It has become clear in recent days just how much damage the
sudden stop in economic activity triggered by the COVID-19 crisis is likely to
cause. The services PMIs across Europe collapsed sharply in March with the UK recording
an all-time low on data back to 1996 which represents five standard deviations
from the mean. The release of today’s US initial jobless claims data showed an
extraordinary rise which was 33 standard deviations from the mean on weekly
data back to 1967 (chart). This is an economic
collapse the likes of which none of us has seen. It can be likened to the
economic equivalent of hitting a wall at high speed: Not only does the car get
smashed up but it will take time to recover from any injuries sustained.
It is for this reason that my doubts about a V-shaped
recovery continue to mount. The BoE noted in the UK context that “given the
severity of that disruption, there is a risk of longer-term damage to the
economy, especially if there are business failures on a large scale or
significant increases in unemployment.” Many companies have effectively
been forced to cease business as a result of the lockdown implemented earlier
this week, which will have major implications for cashflow, and a number of
them may not resume trading when restrictions are finally lifted. To give some
idea of how much the collapse in spending is going to impact on the economy,
UK restaurant bookings have slumped to zero over the second half of March based on data from Open Table.
On average, restaurant traffic is 55% below levels in March 2019 and with a
weight of 9.5% in total spending this alone will reduce consumer spending by 5%
relative to a year ago. Assuming restaurants do not reopen in April, the drag
on annual spending will double. Notions of a 10% collapse in Q2 GDP suddenly do
not look so fanciful.
A measure of the swing in expected 2020 economic growth
against the 2019 outturn gives us an idea of where the Covid-19 effect is
likely to hit hardest. Assuming Italian GDP falls by 5% this year following a
small gain of 0.3% last year this produces a total swing of 5.3 percentage
points. By contrast, Chinese growth is only expected to slow from around 6% to
4%, producing a total swing of 2 percentage points. In the UK I currently
expect something like a 4.5 percentage point swing. Naturally, forecasts at
this stage are little more than guesswork so we should not read too much into
the numbers, but given the severity of the crisis in Italy it is reasonable to
assume it will take a major economic hit.
Obviously we have no clear idea about the duration of the
crisis but the standard assumption is that the bulk of any output contraction
is concentrated in the first half of the year. That is itself a huge assumption,
but even if turns out to be true, many businesses will not survive the current hit
despite the huge amount of support that the government is prepared to give.
This will prove to be a searing economic experience for many of us, and that is
without discussing the human costs associated with coronavirus. But it will not
only be small firms that change their behaviour. Large firms will also be more
circumspect given the impact that this year’s recession will have on earnings
which will act to hold back investment, and in any case they are likely to hold
off on big spending plans until they are confident that demand is once again on
an upward path.
It is, of course, too easy to extrapolate the bad news out
into the future without taking account of the resilience shown by western
economies. On the basis of what we know about the coronavirus now, there will
be an economic recovery and probably sooner rather than later. But to give some
idea of the impact of economic shocks, I looked at the three major recessions
in the UK over the past 40 years and discovered that on average it takes almost
four years for output to recover its pre-recession peak. An output collapse of
4% this year followed by three years of trend growth of 1.5% indeed means the
usual four year cycle will hold. Matters will be all the more difficult for
many western economies given that potential growth today is far slower than
prior to 2008 as a consequence of an ageing population and the sluggish nature
of productivity growth over the past decade. Recall that in the wake of the
Lehman’s collapse it took an awful long time to be convinced that the economy
had turned the corner. I suspect the same may also happen this time around.
That said, the 2020 recession will be a catalyst to revisit
many areas of the economy that have been ignored over the past decade and I
will deal with them in more detail another time. But to throw out a few ideas
at random, we are likely to find ourselves paying a lot more attention to the
lessons of Keynes than we did a decade ago. Whatever else we take away from the
2020 experience, it is that there is a role for the state as an agent of last
resort to step in when there is deficient demand. State capitalism is thus going to
be higher up the agenda in many countries and it will be difficult for governments
to introduce austerity programmes when this is all over. After all, we have had
a decade of it in the UK and where has it got us? We will also have to have a public
debate about how much state we want and how we plan to pay for it. I suspect
the era of tax cutting may be over for a long time to come.
However, the future can make fools of us all so we should revisit
some of this blue sky thinking in future to see whether it stacks up. Nonetheless
I am struck by the fact that just as the post-1945 era was very different to
the pre-1939 world, so we might look back at the unprecedented events of 2020
as the point at which the world economy changed.
