The full blog post can be found here.

 

Corona Virus and the associated shutdowns have shattered the world economy. According to my colleagues at Cebr, it looks as though this year we will see a fall in world GDP of 4% or more, the biggest fall in peacetime world economy growth since the 5% drop in 1931.

 

And it may get worse. In the 1930s GDP fell by around this much in three consecutive years. I’ve been greatly encouraged by the efforts made by fiscal and monetary authorities around the world to prevent the recession turning into a rout. My colleagues at Cebr have calculated that if the fall in incomes and spending power can be limited to at most 10% (and preferably more like 5%) it ought to be possible for the natural forces encouraging economies to bounce back to overcome the lack of consumer spending power. Whether we can hold the fall in incomes to as little as this will be a tough challenge and will probably require the authorities to fire more ammunition at the problem.

 

First, they need to prevent firms from shutting down completely. Because we live in a time of rapid commercial change, there are plenty of businesses that might have been expected to fail even without the lockdown. But keeping businesses in existence, even those that might eventually prove unviable, is the critical first step in ensuring that there is a base that allows the economy to recover.

 

The second step is to limit layoffs and wage cuts. There will have to be some but government support for businesses should be targeted at limiting these to the minimum possible. In addition, those who are out of work or who regrettably have to lose their jobs will require a high level of income support.

 

The third step will be to kick start spending as we come out of the lockdown. One suspects that we will emerge from lockdown with mixed feelings. On the one hand we will be cautious, knowing that any upturn is likely to be fragile and that as government support wears off our future earnings prospects might be bleak. But we will surely want to celebrate any return to freedom with meeting our friends and family, meals out, visits to pubs and clubs and short haul holidays.

 

Where spending might be more depressed is on big ticket items. House purchases are likely to be subdued for a few years. Items like cars white goods, and furniture are unlikely to be priorities. A possible temporary suspension of VAT on such items and of Stamp Duty for a limited period (followed by a gradual phasing back to normal levels) would surely make some sense.

 

Of course, achieving an economic recovery in one country could prove futile if the other economies in the world are still stuck in the doldrums. So, we do depend very much on other countries taking action too. Fortunately, political imperatives are encouraging countries around the world to do much the same thing.

 

It is unlikely that as we recover the world economy will return to where it was. Some changes could prove permanent. One suspects that working from and shopping from home will have become more entrenched than previously, which could leave quite a lot of investment in office and retail bricks and mortar redundant.

 

Globalisation may change as well. Over the past half century globalisation has often reflected arbitrage of labour costs and regulatory environments, where companies from the high cost and highly regulated environments in the West have taken advantage of the lower costs and more lax regulation in the East.

 

This was already starting to change as labour costs rose and regulatory differences became smaller. In addition increasing automation through AI, robotics and 3D printing had reduced the labour content of production and made labour cost differences less important.

 

But the lesson for production from the Corona Virus crisis is that long and inflexible supply chains snaking halfway round the world impose serious risks for companies and it seems likely that the appreciation of this fact will encourage onshoring.

 

Yet it seems unlikely that the globalisation baby will be thrown out with the Corona Virus bathwater. Instead I expect a new form of globalisation to emerge, based on the traditional theory of specialisation and comparative advantage. For the UK we will look to the Flat White Economy, the mix of the tech and creative sectors that has done so much to drive the UK forward in recent years and is arguably already the largest economic sector, financial services including fintech and advanced manufacturing to be in the lead.

 

The question I get asked most often is how all these measures can be paid for. Government debt is likely to reach wartime shares of GDP. Although in a savings glut, which is likely to be the norm for many years, borrowing can be much higher than in more usual times, governments will have to plan to bring this share down gradually.

 

There have been two periods of massive reductions in the ratio of UK government debt to GDP in the past 200 years, after the Napoleonic Wars and after World War 2. After the Napoleonic wars much of the adjustment took place through persistent though relatively gentle austerity and took nearly a century, helped by the fact that expectations for government spending at the time were low while the industrial revolution was expanding the economy. After World War 2 the reduction took place through unanticipated inflation which eroded the value of the national debt.

 

Politicians say that there isn’t a climate for austerity at present. But austerity may be forced upon them regardless if financial markets are not supportive. Meanwhile, it is likely that the disruptions to supply caused by the crisis may have inflationary consequences, particularly for food prices. Whatever happens, it will be important to avoid imposing taxes on such a scale as to drive away entrepreneurs, who will have suffered heavy blows to their incomes and wealth.

 

We will need them more than ever to recover from the crisis.