By Sir Vince Cable on 03/04/2020
We know that COVID-19 is imposing a massive economic shock, leading to a recession that is global – unlike the 2008 crisis, which bypassed countries like China and India.
This will be very deep, with a large part of the economy deliberately shut down by the state to stop the spread, but of indeterminate length. We could see the recession as V-shaped, deep but short, with recovery beginning within months.
But it can also be U-shaped, with slower, longer, recovery; or W-shaped with a second wave of infection or secondary economic consequences; or even L-shaped, if damage is permanent and there is no recovery for a long time.
What we are seeing in the UK at present, as a result of lock-down conditions, is a big supply shock with some sectors effectively closing down and going into hibernation: hospitality and entertainment; most bricks and mortar retail (but not necessarily online); parts of transportation (aviation effectively closed, but continuing rail, road and shipping at lower level); a lot of manufacturing (but not food producers); public and private services, which depend on face-to-face contact, but many others continuing online.
Construction is uncertain. The main utilities and infrastructure industries are continuing normally. Some sectors should remain strong: healthcare (obviously); food (from farming to distribution); bits of the logistics sector (Royal Mail); telecommunications and IT. The big variations in stock price movements reflect this diversity.
There is also a demand shock, as households and businesses cut back on spending because of insecurity or cuts in income. Some governments have moved quickly to act as ‘spenders of last resort’.
The UK has acted with commendable speed, not only to provide credit lines to companies, but to provide subsidies to companies to keep on staff who are otherwise facing redundancy.
For those who are out of work, however, there is the notoriously frugal and inefficient Universal Credit system. Several governments (including Singapore, Australia and the USA) are experimenting with ‘helicopter money’: making direct payments unconditionally to large numbers of citizens.
There is no ‘correct’ solution; experience will provide lessons. But there is a general problem: if governments are to throw money at the problem, there is an issue of what level of government debt is sustainable. If there are sustainability issues, one solution is for governments to borrow from the Central Bank, to monetise the deficit (‘printing money’ in simple language). Japan is already doing that. It is the correct response if controlled and temporary and depoliticised.
One worry is that the Eurozone rules preclude such an approach and this lack of flexibility may be a critical weakness if the crisis escalates (though the asset purchase policy of the European Central Bank should, at least for now, prevent a widening of spreads on sovereign debt and a return of the Eurozone crisis).
How long will the crisis last? There is vast uncertainty around the epidemiology, let alone the economics.
Let us be optimistic. Recovery starts once the virus is clearly seen to be under control, with a sustained fall in the number of new cases.
In the UK we may be talking about three months. Very notionally, we could assume a 50% drop in output from trend in the second quarter, 30% in the third, and we are back to normal in the fourth. That would be a 20% hit on GDP over the year. Maybe that is generous: the US GDP fell 30% in a year at the beginning of the Great Depression.
But the broad profile is that of a V. That is, very tentatively what may be happening in China and other counties that are ‘flattening the curve’: Singapore, Japan, Korea, Taiwan and elsewhere in the region. Places where lessons were learnt from the SARS outbreak and there has been extensive testing of people with symptoms and tracing of their contacts (something not happening in the UK).
There are good reasons for being less optimistic and we may be faced with a U, W, or L-shaped recovery, nationally and maybe even globally. Suppression may be too little, too late: much of Europe including the UK; and the USA (a disastrous situation of heavily underestimated infection due to lack of testing and a President, and his supporters, in denial).
Or the virus might return, possibly in a more virulent form. Many poorer countries in Africa and the sub-continent lack the institutional capacity to impose ‘lock-down’.
Or there may be knock-on effects that stop or slow recovery. There are many companies, loaded with debt and borrowing more to get through the crisis, which will not recover and contribute to ‘balance sheet recession’, Japan-style. Financial institutions are better capitalised than a decade ago, but could be overwhelmed. Global supply chains may not be reconnected because of lack of trust in suppliers and Trump-led nationalism.
My optimistic scenario is that major economies (the EU, the UK, the USA, perhaps India) succeed in adapting the ‘Asian model’ of virus suppression, combined with aggressive monetary and fiscal policy to support demand. We then get a V-shaped recovery, with deep but short-lived disruption.
A pessimistic outlook would be that too many countries, including the UK, are dragged down by failure to control the virus and too weak a fiscal response. There is little cooperation internationally with beggar-my-neighbour trade measures, while global institutions like the International Monetary Fund and the World Bank are overwhelmed by crisis hit economies (including those dragged into a sovereign debt problem, following a flight from local currencies into the dollar; others broken by the collapse in oil prices).
The financial crisis – admittedly different in many respects – produced a shallow U-shaped recovery in the UK and a W-shaped recovery in the Eurozone. In a world where international cooperation was more secure than now, that does not inspire optimism.
The Rt Hon Sir Vince Cable was the Secretary of State for Business, Innovation and Skills in 2010-15 and, in 2017-19, was Leader of the Liberal Democrats.