A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK.
The speed and scale of the economic downturn generated by the coronavirus are unprecedented. There may be no template for today’s crisis, but the past shines light on the choices we face today. History, Mark Twain is thought to have said, does not repeat itself, but it does rhyme.
The policy response to the global financial crisis of 2008-09 offers important lessons. In the weeks after the failure of Lehman Brothers it became apparent that the damage to the financial system could push the world into a 1930s-type depression. The then UK chancellor, Alistair Darling, said in 2018 that Britain came within hours of “a breakdown of law and order” the day the Royal Bank of Scotland was bailed out.
The policy response came quickly and was substantial. Central banks collapsed interest rates, pumped liquidity into the financial system and bought private sector assets.
The conditions of extreme uncertainty at the height of the financial crisis have something in common with those in a war or, indeed, today. Some of the normal rules of good government have to be eased. The emphasis is on speed and scale in the response. Cost becomes a problem for later. Decisions have to be made on the basis of imperfect and changing information. This requires improvisation and an acceptance that most decisions will be imperfect, many will fail and some, even, will prove counter-productive.
With hindsight the decision not to bailout Lehman Brothers in 2008 might be thought an epic mistake. It has been reported that at the time officials concluded Lehman might well have sufficient assets to warrant an injection of public funds. The analysis never reached those who made the decision to let Lehman fail.
In their response to today’s economic threat policymakers seem, consciously or not, to have absorbed many of these lessons. The fiscal and monetary interventions have been on a huge, and in some areas, unlimited scale. UK Treasury officials are unable to cost a raft of new measures to support households because they are dependent on demand, and are open ended. The US Federal Reserve has said it will buy US treasury bonds in unlimited quantities. And, in radical departure, the Fed will, for the first time, buy corporate debt.
Policies have been rolled out at speed, in much the same way that the allies’ wartime economy often prioritised volume over quality. Russian and American tanks were of variable design and quality, but they were produced in far greater numbers than Germany could manage. A national emergency robs decision makers of the luxury of time.
In war, the winner is said to be the side that makes the fewest mistakes. In reality the path to victory is strewn with errors. The Battle of Britain is more remembered now than British military defeats such as the Norway campaign or the fall of Singapore.
Today there is an acceptance, as Britain’s chancellor, Rishi Sunak said last week, that we cannot allow “the perfect be the enemy of the good”. There also seems to be a recognition that inefficiency is the price that must be paid for a comprehensive response.
As Neel Kashkari, President of the Minneapolis Fed, told The Wall Street Journal: “If a bunch of businesses get help that didn’t need it, that’s fine, that’s much better than taking a decade to rebuild the labour market….We just have to get over it, err on the side of getting more help out there”.
The battle against coronavirus is a more unifying cause than the efforts to arrest the global financial crisis. Bailing out banks and supporting financial markets was hardly popular. The mobilisation of the state today, and the expansion of its role, have so far proved uncontroversial. Politicians seem more likely to stand accused of doing too little. Today’s expansion of the state currently commands not just the consent but the active support of the public. Remarkably, 700,000 people, for instance, signed up for the UK government’s NHS volunteer scheme in less than ten days, almost three times the original target.
Popular support, as in wartime, gives the government the scope to act on a significant scale. With much private sector activity suppressed, public spending will is needed to sustain household incomes and support business. Government activism, whether in expanding the NHS, taking over capacity in the private health sector, the suspension of rail franchises or a vast scheme of income support, is the order of the day.
Public spending will soar. Last week’s US $2tn stimulus package is equivalent to almost 10% of GDP. The Financial Times estimates that the increased public spending announced in the UK in the last two weeks amounts to over £60bn, or 3.0% of UK GDP. Public borrowing in 2020-21, which two months ago looked likely to come in at around £50bn, could now hit £200bn according to the Institute for Fiscal Studies.
Countries have always run up huge debts fighting wars and countering recessions. In the UK, the financial crisis lifted debt from 40% to more than 80% of GDP. In the coming months, government spending will be the prop holding up economies across the West. Tax revenues will plummet. Levels of public debt seem likely to rise above the peaks seen during the financial crisis.
