant workers staged protests. Thus far, police in many emerging countries have been able to restrict the protests. However, as incomes are hit and workers face unemployment and an inability to feed their families—particularly within a country’s informal economy—protestors might defy their government “orders” and take to the streets. Inequality will rise. The lower income groups spend a larger portion of income on food, and rising prices will affect the poorest tiers the hardest, possibly exacerbating tensions. Finally, EM governments generally have not provided the same type of income support to their citizens that developed countries have. Further economic deterioration, could cause the protests to boil over, despite governments’ curfew efforts.

ESG Factors and Risk
We can use our ESG factors to identify potential areas of risk; our source of ESG risk data is Verisk Maplecroft. First, since the driving force in the current world is the coronavirus, a good place to start is with a country’s healthcare system, and then identify those countries at risk from a public health threat. Maplecroft has created a healthcare capacity index that assesses the ability of a country to react to a health crisis. That information is found in Chart 2 below, where we show healthcare capacity graphed against COVID-19 tests administered.

Chart 2: Covid-19 Tests And Healthcare Capacity
chart 2

Source: Verisk Maplecroft, Wordometers, Brandywine Global. Please see Definitions section for definitions of these abbreviations.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

A low healthcare capacity risk score suggests a country is ill equipped to handle a pandemic. Latin America appears overly represented in the high-risk quadrant of the chart and includes Colombia and Peru. In Asia, Indonesia—according to this index—is also an extreme risk country. Brazil is a high-risk country, but the government’s coronavirus response has jeopardized the country’s public health. Brazil has just surpassed the U.K. for the most cases. Population density in Brazil’s favelas has enabled the spread of the virus. The rampant outbreak could raise the specter of growing social upheaval and civil unrest and pose a challenge for the government—particularly one that is generally conservative and dedicated its agenda to fiscal reform.

How does an investor make use of such information? A good question to ask is whether there a correlation between the healthcare capacity index and a country’s credit default swap (CDS), which is the relationship shown in Chart 3. A low healthcare capacity score of 0-2 suggests a higher CDS, while countries with higher capacities are rewarded with lower CDS. We don’t believe the correlation is spurious, as a country with an inability to handle a pandemic crisis should pay more for its debt. That higher cost of debt diverts fiscal support for other areas of an economy, which could feed back into social tensions.

Chart 3: Healthcare Capacity And CDS
chart 3

Source: Verisk Maplecroft, Bloomberg, Brandywine Global. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Deep Coronavirus Recession and Political Instability
The global economy is expected to decline—and sharply. That economic deterioration will worsen unemployment rates and negatively affect incomes, which disproportionately falls on citizens that are the least able to manage it: the poor and the low-income worker. Food could become scarcer and more expensive. The coronavirus will only worsen the existing income inequality in the world, but especially in EMs. Widening inequality raises the risks of civil unrest, populist uprisings, and political instability, particularly in those countries facing scarce food supplies. Regime change is certainly a possible outcome from this environment.

Chart 4: Food Security & Civil Unrest
chart 4

Source: Verisk Maplecroft, Brandywine Global. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Chart 4 examines the relationship between food security and civil unrest. There is a probability that food scarcity could catalyze civil unrest. The civil unrest variable in our research measures the perceived business impact from protests over a public concern, whether it be economic, political, or social. Food security measures the risk of having an adequate supply. The relationship between food security and civil unrest is a positive one, meaning the risk of not having an adequate food supply could foment an uprising. Chart 4 above plots a country’s food security score from 0-4 on the x-axis. The cluster of countries—India, Indonesia, and the Philippines—would seem to be at a higher risk for civil unrest, as are many countries in Africa.

What could reduce the risk of civil unrest? An effective government could reduce the tendency for social, economic, and political upheaval. Based upon our research efforts, an effective government would be perceived as seeking policies that benefit its citizens. The relationship in Chart 5 suggests ineffective governments are at increased risk for civil unrest. In the COVID-19 era, citizens would trust the government to act in their best interests. Governments deemed as ineffective in the era of coronavirus would be unable to meet the demands and needs of its citizens, who would then resort to an uprising.

Chart 5: Government Effectiveness & Civil Unrest
chart 5

Source: Verisk Maplecroft, Brandywine Global. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Several conclusions can be proffered:

  • The coronavirus pandemic does not preordain the onset of social unrest, but it can create a fertile environment for social unrest;
  • Countries at risk would be those with the weakest healthcare capacity; and,
  • In the end, how governments address the crisis and the subsistence needs of its citizens will determine how susceptible a country is to civil unrest and even changes in governments.


Legg Mason Key risks and Disclaimers

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

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