The word coronavirus would have seemed somewhat foreign just a few months ago and yet today, it’s something that has affected all parts of the globe. The coronavirus pandemic at its core is a public health crisis, but through the implementation of lockdown and necessary social distancing measures, this has led to an unprecedented shock to both the UK and global economy. Being able to properly assess the nature, scale and path of this economic shock is key in allowing the government to design effective fiscal support. This will help reduce the immediate harm to households and firms in the short term, facilitate recovery over the medium term and ensure a sustainable exit over the long term.
In the first quarter of 2020, the UK economy shrank by 2% according to the Office for National Statistics
The world economy has already experienced a sharp fall in GDP and stark increases in unemployment; projections reported by an IMF Chief Economist suggest the world economy will shrink by 3 percent in 2020, instead of 3.3 percent growth forecast just three months ago. In the first quarter of 2020, the UK economy shrank by 2% according to the Office for National Statistics (ONS), as well as witnessing the largest three-month drop in the stock market since 1987; the market down by about 25% since the start of the year. Despite public health concerns surrounding the easing of lockdown measures, governments are under increasing pressure to return back to normality as soon as possible. There has been a lot of talk about how a recovery after coronavirus may look; V, U, W and L are symbols that analysts have used to depict the possible nature of recovery.
‘V’ is the optimistic scenario where the decline in growth will immediately be followed by a bounce back. A ‘U’ shape would imply a more prolonged period of stagnation after the initial fall, but an eventual return to trend growth. A ‘W’ shape implies a short-lived recovery would be met by another downturn, which could be a possibility should a second wave of infections occur. During the euro sovereign debt crisis, many countries were afflicted by such double-dip (even treble) recessions. ‘L’ is the most concerning as this would mean that lockdown would have permanently reduced economic capacity instead of merely suspending it, exacerbated by ‘scarring’ of households and firms.
As of writing, there is yet to be any official GDP data available for the current quarter and therefore it is sensible to look elsewhere to get a sense of the impact of coronavirus on economic activity in the UK. Social distancing measures were adopted as part of the health responses to the 1918-1920 Spanish Flu outbreak in Europe and North America, in Hong Kong during the 2003 SARS outbreak, and West Africa during the 2013-2016 Ebola outbreak. While social distancing varied significantly across and within different countries, data showed that the average reduction in economic activity in the year following the outbreak of these previous epidemics was 7%, with falls of 20% experienced by Canada during the Spanish Flu and Sierra Leone during Ebola. However, given that the current pandemic warranted a much more comprehensive economy-wide lockdown, this may suggest that we could experience greater reductions in GDP compared to these historic averages.
A survey conducted by the ONS suggested that by mid-April, a quarter of businesses had temporarily closed and a further 40% of firms are experiencing lower turnover, where fewer than 5% of firms are reporting higher turnover than normal. Another survey conducted by a UK business organisation found that three quarters of firms had furloughed at least part of their workforce (British Chambers of Commerce 2020). All things considered, it is estimated that economic activity may be around 30% lower while the current social distancing measures are in place. Without doubt, there is significant uncertainty surrounding the strictness and duration that social distancing measures need to be in place.
Experience from past epidemics have suggested that social distancing measures can last anywhere from a few months as was the case in East Asian countries during the 2003 SARS outbreak to over a year, as was the case in West African countries during the 2014-16 Ebola outbreak. In relation to the current pandemic, the UK chief medical officer has said that, in the absence of a proven vaccine or reliable testing and tracing regime, some social distancing measures will need to be in place for at least a year.
China was the first country to enter lockdown during the current pandemic; first quarter GDP (2020) other economic indicators for China have indicated that they definitely experienced the first phase of the V shape (a sharp decline in GDP). For the first time in over 40 years, the Chinese economy contracted by 6.8% from the same period a year ago where the Hubei Province, the epicentre of the outbreak, experienced a contraction of almost 40%. Important factors affecting growth such as exports, investment and consumption (as measured by total retail sales of consumer goods) fell sharply (by more than 15%) in the first two months.
However, it is not all bad news; the Chinese economy started to recover in March where indicators have shown that some sectors such as manufacturing and services were showing signs of recovery. Furthermore, SMEs were of the hardest hit where their recovery has been much slower than their larger counterparts in all industries and along supply chains. Together, they contribute to 60% of China’s GDP and to 80% of urban employment, and will need support from the government, financial institutions, business partners and communities in order to survive and recover.
