The Covid curse strikes again

If 2020 was the year from hell, 2021 is turning out to be more like purgatory – a temporary version of hell which we hope will end sometime but don’t know when. As the end of 2021 moves into view, it is beginning to feel very much like a year ago: After a summer during which infection rates fell, a new Covid variant has popped up and case numbers are sharply on the rise as we head into winter. The surge in case numbers is especially big in Europe (perhaps less the case in the UK where case numbers have been elevated for the past three months) and the discovery of the Omicron strain has raised a lot more questions than the scientific community currently has answers. New restrictions on social gatherings are being put in place and forecasters are beginning to edge down their economic growth projections for the winter months, which is bad news for those institutions that have already produced their year-ahead outlooks and spent the past few weeks marketing them to clients.

Global case numbers suggesting there have so far been 268 million Covid infections can be taken with a huge grain of salt, especially when they indicate that China has reported less than 100,000 positive cases versus 10.6 million in the UK – a country with a population just 5% of the size. European data are likely to be more accurate given the rigorous testing procedures in place across the continent: they point to almost 86 million cases since February 2020 with a quadrupling in the last 12 months.

Germany has led the way in tightening restrictions, with significant curbs on the unvaccinated who will have to contend with curtailed access to restaurants, cinemas, leisure facilities and many shops. This was described by outgoing Chancellor Angela Merkel an act of “national solidarity.” The new Chancellor Olaf Scholz backs a policy of mandatory vaccinations, although this has yet to go through parliament. Indeed, it is notable that the proportion of the German population vaccinated against Covid currently stands at a relatively low 71%, versus 75% in the UK; 77% in France and Italy and 82% in Spain. In response to the threat posed by Omicron, the British government earlier this week implemented what it called ‘Plan B’, carefully avoiding the word lockdown. This entails reintroduction of working from home guidance; the use of facemasks in “most public indoor venues” and a requirement to show a Covid pass in a number of venues, depending on the number of people present and whether it takes place indoors or outdoors.

The Covid policy tracker, published by the Blavatnik School of Government at Oxford University, shows that the restrictions index jumped sharply in Germany and is now back to levels last seen in January (chart). Such a sharp jump has not yet been seen in the UK, although it is likely to edge up over the next few days as the Plan B measures take full effect. A comparison of the political response in the UK and Germany shows considerable differences in approach. Germany has acted quickly and the political consensus is in favour of action to restrict the spread of Covid. But there is mounting political resistance in the UK to further restrictions, driven in part by the defiant libertarian streak which is present in the governing Conservative Party. The Plan B legislation may indeed only pass through parliament thanks to the political opposition which has said it will support the measures.

This is not to say that there are not legitimate concerns about the damage that lockdowns do to the economy. Of course, we do not yet know what the full impact of the Omicron variant will be but the evidence suggests that it is the most transmissible variant to date. Case numbers look set to rise sharply across Europe and the government responses are unlikely to leave the economy unscathed. Even before the latest concerns about the Omicron variant, the UK economy had lost considerable momentum. GDP in October rose by just 0.1% m/m taking the annualised 3-month growth rate down to 3.2%. Ironically, such growth as there was in October came from output in human health activities, which grew by 3.5% m/m due mainly to a continued rise in face-to-face appointments at GP surgeries. It is a pretty strange sort of economy where growth is being driven by numbers of sick people going to see their doctor. It is still possible that output will get back to pre-Covid levels by Q1 2022, as the BoE projected in November, although this will depend on the extent of any anti-Covid measures.

Omicron has muddied the likely monetary policy response ahead of the BoE’s final MPC meeting of the year on Thursday. After considerable criticism that the BoE had led analysts up the garden path by not raising interest rates last month, it was widely believed that it would do so in December. That expectation has faded and rates are tipped to remain on hold next week. Given the uncertainty surrounding the economic situation, that would seem to be a prudent move. The consensus GDP growth projection for 2022 has slipped from 5.6% in August to 5.1% last month and the likelihood is that it will dip further (for the record, my own projection looks for a growth rate in the range 4% to 4.5%). There are many who believe that high inflation warrants monetary tightening. However this is to miss the cause of the recent inflation spike which is the result of supply chain difficulties. Tighter monetary policy today will do nothing to tackle this problem although once some of the Covid-related uncertainty passes there is a case for modest policy tightening.