Crises or wars can shape economies in other ways. The financial crisis revealed deep fragilities in the financial system. Policymakers today are less tolerant of financial risk and banks face far greater regulatory scrutiny. In the UK, the mass mobilisation of the Second World War helped create a consensus in favour of big government, with the creation of the welfare state, widespread nationalisation and activist economic policies. The war helped popularise the idea of the state as a guarantor of welfare and economic security.
The current crisis has revealed unforeseen weaknesses in food supply chains, medical supplies, healthcare provision and many other areas. What is highly efficient in normal times – such as just in time food supply – can become a vulnerability in a crisis. Governments and voters may be unwilling to return to the status quo ante. The step change in health spending now underway may never be unwound. Switzerland, which for decades has seemed slightly idiosyncratic in its commitment to maintain strategic stockpiles of food, now looks like an exemplar.
Pandemics have long been seen as possible “black swan” events – unexpected negative shocks with major consequences. But for the public and private sectors they have tended to rank low down a long list of threats. This is likely to change, just as Hong Kong and Singapore’s experience of SARS has shaped their health policy and their response to the coronavirus. What is happening today seems sure to establish pandemics as a core risk for large businesses, along with the likes of cyber-attacks, terrorism or climate change.
Often, the long term effects of an external shock exceed the immediate effects, sometimes in quite unexpected ways. Thanks, in part to the vigorous response of the Fed, the 9/11 terror attacks did not knock the US economy off balance. But the attacks transformed America’s defence and foreign policy, triggered two long wars and changed the balance of power in the Middle East.
The Fukushima nuclear disaster in Japan in 2011 led to the closure of the country’s entire civil nuclear programme and a surge in fossil fuel imports and in electricity prices. Economists at the US National Bureau of Economic Research have found that, as a consequence of this, higher energy prices squeezed spending on heating, causing a surge in deaths far larger than had been seen in the original nuclear disaster.
In dealing with pandemics, societies face a trade-off between human health and economic activity. The 1918 flu epidemic killed over 50 million people globally and almost three quarters of a million Americans. Many Americans carried on working because, in the absence of social security, they had no other source of income. Concern about the economic impact of restrictions on movement meant some US cities were slow to act and suffered far higher casualties than those which moved quickly.
Remarkably, the US federal government had little formal role in combating the 1918 flu epidemic and President Woodrow Wilson never publicly mentioned the disease. Richer societies, with more extensive systems of welfare and government, have far greater capacity to control diseases.
The restrictions on movement introduced across the West testify to a collective willingness to trade economic activity for human health. The loss of activity in the near term will be significant. Second quarter GDP in the US, EU and UK is likely to contract sharply.
Last week Professor Simon Wren-Lewis of Oxford University updated his earlier analysis of the effects of a flu pandemic. He estimated that in the initial quarter of a pandemic GDP was likely to contract by 30%. This is at least three times as much as any other forecast I have seen, but it testifies to the potential impact of social distancing on activity.
In one important respect, what we are seeing today is different from anything that has preceded it in modern times. In past crises governments have sought to boost economic activity, whether to fight wars or counter the effects of a natural disaster or a downturn. This time governments are suppressing economic activity, through restrictions on movement, in order to slow the progress of the coronavirus. The vast interventions by central banks and governments are designed not to stimulate activity, but to preserve jobs and businesses for the upturn.
In that endeavour, policymakers seem to have been guided by the experience of earlier crises. They have acted swiftly and on a large scale. Conventional wisdom has been pushed aside, the normal rules of government suspended or altered. This is all to the good. The immediate effects of this crisis are immense. History suggests that it is will have profound long term consequences too.
On a different note: we at Deloitte are launching “The COVID-19 crisis: Economic impact and policy responses” chart book today. This is a report which will be updated weekly and aims to provide a graphical overview of the key economic developments of the COVID-19 crisis. Do feel free to use any of the charts in your own presentations.
You can also join our “Responding to COVID-19” webinar every Thursday at 13:00 GMT. Each week a panel of Deloitte experts are assessing the latest health, business and economic developments and discussing how organisations can navigate the emerging challenges. Our next webinar will take place this Thursday, 2 April.
