The economic headlines throughout the current crisis started with “Worst recession since the financial crisis”, then “Worst recession wince WW2”, “Worst Recession since the Great Depression” and more recently have included “The UK is facing its worst recession for 300 years”. We therefore thought we’d take a look at past economic crisis to see if there are any parallels to the current situation and if there are lessons to be learnt or whether history can give us some clues as to what could happen next.
Economic crises can generally be categorised as being caused or triggered by one of the following:
- Natural catastrophes
- Structural imbalances in the economy
- Boom/Bust (credit driven speculation)
- Political incompetence
The obvious global event to look to is the Spanish Flu epidemic of 1918-19, the most recent and only other global pandemic of the industrial age, however any direct comparison is difficult to make. The dominant global economic forces at the time stemmed not from the pandemic but from the end of the Great War. Demographics and mortality were vastly different and in many countries press reports of the pandemic were suppressed to avoid general panic amongst the population. There was also no global lockdown.
The only other pandemic on which economic studies have been published is the Black Death. Reliable economic data in those studies is obviously limited, and while interesting, again there is little direct comparison to be made. The death rate during the plague was anywhere between 30%-60% of the population, the economy was agrarian and the economic and social consequences were deep and lasted for generations. The resulting shortage of skilled labour drove up wages and led to the emergence of what we would now call the middle and working class. In the generations after the Black Death skilled labourers, previously on not much more than subsistence wages, could afford to invest in their professions, educate their children and establish households and institutions. This also created individual excess wealth and capital and the incentive to innovate, purchase luxuries, consume culture and formed the beginnings of the renaissance.
More recently, the SARS outbreak in HK has similarities in that there was a dramatic reduction in consumer activity and sharp outflows of capital, but this was a regional epidemic and not a pandemic, few other countries were impacted. One notable impact was that HK property process fell sharply with the fear that global businesses would move out. SARS was then very quickly controlled, partly by steps taken by governments, but more importantly due to the nature of the disease. SARS made people very seriously ill very quickly, as such it was easy to medically identify and isolate. Post SARS, the HK economy grew rapidly, pent up demand returned, the drop in asset prices attracted investment from booming mainland China, and the economic impact although severe was temporary.
Other regional epidemics such as HIV/AIDS have had more of a significant ongoing human and economic cost, but without in any way downplaying the tragedy of these, the parallels with coronavirus are slim.
On the face of it then there is no single recent or historic economic event that directly compares to what’s happening in the world today. Whilst that is true, there are still important lessons we can learn by digging a bit deeper.
Human beings are fundamentally economic and social animals
The first lesson we can learn from some of these events is that human beings are by nature economically driven. Taken as a whole, we are capitalist by nature rather than by choice. Non economic events such as pandemics and epidemics may have significant short term economic impact but do not seem to dim the economic nature of society. Often the opposite is true, natural catastrophes tend to be followed by an increase in economic activity as pent up economic energy is released. This is particularly true when there is no physical destruction of wealth. The current pandemic has not destroyed the physical infrastructure of the economy, unlike, for example, Hurricane Katrina where there was significant destruction of capital as well as life. The first lesson history teaches us is a positive one in that, all else being equal, an immediate economic recovery is possible. This crisis may change which products we make and buy, but it won’t change our natural desire to make things and buy things, and such events often create an additional economic incentive and drive. An immediate post coronavirus bounce is certainly possible. People like buying things, like owning things, like making money, like having a nice house and garden, like socialising and like taking advantage of economic opportunity.
The other positives
There are some other economic positives we can take from crisis events such as natural catastrophes and war that could play out. Major non-economic events tend to drive rapid innovation which can generate significant short and long term economic benefits, WW2 being the prime example where technological change and the drive to mass production heralded both the consumer age and the computer age. Innovation is fundamental to economic growth and there is nothing like a crisis to drive rapid technological change. The UK has a significant medical research and development sector which could benefit from similar crisis driven change. The rapid shift to home working could drive productivity gains in many sectors, the government is more likely to incentivise and fund development of certain crucial sectors such as chemicals and green energy. Many such events result in rapid change, advances in productivity, and can lead to generation defining rises in living standards as politics and technology are forced to leap forward.
In short, looking through history, non economic crisis that have a short term negative economic impact often lead to greater innovation and stability and actually contribute to longer term economic growth. There is also the forest fire theory of economics which suggests a short sharp recession eliminates poorly managed and inefficient businesses allowing well run and efficient businesses to then grow and contributes to better long term economic growth.
That said, the downside risks are still considerable. There is a caveat to the above positivity, and that is “all else being equal”.
Downside risks to the economy
The above does not hold true where non economic events are a prelude or trigger for secondary recessionary events. The great depression is an example of all the various recessionary forces combining. The first world war was the start of an economic and political process that created structural imbalances in the global economy, exacerbated by poor government policy, which led to a speculative credit bubble, which burst, was followed by more government ineptitude and was finally made worse by the dust bowl climate in the US.
The question then becomes, will the Coronavirus crisis trigger secondary recessionary events?
