How Bad Might the 2020 Economic Shock Become?

03.04.20 Publication:

Children often have better instincts than us supposedly experienced adults. In early March,
when I was giving a talk to a group of teenage pupils at a school in the English countryside,
one boy asked me: “I’ve heard that the economic impact of the coronavirus could be worse
than the 2008 crisis. Do you agree?”

His question woke me up out of some but not all of my complacency. I am relieved
to say that I did not dismiss his fear, but answered that there was no need for this crisis to
be worse and I hoped it wouldn’t be. I said that it depended on whether the economic
demand that would be lost during any shutdown proved to be just deferred to a later date
or whether it was lost altogether, and what governments could do to maximise the amount
just deferred and minimise the permanent loss. We’d have to wait and see, I said.

One month later and with almost all Europe’s economies in hibernation, what would
I now say to that prescient young man? I believe I would add some more things for him to
be worried about, but to balance that would also provide some reassurance about what we
have learned about the powers of rich countries’ governments in this situation and about
the potential role of technology.

A lesson of the 2008 global financial crisis is that it is a mistake to draw firm
conclusions too soon. Economic shocks and financial crises are so powerful that they can
produce unforeseeable consequences, whether social, political or economic, for several
years. That is where the added worries arise.

The euro sovereign debt crisis did not happen until about two years after the
collapse of Lehman Brothers in September 2008, as it emerged that the Greek government
had been falsifying data about its borrowing and as confidence in financial markets in the
future of the euro started to decline, dramatically. It was at that point that European banks,
holders of huge amounts of sovereign bonds, were seen to be weak and even in danger of

After the health crisis has started to ease, we will need to look out for today’s
equivalents of those subsequent, unforeseen consequences, consequences which multiplied
or deepened the last economic crisis. The first place, again, to look will be banks, for they
are the riskiest components of our economic machines: in good times, they reinforce its
forward propulsion through their lending, but in bad times, if borrowers go bankrupt, so can
the banks, as we saw after 2008. Despite the huge debts governments will now build up,
this time it will be a wave of corporate bankruptcies that will be the worry.

The second worry concerns social disorder, and its political and economic effects.
The longer this crisis goes on, and even during the recovery phase, our admirable solidarity
is likely to fray. It often has in the past, and Italians are already right to worry about tensions
in some regions. In all our countries, a recovery or reopening phase during which some
people benefit sooner than others will risk serious disorder, which could in turn delay the
recovery. The lesson is the one that was not learned after 2008: government fiscal support
must not be withdrawn prematurely.

We can already see some social and political disorder even in highly-controlled
China. Two months after the health crisis erupted in the city of Wuhan, prompting a
draconian lockdown, the economy and society are re-opening. The Chinese stockmarket has
recovered substantially, and indices of business confidence and export orders look very
positive. But reports have nevertheless emerged of political tensions between regions over
the reopening, with some refusing to re-open their borders to migrant workers from Hubei
province, which includes Wuhan. Reopening is not proving smooth.

The third worry concerns other emerging economies, especially in Africa. The biggest
risk for African countries is less that of covid-19 than of the economic shock the pandemic is
delivering. The collapse in the price of oil and other commodities since January will
eventually be good for European consumers but the immediate danger is that it may send
some countries bankrupt. This, in turn, could lead to more emigrants heading to Europe.

Yet having outlined these worries, I would reassure my young student by saying that
there was every reason to believe that the economic crisis caused by the pandemic can be
overcome. As governments have shown during the past several weeks, their capacity to find
extra resources to fight the infection and to provide disaster relief to companies and
individuals has proven to be large, even if often belated.

With central banks able to accommodate that extra borrowing, this phase of the
economic rescue effort promises to be successful. Even if GDP falls by one-third over a four-
month period, which is what looks to be in prospect, the rescue is affordable. And then a
sharp recovery in the rest of the year will be possible as employment and spending returns.

The big questions concern the rescue effort during the recovery phase and, of
course, how quickly that begins. Technology promises to play the key role: first, anti-body
tests to reveal how many people have developed immunity and can swiftly return to normal
life; second the mitigation treatments for the disease that are now being tested; and third,
the vaccine which promises complete reassurance.

Until technology provides at least some reassurance, we will not see a sharp
reopening and a sharp recovery. But once anti-body tests and mitigation treatments
become available, our ability to manage the health crisis and restore confidence in each
other will improve dramatically, enabling economic recovery to begin. I wish I could ask my
prescient young schoolboy whether he agrees.

Image by Gerd Altmann from Pixabay