Markets appear to be taking the view that the Omicron variant will slow economic activity rates and thus cool some of the inflationary pressures. That is not what happened a year ago when the emergence of the Delta variant made these problems worse rather than better. This is a reminder that one of the bigger dangers we face is complacency. The Omicron variant represents a new strain rather than a new disease, so the threat is perceived to be lower than it was in March 2020. That may be true but it may turn out to be wrong if the transmissibility rate is so much higher and the virus mutates yet again. Public health experts are thus warning that we once again need to deploy the toolbox developed in 2020, which entails significant economic disruption.

Quite how long we can go on doing this depends on the duration of the Covid pandemic. Based on the evidence derived from this paper, the average duration of global pandemics over history is around 6 years. It is not an edifying thought that we are barely two years into the Covid outbreak.

Open season

The announcement that the UK government intends to scrap almost all Covid-related restrictions in England on 19 July has led to significant concerns that it is yet again taking a risk with the pandemic that is not justified by the evidence. Covid cases are rising rapidly with latest figures showing a rise of 49% on a week ago (+383% over the last four weeks). Boris Johnson admitted in his speech to the nation that numbers could double to 50,000 per day by the time “Freedom Day” arrives. New health secretary Sajid Javid suggested in a radio interview that they could even rise to 100,000 per day. For the record, the previous record high was 68,053 on 8 January. For those who recall Boris Johnson’s promise that “data not dates” would determine the government’s policy actions, the latest announcement has raised more than a few eyebrows.

Is this a just policy?

There is no support for this strategy from the medical profession with the BMA calling for the continued use of face masks, arguing that even if the vaccination strategy has lowered mortality risks, the risk of infection has not disappeared which could have significant health impacts due to complications resulting from long Covid. However, the move appears to be a political response to the vocal and ill-informed anti-mask movement which somehow sees masks as an infringement on personal liberty. Indeed, this TV interview with a backbench Conservative MP spoke volumes when she called the wearing of masks on public transport “an infringement of civil liberties.” Ironically this concern for civil liberties was invoked on the day that parliament debated a policing bill which even many Conservative MPs find draconian. More seriously, as members of the medical profession pointed out, the wearing of masks gives people freedom to do things more safely that they may not otherwise be able to – such as travelling on public transport or visiting a restaurant.

One of the issues thrown up by this debate is the trade-off between personal and social responsibility. Anti-maskers argue that they should be allowed to exercise their own judgement as to when to wear them. Pro-maskers argue that since masks generate a positive externality by protecting others as much (if not more so) than the wearer, their use generates a wider social benefit. Welfare economics has attempted to build on the idea of Rawlsian justice as a way of assessing social choices, in which we have to balance the greatest possible amount of liberty being given to each member of society subject to the constraint that liberty of any one member does not adversely affect any other member.

To the extent that a person not wearing a mask impinges on the rights of those who wish to take precautions against Covid, the economist (not to mention the Rawlsian philosopher) would argue that simply doing away with masks flies in the face of social justice. After all, a public space belongs to everyone – not simply the group that makes the most noise. For the record, after Israel last month eliminated the requirement to wear a mask, 10 days later it was forced to backtrack.

Is there a herd immunity argument in favour of opening up now?

The proportion required to be vaccinated in order to achieve herd immunity differs according to the disease – for measles it is 95%, for polio 80%. Previous estimates suggest that such immunity for Covid would require between 60% and 70% of the population to be vaccinated (some estimates put the proportion even higher). For the UK alone, we are in the window, with around two-thirds of the adult population now having received two doses of the vaccine (though that figure drops to around 50% once we allow for children, who are not scheduled to receive the vaccine). But on a global basis we are nowhere near this. According to the respected website Our World in Data, only 24.4% of the world’s population has received one dose of the vaccine. So long as country borders remain open – even if only partially – the risk of cross-border transmission remains high.

A recent article in Nature suggested that herd immunity to Covid is now unlikely to be achieved and the epidemiology community is “moving away from the idea that we’ll hit the herd-immunity threshold and then the pandemic will go away for good.” As new variants emerge – much like the delta variant – and immunity begins to wane, the likelihood is that Covid will become an endemic disease in much the same way as flu. In this sense, at least, the UK government’s argument that we will have to live with Covid is consistent with scientific thinking. However, this is not an argument for ending all restrictions.

On the plus side, although cases are rising sharply, hospital admission and mortality rates have not. This provides strong support for the government’s argument that the vaccine programme has helped break the mortality link. Whether or not this remains the case cannot easily be predicted. The UK population is only partially vaccinated and virologists fear that ending restrictions in such an environment will create a breeding ground for new Covid variants. Even if the worst case does not arise, the medical evidence is clear: Avoid unnecessary exposure to Covid.

