By Philippe Waechter, Chief Economist, Ostrum AM
The current COVID-19 pandemic is set to change the pace of the world economy. Countries have voluntarily staged dramatic, synchronized and persistent economic shocks to curb the spread of the virus. No corner of the world has avoided a recession of as yet undetermined dimensions.
The Great Depression of 1929 did not involve this instantaneous synchronization, but rather the crisis hit the United States before spreading to the rest of the world after a lag and with a lesser impact. The crisis in 2008 erupted simultaneously across all areas of the world, yet this first global crisis was not as extensive as today’s situation. Central banks and governments swiftly “put paid” to the 2008 financial crisis with their coordinated intervention, and growth made a comeback in the spring and summer of 2009.
Today’s predicament has very different features. It is not a stock market crisis like 1929 or a financial crisis like 2008, but, rather, the current crisis is a rational response from the authorities to an epidemic that seems to carry considerable risks of spreading. COVID-19 is transmitted primarily through person-to-person contact, so social-distancing strategies have been required, sending economic activity into a downward spiral as several sectors have no longer been able to operate. The other unprecedented feature of this crisis is that we do not know when it will end; economic policy can act only as a support and ease the effects of the pandemic, but it cannot reverse its momentum.
Activity in the services sector has plummeted, while manufacturing-sector operations have hit the breakpoint. Lockdown measures have brought several sectors to a halt in the services industry—ranging from air transportation through retail to the hotels and restaurants business. Meanwhile, in the manufacturing sector, supply chains have broken down, dealing a major blow to an industry that had already been hard hit by the White House’s trade war.
The overarching aim now—particularly in Europe—is to curtail the scope for the virus’s spread as much as possible, and this means a period of recession. In a highly specific feature of the current situation, COVID-19 has developed almost concurrently across all areas of the world, so the standstill in manufacturing is not limited to just one region. Each area is obstructing its trade partners, making for a very particular characteristic of the current crisis. The slew of economic-policy responses have been aimed at putting economies into something of an induced coma by offsetting these effects, and this approach accounts for the various steps taken, ranging from government-subsidized furlough schemes to extended deadlines for employer contributions and taxes, state-guaranteed loans for businesses as well as payouts for self-employed workers who are not eligible for the furlough schemes. The costs of these measures are vast, with amounts initially estimated at €45 billion in France, for example, and currently expected to come to €115 billion.
A deeper recession than 1929
The current crisis has had a massive recessionary impact that is much more drastic than anything we have witnessed in the past. For example, unemployment in the United States soared from 3.5 percent at the start of March to potentially 20 percent in mid-April (the figure will be lower due to the drop in the activity rate). The only equivalent watershed moment in history came two years after the start of the 1929 crisis.
Looking to China, first-quarter GDP (gross domestic product) plummeted 34 percent in annualized terms as compared with the last three months of 2019. Meanwhile, if we look at government projections in France, the expected 8-percent plunge in GDP has only ever been rivalled during wartime. Even the year-on-year decline at the start of the 1930s was not as severe, and neither have post-war recessions been as extensive overall. Each month of lockdown in France slices a hefty 3 percent off annual growth.
What about the world of tomorrow?
The million-dollar question now concerns the aftermath of the crisis—and how the situation will play out in both economic and political terms. How will each economy manage to find its way out of this situation, and how can the world economy as a whole reclaim a robust pace of growth?
These are two very separate questions. The first aspect depends on each country’s specific characteristics, while the second hinges on each economy’s ability to get back on the path to growth—but also the broader potential to promote a worldwide economy that can take a coordinated approach once again. This involves restoring production chains, for example, but also reopening borders.
From a political standpoint, today’s health crisis reveals the need for a somewhat stronger state, but this perception can englobe some very different aspects.
The economic path after the 2020 shock
There is now no doubt that we are witnessing an economic shock in 2020, so the question mark now hangs over 2021 and beyond. A negative shock is always followed by a significant rebound that can set the economy back on its pre-crisis trend. This theory was borne out in the past: for example, the events of May 1968 in France did not hamper GDP trends or growth momentum for the long term. However, this no longer applies; the 1993 and 2009 recessions in France were not followed by corrective recoveries, as the pace of growth in 1994 and 2010 was similar to average figures before the recession. If we apply this to the situation in France, it would mean a growth rate of 1.4 percent in 2021, so in this respect, the country would revisit its 2019 GDP figure only in 2026. This feature is not restricted to France. The US displayed the same profile as France in its 2010 recovery, with a similar situation in the United Kingdom and Italy, but a more negative showing in Spain. Out of the major countries, only Germany and Japan posted much better performances in 2010 as a result of their strong ties with China, which was enjoying very swift expansion in 2010.
