Coronomics: how bad will it get?

Who would have imagined that the economy could be stopped in its tracks? Yet that’s what seems to be happening thanks to the coronavirus lockdown. As Western governments try to halt the spread of COVID-19, young people like you and me are left wondering just how big the fall-out will be, and how much our lives (and finances) will be affected when all this is finally over.

So what do we know so far? Are there any causes for hope? And what should we be looking out for in so-called “corona-nomics”?

What do we know already?

economy

I’ll level with you – the initial outlook for the economy is Not Good.

The Centre for Economics and Business Research predicts that gross domestic product (GDP), essentially the value of goods and services in the economy, will shrink 15% in the second quarter of this year, i.e. from April to June.

The Office for Budget Responsibility has suggested that the economy could contract by a whopping 35% in the second quarter of 2020, leading to an overall fall of 13% in GDP this year. The OBR is an independent body set up by the government in 2010 to help measure the nation’s finances. The Bank of England is predicting a similar squeeze of 14% across the year, based on the lockdown being relaxed in June.

Meanwhile, the International Monetary Fund has now predicted the UK economy will shrink by 6.5% in 2020, compared to its forecast of 1.4% growth in GDP in January.

The figures may vary, but economic experts all agree on one thing. The Bank of England has confirmed that we have already entered a technical recession, where GDP falls for two successive quarters in a row. But the global economy is also set to enter a recession in the wider definition of the word, meaning higher unemployment, lower industrial activity and less money in our pockets.

How badly does this compare to other crashes?

If even the most optimistic forecasts prove to be accurate, the economic impact of coronavirus would far surpass the damage caused by the financial crash in 2008. This was specifically triggered by the collapse of the U.S. investment bank Lehman Brothers and more broadly caused by the failure of subprime mortgages – home loans sold to people who couldn’t pay them back.

The concern now is that, depending on how lockdown lasts, the economy could be heading for a depression. This is much worse than a recession because it would be a sustained, long-term downturn – possibly lasting years. Depressions are far rarer, with only one in the past 166 years (compared to 33 recessions). The Great Depression of the 1930s didn’t end until 1946 after the Second World War.

In fact, we may need to go much further back in history for any real parallels. The OBR’s “reference scenario” would put the current crisis on a par with the Great Frost of 1709, where a deep freeze across Europe killed crops, caused food shortages and cut GDP by roughly 15%.

An even more accurate comparison might be the Black Death, which lasted 1348 and 1350 and caused 200 million people worldwide. It’s thought to have caused a decline in British GDP of around 29%.

While it’s extremely unlikely that Coronavirus will take as many human lives as a medieval plague – thankfully – the worst-case scenario could end up being just as, if not more, economically harmful.

But can we trust economic forecasts?

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Possibly not. Economic predictions are unreliable at the best of times. Despite the rotten mortgage market being common knowledge before 2008, very few people publicly warned about it. Since then, professional forecasters (including investment fund managers and economists) have had a mixed track record on getting major calls right, whether that’s how much the economy will grow or how well stock markets will perform.

But in fairness to the experts, it’s too early to determine the full economic cost of coronavirus with any certainty.

Much of the Western world is still in lockdown, with only a few countries starting to ease restrictions. The OBR’s forecast, for instance, assumes that Britain will enforce extreme social distancing for three months before gradually phasing it out over another three months. But there is no guarantee this will happen.

Experts also disagree on how quickly the economy will rebound once the acute stage of the crisis is over. Chancellor Rushi Sunak has spoken in daily press briefings of how he expects the economy to “bounce back” after Coronavirus abates, in line with what the OBR has assumed. This would be what the experts call a V-shaped recovery, suggesting a quick, steep rise in GDP.

Others are saying it could be more U-shaped, with a slower recovery, while others predict an L-shape, where the economy remains stagnant for some time.

But most economists haven’t even tried to account for the long-term economic impact of the coronavirus, largely because this would be near-impossible. We just don’t know how many of the business closed will ultimately re-open, how many start-up businesses will lose investment for good or how long global travel will suffer after the lockdown ends.

The IMF doubts that developed economies like the UK’s will recover their lost ground by the end of 2021 and expects to see trillions of dollars wiped off global GDP for good.

But until we know when and how countries will start to get back to normal, the economic forecasts are just informed guesswork, even more so than usual.

Is there any good news?

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“The Triumph of Death,” by Pieter Bruegel the Elder, 1562. Let’s hope it doesn’t get as bad as this!

 

According to the Centre for Economics and Business Research, the economy is still functioning, albeit at 69% of its normal levels. Many important sectors like finance, science and agriculture, have seen output drop only by 10-20%. Disruptive, yes. But not disastrous.

It’s also true that the government’s emergency measures for business will avert a much more serious decline. The Chancellor is offering business interruption loans, rate holidays and the option to furlough inactive workers, where salaries will be paid by the government at 80% of their usual level (up to a maximum of £2500). This should stop companies laying off workers and help them snap back quickly post-Corona.

Even if social distancing continues for some time, there are signs that our economy is adapting. One US study has found that 33% of people can work just as well from home. Because these tend to be highly skilled professionals, nearly half (44%) of economic output may remain unaffected. Many people who have lost work or aren’t in education anymore are now retraining or becoming key workers. Opera singers have become supermarket workers, air pilots are now delivery drivers and students have been recruited to pick fruit and veg on farms.

Some supermarkets have already given their workers a 10% pay rise, and there is much speculation that other key workers will get more rights and better pay when the crisis ends (including migrants).

Indeed, history suggests that pandemics can have economic benefits in the long-term. The Black Death empowered workers, as labour shortages led to higher wages and ultimately led to the end of serfdom in Britain. Scholars have also found that survivors had a new lease of life, spending more on leisure in the long run – a silver lining, perhaps, for Britain’s night-time and entertainment economy.

So what’s next?

The government had increased its borrowing even before coronavirus came along because it could benefit from relatively low interest rates. Now, our central bank, the Bank of England, is buying £200bn of bonds to help finance the recovery and government borrowing is expected to be about £218bn higher than before, putting it at about 14% of GDP.

The IMF is suggesting more “public infrastructure investment or across-the-board tax cuts” in the long run. But this means more national debt and potentially a record-high deficit (where a government spends more than it taxes). This could make future borrowing more expensive and make it harder for to deal with future emergencies. The pressure will be on government to reduce the deficit in the long run by raising taxes, limiting spending – or both.

One thing we can guarantee is that this year will be much tougher than normal for all of us. But a solid financial plan will help you get through. See what benefits you can access using the Turn 2 Us calculator. Increase and draw on your easy-access savings if possible and be more mindful than ever of your spending. You can also ask for a mortgage holiday, which won’t affect your credit rating, but be aware the interest will be added to your loan at a later date – so only do this if you need to. Check if you can take advantage of a higher credit card limit or a bigger interest-free buffer on your overdraft. Just make sure you treat this as a last resort, not a first port of call.

Young Money is here for you at this difficult time so check out Iona Answers, a new section designed to clear up your Corona confusion, as well as all our other content to stay bang up-to-date. Don’t get mad, get informed!

This Post Has 2 Comments

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    It feels like we are living in a history lesson- let’s just hope that our current government makes the right decisions to help this “wave” from crashing onto the beach wiping everybody out. The furlough scheme seems like a really good approach, but as with all support- it will really depend what happens at the end when it’s removed…. And yet, I have hope- the government could help with so many other things- rather than just going back to “normal”. Let’s stop supporting oil/gas, invest in green energies/companies. Legalise electric scooters- could end up reducing spending on roads, public transport etc. I guess, when this is all over, history will start to be written… I hope it’s good news!

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