Blogposts » The global economy in the grip of the corona crisis – how bad can it get?

The global economy in the grip of the corona crisis - how bad can it get?

closed shop corona
Foto von Anna Shvets von Pexels

At the beginning of the spread of the COVID-19, in January, there was still hope that economic damage to the world economy would remain manageable. Now it is becoming clear that the economic slump could be even greater than that which occurred after the Lehman bankruptcy in 2008/09.

Understanding the current economic crisis

The current economic crisis is a combination of a demand crisis, a supply crisis, and a financial market crisis:

  1. The Demand Crisis: For fear of contagion, people are avoiding shops in city centers. They refrain from visiting restaurants and cinemas and cancel holidays, etc. Such demand crises are particularly severe when state authorities prohibit such activities for reasons of disease prevention.
  2. The Supply Crisis: An infectious disease leads to the loss of labor and thus reduces production capacities. Even healthy workers do not go to work for fear of infection. If the products manufactured are used as inputs, production is restricted at other companies if there are no substitutes for the missing inputs. The impact of this is particularly severe when global supply chains are broken.
  3. The Financial Market Crisis: Both developments, a demand, and a supply crisis mean a drop in sales for companies, while costs remain more or less unchanged – at least in the short term. The consequence is a loss of profits, which manifests itself in the form of price slumps on stock markets with a considerable decline in assets. The fear of possible losses accelerates the sale of shares and thus triggers a fall in prices.

All three elements of the crisis reinforce each other: if people earn less money because of production restrictions, they fail as demanders and exacerbate the demand crisis. Even in companies that could continue production, production and employment are cut back due to lack of demand.

The international interdependence of national economies means that the production slump in one country spreads very quickly around the world.

How big will the economic slump be?

The expected effects of the coronavirus on economic growth cannot be seriously quantified because there are still far too many uncertainties.

At the beginning of March this year, Warwick McKibbin and Roshen Fernando published simulations of various scenarios for global COVID-19 spread . They work with three pandemic scenarios (low – middle – high):

  • In the most favorable scenario, the real gross domestic product (GDP) in large economies such as Germany, France, Italy, and the USA will be around 2 percent lower in 2020 than in a scenario without the coronavirus pandemic.
  • In the middle scenario, the corresponding GDP losses in these countries are around 5 percent.
  • In the worst-case scenario discussed in the paper, Warwick McKibbin and Roshen Fernando, estimate slumps of between 8 and 9 percent – i.e., more than occurred after the Lehman bankruptcy (2.5-5.5 percent).

The associated GDP losses are enormous: “Even a low-end pandemic modeled on the Hong Kong flu is expected to reduce global GDP by around $US2.4 trillion. A more serious outbreak similar to the Spanish flu would reduce global GDP by over $US9trillion in 2020“. (page 23)

The crucial factor will be how quickly the current economic standstill can be reversed. A rough calculation to illustrate this:

  • Assuming that the total economic value added per year can be distributed evenly over 50 weeks, then one week with a complete halt of the economy will cost 2 percent of the annual value-added, i.e., of the GDP of the affected economy.
  • If only half of the economic activity is halted, each week costs 1 percent of GDP. A two-month decline in economic activity would, therefore, reduce the GDP of the affected country by 8 percent.

What needs to be done?

The extent to which growth – and the incomes associated with the production of goods and services – will be reduced depends on how economic policymakers respond to this economic shock.

At present, the severity of the economic crisis is leading to the application or at least consideration of exceptionally far-reaching measures. Here is just a small selection:

  • Liquidity assurance: Companies that suffer losses in turnover need financial resources (i.e., loans) immediately in order to meet their current payment obligations. This is where monetary policy comes in to play (interest rate cuts and quantitative easing). The state can support this process by providing guarantees.
  • Securing the income of private households: People who suffer a loss of income due to the crisis can receive state transfer payments. Tax cuts can also increase the disposable income of private households. To avoid time-consuming bureaucratic checks, all adults in a given country could also receive a certain amount of money immediately. Finally, private households can also be exempted from certain payments, e.g., electricity and water bills or even rents.
  • Income security for businesses: Direct government support, tax cuts and a reduction in social security contributions are a possibility. It is also conceivable that the state – either temporarily or permanently – could become the owner of systemically important companies.
  • Stabilization of demand: If private consumption and private investment decline, the state can compensate for this loss of demand. Public investments that support the socio-ecological transformation of society and the economy are particularly useful in this context. Here, for example, investments in carbon-free production and transport technologies or investments in the public health system to be better prepared for a new pandemic, which cannot be ruled out.

 

Regardless of the mix of measures a country decides to implement: the financial resources required will be enormous. An increase in public debt is unavoidable.

The ultimate goal, however must be to prevent the spread of the coronavirus which is the first step in getting economic life back on track.

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