A recipe for economic chaos

It is perfectly understandable that parts of the hospitality industry want to get back to business as usual. But the wider economic costs of opening up are potentially significant. The government plans to scrap the working from home guidance and it will be up to employers to find an agreement with staff as to how the transition back to the workplace will be managed. However, the self-isolation rules requiring people to quarantine for 10 days in the event they come into contact with Covid will only be lifted on 16 August. On the basis that two people are forced to isolate for every recorded case, 100,000 cases per day as per Sajid Javid’s suggestion, would result in 1.4 million people having to self-isolate in the second half of July and first half of August.

Even if the number of cases is “only” 50,000 per day, it still implies that 2% of those in employment will be affected which will have significant implications for businesses. It is likely that many employers will continue to allow their employees to work from home but there are many jobs where this is simply impossible (e.g. retail). There will thus be some very heated conversations between employers and employees about the appropriate time to return to work.

Last word

In some respects the government’s insistence on setting a date to end restrictions is reminiscent of the approach to the Brexit deadline: Announce the date; implement the policy and deal with the fallout later. But given the government’s past approach to Covid which has seen it criticised for being too slow in applying lockdowns and closing borders, not to mention the policy towards old-age care homes, it is reasonable that people are concerned about the consequences of opening up at a time of rising Covid cases. The government knows that it cannot afford to get this policy wrong. Many people’s lives literally depend on it.

No vaccination against politics

Doing drugs may be a lifestyle choice for many people but for pharmaceutical companies there is little choice – if they are not in the drugs business, they are not in business at all. But the drugs business is not quite like any other. Although pharma companies are similar to other private sector companies in trying to make a profit from their work, they are also very different in that much of their input yields very little return. The industry also runs into a host of ethical problems. One of the trickiest issues is whether it is right that they should generate abnormal profit at the expense of the sick? Yet over the last 12 months we have been very glad of their efforts as the industry has produced a number of vaccines against Covid-19. But even these heroic efforts have not prevented companies from being drawn into major controversies as the politics of vaccination starts to kick in.

Four vaccines have been authorised for use in the EU: Comirnaty (aka the Pfizer-BioNTech vaccine); the Moderna vaccine; the Janssen vaccine and Vaxzevria (known until yesterday as the AstraZeneca vaccine). It is the latter of these which has fallen foul of vaccine politics to a far greater degree than the others.

The (drug) trials and tribulations of AstraZeneca

Since the start Vaxzevria (known hereafter as the AZ vaccine) has suffered from the perception that it is less effective than its competitors. Back in November Pfizer was the first producer to announce the results of its clinical trials, suggesting that its vaccine had an efficacy rate around 94% whilst Moderna made a similar claim. Initial trials of the AZ vaccine suggested an efficacy rate of just 62%. But AZ subsequently announced that the efficacy rate amongst participants who received a lower amount of the vaccine in the first dose and then the full amount in the second dose rose to 90%. For the layperson, the suspicion was sown that AZ had somehow tried to “fix” its results to bring them into line with those from other producers. The waters were further muddied when it subsequently came to light that the low dose trial did not include anyone over the age of 55, raising concerns that the higher efficacy was merely a by-product of excluding an age group that is particularly vulnerable to Covid. This led to a situation whereby many EU countries initially refused to licence the AZ vaccine for older age groups. Bizarrely, Germany has now licensed it only for the over-60s. 

Although the EU and UK did grant a form of authorisation to the AZ vaccine, it had until recently still not received a licence for distribution in the US which is critical to global acceptance. The US Food and Drug Administration (FDA) had asked AZ to conduct a larger trial in order to get clearer data than they obtained in their first rounds of testing. In late March, AZ thus released data showing that its vaccine is 79% percent effective at preventing symptomatic disease. But in an unprecedented move the National Institute of Allergy and Infectious Diseases (NIAID) released a letter stating that the AZ results were based on outdated data. Within 48 hours AZ released an updated set of results stating that the vaccine has 76% percent efficacy in reducing symptomatic Covid-19 overall, and 85% in people 65 years old and older.  

To make matters worse a number of countries suspended the use of the AZ vaccine altogether on reports that a number of patients suffered blood clots (thromboembolic events) as a reaction. Although the European Medicines Agency subsequently stated that “the number of thromboembolic events in vaccinated people is no higher than the number seen in the general population” this is just another example of the reputational damage which has been inflicted on the AZ vaccine.  

