Policy Impact

Although it may seem like a novel phenomenon, current social distancing and other interruptions to our daily lives are nothing new. Similar patterns were exhibited during the 2003 SARS epidemic and the Spanish flu in 1918. We have experienced other pandemics, such as cholera or HIV. But what makes the corona crisis different from the mentioned cases is the scale of the current economic crisis. Even though countries are now moving towards easing lockdown restrictions, the coronavirus pandemic has already hit the global economy hard. Gross domestic product figures from the first quarter of 2020 show economic declines not seen since World War II. Economies everywhere have been hardly hit, and unemployment is rising. The world is braced for a recession even after governments and central banks have pumped money into their economies and slashed interest rates.

 

The Shape of the Economic Recovery

Recessions do not last forever, and neither will a coronavirus recession. At this point, the question is not whether the economy will return to previous levels, but when will this happen and how long will it take. The answers to both of these questions will usually involve the use of one of four letters: V, U, W and L. These labels come from the shape of the charts typically seen during periods of recession that track economic activity such as employment, gross domestic product (GDP) and industrial output.

The best-case scenario for the COVID-19 crisis is a V-shaped recession, such as the one caused by SARS in all its affected economies.  Under a V-shaped recovery, the economy will rebound as quickly as it has declined, with minimal long-lasting financial damage. This scenario is possible but aggressive, well-targeted government action is required. Enough coronavirus testing would be needed to allow people to go back to work without creating another surge in cases. Additionally, rapid government intervention would be essential to protect jobs, businesses and consumers.

Many have argued that a V-shaped recovery is not realistic because it does not account for potential lockdown extensions and shifts in consumer behaviour. Under this argument, a U-shaped recession such as that seen during the Great Recession (2007-2009) is much more likely. A U-shaped recovery entails a similar return to normality but after a more prolonged downturn. Given the current situation, this could mean that the economy would not begin recovering until 2021. There are a few reasons this could happen. First, if it takes longer to have coronavirus cases under control, states and regions will take longer to reopen their economies. Second, many businesses may find themselves incapable of surviving and may file for bankruptcy. Consequently, fewer jobs would be available when the lockdown measures end, thus, rising unemployment and potentially reducing consumer spending.

Source: The Conversation

 

In a W-shaped recession, also known as a double-dip recession, the economy would begin to recover rapidly but fall into a second period of decline. The W shape describes a second hit to the economy, most likely caused by a second wave of infections and by misguided economic policies. Most worrisome here would be a premature withdrawal of government spending support.

The worst-case economic scenario is an L-shaped recession. In this outcome, growth would decline and not recover for years, creating the long shape of the L. The official recession could end within a few quarters, but the recovery to a pre-recession level of economic output would take years. There is a potential for an L-shaped recession if we cannot control coronavirus outbreaks, which would lead to years-long shutdowns and weak growth, if not outright stagnation.

Source: The Conversation

 

Hope for the Best, Prepare for the Worst.

There is widespread agreement among experts that countries must get the COVID-19 health crisis under control before they can prepare for any type of economic recovery. This, however, comes at a cost: the longer it takes, the less likely will the recovery be shaped like a drawn-out V. Nonetheless, authorities should be reluctant to completely loosen controls, given how much it is still unknown about the virus. As for the race to develop a vaccine, a yet-to-be-developed COVID-19 vaccine may solve part of the problem but may not necessarily erase the need for some restrictions. Lockdowns might end, but other measures such as social distancing, limits on gatherings and travel restrictions might continue – perhaps on a seasonal basis.

The current challenge for governments is to manage both expectations and spending to drive recovery. Without expectations that we will find a solution to COVID-19 – with a vaccine or effective control – a full recovery will be highly unlikely. Targeting of recovery funding is, therefore, essential. Governments must heavily invest in more testing to prevent future outbreaks. Furthermore, economic policies should target business survival and the maintenance of labour markets, even if it means sustaining them on life support. A good government response could mean the difference between a V- or U-shaped recovery, or a gloomier W- or even L-shaped journey. The latter will put a far more significant burden on future generations than any debt governments might take on how to develop a vaccine or keep people on payrolls.