The economic impact of Covid-19 is likely to be huge, but it need not be permanent. The extent and speed of the recovery – whether V-shaped or L-shaped – depends on getting the immediate economic response right today. Our Economic Policy-Response Observatory (see interactive map below) tracks the latest developments in countries around the world as they respond to the economic shock created by the pandemic.
This briefing sets out the nature of this unique economic shock and what that implies for the design of an effective policy response.
Public-health measures to suppress Covid-19 will cause a severe economic shock in all directly affected economies. There is an established international consensus around the need for social distancing to combat the spread of Covid-19. At least until easy testing or contact tracing systems become widely available, suppression appears to be the only way to control the epidemic and may be in place for many months. The economic consequences of this are profound in the short term and will be severe in the long term unless governments get their economic policy response right now.
Early indications suggest that the economic hit will be significantly worse than the Global Financial Crisis. Predicting the scale of the economic damage at this point is impossible to do with any confidence, but the early signs are very bad. Evidence from China, which has implemented suppression policies, suggests that both the service and manufacturing sectors entered a deep contraction in February, far more severe than that seen during the global financial crisis. While there has been some recovery in recent weeks, activity appears to be well down on last year. The latest leading economic indicators for the Eurozone paint a similarly bleak picture for manufacturing and unprecedented falls in the service sector.
Meanwhile unemployment appears to be rising rapidly around the world. In the United States there were almost 10 million new unemployment claims in the second half of March, an increase that may leave unemployment at around 10 per cent as large parts of the economy grind to a halt. In Norway, unemployment jumped to a post-war high of 10.4 per cent last week.
The GDP falls are likely to be unprecedented. It would not be surprising to see double-digit quarter-on-quarter economic contraction across much of the developed world, depending on how long intensive suppression measures remain in force. For comparison, the global financial crisis was accompanied by a peak-to-trough decline of 3.7 per cent in US GDP and 6 per cent in the UK. The knock-on effects of these contractions for global trade are similarly severe, affecting many countries even before suppression measures have been implemented.
The impact on trade has disrupted the food and agriculture value chain, putting the food security of countries that rely on food and agro imports in peril. Hikes in food prices and disruption of local production, global supply and logistics make low-income economies particularly vulnerable to food shortages. Beyond the sheer numbers describing the economic contraction expected for developing nations, the impact will be experienced by people in many countries as a bout of undernutrition with permanent effects.
The scale and speed of the economic recovery around the world will depend critically on the economic policy actions taken now. While the recession will be deep in many countries around the world, there is one cause for optimism: Because the recession was caused by shock that came from outside the economic system, it should be possible for recoveries to be strong and swift as economic activity bounces back to its previous level. This will happen if companies remain afloat, workers hold onto their jobs and supply chains hang together despite the sudden halt to economic activity. However, without immediate policy action to preserve the economy, the shutdown will erode its potential. If workers are laid off and companies go to the wall, economic recovery will be much slower and the damage to people’s prosperity is more likely to be permanent. So how should countries think about designing an effective economic policy response to counter the crisis?
This recession is different. In economic terms, the pandemic is highly unusual for two reasons, and these features determine the shape of an effective response.
First, unlike past downturns, this recession is the result of intentional policy measures. Normally, recessions emerge due to a shock within the economic system, and policymakers see their role as being to tackle it with macroeconomic stimulus measures to raise the level of demand in the economy. In this case, however, the recession is caused by a combination of supply and demand shocks triggered by public-health policies to suppress the spread of the virus. For public-health reasons, governments are actively preventing people from consuming. Consequently the shock has two components. Many people are unable to go to work, or the efficiency of their work has been reduced, due to social distancing – a supply shock. Meanwhile, various businesses simply cannot function due to the loss of customers (for example, restaurants and airlines) – a demand shock.
Second, the recession is likely to be very deep. Potentially much deeper even than that following the 2008 financial crisis. This is because, rather than declining marginally due to the changing sentiments of consumers and investors, demand is being directly stopped – almost by government fiat.
The unusual nature of the economic shock triggered by Covid-19 means that an effective response, to try to ensure a V-shaped recovery, consists of three elements:
Mitigation: Demand stimulus measures are critical to limit the collapse in economic activity. The most obvious targets for fiscal measures are emergency support for health systems and transfers to workless households to limit poverty and destitution as far as possible. Wider monetary and macro-prudential measures are also a critical part of the mitigation response.
Preservation: Supply-side measures should be aimed at keeping workers attached to companies, keeping companies afloat, and preventing supply chains from disintegrating. Employment retention schemes, whereby the state pays employee wages, are designed to achieve the first, while grants, loans and tax breaks for companies can sustain them through the collapse in demand.
Recovery. For recovery to be strong later, mitigation and preservation responses need to be implemented immediately – time is of the essence. But governments also need to make credible commitments to sustain the economic support well beyond the end of the health emergency. Businesses that are confident of a strong recovery will be both more likely to avail themselves of financial lifelines today and more able to pay down debts tomorrow, creating a virtuous cycle.
Targeting swift and comprehensive measures at the goals of mitigation, preservation and recovery will ensure that the economic bounce-back is as strong as it can be. Inevitably, the unprecedented nature and scale of the economic shock means that policymakers will have to be vigilant and innovative in responding to gaps in their measures as the pandemic progresses. Our Economic Policy-Response Observatory allows users to see the latest steps being taken around the world, and understand the extent to which their responses measure up to the task.