Was it worth it?

AstraZeneca’s management can be forgiven for wondering whether their efforts to develop a vaccine which is significantly cheaper than its competitors and which will be sold at cost to developing countries were worthwhile. There is considerable evidence that people in many countries much prefer to be injected with the Pfizer vaccine rather than the AZ version with Germans and Canadians showing a clear preference for the former. As a result AstraZeneca’s share price has underperformed that of Pfizer in recent weeks.

Under normal circumstances AZ’s efforts to deliver a vaccine to combat a new disease at such a rapid pace and at a low cost would be lauded as a miracle of science. Yet it has dominated the headlines for all the wrong reasons. In some ways it is hard to refute the claim made by Anthony Fauci, the US President’s chief medical advisor, that AZ has made “unforced errors” in its handling of the process. Communication of the drug trial results has been very confusing and the issues with NIAID could perhaps have better been handled had both sides liaised better before announcing the results.

Some of the issues may also stem in part from the fact that AZ does not have a lot of experience in vaccine production. According to the experts, the productivity of identical plants can differ for no apparent reason with the result that there can be considerable variation in quality across batches. The international supply chain dimension further adds to the complexities of vaccine production. As a consequence AZ may have underestimated its ability to produce the volume of vaccine which it promised. This became a convenient stick with which to beat the company, thus diverting attention away from the failures of the vaccine rollout programme in parts of the EU.

For all this, the work of AstraZeneca deserves a lot more praise than it has so far attracted from large parts of the international press. The vaccine is far easier to store than those developed by Pfizer and Moderna, making it much more useful in those countries which may not have the capacity to store it at the low temperatures which they require. Moreover it is being used and saving lives which is more than can be said for all those companies which are engaged in vaccine research and whose products have yet to see the light of day – not because they are not good at their work but because vaccine development is a difficult process.

AstraZeneca has unfortunately fallen victim to vaccine politics

Indeed, not all the blame attributed to AZ is of its own making. Whilst it is true that the EU countries have exported the AZ vaccine to the UK whereas there has been no flow in the other direction, this is partly to do with the details of the respective contracts drawn up between AstraZeneca and the UK/EU. This article, quoting a Belgian contract law specialist, explains why the UK’s legal position with regard to supply is stronger than that of the EU. Interested readers are referred to the article for the detail but the key points are:

1. The UK contract is written in English law which is quite specific about assessing whether both parties delivered the goods. By contrast the EU contract is written in Belgian law, which puts a lot of emphasis on the concept of good faith in determining whether both parties tried their best to deliver the goods; 
2. The UK contract made it clear that the whole supply chain process was taken into account whereas the EU focused only on delivery;
3. The UK contract has stricter enforcement penalties than that drawn up by the Commission which left it somewhat toothless.       
   

The influential MEP Guy Verhofstadt is quoted as saying “since the outcome of this particular contract has led to an enormous amount of public distrust, both the Commission and AstraZeneca have a lot of explaining to do.” But it rather looks as if it is the former, rather than the latter, where the problems lie since the contract drawn up by the Commission appears to be less watertight than the one AZ signed with the UK. That said, AZ has under-delivered and if it has learned anything from this debacle, it is that it needs to manage expectations more effectively.  

But we should not rush to judgement. Only once the recent teething troubles have been sorted can we can really assess whether the EU’s vaccine rollout has really been so bad (it is likely to catch up quickly) and whether AZ has lived up to its promise to deliver a low-cost vaccine that has saved the world.

24 March 2020 BC

We all undoubtedly look back wistfully to a time when we could go where we wanted and meet whom we wished. That was, of course, in the time before Covid – the ancient past we now call BC. It is hard to believe that here in the UK it is now exactly a year since the first lockdown was introduced. Following Boris Johnson’s announcement on 23 March 2020, the country changed overnight. Although there had been a reduction in activity ahead of the announcement, which was widely expected, on the morning of 24 March our once-bustling high streets resembled a post-apocalyptic film set in which our hero awakens to find everyone has disappeared. That morning, it felt as though London had become a ghost town – indeed the UK had become a ghost country.

Whilst a lot of economic activity simply stopped – we could no longer go to a restaurant or visit the cinema, for example – a lot of it was merely displaced. For many people their homes became a shelter from the ravages of Covid and for some a prison. More important economically, for many of us our homes also became our workplaces. This has had profound consequences for the shape of the economy and there have been some remarkable changes to the way in which it operates. Many of these changes are likely to be temporary but some will undoubtedly be permanent. What does the data tell us about how the economy – and indeed our lives – have changed since March 2020?

