23 April 2020
The Alphabet of Recessions?
T, V, L, U, W – or a swoosh
By Frank O’Nomics
There is no doubt that the UK is in the midst of a recession. The Office for Budget Responsibility has warned that the pandemic could lead our economy to shrink by 35% by June, and 12.8% this year. The IMF is a little more optimistic (a lot depends on the length of the lockdown) seeing a 6.5% contraction in 2020, with a backdrop of a 3% drop in the global economy. Put into a historical context this is very bad, marking the severest slump in the UK for a century. However, while there is a wide agreement that the recession is severe in the short-term, the bigger question is: How long will it last? There are many differing views as to the path that GDP growth will describe and it is important to understand the risks of each to generate the right policy response.
Let’s start with the optimistic scenario. A T or V-shaped recession. This is the kind of environment that President Trump loves to predict. The short term hit may be savage but the economy will bounce back and be just as strong as it was in very short order. Whether we see a T or a V may depend on how long a time scale you are looking at – viewed over a number of years the recession could look like a mere statistical anomaly. For government officials, who believe in the measures taken to ensure that good businesses do not fail (massive loan provision) and that unemployment is contained (extending the furlough scheme), this approach may seem justified. In addition asset purchases by governments are tremendously supportive, with the G7 buying a total of $1.4trn in March, and potentially $6.8trn by the end of the process.
There is also some reasonable historical evidence to support the prospect of a relatively prompt return to normality. Over the last 200 years, according to Goldman Sachs research, the average length of an “event” driven recession, (rather than one prompted by structural or cyclical factors), is around 3 quarters, and the average time to recover from the event is just over one year. With that as a guide, a T or V is a justifiable prediction. The OBR itself expects the UK to be back to its pre-crisis growth trend by the end of the year. However, this may be the kind of Pollyanna thinking that made the situation so bad in the first place – all events are unique and we risk denying the true realities of this pandemic. Further, while this is an event driven recession, it does occur at a time when the business cycle was running out of steam, with the UK in particular facing structural issues which have constrained productivity for many years.
There is then a danger of a recession of an entirely different shape. The worst is that it is L-shaped, with the economy refusing to bounce despite the resources thrown at it. Given that we operate in a global market place, there are concerns that, with other nations (outside of the G7) unable to generate similar stimuli, international trade remains depressed for much longer, thereby constraining the UK. China, for example, has come through many of the domestic effects of the virus quite quickly, but is now finding little overseas demand for its production. It would be too gloomy to suggest that the “L” lasts forever, but at the very least we could be looking at an elongated U-shape, and there are many who agree with that prognosis. Bear in mind that it is in the interests of bankers and government officials to be optimistic – the corporate world has a distinctly different view. A survey of 3,534 CEOs last week showed that 60% of them were preparing for a U-shape. 11% saw coronavirus as a threat to their survival and 40% as a severe threat.
Perhaps the greatest risk is one of a false dawn – a W-shaped recession. There is some inevitability that this will be what we face. It is entirely reasonable that, once restrictions are lifted, there is a sharp bounce in the economy as the spending and production shortfalls are addressed to satisfy pent-up demand. What then? Without further support from the government, and they must already be baulking at a furlough scheme that is expected to cost £50bn under the measures so far announced, and a more favourable international backdrop, the weight of much greater debt accrued during the crisis becomes too much for many corporates and individuals to service. The result could be a renewed plethora of corporate failures and personal bankruptcies, resulting in a wave of asset disposals and a fresh dip in economic activity.
Perhaps the best that we can hope for is a kind of Nike-swoosh recession. One where, after a steep decline, UK GDP returns very gradually to its long-term trend level. To do this the authorities will need to retain some firepower so that, whenever there is a sign of a renewed decline, they can step in to provide an appropriate level of support. Given the extent of the current programme it is going to be hard to find that extra help. Further, it will be hard to discern which areas of the economy merit those scarce resources and which are just basket cases. For so long we have preserved a plethora of “zombie” businesses via artificially low interest rates, and this has been a significant drag on UK productivity. It may soon be time to set them adrift, but we must remain aware of the consequences, and whether it fits with a consistent reflationary policy – to the letter.
