The Great Depression is the closest comparison to the deep economic pain caused by the pandemic. The mounting economic costs are prompting many countries to start easing lockdown restrictions. However, ending lockdowns too early in economies such as the US could lead to more relapses and further shutdowns later. We do not expect a COVID-19 treatment or vaccine to be available until 2021 at the earliest, even in an optimistic scenario. In any economy, even one or two months of countrywide shutdowns are likely to mean a deep recession for the full year – even if followed by a sharp rebound in activity. If a second wave of infections necessitates the re-introduction of shutdown measures later in the year, this could have non-linear effects. The cumulative impact of many months of restrictions could magnify the negative outcomes for economies. A useful comparison is a muscle that loses blood flow – the longer the blood does not flow, the more dangerous the consequences.
Comparing the current economic shock with the start of the Great Depression of 1929-31, a key difference is that policy makers have learned the lesson that governments and central banks need to act as lender and buyer of last resort in such circumstances. We expect the global economy to avoid a prolonged depression as governments and central banks keep enough parts of the economy afloat to enable a relatively smooth eventual recovery. The COVID-19 crisis also shares a key similarity with the 1930s: the rise of nationalism and protectionist tendencies. If it continues, this would have a lasting negative impact on global growth. De-globalisation was already a trend before this shock. With the extreme economic pain of mass layoffs and bankruptcies, the push to address domestic challenges by turning more inwards may lead to a worrying parallel with the 1930s, when protectionism exacerbated the Great Depression.
In some emerging markets, the quantitative easing measures currently being implemented could raise the risk of sovereign debt crises over the long term, even if they are politically more palatable today than raising taxes or increasing debt issuance. This is especially true in economies that depend on foreign capital flows to fund their current account and fiscal deficits.
Several other lingering effects of COVID-19 are likely to weigh on the growth trajectory this year and beyond.
This unprecedented experience is likely to have a negative psychological effect on households’ propensity to spend. Having been confronted with the fragility of their lives and livelihoods, many people are likely to want to increase precautionary savings and spend less during the recovery. Businesses will likely need to adjust their operations to account for reduced demand and may hold off on major investment plans. This is particularly true in the oil and gas industry, which has suffered price collapses.
The crisis has also exposed the vulnerability of supply chains to concentration risk, and this will have consequences for years to come. Some governments are now prioritising the health-care industry as a matter of national security; many countries are likely to try to bring these supply chains back home, or closer to home. Protectionist tendencies may also be rising due to domestic pressure to help the laid-off find work. The US and key economies in Europe are already showing signs of going down this path.
Many supply chains have been shown to be vulnerable to concentration risk. When one production location in the chain shuts down, companies have no (or few) other sources to divert their orders to. As companies focus on making their supply chains shorter and less complex, we may see a shift from ‘just in time’ inventory management to ‘just in case’. This means less efficiency and more capital-intensity in production. Another source of uncertainty is the financial soundness of suppliers along the chain whose cash flows have dried up. These risks are hard to quantify on a global scale. This quote from a Financial Times article earlier this year sums up the challenges to growth from disrupted supply chains: “It takes 2,500 parts to build a car, but only one not to”.
Finally, the massive fiscal and monetary support put in place around the world to counter this shock will need to be reversed in the coming years. This may also weigh on the recovery – hopefully not in the form of a large ‘fiscal cliff’, as was the concern in the aftermath of the global financial crisis of 2008-09.
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