The big picture

Turning to the aggregate economic picture, over the last twelve months the UK economy has suffered an impact similar to that of a war. GDP in 2020 slumped by 9.9% – the biggest drop in over 300 years – whilst latest monthly GDP data to January show that output is still 10.6% below its October 2019 peak. Contrary to expectations, the labour market has held up relatively well. Although the unemployment rate has risen to 5% versus 3.9% a year ago, employment is down “only” 1.9% which is a considerably smaller decline than the collapse in output. In this sense the labour market support measures put in place by the government have done their job by preventing a much bigger labour market shakeout (so far, at least). Whilst evidence suggests that payroll employment has increased in each of the three months to February, it remains well below the January 2020 peak. What is more, two-thirds of the decline in jobs has been concentrated in the under-25s with over half occurring in the hospitality sector.

But the devil is in the detail

Over the past year we have had to cope with conducting our lives in a very different way compared to the pre-Covid era and economists have devoted a lot of time to looking at non-traditional data to measure changes in the composition of activity. One of the first things we noticed last year was the sharp decline in the number of people on the streets as they obeyed the call to stay home. This was reflected in a sharp drop in the number of car journeys and the numbers using public transport (chart 1). The number of car journeys, which dropped to 20% of normal levels as the lockdown was introduced, got back to more normal levels by the summer but rail journeys never returned to anything like BC levels. Similarly UK air passenger numbers as of last month were almost 88% below year-ago levels. This has major implications for companies that rely on fare-paying passengers. For example, the government has provided £10bn of funding to the railways whilst the London transport network has only been kept afloat thanks to a government grant which will entail measures to recoup additional revenue in future.

Traffic congestion data also reveal some interesting insights into commuter behaviour. A couple of things stand out from a year’s worth of hourly data on London traffic congestion. First, congestion levels have increased more quickly than the numbers travelling by train or bus. One takeaway from this is that people are more prepared to drive to work in order to reduce their Covid infection risk on public transport. Another noticeable trend is that the peak of the evening rush hour – at least in London – has shifted slightly forward from 5pm to 4pm as workers are encouraged to spend less time in the office during lockdown.

The retail sector has been hit hard by measures which have required most non-food establishments to close. Many of them will not reopen once restrictions are lifted. According to the Centre for Retail Research last year’s trends were a continuation of those in 2019 with almost 183,000 retail sector jobs lost versus 143,000 in 2019. As the CRR points out, the industry has been under pressure for years due to high costs and increased pressure on margins. But an additional threat has been the rise in online sales which have boomed over the last year. Prior to the lockdown roughly 20% of retail sales were conducted online. Latest data to January show that in the depths of the second lockdown the share rose to 36% (chart 2). This is a trend which is likely to remain in place.

By far the most radical economic change during the pandemic has been the huge shift towards working from home. According to ONS data, almost 50% of workers did so from the comfort of their own homes last spring – a figure which was replicated again during the most recent lockdown. As I noted in this post, although there are many advantages associated with working in an office – most notably the creation of network effects – many people do not miss the downsides, particularly the commute. One advantage of doing away with the commute is that it gives us extra time in bed. Evidence that we are starting our day a little later can be gleaned from electricity generation data which suggest that in the first 12 weeks of 2021 electricity generation measured at 0700 is running at an average of 2GW below corresponding levels a year ago, whereas generation over the rest of the day is broadly unchanged (chart 3).

Improvements in communications technology in recent years mean that it is now relatively straightforward to remain in contact with office colleagues without having to meet in person. As a result, many of us are convinced that remote working will be a part of the labour market in the years ahead, even if people do spend at least part of their week in the office.

The extent to which we quickly got used to dealing with this way of working can be seen from Google searches for the term “Zoom” in the UK. This hit a peak in late-March/early-April 2020 but subsequently tailed off quickly (chart 4) indicating that large numbers of people are now familiar with the technology. Looking more widely, web searches give an insight into the things people are interested in and Google’s analysis of UK search trends in 2020 is a mine of useful information (readers can go to the link and change the country of interest if they so wish). Not surprisingly, coronavirus topped the list but amongst the top-5 “how to” searches were “how to make a face mask” and “how to cut your own hair” (and for some bizarre reason “how to cook eel” made it to number six).

