By Professor Sir Anton Muscatelli, Vice-Chancellor University of Glasgow
The global spread of the new coronavirus has required a major healthcare response in those countries with major clusters. Other countries are bracing themselves for impact as the virus spreads. Of course, our immediate concern has to be for human health. Healthcare systems will have to respond to the emergency with all available resources.
But, although it’s a secondary consideration, it is important to consider the economic impact of the outbreak and how the world economy can best attenuate further long-term misery due to the effect the virus will have on our economies and social fabric.
The Organisation of Economic Co-operation and Development’s (OECD) economic impact assessment of COVID-19 is stark. It predicts a 0.5% decrease in 2020 world GDP growth to 2.4%, assuming no worsening of the epidemic.
Threat of global recession
But it also warned that a worsening of the coronavirus spread could take world growth as low as 1.5% in 2020. This ‘low case’ scenario is well below the level which signifies a global recession. The OECD’s ‘base case’ sees a drop of UK growth to 0.8% in both 2020 and 2021, with the danger of outright recession.
World stock markets have reacted to the worsening economic prospects with the biggest percentage drops in equity values since the Great Financial Crisis in 2008.
So, how different is the COVID-19 crisis to the financial crisis? And what should our policy response be?
The current crisis triggered an initial global supply shock, as the sudden reduction in China’s production spills over to all the countries with trading and supply-chain links to China. We have seen very similar disruptions to production systems in other countries like Italy as workers stay at home and plants pause production (the outbreak is centred on Italy’s manufacturing and economic heartlands, in Lombardy and surrounding regions), and in Japan.
Consumer spending reduction
A fall in production in these regions has also impacted on global supply chains. Following the initial supply shock, we are now seeing a demand shock as consumer spending is reduced: initially on travel and other services, but also as a result of the negative wealth effect from declining financial markets on consumer spending and business confidence more generally. This came on top of an already slowing world economy.
In contrast, the great financial crisis was arguably the reverse: initially a major demand shock as consumers and business reduced spending and deleveraged, reducing debt. It also did have a long-run adverse supply effect through its impact on lower business investment. The response across the major industrialised economies was for governments to take on additional debt to support financial institutions and to support demand in the economy. It also consisted of major reductions in interest rates and an expansion in liquidity in financial markets.
So how should the major world economies react to this latest challenge? The first response will be, quite correctly, to increase spending on health service capacity, to offset the immediate health emergency and to try to mitigate the supply shock.
Less scope for monetary policy
But beyond that there is less scope to act in 2020 through monetary policy. Unlike 2008 policy interest rates are already close to zero, and additional liquidity will not stimulate demand: in these circumstances as in that quote attributed to John Maynard Keynes, monetary policy is as effective as ‘pushing on a string’.
A temporary fiscal policy stimulus would be more potent. It might best target the suspension of state aid rules to support companies who are experiencing a temporary slump in demand and avoid major collapses and consequent reductions in employment and economic capacity.
This could be targeted to those companies where the ‘deglobalisation’ impact is greatest. In Europe (including the UK in the post-Brexit implementation period in 2020) this may need to be decided at the EU level.
Need to reduce barriers to trade
But ultimately a supply-side shock requires not only a demand-side response, helpful though that is to protect output and employment during the immediate crisis. The best supply-side response in the medium run would be for the G-20 economies to offset the shock by reducing trade barriers. The USA and China would need to accelerate their trade talks and move beyond their phase 1 deal to reduce tariffs further. Similarly, there could scarcely be a greater incentive for the EU and the UK to reach a trade deal quickly in 2020.
Above all the coronavirus crisis needs concerted action. In 2008 the G20 briefly acted jointly to help rescue the world economy.
It’s time to work together again.