UK economy makes a handbrake turn

How hard will coronavirus hit UK GDP? This may seem like the wrong question to ask in the midst of a health emergency. The new coronavirus outbreak is a social crisis above all else. Even in narrow economic terms, some sort of hit to GDP is inevitable and even desirable: we actually want many people to stop doing what they normally do in order to protect the lives of others.

It also makes sense to pay more attention to what happens to the jobs and incomes of the most vulnerable households, and the survival rate among businesses. These factors will tell us more about how quickly the economy will recover when the pandemic eases (as it surely will).

Nonetheless, GDP is still the single best measure of overall economic activity, and it is the economy that keeps the shops stocked, our hospitals staffed, and the lights on. So here goes…

To recap, the coronavirus outbreak will hit the UK economy (and others) through three main channels. First, there is the blow to sentiment, even before there is much tangible damage. This is already being reflected in lower consumer and business confidence and collapsing stock markets. It is also reflected in panic buying (which will provide only a small and temporary boost to GDP).

The second channel is the potential impact on the supply-side of the economy, or the ability to produce, and deliver, goods and services. International supply chains have already been disrupted, but the biggest shock will come if, or when, large parts of the UK labour force are unable to work as normal.

The third channel is the impact on the demand-side of the economy, as businesses and (especially) consumers reduce their spending, either because their incomes have fallen, or because they are unwilling or unable to buy the goods and services that they would normally buy.

These three channels are, of course, interrelated, but together they are likely to be enough to tip the UK economy into recession. Indeed, we are probably already in one.

Here I would forget the usual UK definition of a recession as two successive quarters of falling GDP. The hit to GDP in Q2 (April-June) is likely to be large enough to ensure that this will feel like a recession, regardless of what happens in Q1 or Q3.

The US definition of recession is probably more appropriate in these circumstances anyway. The NBER defines a recession as a ‘significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales’. This seems inevitable.

As for GDP itself, there is so much uncertainty here that it’s not sensible to do much more than give a broad indication of the orders of magnitude. Most people have been caught out by how rapidly this crisis has escalated (my own initial assessment of the economic and market risks has not aged well).

That said, a back-of-the-envelope calculation suggests that UK GDP could easily fall by as much in percentage terms in a single quarter (6%) as the peak-to-trough decline during the entire global financial crisis (from Q1 2008 to Q2 2009). This will be like a handbrake turn, rather than a slow-motion car crash.

There are several different ways of arriving at this conclusion. As a starting point, the government’s own ‘reasonable worst case’ assumes that up to a fifth of the labour force might be sick, or otherwise not able to work normally, at any one time. Or looked at from the demand side, spending could easily fall by a fifth as discretionary spending is cut back.

At face value, this suggests that the hit to GDP could be more like 20% than 6%, and a figure as high as 15% for the fall in Q2 alone (suggested by my friends at Capital Economics) is now highly plausible. But there will also be some offsetting factors.

For example, on the supply side, some people unable to get to their normal place of employment will still be able to do at least some work from home. Many of the rest will be able to work longer than their normal hours. Some gaps could also be filled by people who have recently retired, or the armed forces.

On the demand side, provided their incomes are protected, some consumers may simply divert spending from some goods and services to others. For example, people who are less willing or able to travel abroad may spend more money in their local economy instead. Even people stuck at home may spend more on having goods delivered, or on services that they can enjoy without leaving the house.

What’s more, there has already been a substantial policy response (at least in the UK). The government, in the Budget, and the Bank of England have launched a coordinated fiscal and monetary stimulus, plus targeted support for public services and the most vulnerable individuals and businesses. Yes, much more will probably be needed, but the taps are now open.

It is also worth stressing that the hit to GDP should be relatively short-lived, provided the temporary shock is not extended by multiple bankruptcies, job losses, and so on. (Preventing this from happening is, rightly, now the focus of the policy response.) Some of the missing activity will also only be delayed, rather than lost altogether.

To be clear, it is probably too optimistic to hope for a rapid V-shaped recovery, where the output lost in one period is fully recovered in the next. The hit may also last much longer than one quarter, or even two. However, I do think it is reasonable to think in terms of a tick, or Nike ‘swoosh’, where 2020 is a write-off but the economy rebounds in 2021 and beyond. Just be prepared for some pretty ugly numbers in the meantime.

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