Last word

As Covid cases rise across Europe we are clearly not out of the woods, despite the fact that the UK numbers so far have been running in the right direction. However, after a year of restrictions on their way of life the vast majority of people are looking forward to a return to something closer to BC normality. Quite when we will get to that point is unknown. England’s chief medical officer, Professor Chris Whitty, has warned that there will “definitely be another surge” of Covid and while “the path from here on in does look better than the last year [there will be] bumps and twists on the road.” He went on to say that “the chances of eradicating this disease – which means getting rid of it absolutely everywhere – are as close to zero as makes no difference.”

In such a case, it is likely that the economic upturn will be slower than many suppose and in keeping with my prediction from a year ago, there will be a lot of economic scarring to contend with. The economy in the AD (after danger) era is likely to be very different to the BC world as the trends that have emerged over the last year become a permanent feature of the landscape.

Reflections in a time of Covid

A year on

Last Thursday marked the first anniversary of the World Health Organisation's classification of the Covid-19 outbreak as a pandemic. The lives of millions of people have since been put on hold as governments have been forced to lock down their economies in a bid to halt the spread of the disease. There have recently been some signs of improvement with the mortality rate across Europe significantly below its January peak as a result of renewed lockdown conditions and the acceleration of the vaccine rollout. However, daily case numbers are rising again in a number of continental European countries. They have almost doubled in Italy in the past three weeks, prompting the government to tighten restrictions, whilst in Germany the Robert Koch Institute for infectious diseases predicted that the number of daily reported cases could exceed the December peak by mid-April. The rate of decline in UK cases, which has been proceeding rapidly for the past two months, has recently slowed although there is insufficient evidence to know whether this marks a turnaround or is just a blip.

We have learned a lot about pandemics and how to manage them over the past year. The most important lesson is that lockdowns do work and in this regard the UK was slow off the mark in spring 2020. It is sobering to recollect that health experts were aware of the scale of the problem ahead of us. This edition of Question Time, the BBC’s weekly topical debate programme, from 12 March 2020 featured Professor John Ashton who delivered a withering critique of government policy and accurately predicted what was about to unfold. His efforts to highlight the extent of the disaster stood in stark contrast to the complacency of government ministers at the time. The fact that more than 125,000 people in Britain have died from Covid over the last year – the fifth highest total in the world – is testimony to policy failings. When normalised to account for the size of population, the UK’s mortality rate of 188 per 100,000 is the highest of any country with a population over 12 million (chart 1).

The more positive news is that the vaccination rollout appears to be a great success. Although Israel is well out front in terms of vaccinations delivered, the UK and US are gaining momentum (chart 2). It is sobering to recall that a year ago we were warned that it could take years for an effective vaccine to be developed. At that time the fastest any vaccine had previously been developed, from viral sampling to approval, was four years – for mumps in the 1960s. The vaccination process has not been without its controversies: Concerns persist about the effectiveness of the AstraZeneca vaccine with the most recent issues surrounding its potential side effects. In addition, there is a vaccine hoarding problem with the developed nations having bought a large supply of the world’s available stock, thereby leaving less for the poorer nations. Nonetheless, it is remarkable that such huge strides have been made in the space of just 12 months.

But we are not yet out of the woods. Lockdowns in some form or another are likely to remain in place well into April, which effectively means that economies in most parts of Europe will be operating under highly restricted conditions for up to one-third of the year. So long as concerns about new Covid variants remain a live issue, we cannot afford to be complacent with regard to the prospect of a further coronavirus wave.

Counting the economic cost

From an economic and market perspective it has been a wild ride. Last year saw the largest peacetime contractions in output in almost a century (more than 300 years in the UK case) and we cannot be confident about the pace of the rebound in 2021. In spring 2020 it was widely assumed that the contraction would be followed by a rapid recovery but a second wave of the pandemic has led to rather more muted hopes across Europe. That said, the OECD recently revised up its expectations for global growth in 2021 compared with last November with particularly rapid growth projected for China (7.8%) and the US (6.5%). Latest UK figures give some grounds for optimism, with GDP in January falling by only 2.9% versus expectations of something closer to 5%, and as a consequence it is likely that Q1 growth will turn out less bad than the 3.5% contraction currently pencilled in by the consensus (which will raise the annual growth rate, ceteris paribus).

