Originally published on April 3rd, 2020
The question of ‘What comes next?’ is the reason why I started this blog and what I wanted to explore. A nice way I thought of setting the question up was to paraphrase Donald Rumsfeld, US Secretary of Defence from 2001-06. What are the ‘known knowns, the known unknowns and the unknown unknowns’? I thought it best to start with the former of those three, known knowns; try and draw as many sensible historical comparisons as possible with something so unprecedented, and eliminate unwise comparisons
To start off, what are the known knowns and what predictions are we certain about? Sorry for the cop out; there are none. The future is naturally uncertain, but because of how unpredictable the next year looks economically, already dubious neo-classical consumer theory becomes useless when discussing how economies weather such a storm. ‘Rational Expectations’ cannot be had with streams of conflicting information coming from all sides of the political spectrum and therefore one rational consumer cannot be scaled up to represent the whole economy. Conclusions (predictions) will thus be drawn from extrapolating data from the last two months, analysis of already employed fiscal policy (e.g. the stimulus package in the US), Keynesian macroeconomics and (as sensible as possible) historical comparisons.
Well, to start with, we’re going into a recession and it’s going to be deep. Deeper than anything most of us have ever seen. From the beginning of the lockdown in Wuhan on January 23rd to April 2nd, the MSCI World Index has dropped 26% (Shahine 2020). For the week ending March 21st, unemployment claims had risen 1052% from the previous week to over three million (Department of Labour, 2020), with predictions for peak unemployment in the US ranging from 15% by Goldman Sachs (Shahine, 2020), to an upper bound of 32.1%, predicted by the Federal Reserve in St. Louis (Klebnikov, 2020). Goldman Sachs astonishingly forecasts that GDP ‘will shrink an annualised 34% in the second quarter’ of 2020 (Shahine, 2020). Simply put, we haven’t seen anything like this before.
Pundits have tried to compare the figures soon to come out with those of the end of the last decade, or during the Great Depression (GD). I believe, however, that whilst there will be some similarity between the magnitude of the figures, it is dangerous to draw too much of a similarity between the current pandemic and the Great Recession (GR), or the GD. For one, the GD and GR took place over the course of years, and the trough was felt in several years after the first spark. For the GD the stock markets first crashed in 1929, but GDP kept declining up until 1933 and for the GR, the markets first crashed in 2008 but GDP declined until 2011. This upcoming recession is likely to be incredibly deep, but last less than a year.
The GD and GR are unbelievably complex, and no one cause can be identified, but false levels of confidence and sky-high of debt certainly played roles in the sparking and development of the crises – internal failures of the market. Today, markets aren’t currently tanking because of internal failures; they are tanking because of an external unprecedented socio-economic shock – this isn’t ‘their fault’. This belief is on the side of big business around the world, as it essentially takes away most moral culpability. There won’t be a lingering ‘Lehman Brothers’ question about whether to let firms fail, because it wasn’t malpractice (mostly) that brought about current problems. Even with this lack of moral culpability, not all industries will escape relatively unscathed. The aviation industry has taken an absolute battering that will lead to firms going under, even with financial assistance from their respective state. However, outside global pandemics, demand for airline tickets are relatively inelastic – those for cruises are not. Over the past 3 months cruises have been portrayed as floating petri dishes; The Diamond Princess, The Grand Princess and Carnival Cruises have all had major coronavirus outbreaks aboard their ships, and people can much more easily choose a different style vacation than choose another form of travel for travelling overseas.
Examining the peril of the cruise industry leads into my second factor for differentiation. Governments worldwide have put extraordinary effort in helping keep firms in their own country above water through the passage of stimulus packages for respective economies. For example, 2 trillion dollars in the US and 434 billion dollars (although effectively limitless) has been made available to businesses and workers in the UK. These are roughly double those introduced a decade ago, and crucially, those were introduced primarily to bail out the banking industry. Now all corners of the economy need to be bailed out. Because of the previous bail-outs a decade ago, this places even more pressure on banks to be lenient in lending to firms in financial difficulty, as Alok Sharma (Business Secretary in the UK) said, it is time for banks to ‘repay the favour’ as the private sector tries to stay afloat.
This has been to the detriment of the cruise industry in the US and worldwide, as ‘around 90% of all commercial marine vessels calling on US ports are under foreign flags” (Chanev, 2020). Many won’t qualify for benefits from the stimulus package because they are legally registered in poorer countries, such as Panama, with far more lax labour laws. Carnival Cruises and MSC cruises don’t let workers unionise and don’t have to be subject to any substantial regulations with regard to wages or working conditions (Chanev, 2020). This could prove to be the nail in the coffin for the cruise industry; the stain of disease-ridden ships, along with no financial help.
These stimulus packages have been rolled out because of a great public need, but also because we are generally more confident as to predicting how long the effects, as opposed to when we were predicting the full effects of the GD and GR. During the start of both the GD and the GR, analysts could only give educated guess as to when economies would re-emerge, whereas there is a relatively hard and short cap on how long the pandemic, and thus the economic downturn, will last. Dr Anthony Fauci, spearheading US’ response to the coronavirus, said a vaccine could be deployed (at the earliest) “in a year to a year and a half” (Kormann, 2020), and there could be effective treatments devised before then to minimise spread and mortality. Combining this cap with the lack of moral culpability for firms, this gives governments all over more confidence (on top of the political pressure) to go into amazing levels of debt and act as employer for much of the labour force whilst many private-sector employees become furloughed.
