Real time economic reality

As the Covid-19 horror unfolds before us, it becomes clear with each passing day that this is a humanitarian crisis the like of which none of us have experienced in our lifetime. The economic consequences are a second order issue but over the coming weeks and months we will realise just what a huge hit the economy has taken. Central banks and governments are doing their best to mitigate the worst impact of the downturn, but they can never do enough. But just how bad is the downturn likely to be?

I have spent the last week trawling through up-to-date high frequency data to get a sense of where the UK economy stands. It does not make for pretty reading. Without going through all the indicators, one of the obvious places to start is with electricity output, taken from the National Grid at four hourly intervals. It is difficult to draw direct inferences for output given that factors such as temperature play a significant role in determining demand, but the fall in output following the introduction of the UK lockdown on the evening of 23 March is very marked (chart below). It is particularly noticeable that output during the day has fallen sharply whereas off-peak output has not, which is indicative of the collapse in demand from businesses that would otherwise be open and consuming electricity, such as shops and offices not to mention the power hungry manufacturing sector. A rough estimate suggests that output is down by around 3-4% compared with pre-lockdown trends, which I reckon is consistent with a GDP decline of up to 15%.

Wherever you look there is evidence of an economy which has simply hit the buffers. Rail journeys are down 95% on this time last year whilst the number of bus passengers is down 88%. People are also using their cars much less, with overall traffic numbers down 71%, though on the plus side those that do have to travel on the roads find that congestion has eased considerably (chart below).

The retail sector has also taken a significant hit. Footfall is down by around 80% compared to a year ago whilst the collapse in spending in the leisure sector has been almost total, with restaurants and pubs having been shut for two weeks. My calculations suggest that consumer spending in Q2 could fall by up 20% which is likely to mean a double-digit collapse in GDP growth. As workers are laid off, some temporarily but some perhaps permanently, we are likely to see an unprecedented rise in unemployment. We already know that the number of claimants for Universal Credit rose by almost a million in the second half of March, although since this includes people claiming in-work benefits as well those making unemployment claims, it is difficult to know how this will impact on the labour market figures. However a conservative estimate suggests that the jobless figures for April could show a rise of up to 2% in the unemployment rate. We have never seen such a sharp jump: the usual pattern once an economy falls into recession is for unemployment to pick up with a lag as the corporate sector adjusts slowly.

My guess is that this will lead to an annual reduction of around 6.5% in real GDP this year. To put this into context, based on the BoE’s long-term historical databank which contains GDP data back to 1700, this would represent the sixth worst output decline in the 319 years for which estimates are available. We have to go back to the immediate aftermath of WW1 for anything remotely like it. Faced with an output reduction of this magnitude, my concern remains that any economic recovery will be a protracted affair. Company earnings will take a huge hit which will shape their business practices for a long time to come. In many instances this will force a strategy rethink with attendant consequences for investment and employment. Unlike the post-2008 period which was characterised by companies being propped up by low interest rates and the substitution of labour for capital, the coming years may well see a more pronounced period of Schumpeterian creative destruction. 

Business models which rely on complex supply chains will likely be overhauled. If we had concerns about rolling back the globalisation trend before, the post-crisis world will almost certainly produce a sea change. The inability of countries like the US and UK to produce sufficient personal protection equipment for front line medical staff can be expected to spark a debate about the extent to which western economies rely too heavily on foreign producers to provide the manufactured goods they need. Suggestions that the likes of India are withholding drugs for use at home that they would otherwise export will further fan the flames of economic nationalism.

I will deal with the fiscal fallout in more detail another time but it is clear that we are going to be awash with government debt for years to come. It is unlikely we will be able to grow fast enough to significantly reduce the debt-to-GDP ratio given that we are faced with an ageing population, which leaves us with two alternatives. Either governments will have to embark on a policy of major austerity, which is likely to be highly unpopular given the experience of the past decade, or the real value of debt will have to be inflated away. Central banks have spent the past 20 years lauding their achievement of taming inflation and tell us today that they have no intention of relaxing their vigilance. I would not be so sure: Policymakers have a habit of changing their mind if the circumstances demand it.

Flexibility will be the name of the game in future as electorates make different demands of their governments than they have in recent years. We should be no illusions as to the profound social and economic changes that are to come. But first we have to get through the current crisis!