By Professor Sir Anton Muscatelli, Principal of University of Glasgow
The Great Financial Crisis of 2008 had many similarities to previous deep recessions. It was led by a financial boom-and-bust cycle. It had its origins in the financial sector.
But this economic crisis, which is unfolding in the light of the Covid global health emergency is very different.
It is the first time that governments around the world are having to shut down their own economies willingly to slow down the progression of a deadly disease. It’s already clear that the impact on our economic activity is staggering and exceeds that of 12 years ago. Economic forecasts vary widely given the current level of uncertainty. But to just take one from the National Institute of Economic and Social Research (NIESR) which predicts that the UK economy could shrink by 5% in the first quarter and then by up to a further 25% in the second quarter of this year if the lockdown continues.
This is unprecedented. It is economic Armageddon.
Governments have moved swiftly to sustain economic activity and, as far as possible, employment. Business support and employment support schemes through both grants and loans represent a much bigger fiscal stimulus than we saw during 2008-09.
Whilst difficult to forecast the impact, as we don’t know the duration of the interventions, the Institute for Fiscal Studies (IFS) has estimated that UK borrowing could rise by up to £177 billion, which is around 8% of GDP. In the Eurozone some forecasts see France and Spain’s debt rising to over 110%, and Italy’s to over 150% of GDP. Germany is the only country which would retain debt levels at moderate levels. A lot has been said about a ‘battle’ against Covid – and the impact on the public finances mirrors that of the Second World War when the UK ran fiscal deficits in excess of 20%. Central banks have also pledged major quantitative easing programmes purchasing government and, in some cases, corporate debt. This is a temporary measure we are told, and the Governor of the Bank of England ruled our permanent monetary financing. But carefully co-ordinated monetary and fiscal financing will be important post-crisis to avoid a major austerity phase as we saw post-2010.
The key question on everyone minds is: will this be enough, and will the economy recover quickly?
The answer to this mostly lies in the nature of the shock and the health mitigation measures. On the assumption that a vaccine will not be available for at least a year, if the industrialised economies move into and out of lockdown repeatedly in the next 12 months, then a V-shaped recovery – where there is a sharp decline but a relatively swift correction – is unlikely. It would take several years (2-3 at least) to recover pre-crisis GDP levels. The fiscal position of many countries would be seriously impaired. This potentially bad scenario should make us invest seriously and rapidly in research and clinical trials around both treatments for COVID-19 using re-purposing of existing drugs and technologies which facilitate containment (such as antibody testing at scale).
But there are also (at least) three major considerations for economic policymakers.
First, as the IFS stated, there will be domestic distributional impacts of the Covid crisis, both on incomes and on health. Tax systems can deal with that: progressive taxation should be used more actively.
Second, there will be massive distributional effects across the globe. Low-income economies will be hit hardest by COVID-19 and will require international assistance. Ultimately this type of co-operation as well as maintaining international trade as open as possible will be a win-win for every country on the planet. It’s never a good time for trade wars but after an economic dislocation like the one we are facing is the worst possible time. The world’s leaders in 1945 knew that when they created the global institutions which underpinned the post-World War Two economic recovery.
Finally, policymakers will be faced with some very difficult choices in the coming months: every economic activity cannot be saved, unless the pandemic disappears very quickly, and the recovery is V-shaped. We know which sectors will be hit hardest: services and goods linked to the movement of people and which rely on social interaction.
But to defend our economic future, prioritising high-productivity sectors and associated skills which ensure a rapid economic recovery will be important to create new jobs quickly, to reduce the debt burden as a proportion of GDP, and ultimately avoid a re-run of the austerity which followed the GFC: this time it must be different.
This article was first published in the Sunday Times, 12 April 2020.