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Sun 9 August 2020
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Jonathan Portes, Professor of Economics and Public Policy at King’s College London, explains why we don’t need to turn a health crisis into an economic depression.

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Thomas Carlyle famously described economics as the “dismal science”. Less well-known is that he was complaining about economists’ unreasonable opposition to slavery and arguing for its reintroduction. 

Something similar appears to be happening with the COVID-19 crisis. 

Reading the papers, you might be forgiven for thinking that the partial shutdown of our economy – and that of the rest of the world – means that we’re inevitably doomed to an economic apocalypse. Some, especially among the more hysterical elements of the right-wing press and commentariat, are therefore pressing for an early end to lockdowns.  

By contrast, economists, across the political spectrum, tend to disagree – and indeed argue that restrictions should continue until there is little risk of a resurgence. 

So are we really heading into a second Great Depression? 


Between the 1929 Wall Street Crash and the nadir of the Great Depression three years later, output in the US fell by about a third and a quarter of the workforce lost their jobs (by comparison, the UK got off lightly, especially after we left the gold standard). 

The COVID-19 crisis, and the resulting restrictions, may lead to a comparable fall in output in the space of just a few weeks – the Organisation for Economic Cooperation and Development (OECD) estimates that the US and most major European economies are operating at perhaps 25 to 30% below normal levels. 

So comparisons are inevitable. But alternative analogies are available.  

If we suffer a fall in output of 30% for three months, that’s £200 billion — less than 1% of our “national wealth”. 

Less than a year ago, Spain saw a monthly fall in industrial production of comparable magnitude – about a third.  The consequences for incomes and employment? Almost none. Indeed, nobody actually noticed, and it wasn’t reported in the papers or even in the main economic data published by the official statisticians. What happened?  Simple. It was August and people went on holiday. This happens every year – there are similar big swings around Christmas in the UK, and the statisticians adjust the data so that it doesn’t even show up.  

At this point, you may wonder what I’m on about – how does a summer break help us analyse the consequences of a very different shutdown? Three points are relevant. 

The first is simple. The fall in output we’re seeing now is both inevitable and desirable. Just like a holiday, we are collectively choosing to shut down large parts of the economy. The difference is that it’s by necessity – to save lives – rather than by choice, but the consequences aren’t that different. Of course, GDP will fall and by a lot. The objective of policy is not to stop this fall, that policy itself has caused, but to ensure that, just as after a holiday, we can restart the economy without having done any permanent damage.

This leads on to the second point. Holidays don’t reduce the productive capacity of the economy. If a factory shuts down for a month, the machines are still there when it reopens. Similarly, when workers return, they still know how to do their jobs. Broadly, the same is likely to be true of the COVID-19 crisis. The virus does not destroy factories, roads, buildings or software and, while its human toll is dreadful, the impact on the size or composition of the working age population will be insignificant in macroeconomic terms. 

Looking at the numbers, the UK’s physical and human capital is estimated to be worth about £25 trillion; putting that capital to work enables us to produce about £2 trillion of goods and services a year. If we suffer a fall in output of 30% for three months, that’s £200 billion – not a small number, but still less than 1% of our – rather conservatively calculated – “national wealth”.  If we can just get back to doing the things we normally do, with the same people and the same factories and companies, the virus shouldn’t make us noticeably poorer. 


The second point is more subtle and more complex. Economies aren’t just about factories and workers – or even servers and cloud-based databases. They are a complex web of social, legal and economic interactions: firms, contracts, networks, relationships.

The reason that holidays have no lasting economic effect is that, by and large, these interactions are preserved. And that, in turn, reflects that fact that we, collectively, have evolved mechanisms that allows that. Employment contracts and paid holiday means that firms don’t fire workers on 1 August, even though they may not be doing any work for a month. Companies and households still repay bank loans or make mortgage payments. Moreover, these mechanisms are relatively recent; shutting down for a month in the 19th Century would almost certainly have led to very widespread disruption and hardship.

And this illustrates both the dangers of the COVID-19 crisis and the necessary policy responses. There are two big worries. 

The first is that businesses will go bust. Unlike annual holidays, businesses haven’t planned and managed their finances to cope with a sudden shutdown and the resulting consequences for their cashflow. Now, if markets worked perfectly, a business shutting down wouldn’t be a problem – the resources, human and physical, that it employs would simply be reemployed somewhere else, as an existing business expanded or a new one was formed. But, in practice, each business represents a web of relationships, both internal (between its employees) and external (with its customers). Recreating those takes time and effort, and entails costs. 

In the normal course of events, those costs are outweighed by the benefits of allowing unprofitable businesses to cease operations and to be replaced by more efficient ones – the process of creative destruction. But a mass cull of generally profitable businesses, simply because they happened to be in a sector that was shut down for health reasons, would do long-lasting damage.

