The writer, a former head of forecasting at the OECD, is a partner in Llewellyn Consulting
Forecasters least understand what is going on, and so make their biggest errors, when an economy is hit by a shock that is both novel and large. The coronavirus pandemic is both.
Most recessions are caused by stresses that come from within the economic and financial system; this new threat originated from outside. And certainly the shock is large. The UK has been hit particularly hard. In the second quarter, gross domestic product fell by more than 20 per cent, twice as much as in the US and Germany, and significantly more than in France and Italy.
Private consumption, the largest component of GDP, contributed most to the overall fall in demand, as it generally does. But there were also big declines elsewhere, particularly in gross capital formation. On the output side, all major sectors — services, production, and (particularly) construction — contracted strongly.
One reason why the UK has suffered more than other European countries is that it went into lockdown late, and emerged correspondingly later. When lockdown finally came, it was stringent, not least with the closure of schools, which kept many parents at home.
What now? Clearly, humility is in order. Economies are being driven in large part by a virus that is not yet well understood. Nor is it clear when, or even if, there will be an effective vaccine. In the near term, it looks as though a pick-up has begun across Europe. The UK, with its hesitant consumers, may be rebounding less confidently than some.
All is not lost. UK GDP grew by fully 8.7 per cent in June — faster than many economists expected. That said, the first step is often the easiest. In major economies, it generally takes three to six years for GDP to regain its pre-recession level. Thereafter, growth sometimes returns to normal speed (although absolute GDP levels are set back). On other occasions, the early years of recovery have been slower than pre-recession.
There is an important reason for this. The spending component that is hit hardest in recessions is investment. It is an easy item to cut: which chief executive would go to their board amid a deep recession to argue that now is the time to expand capacity? Thus, in the second quarter UK business investment fell by more than 30 per cent.
Unfortunately, this really matters. Not only is vital investment forgone but also — and particularly in this recession — changing patterns of demand render parts of the existing capital stock prematurely obsolete, even though they remain physically sound. Think of all those long-haul aircraft, years from the end of their physical lives, yet unlikely ever to fly again. Or the cruise ships, convention centres and high-rise office buildings standing empty.
Added to this are the consequences of switching from fossil fuels to renewable forms of energy. This leads to any number of knock-on structural changes — the car industry, for example, is in turmoil. Adjusting requires investment on a huge scale.
With the private sector having temporarily lost its investing mojo, there is a clear case for public investment to fill the hole, not least in infrastructure. Such investment is not a direct substitute for private sector capital formation. But it is a most useful complement that does much to enhance an economy’s productivity in the long term. Hopefully, as the UK government eases back on income support it will switch progressively towards investment support.
There are clear risks. After the 2008 financial crisis, governments, alarmed by ballooning public debt, tightened fiscal policy too soon, increasing taxes and cutting government expenditure before their economies were back on a self-sustaining, investment-driven growth path. The UK shows no sign yet of making this error: but another chancellor might make the same old mistake.
A possibly bigger risk is that the sheer complexity of this crisis will become overwhelming. Governments need the full support of a competent and committed civil service to deal with just one significant challenge — fighting the pandemic. Here, they are having only mixed success.
For the US, its socio-economic model normally handles change quickly and effectively — if at times brutally. But it has not proved well oriented to action in the collective good.
The EU, however, has surprised. Just when it seemed that the pandemic might be a shock too far, EU governments agreed a well tailored €750bn policy package with emphasis on economic resilience, hefty transfers to poorer regions and substantial green investment.
The standout case is the UK, which faces not just one fundamental challenge, but two. An instinctively-centralising government is not best placed here, as we have seen from the failure of the test, track and trace programme.
Yes, the Treasury and the Bank of England have done a good job. But the big unanswered question is whether the British government, with the effective capacity of its civil service significantly reduced over the past decade, will be able to handle the complexities of the pandemic at the same time as Brexit fundamentally changes UK relations with its largest trading partner.
On the evidence so far, that is not obvious.
Source: Economy - ft.com
