Shocks, recessions and recoveries – lessons from history

Shocks, recessions and recoveries – lessons from history

In their response to the pandemic, Western governments have learned and applied many of the lessons of past crises.

 

• The most recent lessons, from the last six months, have come with a heavy cost. Early testing and tracing at scale gave countries including Germany, Taiwan and South Korea a lead in combating the virus. The West has followed many East Asian economies in adopting lockdowns, social distancing, quarantines and face masks. The first waves of the virus underscored the need to protect care homes and to maintain supplies of personal protective equipment (PPE).

 

• In a pandemic public health determines economic performance. The East Asian countries which were quickest to control the epidemic registered milder downturns than European or North American countries. China, Hong Kong, Singapore and Taiwan’s experience of SARS in 2002–03 prepared them for future epidemics and reinforced the widespread use of face masks.

 

• In the early months of this year comparisons were often made with the 1918–20 flu pandemic. One widely cited lesson from 1918 was that locking down early was vital to controlling the virus. St Louis’ quick response to the 1918 flu, limited activity within 48 hours of the first case, helped half its death rate relative to Philadelphia, which waited two weeks.

 

• There are limits to the comparisons that can be drawn with 1918. Social safety nets were rudimentary or non-existent then, and wholesale workplace closures were not feasible. In the wake of the destruction of the first world war, and the repatriation and demobilisation of huge numbers of troops, governments had to maintain activity and the movement of people.

 

• Rich economies have, historically, proven resilient in the face of external shocks. After Japan’s Kobe earthquake in 1995, the 9/11 terrorist attacks and the SARS epidemic growth bounced back, fuelled by pent-up demand, easy policy and reconstruction.

 

• These shocks were localised, discrete events. Today’s pandemic is global in its reach, and, in the absence of a vaccine, persistent. The impetus to growth from pent-up demand and loose policy will be dampened by continued caution and uncertainty. The global downturn will, as a result, be more severe, and the return to normal slower, than for decades.

 

• Policymakers have clearly absorbed the lesson of the 2008 global financial crisis on the need to act quickly and at scale. Central banks deployed the tools they developed over the course of 2008–09 in a matter of weeks at the onset of the pandemic. This intervention succeeded in avoiding what, at times, came close to a meltdown in some financial markets.

 

• The experience of the global financial crisis has left governments and central banks more willing to adopt radical policies and err against the early withdrawal of support. It is hard to imagine governments borrowing to fund private sector wages, Germany abandoning its balanced budget rule or the EU signing up to shared borrowing without the prior experience of the last recession.

 

• A stronger, better capitalised banking sector is one of the benign legacies of the financial crisis. As a result banks have been able to play a vital role in maintaining private sector liquidity and in channelling government support to corporates.

 

• Economic policy evolves in response to the challenges of the day. The Great Depression and second world war paved the way for the post-war Keynesian policy consensus. The stagnation and inflation of the 1970s created a new economic orthodoxy, around monetarism and neoliberalism, which took hold in the UK and the US in the 1980s. The pandemic, coming after a decade of low growth, is fuelling a search for alternative economic models. Some foresee an era of higher government borrowing and activism designed to boost growth.

 

• COVID-19 has naturally added to concerns about the growth potential of western economies. Yet the economic future is not preordained and things do not always turn out as expected - sometimes in positive ways. After the global financial crisis few expected unemployment rates to fall to near record-lows in Germany, the UK and the US. The UK’s vote to leave the EU in 2016 slowed growth, but less than the more pessimistic forecasts suggested, and unemployment continued to decline. Following the second world war, many feared another Great Depression as millions of demobilised troops struggled to find work. Instead growth boomed. Few could have predicted the economic miracle in post-war western Europe, the Asian Tiger economies and later, in China.

 

• A long history of financial, economic and external shocks has left policymakers with a wide range of tools to combat downturns. Even after the hyperactivism of the last six months governments have scope to increase spending and central banks have monetary policy firepower. Yet increasingly the task is shifting from providing short-term support to activity to aiding structural change and raising trend growth. This is altogether more complex and long term in nature. It requires greater selectivity and harder judgements to be made about the capacity and competence of government.

 

• What marks this crisis out from those of the last 80 years is that Western governments have so far been fiscally unconstrained – they can borrow at negligible cost on a vast scale. The economic and political difficulties of raising taxes or cutting public expenditure suggest that, bond markets permitting, governments are likely to run sizeable deficits well into the recovery.

 

• Economic policy makers have torn up the old rule book in their response to the pandemic. That has helped avoid a far deeper, more damaging economic crisis. The challenge now is to harness the same spirit of urgency and creativity to secure the recovery.

 

PS: The pandemic has raised new questions about the future of cities. The fortunes of great cities have, of course, always ebbed and flowed. London’s population and economic importance waned between the 1940s and 1970s since when it has enjoyed a renaissance. Its population rose from a trough of 6.4m just under 30 years ago to 9m in 2019. This growth has been driven by international migration, which provided an annual net inflow of about 100,000 during the 2010s - by contrast, domestic migration has seen UK residents increasingly leaving London to live outside the capital. Brexit, higher unemployment and a more challenging environment for globalisation seem likely to affect the international migration which has been such a factor behind the recent growth in London’s population.