The second issue is potentially even more worrying. If people lose their jobs, they are unlikely to get them back immediately after the restrictions end – their former employers may not need them, or may not even exist. Some may never find new jobs at all, or not for a long time; others may have to take a worse job in terms of pay or one that does not match their skills.

If either or both of these effects are large, then the economic damage will be long-lasting, maybe permanent. That is what we should really care about. A 3% permanent fall in output would cost us all far, far more – perhaps five or 10 times as much – as the largest plausible estimate of the short-term hit.  

But neither need happen. If governments do the right things, they should be able to minimise the permanent damage. 

The objective is not to stop the fall in output in the short-term – that would both be impossible and undesirable – but to ensure that it can quickly recover when the restrictions are lifted. We need to put the economy – specifically the affected firms and workers – into a state of suspended animation; the economic equivalent of a voluntary coma.

The good news is that, in Europe at least, most governments have grasped this. The Treasury’s schemes to guarantee loans to business (and some direct grants) and to subsidise companies that keep on workers they don’t need are precisely what’s needed. Delivering these programmes – actually getting the money to businesses and individuals before the damage is done – will be the difficult bit. 


Will this work? I think there are grounds for optimism. 

True, some firms will go under. But – while this will of course be devastating for some owners and workers – the fact is that most are likely to be relatively small firms in sectors, such as retail, hospitality and tourism, where turnover is relatively high in normal times. That doesn’t make it a good thing, but it does mean that the damage will fade out relatively quickly. 

As for unemployment, we’ve learned from the past decade that the UK labour market is remarkably good at creating new jobs even in hard times. The policy errors of the post-2010 period – unnecessary and premature austerity and underinvestment – may well have contributed to our abysmal levels of productivity and real wage growth, but jobs did come back.


So what are the risks? 

The first, and most obvious, is that the lockdown lasts longer than we hope or think.  As we’ve seen, the right structures enable businesses to survive a month without revenues relatively easily. 

With the right government policies, and enough money, it seems plausible that they can survive for two or three months, which seems at the moment to be the likely length of the initial phase.  But what if it goes on longer? A six-month shutdown wouldn’t lead to twice as large a fall in output as a three-month one – indeed, the depth of the trough would probably be about the same. But the permanent damage would almost certainly be far more than twice as great.  

Equally, however, removing the restrictions too soon – if it led to a resurgence of the virus and to a re-imposition of the lockdown – would be deeply damaging, not just in health terms, but in economic ones. The damage to confidence, both consumer and business, would be huge. So the Government has to strike a balance – lifting the restrictions when, but only when, it can be reasonably certain it won’t need to reintroduce them. That almost certainly means being prepared to counteract future local outbreaks with systematic tracing and testing of people likely to have come into contact with those infected. 

So one big risk is man-made. The hysterical calls from parts of the right-wing press and commentariat for an early end to lockdowns get it precisely the wrong way round. Contrary to the logic that suggests that we need, for economic reasons, to accept the health implications of such a move, they cannot be separated or traded off in this fashion. The economic damage of a premature end – and a damaging reversal – would be significantly greater than that of prolonging the restrictions for a few more weeks. 

And there is one further risk. The impact of the policies needed to get us through this crisis with the minimum damage will be a huge increase in debt and deficits. In the short-term, financing this is highly unlikely to be a problem. We know from the experience of the global financial crisis that the response of markets to such a rise is – far from punishing supposedly profligate governments – is to beg them to take their money. Interest rates on long-term government debt are at historic lows; with business investment at a standstill, and with consumers either unable (because of the closure of so many services) or unwilling (because of fear of unemployment) to spend, there is plenty of private saving looking for a safe home. 


But what about after the lockdown? Will – as in the aftermath of the financial crisis – the Government seek to reduce the deficit by cutting spending? 

Almost certainly this would be a mistake. If the Government gets the wider economy right, the deficit will mostly take care of itself – tax revenues will bounce back and the benefit bill will fall. And if this doesn’t happen – if demand and confidence remain weak – cutting spending would be the worst possible medicine.  

Chancellor Rishi Sunak learned from George Osborne’s errors when he introduced an even bigger package of support than Gordon Brown and Alistair Darling. Let us hope he does the same when it comes to the recovery.

That doesn’t mean that taxes won’t need to go up. But this isn’t – at least not directly – the result of the COVID-19 crisis or its economic impacts. Rather, the crisis has revealed what many of us had been saying for years – and which this Government had grudgingly begun to recognise: that austerity was a false economy and, for the sake of small and short-term improvement in the public finances, we’d undermined the public services – in particular, the NHS and the benefit system, needed to make the country resilient in the face of a crisis like this one. Funding those services, not just during the crisis but for the next one, will indeed, require higher taxes, albeit not immediately.  

So there’s plenty to worry about. But our fate is in our own hands. The virus is taking a terrible toll in human suffering; but we don’t need to turn a health crisis into an economic depression.  


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