The jury is still out as to the nature of the economic recovery. The economic shock has had implications for both the supply and demand side and the shape of the recovery will be determined by trends on both sides. Demand is likely to rebound fairly quickly, particularly given the extent of unanticipated household saving which is likely to be rapidly run down (chart 3). That said whilst spending on goods may pick up as the retail sector opens up, a lot of the spending on services which has not taken place over the last year will simply not be recouped. After all, we are unlikely to go on more holidays or make up for a year’s worth of foregone restaurant meals. It is for this reason that the damage to the supply side of the economy is hard to gauge. The future states of the airline and retail sectors are likely to be different to their pre-Covid form, whilst the leisure sector has taken a battering from which many establishments will find it difficult to recover. It is for this reason that I maintain the recovery may prove slower than a lot of projections currently suggest. 

Markets on edge

From a market perspective, in March 2020 we were about to step into the unknown – never in living memory had we experienced a global pandemic and equity markets quite simply collapsed in the face of unprecedented uncertainty. Following the actions of central banks to provide unlimited liquidity, the subsequent rebound took many by surprise – myself included. Indeed, we are now at the point where many investors believe the equity rally is overdone with the S&P500 closing last week at a record high – around 17% above the pre-pandemic high in February 2020, despite the economic collapse, and 76% above the low a year ago. This has occurred at the same time as fixed income markets have sold off as inflation concerns mount in the wake of the huge US stimulus package – a fiscal strategy which might have been better served had it been introduced last year.

It remains to be seen whether inflation fears will be realised. However, if inflation does pick up the fiscal stimulus is unlikely to be the only catalyst. Equally important – if not more so – are events in China where demographics mean that it will be increasingly difficult in future to generate big increases in output by increasing the labour contribution. To the extent that the quiescence of inflation over the last twenty years has had more to do with the expansion of low-cost global production capacity in emerging markets than anything that has happened in the industrialised world, events in China will be the key to markets in the years ahead.

One of the potential side effects of the Covid crisis is that it may serve to mask a number of secular trends that we initially ascribe to the events of the past year but are in reality due to other factors. This was the case following the bursting of the Japanese bubble economy in 1990 and the GFC of 2008-09 when a slowdown in population growth resulted in slower potential growth in the wake of the crisis, giving rise to a much slower recovery than anticipated. As we reflect on an unprecedented year, we have learned a lot about pandemics and how to combat them but we have a lot still to learn about the long-term effects on the economy and markets. There is a long way to go before we can contemplate a return to economic normality, and whatever the new normal is, I suspect it will not be like the old one.

A border skirmish

I have spent the last five years hammering the British government for its failings in dealing with the EU so it is only fair to apply the same criteria to the EU when it gets it wrong. Both sides of the Brexit divide in Britain were critical of the European Commission’s (EC) decision to impose a border in Ireland for the purposes of halting the export of Covid vaccine. This follows AstraZeneca’s (AZ) announcement that it would only be able to deliver 25% of the planned 100 million doses of the vaccine to EU members by March. The fact that the Commission subsequently backtracked suggests it realises it made a mistake. Although no physical harm was done, it shows the extent to which relations between both sides remain tense and calls into question a number of aspects of Covid management on both sides of the Channel. 

How did it come to this? 

There has been growing discord across continental Europe about the slow pace of vaccine rollout which lags well behind the UK (chart above). For the British government, which this week came under renewed pressure as the UK death toll topped 100,000, it is important that the vaccination rollout is a success after the failings in many other parts of the Covid response programme. Indeed, despite the apparent success (so far) of the UK vaccination rollout, it cannot detract from the fact that the UK has one of the highest per capita mortality rates in the world. But this is about more than just the UK.

In June 2020 the EC set up a scheme whereby vaccine purchases are negotiated centrally on behalf of all member states. This was not a compulsory scheme but all members signed up to it on the basis that the enhanced buying power of the EC would reduce costs and ensure that all would be treated equally. Under the terms of the agreement, no member can negotiate with a supplier who is already in discussions with the EC. However, the German government did a side deal with Pfizer in September, with whom the EC was already in negotiations, by signing up for an additional 30 million doses.

The German action was in part motivated by the EC’s slow progress towards signing contracts with vaccine producers. One reason for this was that the EU insisted that the drug companies assume liability for any side effects resulting from the use of the vaccine, which slowed down the negotiation process. Accordingly, the EU signed its first contract with AZ only in August, three months later than the UK. Similarly, the EU only signed a contract with Pfizer in November whereas the UK signed up with them in July. The EU was also a bit slower to approve the first coronavirus vaccines than the UK and US. The UK approved the Pfizer vaccine on 2 December, just over a week earlier than the US, whereas the European Medicines Agency did not grant approval until 21 December. This is not necessarily a criticism of the EU approach. Its cautious approach to the science was justifiable and it was buying in much larger quantities than the UK. 

