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Looking on the bright side: another decade of austerity. At best

March 20th, 2020

The economic damage from Covid-19 will likely be worse than the 2008 Financial Crisis

This is Year Zero. We are at the cusp of the Before and the After. Covid-19, and the policy responses to it, are changing the world in a way that will affect it for decades and to put it bluntly, it doesn’t look good.

Economies are delicate things. Analysts and commentators get excited about changes in growth figures or unemployment rates of 0.1% – one part in a thousand – or they did. And that’s because in normal times the great majority of the economy one year looks very like it did the previous year and expectations and plans are built on that very assumption; an assumption that no longer holds. Indeed, no assumptions from 2019 hold.

Instead, the world economy has come to the kind of grinding halt not seen since the Great Depression. Unlike that occasion, this one’s been enforced by governments rather than an organic snarling up of finance, business and trade but let’s not get too caught up in how it’s come about. Let’s look instead of how the world looks like on the other side if things go well. We can come back to the pessimistic scenario tomorrow.

Of course, we don’t know exactly how long it will take for something like normalcy to return, nor what policy route will take us there but we can make some assumptions.

If huge sections of the global economy are shut down for several months, there’s likely to be an initial hit, based on those closures alone, to GDP in those countries most affected (which are all the biggest economies in the world). That kind of hit would, as is obvious from the screams of shock and anguish from all kinds of industries and sectors at the moment, destroy many previously viable businesses and many jobs from other businesses that shed staff in a desperate attempt to survive. Massive government support will be needed to prevent that.

And if we assume that massive government spending – probably ‘funded’ by what amounts to printing because there’s no other source for the scale of funds needed in a stalled and panicked economy – is undertaken in order to tide over these businesses, then more money chasing fewer things (production, by definition, must be down if people are not working), would naturally lead to inflation.

However, people, businesses and governments spending money out of desperation must also lead to a huge increase in debt at all levels. This on top of already high pre-crisis debt levels. That should naturally send interest rates upwards, as should inflation – providing it’s not held artificially low for political reasons.

Elsewhere, pension-funds will have taken an almighty hit from the shellacking the stock markets have taken over the last month (the FTSE is down around 30% on a month ago, for example). Unless they recover rapidly, defined benefit schemes will be carrying lasting deficits – another cost for firms to find – while individual DC funds will be paying out far less. Similarly, triple-lock or not, the state pensions paid may have to be cut in real terms if the tax base simply isn’t there to support it.

But taxes will have to rise one way or another to service the debt and the costs of economic dislocation, whatever else. After ten years of spending restraint, it will be hard to squeeze much more out of that side of the equation (bar, as suggested, the state pension), so it’s to taxes that the government will need to look.

The political consequences of all that will be almost incalculable, though we should almost certainly factor in changes in how people think about the relationship between the state and the individual. And that all assumes the Covid-19 pandemic will be dealt with this year, sustainably and effectivel,y with life after looks roughly like that before, following a rapid V-shaped economic recovery rather than a Depression, for example. Maybe it will. Let’s hope so.

David Herdson