The economic effect of Covid-19: Please, let us not repeat the errors of history

The economy is obviously going to crash this year. But what will the long term effects be? We are in danger of making calamitous errors which will make the Great Depression seem mild.

Article updated: 16 April 2020 11:00am Author: Michael Baxter


Most governments around the world are correctly putting human lives before the economy. Actually, I go further than that. I don’t think the two are mutually exclusive. If there had been no lockdown, the death toll would have been many times higher, and in the resulting environment of fear, the economy would still be tanking.

And for those people who have lost loved ones as a result of this crisis I am so sorry. These are terrible times, let none say otherwise.

But what about what will happen next! What will happen to the economy?

IMF and predictions

The IMF is predicting the deepest contraction in global GDP since the Great Depression. It is predicting a cumulative loss of GDP of around nine trillion US dollars (greater than the combined annual GDP of Germany and Japan.) Global GDP is expected to contract by three per cent, and advanced economies are expected to contract 6.1 per cent. It also predicts a strong bounce back next year — global GDP to increase 5.8 per cent. But this is the IMF’s baseline assumption. It admits that things may be far worse.

Compared to the UK’s Office for Budget Responsibility (OBR), the IMF is being optimistic. The OBR warns that by the end of June, it expects UK GDP to have contracted by 35 per cent. It does expect a partial recovery in the second half, but even so expects GDP to have contracted by 12.8 per cent by the end of the year.

No one knows how long the recovery will take. Some argue that the crisis won’t do any lasting damage — that infrastructure will still be there, human capital will largely still be in place. The longer the crisis, the bigger the risk that corporate failures will lead to a permanent loss of corporate expertise, while individual skill sets may get rusty.

Some argue that the crisis will bring with it great gales of creative destruction — and the economy will come out the other end in better shape — this is akin to pruning a plant to make is stronger.

It is clear that the crisis will mark an acceleration towards digital — automation technologies, technologies that support home working and technologies that support online commerce will flourish. I think the shift towards digital will be permanent.

But unemployment will reach terrifyingly high levels. With unemployment so high, demand may drastically fall, without this demand, recovery may be slow.

I also happen to think that the Covid-19 crisis has much longer to run. Until a vaccine is in mass production (probably the end of next year) there will be a permanent risk of a resurgence in the virus. Either we will have a period of intermittent shut down, followed by a return to work, followed by another lockdown, and so on for at least another year, or we will see Chinese style draconian measures including mass testing (when testing kits are ready), mass surveillance and assertive police activity enforcing government policy.

Government stimulus’s may eventually kickstart the economy, and that is what brings me to my big fear.

The biggest danger

It relates to how governments fund their stimulus, but whether this is a problem depends.

If inflation continues to be extremely weak post crisis, interest rates are likely to remain extremely low and governments will either be able to borrow at near zero per cent, or central banks could fund government stimulus by printing money — helicopter money. 

But, if we see a reversal of globalisation, if we see a backlash against China, and growing anti-Chinese rhetoric and a reversal in ‘just in time manufacturing’ then the result of this will be a massive and permanent fall in global potential capacity.

No amount of government stimulus will be able to fix this problem.

Furthermore, such a contraction in potential capacity may lead to inflation — after-all, globalisation is probably the main reason why inflation and interest rates have stayed so low throughout this century so far.

Under these circumstances, governments would not be able to afford stimulus’s without massive tax hikes combined with austerity for years into the future.

The stock market reaction, by the way has been hopeless. The markets are way too optimistic, and much deeper falls are set to follow — or so I believe.

The fix and lessons from history

The only real hope, as I discuss in my forthcoming book, Living in the Age of the Jerk, is that technology advances will create such a revolution in productivity that a reversal in globalisation can be compensated for. But even in that respect I have my doubts, new technologies need global collaboration for them to truly fulfil potential.

Contrary to what some politicians say, the Covid-19 crisis is like a war. At the end of the First World War we made calamitous errors — The Treaty of Versailles tried to make Germany pay for the war. The League of Nations was insipid — the US never joined. And in 1930 the US Smoot Hawley tariff marked a virtual halt in global collaboration. And so the seeds of the Second World War were sown.

After the Second World War we saw the Marshall Plan, Bretton Woods agreement of 1944 take effect, meaning among other things, the IMF and World Bank, the UN, and the a number of global institutions such as the Wealth Health Organisation, and the European Coal and Steel Community — which eventually became the EU. Institutions and agreements like these helped created 75 years of relative peace and the greatest three quarters of century of wealth creation ever.

We risk repeating the errors that followed World War I, and that worries me even more than Covid-19, terrible though it is.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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