So, the recovery expected by the IMF (International Monetary Fund) is probably excessive. Yet, even if we take on board the Fund’s figures, we would only revert to 2019 GDP showings in 2023 at best—and this time, China cannot have the same influence on Germany and Japan that it had in 2009-10.
Deterioration in the labor market
Economic activity will remain more sluggish than in 2019 on a long-term basis, triggering a downturn in employment. Lower GDP figures will mean closures for businesses and companies, so employees who have been furloughed during the pandemic will not all be able to find a job after the crisis, with this situation even further exacerbated by uncertainty surrounding the end to the crisis. The possibility of a second or even a third wave of the virus and the ensuing lockdowns for each outbreak will discourage business leaders from restoring the staff numbers that they had before the crisis. In other words, the surge in furloughing will lead to unemployment for many workers after the epidemic.
Alongside this, French recruitment statistics for March have nosedived. The drop in economic activity has pushed down new hires and added workers who would have found a job under normal circumstances to the list of jobless stats.
We can expect the drop in economic activity and employment to encourage more cautious behavior in the labor market, which will be to the benefit of those already in jobs. The jobless total will probably be higher than before the crisis and is set to remain that way for a long time to come.
Recovery dented by uncertainty
The plunge in demand has triggered a sharp surge in savings, which is the best response to uncertainty. However, during such times as this, when uncertainty prevails regarding both health risks and job-market risks, household and corporate spending levels remain lethargic. This will necessarily require an ambitious economic-policy response to breathe life into the labor market and spur investment. The role of the “State” will not come to an end when the pandemic is over.
Borders have closed during the current crisis, and supply chains have been fragmented, so one of the difficulties involved in coaxing a recovery will be getting these chains up and running again. Surveys attest to supply difficulties in the manufacturing sector, and delays in China since January have led to lags at all levels. These delays are building up and preventing a swift resumption of activity. The various operations required to manufacture a product need to be coordinated. This will eventually happen, but it will take time, thereby denting economies’ ability to recover and hampering the speed at which we exit the current crisis. The other key international aspect is the resumption of trade and travel, which will take place in three stages: firstly, locally at a country-wide level; secondly, regionally when country-wide movements are restored; and thirdly, internationally when regional movements are successful. This aspect is also holding back the recovery.
Will public debt also be affected?
It is important to make a distinction between the euro area and other countries. For example, in the United States, additional public debt is held primarily by the American public or Federal Reserve (by consolidating the public sector, net debt issued is reduced as a result of the central bank’s substantial purchases). Public-debt issues allow for a reallocation of resources within the economy, which then owes itself higher debt, although this is not problematic.
However, the situation is more complex in the euro area, as the public sector cannot be consolidated given that there are 19 governments and only one central bank. Additionally, there is no public-debt structure at the euro area level for Europeans to effectively lend to themselves. Each country is highly guarded about its own public debt and does not want to have to take on its neighbors’ debts, too: this is reflected in the failure of recent talks on coronabonds.
The ECB (European Central Bank) is now spearheading the fight against the crisis as none of the member states want to diminish their sovereignty. The bank has rolled out a series of programs to tackle the pandemic, in particular, the Pandemic Emergency Purchase Program (PEPP) worth €750 billion, which deserves a closer look. This program does not have the asset-purchase restrictions involved in the ECB’s quantitative-easing program; neither does it require the central bank to follow the usual capital key that caps purchases at a percentage consistent with the weighting of each country in its capital; nor will it have to restrict holdings to 33 percent of each issue. So the ECB’s balance sheet will now be skewed in favor of the countries of the south. Cancelling debt would provide an advantage for southern countries, which are hardest hit by the pandemic. These federal aspirations from the ECB could eventually trigger tensions with the more stringent countries, and feathers would really fly in the event of public-debt cancelation.
A political dimension
The need for the State seems more urgent than before, and management of this crisis has given the State back a role that it had lost. Of course, we can see that the State can have a crucial role to play in strategic sectors and relocations; it will probably play this role. Simply speaking, the State is too vast a term to be reassuring. Events of the past have shown that political responses can be very different. The October revolution in Russia or the surge in extremism in Europe would probably not have happened without the First World War. This is another reason why uncertainty remains regarding the end of the current health crisis: Its political dimensions may not live up to the democratic expectations for which we would like to hope.