So, what happens next? How does the world recover? In a sense – as quickly as possible. The boom that will be seen when the tide is turned and the economy can safely open back up, will likely be almost as shocking as the decline prior. Using the US economy as an example, the same previous Goldman Sachs’ prediction says that GDP will expand 19% in the 3rd quarter (Shahine, 2020). The prediction of a specific quarter for this expansion to happen is purely speculation, and probably a little over-optimistic to place the bulk of the recovery in the 3rd, but a rebound expansion on the scale of 20% of GDP in a quarter is very likely to happen. Unemployment numbers will likely rebound as well, as after horribly fumbling their response, the federal government has committed to putting money in millions of Americans’ pockets and have agreed a bail-out of the aviation industry. For those furloughed or laid off, when they can go back to work, there will be an immense demand from firms for labour, which will lead to some of the largest and quickest job gains in the history of the US. There are no historical comparisons for the private sector jobs recovery, the only historical decline in total unemployment for the US will probably be the period from 1940-43, with unemployment declining from 14.6% to 1.9%, as the draft was instituted and the economy went into a state of total war (Amadeo, 2020).
However, due to the likely pace of the stock market rebound, GDP growth will probably outstrip the decline in unemployment relative to returning to their point before January 23rd. Currently there is little room for monetary policy to go with regards to interest rates, with the interest rates in the UK, the US and the EU all close to, at, or below 0. This leaves monetary policy in a liquidity trap and ineffective. Paraphrasing the Keynesian argument, when expectations for the economic growth turn more positive, the volatile nature of investment will drive GDP growth, as although investment is a lower percentage of output, given the magnitude of the likely growth of the stock markets and lowering of travel and financial barriers, investment will drive growth (Keynes, 1936).
A lack of moral culpability for firms, a relatively hard and short cap on the crisis, and a moral imperative for banks to lend, completely differentiates the current situation from the GD or GR. This is why, when we reach the trough of the recession, it is predicted that we will enter into an immense boom period as the global economy races up to close to full capacity again. I’d say that comparisons to war are far more apt, economically, than to other financial crises – albeit on a smaller and shorter scale.
In World War 2, states faced external threats, leading to economic decline and unprecedented levels of government spending and a rallying around defeating a common enemy, with afterwards being declared as the ‘golden age of capitalism’. Thirty years of consistent and stable growth in countries devastated by the war, like Japan, Italy, France and Germany, and although we won’t see a new ‘Trente Glorieuses’, a few of years of high levels of economic expansion are hopefully over the horizon.
Pictures won’t come out of people sleeping on the street because they’ve lost their jobs – far from it – we’re going to see close to nobody on our streets for quite some time – but when people come back, the economy will roar back as well. Hopefully the lessons we learn now will leave us better prepared for the next pathogen to take society in its grasp, and to quote former VP Joe Biden – ‘No life is worth losing to add one more point to the DOW’ – because that’s what really matters.
Clarifications to Rumsfeld Ruminations published on: April 18th, 2020
I must recognise I have made a mistake in my previous piece. Throughout my analysis of predictions for a quick recovery from COVID-19, I diagnosed an economy which wouldn’t be so heavily scarred by the current crisis because of one crucial assumption that I shouldn’t have made. I assumed that the government stimulus packages in the US and the UK specifically would have their desired effect, of allowing individuals to keep a somewhat stable income, and to allow firms to stay afloat during this period, with near-perfect implementation. Whilst I definitely should have acknowledged this, it has become even more clear in the past two weeks that, in the US specifically, there has been failure at every level to introduce the stimulus into the economy. In the United States, banks are legally allowed to withhold payments going into accounts if they are in overdraft and even in these pressing times, banks have exercised this power. Safe Federal Credit Union and USAA have both intercepted payments from the government to individuals to pay off their overdraft, making it even harder for people to make their essential payments to survive (Flitter and Rapaport, 2020). This practice poses a daunting future for the 39 million Americans who went into overdraft between March 2017 and 2018 (Flitter and Rapaport, 2020). Other glitches have been reported, with millions of people who filed their taxes through H&R Block, turbo tax and other popular services unable to get their payments (Long and Singletary, 2020). To be clear, this isn’t the case everywhere, there are countries outside the US and the UK who have handled local outbreaks exceptionally well. South Korea has been widely lauded for flattening the curve due to aggressive testing and pro-active government lockdowns (Beaumont, 2020), leading to it being deemed safe for millions of South Koreans to vote in their parliamentary elections (The Economist, 2020). These elections brought a resounding victory to the ruling Minjoo Party, largely attributed to their ability to handle the outbreak in the nation (The Economist, 2020). However, although certain countries have been effective in containing the outbreak, in such a globalised world, even South Korea will certainly suffer for others’ inaction. There will be an estimated loss of 20 trillion dollars in capital worldwide (Dalio, 2020), whilst the central bank reported in February that South Korea had reached its largest net international financial position ever, at a round 500 billion dollars, with foreign assets totalling $1.69 trillion (S. Korea’s net foreign assets hit a new high in 2019 | Yonhap News Agency, 2020).
To sum up, if all governments of the world took proactive steps such as implementing free, widespread testing and cautionary lockdowns like those detailed above, then the human and economic impact of the virus would be on a far lesser scale than what we are currently seeing. Make no mistake, in a situation that has necessitated good government, there has unfortunately been a distinct lack of it. There was always going to be a heavy economic impact regardless, but the inaction of the governments in the UK, US and others not strictly following scientific advice have greatly exacerbated the worst economic crisis since the 1930s.
– Fred Alldridge is an economics student at the University of York
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