The Commission’s real problem is with AstraZeneca 

But where the EC can be criticised is that although it signed contracts with AZ much later than the UK, it still expected deliveries to be made at the same time – a point made by the company’s CEO Pascal Soriot, who is ironically a French national. At this point, the legal implications of the case start to get murky. The EU believes it has the right to insist that AZ delivers on its contractual obligations and was so convinced of the rectitude of its position that it released online a redacted version of the purchase agreement (here). The first thing that jumped out at me was the sentence “AstraZeneca shall use its Best Reasonable Efforts to manufacture the Initial Europe Doses within the EU for distribution.” This is a standard legal phrase which basically means that AZ will do the best it can to deliver but it does not specify that it must do so at any cost.

The EU’s objection is that if it can be shown that AZ is producing in the EU to satisfy orders outside the region, this constitutes a breach of contract. There is no clear cut answer to this. If there were, neither side would be engaged in dispute in the first place. But the Commission believed that a breach of contract had occurred and in retaliation invoked Article 16 of the Northern Ireland protocol which allows the EU or UK to unilaterally suspend cross border trade if either side considers that trade actions lead to “economic, societal or environmental difficulties.”

It is important to understand the implications in this case. The EC initiated trade sanctions against a third party despite no evidence that the UK government did anything wrong. AZ is responsible for the production and delivery of the vaccine and any action that the Commission wanted to impose should have been directed at the company. I am obviously not an expert on contract law but surely the EC should have taken its dispute against AZ to a court of law, arguing for non-fulfilment of contract, rather than impose border controls without having the courtesy to inform the Irish government first. After all the talk from the EU during the Brexit negotiations about protecting the open border in Ireland, as enshrined in the Good Friday Agreement, this kneejerk reaction from the EC seems rather ill-advised. The fact that the Commission quickly backed down after discussions between Brussels, Dublin and London suggests it realised it had acted too hastily. 

Two unfortunate consequences: (i) Shaky UK-EU trade foundations 

There are two obvious consequences which flow from this unfortunate spat. In the first instance it acts as a reminder that the post-Brexit trade deal is built on shaky foundations. Just 29 days after the trade agreement came into force, with the ink barely dry and exporters on both sides of the Channel struggling to come to terms with the new arrangements, we have a demonstration of the weakness of the UK’s position. Such capricious behaviour does nothing to bolster confidence that there will not be similar tit-for-tat actions which will disrupt trade flows in future. Obviously the EU has no need to take account of British public opinion when taking action but the events of recent days act as a propaganda gift to Brexit supporters who have railed against the EU’s overbearing attitude and will lead to calls to revisit the treatment of Northern Ireland in the trade agreement. Admittedly the British government has form when it comes to dealings in international law, but as the old saying goes “two wrongs don’t make a right.” 

(ii) The ugly spectre of vaccine nationalism 

A second, and perhaps more worrying, aspect is that this is a demonstration of vaccine nationalism that the WHO long ago warned about. In response to concerns that AZ is prioritising deliveries to the UK at the expense of EU countries, the EC imposed controls on vaccine exports to keep track of how many doses were leaving the EU and where they were going. Although EC Vice-President Valdis Dombrovskis told the press that “The measure is not targeting any specific country," the list of countries exempt from the controls unsurprisingly excluded the UK. The EU may call this a transparency measure but in reality it looks like a targeted export ban.

Poorer countries are vulnerable to the actions of the industrialised nations. The UK and Canada have options to purchase enough vaccine to immunise their population four times over whilst the much larger EU has purchased 1.6 billion doses – more than three times the population. This has given rise to accusations of hoarding and the concerns raised by international bodies such as the WHO appear to be falling in deaf ears. Although the COVAX programme is designed to ensure access to Covid-19 vaccines for all countries, many people in world’s poorer nations will not be immunised in the course of this year. Unequal distribution of the vaccine will impose economic costs, with the Rand Corporation  suggesting it could knock $1.2 trillion off world GDP.

Whilst vaccine nationalism is understandable as governments seek to protect their populations, it is not a zero-sum game. From an economic perspective, there are spillover effects from ensuring that poorer countries also gain access to the vaccine (e.g. there will be less disruption to global supply chains from which industrialised nations benefit). From a health perspective, it helps to ensure faster global herd immunity. As the head of the WHO said last September, the vaccine should initially reach "some people in all countries, rather than all people in some countries." Viewed in that light, the actions of the EC do not look good.