Ever since the global health crisis caused by the new coronavirus began to wreak havoc in the world economy, analysts have struggled to draw the right parallels.
In March, what feels like an age ago, the comparison most present in the minds of commentators was the global financial crisis.
Now, this already seems out of date. The crisis before us is already much larger in scale than the emergency of 2008 in its impact on markets, growth and sovereign debt.
According to UK’s Office for Budget Responsibility, the British economy is anticipated to take a dive in GDP of 35% in the second quarter of 2020, the period comprising of April, May, and June. Some two million Britons will be unemployed as a result.
Reminder: Just a month ago, at the Budget presented by a grinning new Chancellor, Rishi Sunak, the OBR suggested that growth for 2020 would come in at 1.1%.
Today, the newly-estimated downturn would be the greatest contraction in output since 1908 at least, when the world economy was hit by the aftermath of a financial crisis known as “the Panic of 1907”.
It is a larger hit than the contractions suffered by the UK economy during both world wars. But this crisis is quite different in character from such conflicts.
During the Second World War, the shock to the national economy was to a degree mitigated by the switch in industries which could alter their production to produce war goods. The vehicle makers, Daimler, produced armoured cars. The upmarket shoemakers, Church’s, switched production to turn out military boots.
After the war, there was a transition period as these companies returned once again to civilian, peacetime production.
The Covid-19 crisis, on the other hand, is not a post-war dip or a market correction. The government is not spending to stimulate demand but to cover the losses of households and businesses while it suspends normal economic activity altogether, stifling demand in order to save lives.
Hopefully, this will mean that, if the fundamentals are sound, the economy should bounce back sharply. The OBR’s figures predict such an outcome. Its scenario suggests that GDP will revive significantly in the third and fourth quarters, even if there will still be a massive decline of about 13% for 2020 as a whole.
A more appropriate comparison is perhaps with the data on the impact of the Spanish Flu, the global pandemic which broke out in the aftermath of the First World War. Then, a -10% contraction in GDP was followed by a far swifter rebound to growth than after the Second World War.
The OBR’s scenario is based on two key calculations – on the one hand, it estimates decline in GDP from the share of output lost in every UK industry, from financial services and real estate to agriculture and manufacturing. It assumes that this will take place if a lockdown to fight the epidemic stays in place for a period of three months, with three further months of partial lockdown to phase out these restrictions. So far, so plausible.
But the assumptions about what happens after that look optimistic. The OBR’s hope is that the economy rebounds back to its pre-crisis trend rate by the end of the year, leaving almost no scarring or lasting economic impact from this recession.
Is this credible? It’s important to remember that the OBR’s estimates are largely statistical in character. They do not consider the psychological impact on consumers of this emergency.
Will we really all get back out there spending – in restaurants, cinemas and shops – with no reservations in the second half of this year? By then, Britons will have experienced the shock of being short on savings and been exposed to the instability of a fragile employment market. It seems doubtful that consumers will be sanguine and come roaring back straight away.
Then there is the issue of the debt which will be gathered in the process of supporting struggling households and businesses.
Paul Johnson, Director of the Institute for Fiscal Studies, has warned that the UK’s fiscal policy is now likely “to involve tax rises and higher debt for some time to come”.
