The global picture
As the official bodies begin to put out their growth
forecasts for 2020 and 2021 the magnitude of the hit facing the global economy following
the Covid-19 shutdown is becoming increasingly clear. The IMF’s latest
projections suggest that global GDP will contract this year by 3%, rebounding
by 5.8% in 2021. We have not seen anything like it in 90 years since the Great
Depression, when world activity is estimated to have fallen by 10% between 1930
and 1932 with three successive annual declines of 3% or more. For the record, it took six years for output
to regain its pre-crash highs. The IMF is suggesting that next year we will be
able to put all of this behind us and push output back above pre-crash levels.
I remain highly sceptical.
The good news, as the IMF points out, is that we do not
currently have the degree of protectionism and beggar-thy-neighbour policies of
the early-1930s which made the downturn so much worse than it needed to be. But
economic nationalism is clearly back in fashion, and Donald Trump’s decision to
halt US funding to the World Health Organisation during the greatest public
health threat in a century is indicative of the febrile sentiment currently at
play (not to mention the fact that it is probably one of the dumbest of petty
acts and says a lot about Trump’s way of doing business, but in the interests
of politeness to my American friends I will leave it there). Interestingly, the
IMF’s forecast makes it clear that whilst output in emerging markets will
rebound quickly, the advanced economies will not recoup their output losses in
2021. Indeed, EM economies take a relatively small hit with output projected to
fall by only 1% this year and surging by 6.6% next year. My concern with this
is that many EMs are export-driven economies, and if the developed world is
growing relatively slowly, the demand for EM exports may not recover
sufficiently quickly to drive the expected global growth surge.
The big imponderable is how deep will be the scars left by
the current shutdown? The cause of the economic collapse is simply that much
economic activity is prohibited as lockdowns came into force which has resulted
in many people having to remain at home. Such impacts will ripple throughout
the economy in as-yet unpredictable ways, and whilst fiscal and monetary
policies have been turned up to the max they can only mitigate and not totally
offset the economic damage. For example, even though interest rates are at rock
bottom levels everywhere, this is no guarantee that people will want to borrow
when the worst of the crisis is past. Nor will lenders necessarily be willing
to grant credit to those individuals and businesses who are struggling to stay
afloat if they are perceived to be a bad credit risk. This puts banks in a
difficult position. Whilst they were perceived as the bad guys a decade ago,
they want to be seen to be making a positive contribution today. But they also
have a duty to their shareholders whose returns have taken a beating, and who
will not thank them for any big rise in loan-loss provisions.
So far, all of this has been predicated on the assumption
that the Covid-19 crisis can be compressed into the second quarter of 2020.
This is far from a certainty. Much will depend on what form of exit strategy is
adopted by governments: How long will it take to reopen the economy even if the
threat passes relatively quickly if the process is staggered over several
stages? Then there is the question of whether the viral threat will indeed pass
so suddenly. Scientific evidence suggests that social distancing measures may have to remain in place until 2022 and vigilance maintained until 2024,
neither of which are conducive to a sudden pickup in activity. For the record,
the IMF did conduct alternative scenarios. In one of the worst case outcomes,
the assumption of a longer Covid-19 outbreak in 2020 together with a renewed
outbreak in 2021, results in a level of GDP next year which is 8% below the baseline
discussed above. This would imply an output loss of more than 5% over two years
which starts to look more like a 1930s outcome.
The local picture
Closer to home, the UK Office for Budget Responsibility came
out with an illustrative scenario earlier this week which suggested UK GDP
could collapse by 13% in 2020, with a 35% contraction in Q2 alone, which is
followed by a rebound of 18% in 2021 (chart below). To put that into context, this would be
the largest annual contraction in GDP since 1709 when the Great Frost wiped out agricultural output. The projected rebound in 2021 would also be the
largest since 1704 (apparently). Even allowing for the fact that the historical
data are subject to a huge degree of uncertainty, the OBR figures suggest the
most volatile swings in output for over 300 years. Like the IMF (whose
predictions for UK growth in 2020 and 2021 are a more modest -6.5% and +4.0%
respectively), the OBR figures effectively assume that there will be no
economic scarring although I doubt very much that if the OBR’s awful 2020 forecast
is realised there will be much of a rebound next year.
Predictably, the IMF and OBR projections were met with the
usual scepticism from those who have nothing better to do than criticise the
forecasting efforts of others. I am not going to jump on that bandwagon. After
all, these forecasts are produced because there is a need to have some basis
for planning. What would the sceptics rather we do? Produce nothing and trust
to luck by making it up as we go along? Just imagine the howls of rage if
governments were not prepared for the worst case outcomes. But it does raise a
question as to how such analysis should be treated at a time when predicting
the future is little more than guesswork. The OBR made it clear that its
analysis was a scenario, not a forecast, yet the media treated it as if it were a forecast. You may ask what is the difference? The answer is that a
scenario is a conditional assessment based on a “what-if” approach
whereas a forecast is typically viewed as an unconditional, what-will-happen
event.
Obviously this is a fine distinction but it is important.
The OBR is not suggesting in its analysis that it believes the outcome will
necessarily be realised but it is an attempt to highlight the economic risks.
Arguably there are better ways to do it. It could, for example, have prepared a
range of outcomes along the same lines as the IMF and not chosen to discuss one
illustrative case which runs the risk of being treated as an unconditional
forecast. As former BoE insider Tony Yates pointed out on Twitter, the
criticism levelled at the OBR is “the
kind of thing that makes policy bodies nervous about being as transparent as
they should be to help us hold them to account.
The BoE was paralysed by this nervousness, and made themselves hard to
scrutinise.”
The one thing we know is that all forecasts produced in the current uncertain environment will be wrong in some way. They
should be viewed as an attempt to shine some light in the dark, however feeble.
In truth, the ordinary voter does not care about GDP growth but when you tell
them it is a proxy for the path of employment and incomes, we are then talking
about something meaningful for them. As a final thought, when the IMF and OBR
are so far apart in their views on the UK, this is an indication that the light cast by the forecast insight is dim indeed.
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