Saturday, February 29, 2020
A nasty shock - but only if we panic about the pandemic
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

Once it would have been easy. People like me would have looked at the deadly effect of the coronavirus Covid-19 outbreak on the stock market, concluded that it must be telling us something important and worrying, and wheeled out our recession predictions.

Times have changed. The FTSE 100 and other markets have taken a very nasty tumble and, as I write this, London’s main index has not only wiped out all its post-election gains but is quite a bit lower than it was a year ago.

But the mechanism through which falling stock markets were traditionally supposed to feed through to the economy, notably wealth effects on households as they saw their financial wealth battered, is very weak. Business investment is adversely affected by a very weak stock market, but in the case of the UK it was very weak anyway.

The old joke about stock markets having predicted five of the last two recessions also applies. The stock market matters a lot to Donald Trump, who regards what happens on Wall Street as a key measure of US economic success, but it does not matter so much to the economy.

There was a big fall in global stock markets at the end of 2018 and, while it was followed in 2019 by the weakest year for the world economy since the global financial crisis, which is interesting, it was not followed by recession.

Stock markets are telling us something, which is that many people, and many businesses, are worried about the impact of this coronavirus. Goldman Sachs says that earnings growth for US companies will be knocked down to zero by it. But markets are not telling us everything.

What else is driving the economic impact of Covid-19? Last year was a poor one for world trade, which fell by 0.4% according to the CPB think tank in the Netherlands, the recognised source for monitoring trade.

The OECD, which released its latest trade update for G20 countries last week, noted that merchandise trade “continued its downward path” in the final quarter of last year and added: “Evidence of significant disruption to Asian (in particular) supply chains related to the Covid-19 outbreak suggests that this downward trend is likely to continue into the first quarter of 2020.” Hopes that the small thaw in trade relations between America and China would lift trade have been dashed by the virus.

There is also the impact of cancelled events, including Six Nations’ rugby games and business conferences and exhibitions. Having been in Barcelona when the Mobile World Congress was taking place in past years, I know how big it is. It was cancelled last month after a number of big firms pulled out. Other events will follow.

The question here on the economic impact is whether events like these are cancelled for this year or merely postponed. In the case of the latter, there will only be a temporary loss of economic activity. If events are cancelled outright, the loss is permanent, even if some of the costs are covered by insurance.

The biggest economic impact of the outbreak, interestingly, is likely to be from changes in behaviour from people who do not fall ill. David Owen, an economist with Jefferies International, in a review of the potential economic impact of Covid-19, quotes a World Economic Forum paper from last year. It concluded that: “Most economic losses caused by infectious disease outbreaks result from the actions of unaffected individuals.”

Owen also cites a 2009 paper by the economist Simon Wren-Lewis and others, “The possible macroeconomic impact on the UK of an influenza pandemic.” It found a big initial impact on the economy in the quarter in which the pandemic occurs, more than 3% of GDP, but that this levelled out to a smaller annual impact of less than 0.6% of GDP.

It also found that school closures, if prolonged, have a big impact and, as Wren-Lewis put it on Twitter this week, “the biggest economic costs is when people stay away from pubs, restaurants, sports events, supermarkets, etc.”

School closures have a direct and indirect cost. The indirect cost, particularly with two parents working in many families, is that one may have to stay at home to look after children. And, while modern communications have made working from home much easier, it is not possible in many jobs.

We come back to a terminology that was fashionable during the crisis a decade ago, that of attaching letters of the alphabet to the expected shape of the hit. If you are an optimist, then the expectation will be of a “V” shaped effect. China, the global economy and world trade take a significant hit in the current quarter but then bounce back strongly when the health danger is seen to have passed. If it takes that view, given that there is a limited amount a cut in interest rates can do, the Bank of England will be happy to sit on its hands.

Those who take a more pessimistic view, in contrast, would see a prolonged negative impact, more of a “U” shaped cycle, which could be enough to tip some economies into recession. Italy looks to be heading that way under any scenario. Those are the circumstances in which the Bank might be inclined to cut rates.

Which will it be? We are at a stage in which the virus is still spreading and claiming new victims in new territories. It is unlikely that this process will neatly come to an end by the end of this month, and thus by the end of the current quarter, so the depressing effect of this coronavirus will be a first half, rather than just a first-quarter effect.

Without being overly complacent, a big effect on the global economy, comparable with the 2009 H1N1 influenza pandemic, would be to reduce global GDP by around 0.5%. Not huge, but big enough to make this the new weakest year for the world economy since the crisis.

For Britain, Covid-19 has come at a time when, despite tentative signs of sunlit uplands in business and consumer surveys, forecasters are downbeat, the average independent forecast for growth this year being just 1.1%, again a post-crisis low.

Capital Economics has just downgraded its 2020 growth forecast to 0.8%, in line with the Bank. When there is much already weighing down on the economy, you do not need anything else. There is no need to panic. There is some reason to be worried.