We should be very wary of spurious quantification at this stage—but some key economic themes have emerged already.
It will come as no surprise to readers of this blog—which has always sought to link financial services to the real economy—that a lot of work is underway at TheCityUK trying to assess the impact of Covid-19 and its attendant policy measures on the economy and the financial and related professional services industry. But what is the best way to approach the question of the extent of that impact?
It goes without saying that the economic impact of the pandemic is going to be enormously negative for the global economy as well as for the UK. But the main multilateral forecasters (the IMF, OECD and World Bank) published their latest forecasts for global GDP growth before the scale of the pandemic became apparent. More recent research from economics consultancies and investment banks projects a global growth slowdown far more severe than the earlier ‘official’ estimates (which ranged from 2.4%-3.3%).
My own view is that it is premature at this stage to give too much weight to specific numerical estimates of the extent of the damage. For one thing, even at the best of times economic models are constrained by the assumptions that are fed into them, and these are certainly not the best of times in that regard. The duration of the pandemic is still unknown, and the duration of lockdown measures in various major economies will essentially be a political decision guided by public health advice. Unfortunately for economists, these two factors must be at the heart of any assessment of the economic impact of the pandemic. The impossibility of making numerical forecasts with any certainty at this stage is demonstrated by the wide range of the published estimates to date.
Rather than engage in spurious precision, here are 3 key themes to consider:
- 2020 will not look anything like 2009. Commentators are drawing comparisons to the 2008-09 financial crisis—perhaps inevitably, given its status as the major recent unexpected economic downturn. But such comparisons are of limited value because what the world experienced in 2008-09 was a financial crisis that triggered a downturn in the real economy. Now, we are faced with a real-economy crisis triggered by an unprecedented shock to supply and demand simultaneously - which has the potential to trigger a financial crisis…which could then potentially come back to deepen the economic crisis. This is not to say that this full negative feedback loop is expected or even likely—but the possibility highlights how very different the current situation is from a decade ago.
- The global nature of the pandemic is far more ‘global’ than the global financial crisis. Another very serious difference between this crisis and the 2008-09 crisis is the simultaneous impact across the world. The effects of the global financial crisis were staggered across different regions of the world over a number of years. Today, we must contend with the pandemic’s impact across all major economies simultaneously on things like global value chains and financial flows. Emerging markets are particularly vulnerable; for example, oil exporters will face acute challenges stemming from the collapse of the oil price from $66/barrel at the beginning of this year to today’s price of just above $30/barrel (Brent). Some emerging markets will be particularly hampered by weak fiscal capacity to cushion the economic impact of the pandemic; for some, this constraint will be exacerbated by increased borrowing costs stemming from the appreciation of the US dollar.
A key consideration for the fate of the global economy will be the extent of the economic recovery in China. China accounts for 16% of global GDP and fully one-third of global economy growth. And although it has been engaged in a programme of longer-term economic rebalancing away from exports and investment and towards domestic consumption, it is still very highly integrated into the world economy. Given that Covid-19 originated in China, and that the lockdown measures implemented in China to control the epidemic were the earliest and strictest seen anywhere, China’s economy suffered before any other country’s, and is now beginning to show very tentative signs of recovery. The composite PMI (covering manufacturing and services) rose to 53.0 in March from 28.9 in February; this reading was also in line with the average index level over the second half of 2019.It is impossible to draw any conclusions from one month’s data, but if this tentative recovery is sustained, it offers more hope for the global economic recovery. If, however, a second wave of infections prompts another near-halt to economic activity, it will pose serious risks to the emerging markets—predominantly, but not exclusively, in Asia—which serve as intermediaries in China-based global supply chains.
- Post-2009 vulnerabilities will make the economic fight back from Covid-19 even more challenging. Even before the pandemic outbreak, monetary policy was being used to support the economy in a number of advanced economies—in some cases I would have described it as a sort of pre-emptive stimulus, or monetary easing in the face of the potential negative impact of tougher global conditions. The problem is that even before last month, there was not a great deal of room for central banks to act to support the economy given that policy interest rates in advanced economies never rose to anything close to their historic levels before being cut again. The fact that monetary financing is being debated as a possible central bank response to the pandemic in the UK demonstrates just how extreme the circumstances are (notwithstanding the fact that Bank of England Governor, Andrew Bailey, has rejected the suggestion for now).
Meanwhile, public- and private-sector debt levels have risen significantly across the world in recent years, and this rise in indebtedness was an economic vulnerability even before the outbreak of Covid-19:
The unprecedented fiscal response to the pandemic that many countries have committed to may ultimately exacerbate that structural weakness. In the UK, that fiscal response—specifically the promised salary support to workers affected by the crisis—will be critical to mitigating the economic contraction. It is useful to remember that the UK economy is predominantly based on private consumption, with consumer spending accounting for more than 60% of GDP. From a sectoral perspective, ‘distribution, transport, hotels and restaurants’—the sector which is suffering the biggest direct hit—accounts for almost 30% of total UK employment. But although the ‘whatever it takes’ approach to fiscal support is to be commended, concerns about the sustainability of that approach will mount the longer the pandemic and its associated effects on the labour market persist.
Although it may feel unsatisfactory to those who prefer economics to be first and foremost a guide to the future, when it comes to assessing the impact of Covid-19 at this early juncture perhaps the most important thing is to understand the limits of economic models, the channels through which different economic actors will be affected, and the ways in which the current crisis will be overlaid onto existing structural economic weaknesses. In the weeks and months ahead, as we gain more information about the nature of the disease and the likely trajectory of the public health response, forward-looking economic assessments can be refined with additional detail.