The low interest rate and loose corporate credit environment is almost certainly creating growing structural imbalances, however, since the 2007 financial crisis governments have shown willingness to throw everything at keeping liquidity and credit markets going. Although this creates asymmetric risk and at some point there will be a reckoning, it could take years or even decades to play out while the government taps stay open. There is probably a savings and pensions crisis looming somewhere on the horizon but it could be a generation away and unlikely to be triggered by the current crisis.
Likewise, in trying to identify whether the coronavirus crisis will trigger a boom bust recession, outside of ballooning corporate debt, asset prices and credit have been largely stable. The boom in car financing is a concern but at £75bn in the UK is not big enough to puncture the economy as a whole.
The risk of ongoing demand and supply shocks
This leaves us with potential imbalances in supply and demand to worry about. The coronavirus crisis has created both a demand shock and a supply shock to the global economy. We see above that demand can and often does quickly return, the main factor here is confidence and certainty amongst consumers. The effective ending of lockdown, avoiding a second spike, and confidence in the government are probably key to consumer demand returning quickly. A longer lockdown but with a more certain outcome would likely be much better for demand than lockdowns ending too quickly or being fudged and a second wave causing lockdown to return. History shows secondary events do much more to damage consumer confidence and suppress demand. Here there is real risk. Consumer demand is unlikely to return quickly if people lose confidence in governments and in the virus being controlled.
Those economists who predict doom and gloom from the current crisis are worried more worried about the supply shocks. This happens when an event dramatically and almost overnight impacts the global supply chain, the oil shocks of the 70s being the prime example. Dramatic rises in the oil price had major impact on input prices and the value chain and lead to a period of stagflation. A contracting economy with increasing unemployment on the one hand with rising prices and wages on the other. On the face of it the parallels are there. This worst case scenario depends on there being rolling lockdowns around the world meaning that the supply chain is constantly being interrupted, leading to reduced supply of both consumer goods and raw materials or components, rising inflation as the supply of goods is constrained while at the same time rising unemployment as factories have to partially shut down. Whether this happens again comes down to the ability of governments to control the virus and avoid a situation where different countries are locking down at different times.
What governments do next is therefore what really matters.
At the heart of any deepening recession stemming from the current crisis will be what governments do and their impact on global supply chains and consumer demand. The global economy was stagnant going into this crisis largely as a result of the US-China trade wars. These wars were in the process of being resolved but there is an obvious concern that the political tension the coronavirus crisis is causing in the US will bring this back to the fore. At the heart of the depression were protectionist trade and tariff policies, and there is a real risk that going into a US presidential election the anti-China rhetoric will ramp up and spill over into policies that disrupt trade. The UK government has not been particularly vocal in it’s anti china rhetoric through this crisis, a reflection of the likelihood of realpolitik prevailing.
There is also a massive elephant in the room in the UK. The UK is in the process of trying to renegotiate across the board trade deals with the EU, the US and China, the only 3 trade deals that really matter. The coronavirus crisis is going to place significant obstacles in the way of the UK government achieving this anytime soon. The UK government is hard balling the EU on the assumption that because the UK is a net importer of EU goods, that the EU will blink first. Coronavirus has caused a significant political crisis within the EU, strengthening the forces seeking to end the current political union. Anything that risks the political union at the heart of the EU is an existential threat to Germany and France that far outweighs the risk of a no deal with the UK. Put simply, the real economic and political risk to Germany and France is not a UK no deal, but a further break up of the EU. The current crisis will strengthen the resolve of the EU to show that countries will not be given an easy route of succession. The total break up of the EU would do far more economic damage to France and Germany than a no deal Brexit. The EU is therefore unlikely to blink in the UK trade negotiations. This leaves the UK with a tough political choice of extending the current agreement or no deal. No deal means WTO tariffs on goods, in a booming global economy this could be overcome, in a global recession suffering supply shocks this could be economic suicide. Unilateral risis in global tariffs without any new trade deals would replicate the mistaken policies of the US that turned the 1929 recession into the depression of the 30’s. So the UK government choice could end up being political suicide or economic suicide. Effecting a unilateral rise in tariffs with our major trading partners at a time the global economy is suffering supply shocks would almost certainly reduce the UK’s share of global trade. Market share is easily lost but hard to win back, the UK’s loss in the share of global trade cause by WW1 was at the heart of the UK economic malaise that lasted for the next 70 years. With Trump dropping in the polls, the chance of any advantageous trade deal with the US happening to take up the EU no deal slack is slim before next year at the earliest. China would probably love to do a deal, but if the UK tried to negotiate with China first the EU and US would almost certainly look to punish us. Predicting the outcome of this Hobson’s choice is far from easy.
Looking at history there is cause for optimism, there is historical precedent that means a V shaped recovery has every possibility. There are also considerable concerns that could tip the UK towards a deeper secondary recession. The key is avoiding a second peak, maintaining consumer and business confidence, avoiding rolling global lockdowns, hope that the virus does not significantly impact raw material supply and pricing, and resolving the UK’s precarious cliff edge in trade negotiations.