 

For the latest charts and data on health and economics, visit our COVID-19 Economics Monitor:

https://www2.deloitte.com/uk/en/pages/finance/articles/covid-19-economics-monitor.html

 

OUR REVIEW OF LAST WEEK’S NEWS

The UK FTSE 100 equity index ended the week down 0.6% at 5,964.

 

COVID-19

• The UK recorded 8,088 new cases in the week to 28 August, up from 7,353 the previous week
• New confirmed cases and deaths in the US appear to be falling, suggesting the resurgence of the virus has been checked for now
• The number of deaths in Mexico exceeded 60,000. The country has the third-highest death toll in the world behind the US and Brazil
• Researchers in Hong Kong found an individual who had been reinfected with the virus. The second infection was not serious and the World Health Organisation cautioned against jumping to conclusions based on the case of one individual
• The UK government will encourage businesses to regularly test their workforce for COVID-19, the FT reports
• UK secondary school pupils in lockdown areas will have to wear face masks in communal spaces. Separately, teaching unions backed a return to school
• Cambridge University is to start clinical trials of a potential vaccine in the autumn
• The UK has extended its two-week quarantine requirement to travellers returning from Switzerland, Jamaica and the Czech Republic

 

Economic developments

• US corporates’ profits were down 20.1% in the second quarter compared to the same quarter last year
• Weekly new jobless claims fell in the US to just over 1m, a fraction of that seen in late March and April
• US consumer confidence fell to its lowest levels since 2014 in August as government income support expired. Congress remains deadlocked over further assistance
• Money deposited in bank accounts surged in the euro area, growing 10.3% in the year to July. This reflects cautious behaviour of households and businesses
• UK retail activity slowed in August as retailers shed jobs at the fastest rate since February 2009, according to a CBI survey

 

Policy response

• The US Federal Reserve signalled a major shift in its approach to tackling inflation. It will now target an average of 2% inflation, rather than a fixed level of 2%. The move will give the Bank leeway to keep interest rates lower for longer, helping to stimulate growth and reduce unemployment
• The UK government is to launch a campaign to encourage workers back to offices amid fears that the COVID-19 pandemic could permanently damage city centres
• An ECB board member Isabel Schnabel warned that “absent a forceful policy response, the current pandemic is likely to put substantial pressure on banks’ profitability due to rising loan-loss provisions and defaults”
• The Financial Conduct Authority has told UK banks to extend assistance to mortgage holders when the ability to claim three-month payment holidays expires at the end of October 
• Workers on low incomes in areas of England where there are high numbers of COVID-19 cases will receive £13 a day if they have to self-isolate

 

Business news

• Jet engine manufacturer Rolls-Royce announced a £5.4bn loss for the first half of the year and said it does not expect orders to return to pre-crisis levels until 2025
• Pret A Manger is to cut one-third of its workforce, or around 3,000 jobs. CEO Pano Christou said “the pandemic has taken away almost a decade of growth at Pret”
• Gatwick passenger numbers dropped by two-thirds in the first half of the year. The airport also announced that it will take four to five years to return to pre-crisis passenger levels
• US retailer Walmart is to join up with Microsoft to bid for Chinese technology firm TikTok’s US operations. President Trump has given TikTok 90 days to sell its US business or face a ban after alleging the company shares its user data with Beijing
• Some restaurants have announced that they will extend the ‘Help Out to Eat Out’ scheme by funding it themselves once it expires at the end of August
• Commercial landlord Grosvenor, which owns property across London, will reduce rents for tenants that continue to offer half-price meals
• Coca-Cola is to make 4,000 redundancies across the US, Canada and Puerto Rico due to a fall in demand at bars, restaurants and other venues that have suffered due to the pandemic

 

Politics

• Japanese prime minister Shinzo Abe is to step down after eight years due to ill health
• President Trump accepted the Republican Party’s nomination for the presidential election
• The latest Economist US election model shows Joe Biden winning 54.7% of the vote against 45.3% for Donald Trump, a similar result to what it has been seen since mid-June. It gives Mr Biden an 88% chance of winning the electoral college, securing 350 votes against 188 for Mr Trump (270 are needed to win)
• According to betting odds on Betfair exchange, there is a 52.4% implied probability of Mr Biden winning the presidential election, and 50.0% chance of Mr Trump being re-elected. The combined odds sum to over 100% due to the ‘over-round’, the profit margin of those laying the odds
• Sir Ed Davey won the race to become the new leader of the Liberal Democrats

 

And finally… a sheep has been bought for £367,500 at an a auction, making it probably the most expensive ever sold. Double Diamond, a pedigree Texel ram lamb was sold to three farmers in Scotland last week after a frantic bidding war - fleece(d)