Just as in China, it is key for other countries such as the UK to continue to provide financial support for households and firms and successfully facilitate economic recovery. The damage done to the economy as a result of the Great Depression of the 1930s was in large part due to poor government policy, which we will need to learn from. The UK have been proactive in that they have launched a massive stimulus package (upwards of £330 Billion) as well as expansionary monetary policy (at the time of writing the base rate of interest is 0.1%), but the sustainability of these measures will have to be assessed. It is also not entirely out of possibility that a future government could increase taxes and freeze wages in order to help fund the increase in fiscal stimulus.
The longer-term impact of coronavirus on the UK economy and public finances will depend on the extent to which output contracts this year as well as the time it takes the economy to recover after social distancing is lifted, which may leave permanent damage to households and firms. Previous epidemics have shown that it may take an average of three years for real GDP to return back to its pre-epidemic level. While growth may return to its previous level, it is unclear how lost economic output during lockdown will be recovered if businesses begin to default.
At this point it seems very unlikely that there will be a V-shaped recovery where some have suggested that the contraction of GDP in 2020 will have lingering effects. Factors affecting future growth include a collapse of human capital for unemployed workers, loss of labour market connections, damaged firm and household balance sheets, precautionary saving post-coronavirus and weaker global trade and investment links. These effects are likely exacerbated under a prolonged lockdown where economic recovery will be deferred the longer social distancing is in place. While fiscal and monetary policy have been playing a key role in reducing the extent of the damage caused by coronavirus, prolonged lockdown also increases the associated costs and risks of these interventions such as increasing public debt to name one example.
It is expected that the fall in GDP will have a profound impact on the labour market; it was found that the fall in employment during the Liberian Ebola outbreak was 24%, with the retail and hospitality sectors being hit the hardest. The total number of workers furloughed in the UK already exceeds 6 million and there have been 2 million new welfare claimants, which together represents more than a quarter of all private sector employees in the UK. One study suggested that annual average unemployment could be 5.4% in 2020 under a three-month scenario of lockdown and potentially rise up to 20.8% in a twelve-month scenario of lockdown.
As the race to develop a suitable vaccine continues, our experience with flu vaccines have reduced the risk of illness by around 40 to 60% compared to 97% for measles vaccines and 88% for mumps. This could mean that a coronavirus vaccine may only serve to solve part of the problem, not eradicating the need for lockdown measures to continue to be in place, perhaps on a seasonal basis. Should this become the new semi-normal, the restaurant, sports, leisure and entertainment industries could be at risk. South Korea’s cinemas have experienced a 90% decline in attendances, for example. Perhaps the more consequential is the potential impact on factories and warehouses and knowledge workers. While some professional industries can operate with a substantial portion of their work force working from home factories, construction sites and warehouses will need to accommodate to comply with social distancing measures amounting to a considerable cost to the economy.
Overall policymakers have their work cut out in order to deliver successful stimulus packages alongside reducing the effects of coronavirus to public health. Whilst China is exhibiting signs that their recovery will be ‘U’ shaped, there is the real danger that there could be a ‘W’ which could be a real worry for both Eastern and Western economies. Places such as America and Europe, with large service intensive economies are most at risk of an ‘L’ shape and will depend largely on when the government feel comfortable to ‘re-open’ parts of the economy. A further question mark remains regarding how developing countries not severely impacted by coronavirus, with trade connections with the UK, will be affected.
Should the countries hit hardest by the pandemic contain the outbreak by the summer and begin the road to recovery during the back end of 2020, it could prove to be that the ‘V’ or ‘U’ scenarios are not out of possibility. However, given that there is evidence of patterns of a second outbreak already observed in some Asian countries such as Singapore, and the fact that the impact of the UK recently easing lockdown is unknown, it is entirely conceivable that a second wave of outbreaks will occur in a number of large economies, leading to a possible ‘W’ shape, postponing growth further into 2021. It is in the governments best interest to avoid the ‘L’ shaped scenario as this permanent loss of productive potential will have lingering effects into the future.
The coronavirus crisis is also a great opportunity for the government to prioritise a green UK economic recovery following the coronavirus crisis. Halting portions of the economy has served to dramatically reduce pollution globally and help reduce the climate crisis. Therefore, the government should ensure that they have a suitable plan so that the economy and society continue to be cleaner, greener and more sustainable.