Elevator Down, Stairs Up, and Lots of Open Questions
Every crisis teaches important, if often painful, lessons.
As the corona crisis follows no known script, forecasts are riddled with more than the usual uncertainty. I’m Holger Sandte and here are my thoughts as a macroeconomist – on what is going on and what might be ahead.
The Great Recession and Depression as benchmarks
Many economists today are marked by the experience of the financial crisis and recession in 2008/09, a period often called the Great Recession. The term indicates that it was more severe than normal recessions, but also that is was less devastating than the Great Depression in the early 1930s. During the Great Recession, economic output in many highly developed countries shrank by around 4 – 7%. The recovery that followed was often painfully slow, especially in countries where ongoing problems in the banking sector held back investment activity and job creation.
A steep recession and possibly a protracted recovery
In all probability, the Corona Recession will be deeper for the world economy. For some countries, it could be much deeper, depending for instance on the strength of the health care system and the length of the shutdown. What makes the current slump so special is that it is a global health crisis leading to a simultaneous shock to the supply and the demand side of economies, again on a global scale.
Supply chains are being disrupted due to factory closures, while the measures put in place by governments to contain the spread of the pandemic decrease demand. On top of this, uncertainty about the future restrains spending of private households and companies. When visibility is low, companies put investment plans on ice and private households typically don’t buy big-ticket items.
There will be sunshine after the rain, but when? Very often, jobs are shed faster in a recession than they reappear during the recovery. The virus containment measures will probably be lifted only very gradually and there might be setbacks and further waves of infections. This suggests that the recovery could be a pretty stony uphill struggle.
Governments and central banks to the rescue
When in trouble, companies need reserves to fill revenue holes and the ability to adapt fast. Cutting costs is often easier than generating new revenue streams. However, in the wake of an economic shock of this size, with demand in some sectors falling like a stone, the economy as a whole needs strong helping hands.
Governments and central banks have to step in massively to attenuate the slump. They have learned this key lesson from the past and have reacted with temporary measures of unprecedented scale, e.g. additional spending, loans and loan guarantees, support for reduced-hour schemes, liquidity support through postponements of tax payments and – regarding central banks – interest rate cuts and asset purchases. It is safe to assume more measures to come if needed. To a large degree these measures are being funded by government debt, and fortunately interest rates are very low. In the long run, coping with the debt will not be easy for countries where the new debt comes on top of a mountain of old debt.
The economic post-crisis world
The post-crisis world is hard to predict. The current events can potentially have a lasting impact on economic structure for years to come. Here are just four relevant aspects:
- This crisis is a stress test for international relations. Wouldn’t it be great if one result was increased international cooperation to prevent future pandemics from happening? Countries could learn from each other what works and what doesn’t in terms of health policy and economic policy. (Read my colleague Martin’s blog post to get an idea of the different approaches taken in Denmark and Sweden).
- In a less positive scenario, nationalism and a sauve-qui-peut / “save yourself if you can” mentality dominates over solidarity between countries. The integrity of the EU or the euro area could be at stake. During the height of the financial crisis, a break-up of the euro area was not a very far-fetched scenario. The corona crisis is a new test for how much ‘union’ there really is in European Union.
- Digitalization and inequality: At a time of physical distancing, digitalization gets a big boost as online solutions for working, shopping, teaching, learning, and socializing are in high demand. This is an opportunity and a risk at the same time, as the digital divide risks getting wider, between those who have the necessary skills and means and those who don’t.
- Globalization: the ever-closer global interconnectedness of countries faced serious headwinds even before the corona crisis. As a response to disrupted global supply chains, we could easily see a period where the optimal supply chains could be shorter than they used to be, less global and more regional, which may be more costly in quiet times, but safer under stress.
- Market power: In many sectors, the market power of large corporations has recently increased at the expense of smaller companies. Think about Amazon, Facebook, and Google, to mention just a few. Although many governments are trying to help small and medium-sized companies through the crisis, ’big business’ might have better chances to weather the storm and lobby for support. Higher market concentration means less competition – bad news for consumers and smaller companies.
In the corona crisis, economists – like everyone else – are in unchartered territory. Not much is predictable with a reasonable degree of precision. One exception may be that studying topics like health policy, economic policy, and globalization will become even more fascinating and relevant.
Holger Sandte is a DIS Copenhagen Semester Faculty Member. He teaches courses in Globalization and European Economies, Health Economics, and Health Policy in Europe, as well as Applied Econometrics. In one of his earlier positions, he has seen the financial crisis from within working as a bank economist.