After the carnage in global financial markets in early March, a degree of stabilization has taken place. However, as recent gyrations in oil prices show, this might just be a lull before another storm.
The problem is that many financial analysts, and even more so politicians in the United States and beyond, hope for a V-shaped recovery: a big fall-off in economic output followed by a rapid and sustained recovery. The experience of China, the first country to successfully suppress the virus in its first wave, illustrates the incredible difficulty of a V-shaped recovery.
While Chinese industrial output is recovering, especially for large firms, consumption is still lackluster. Most indicators point to a roughly 60-80 percent recovery of the Chinese economy, though some areas such as travel are down much more.
China’s example thus shows that there will not be a full recovery any time soon and the aftereffects of the pandemic will linger. Indeed, studies of past pandemics illustrate that economic damage tends to persist for about 40 years. Wars and other natural catastrophes, such as earthquakes and hurricanes, have no such effect. In fact, the opposite is the case, being that these events destroy capital that has to be rebuilt. Rapid economic recoveries often follow, such as seen after World War II.
Pandemics create no such capital stock destruction. Rather, COVID-19 is likely to create three broad obstacles to a quick rebound. First, until there is a cure or vaccine for the virus, consumption will remain subdued. Certain segments of the economy will be impaired long into the future, such as leisure and hospitality industries, as well as conferences, sporting events, art performances, etc.
Even with a vaccine or effective cure/management of the virus, consumption patterns will take time to recover. Many consumers will engage in precautionary saving due to increased economic uncertainty. Moreover, consumption patterns are likely to shift long-term, such as more at-home meals and video-conferencing to avoid business travel.
The good news is that patterns of consumption can shift more rapidly than other aspects of the economy. Human beings will reel from the shock of the pandemic, but there will be big differences in how it is experienced. The severity of the pandemic in each locality is vital, as are the levels and effectiveness of containment measures.
Contrary to what some are advocating in the United States, the more economies are forced to slow down or halt to create effective social distancing, the more successfully the pandemic can be managed. And this, in turn, influences how rapid economies can recover.
The case of China shows how drastic measures can generate a degree of effectiveness in controlling the pandemic. These can then allow an economy to mend quite rapidly. But even in this case, a V-shaped recovery is unlikely. If continued vigilance against the coronavirus is required for years, anxiety will endure and people will be reluctant to spend.
The second and more serious obstacle to economic recovery is the damage that results when firms go bankrupt. The more severe and long-term such economic dislocation, the more will financially sound firms be destroyed. And since many companies across the globe are saturated with debt, there is a distinct risk of a financial crisis.
Widespread bankruptcy could leave economies in a weakened state, depleted of investment and innovation. Indeed, if corporate destruction spreads to the financial sector, impairing banks and investment houses, then the long-term damage could be cataclysmic.
Various schemes across the developed world are trying to forestall mass bankruptcies and unemployment; and with this a financial crisis. European programs such as Kurzarbeit in Germany are likely to be more successful than efforts in the United States. Already considerable shortcomings of the Small Business Administration’s Payment Protection Program are appearing; specifically a bias for large, well-established firms that leaves many smaller employers out in the cold.
The final long-term obstacle to an economic rebound is found in the realm of international politics. Fears about economic interdependence, most poignantly expressed by far-flung value chains, are set to deepen. The instinct to protect one’s own country by reducing dependence on “foreigners,” in particular the omnipresent role of the Chinese economy in segments such as medical supplies, will create fertile conditions for the world’s major powers to succumb to suspicion and scorn.
A further unraveling of global trust, already under threat in recent years due to heightened friction in US-China relations, could prolong the crisis and make it deeply divisive. For sure, there are reasons to hope that the pandemic can lead to greater international cooperation. Unprecedented levels of open scientific teamwork aimed at developing vaccines, diagnostics, and therapeutics are occurring.
But even these shoots of cooperation are being drowned out by a sense of alarm in every inhabited part of the globe. COVID-19 is truly an international pandemic with no one world region spared. The whole global system is thus experiencing prolonged border closures, permanently disrupted supply chains, and rapid increases in fiscal deficits and debts. Perhaps most significantly, the political consequences of the economic crisis could create fertile ground for more extreme nationalist platforms.
The longer the pandemic lasts, the more likely it will do sustained damage to consumption, productive capacity, and global cooperation. Each of the above three obstacles could then trigger a metamorphosis in the nature of the crisis from temporary economic shock to a lasting breakdown of the global system.
This is a doomsday scenario that will hopefully not unfold. However, it indicates that a painful but short-lived economic crisis giving way to a robust recovery later in 2020 is highly unlikely. The global economy is in a temporary deep freeze, but it cannot just thaw and return to normal.
Policy-makers will need to think about the potential long-term damage that could occur and devise policies now to forestall it. The greatest pay-off could be garnered from rapidly increasing international cooperation to exchange information and best practices on how to manage the pandemic before the possible development of a vaccine. Nobody gains from a prolonged blame game that only serves to lengthen the global economic malaise we are now facing.
