WILL THE COVID-19 PANDEMIC CAUSE A BREAKDOWN OF THE GLOBAL ECONOMY?
The coronavirus pandemic is an unusual period for all of us. We are facing the fear and uncertainty about our and our close ones’ health, about the job and the future. Some of us are facing loss of our loved ones. We had to change our daily routines, reorganise our work, learning and looking after children. We do not know when everything will come back to normal or whether this “normal” that we used to know will ever come back. We are not able to predict how the situation will develop.
In these difficult times, we have asked the scientists from the University of Wrocław to share with us how they look at the situation from their scientific perspective. Below, we present a text by Dr Arkadiusz Sieroń from the Institute of Economics at the University of Wrocław.
The COVID-19 pandemic is mainly a humanitarian crisis but it also entails important socio-economic implications. The probability of a recession in 2020 has increased. Certainly, there will be economic growth after the epidemic but, possibly, the revitalisation will not take the shape of the ‘V’ letter. Probably, the recession in Poland will not be as deep as in other European countries but it will cause a slower growth anyway, especially in the first half of the year.
In today’s highly globalised world, pandemics are one of the biggest global risks. They may cause high morbidity and mortality as well as negative socio-economic consequences. Now, the world is fighting with the coronavirus disease (COVID-19) caused by the SARS-CoV-2 virus, which has reached a pandemic status. It has caused serious concerns about how it will affect the global economics. Some analytics claim that the coronavirus will trigger the long-lasting global recession, others maintain that the new virus will be stopped relatively quickly and that the global economic will come back to normal. Where is the truth?
In this part, I am focusing on the economic side of the coronavirus. However, I do realize that the pandemic is mostly a humanitarian crisis. Therefore, I would like to express my sympathy to the families of the victims.
Economics of an epidemic
By and large, an epidemic affects the economy in two ways. There is a decline in consumer spending, people become sick or try to avoid sickness. They decide to quarantine themselves and stay home instead of traveling or going to the shopping centres. Therefore, the tourist, transport and entertainment industries become soon crippled. The best example of the demand effect is decrease in the demand for oil (less demand from the transport industry) and, thus, a drop in its price.
Equally, if not even more, important consequence of an epidemic is a supply shock. Epidemics reduce primarily the supply of workforce. In most cases, it is temporary because some employees are sick or remain under quarantine. When the production rate drops but the overheads and salaries must be still paid, problems appear and a risk of bankruptcy increases.
According to the World Bank, pandemic costs can be divided into three main categories: around 12% of total cost comes from mortality, 28% from the long absence of staff, and as much as 60% from the behavioural changes, i.e. from the fact that people try to avoid the danger. It means that the coronavirus does not need to be fatal or have the mortality rate as high as Ebola in order to be costly.
What is more, during a pandemic all economic sectors experience disturbance, which may lead to shortage of goods and, thus, their higher price. Also, reduced economic activity generates lower tax income. Since it happens during the times of increased governmental spending, it results in fiscal deficit and deeper public debt. Many governments are already overleveraged. An example might be Italy, whose public debt amounts to 135% of its GDP and it may increase.
The economic consequences of the coronavirus
And what exactly will be the implications of the pandemics? It is not easy to quantify this as the number of similar cases in the history is not sufficient enough. The World Bank estimates that the pandemic might decrease the global GDP by 4.8% in the worst case scenario (pandemic similar to the Spanish flu), 3.1% in a moderate case scenario (pandemic similar to the flu in 1958), and 0.7% in a mild case scenario (pandemic similar to the flu in 1968).
Initially, commentators compared COVID-19 to SARS, which was understandable considering the type of virus and the place of outbreak. This pandemic slowed down the growth of China’s real GDP from 10.5% in the first quarter of 2003 to 8.9% in the second quarter of 2003, but it bounced back in the next quarter. Because of these low costs of SARS for China’s GDP, investors underestimated the coronavirus for a long time.
It was a mistake. The economic impact of COVID-19 will be significantly bigger. That is because the role of China in the world economy has increased. In 2003, China represented only around 8.3% of the world economy, while today it is 19.3%. Additionally, China has become more strongly connected with the rest of the world and established a firm position in the supply chain. That may have major repercussions for international companies, which was emphasized in February in the Apple’s announcement that caused panic on Wall Street. Another difference is that China has significantly higher debt: total private debt (loans and debt securities) increased drastically from 102% of GDP at the end of 2002 to 208% of GDP at the end of 2018. What is more, the COVID-19 pandemic began during an economic slowdown.
The current epidemic has much broader scope. In case of SARS, there were 8096 cases of infection in 37 countries but now, there are already almost 250 thousand in 163 countries (data from 20 March 2020). It means that the outlook for the future is not bright even if the epidemic in China will be over and the Middle Kingdom will resume production and get back on the earlier economic development path.
As opposed to the previous epidemics, which mostly affected the underdeveloped countries (like Ebola), this time it is differently. The highest number of infections was recorded in China, Italy, Iran, South Korea, France, Spain, USA, i.e. except Iran, the strongest economies in the world. Together, those countries constitute 45.5% of the world economy according to Purchasing Power Parity (54.5% according to the Nominal GDP).
It is worth remembering that Italy and Japan were at the verge of recession already in the fourth quarter of 2019. Next quarter of a negative growth will cause a technical recession of the eight and the third strongest economy in the world (according to the Nominal GDP).
Although the US economy is relatively better off, it might not be immune to the coronavirus. Taking into consideration an inversion of the yield curve in 2019 and again in 2020, an alarming signal sent by the HIS Markit Flash U.S. Composite PMI Output Index, and the people’s and government’s reaction to the pandemic, analytics increasingly talk not about whether a recession will occur but rather how bad it will be. Investors see the future rather pessimistically – the American stock indexes dropped by 29% compared with their recent peak. According to the International Monetary Fund, the global economy improved by mere 2.9% in 2019 (the slowest rate since the Great Recession), and only 0.4 percentage points above the level that is considered a recession. That means that the world, most probably, is going to face a recession in 2020.
Will central banks save us from the coronavirus?
No, but certainly they will be trying. Some of them have already cut interest rates. In the western countries, the first one that came with rescue was Fed, who lowered the federal interest rates on 3 March 2020. It did it with a grace of bull in a china shop by cutting rates by 50 basis points instead of ¼ of a percentage point, and it did it at a casual session. Not only has this decision not stop the drop of the prices but it also deepened the anxiety in the market. Again on 15 March, the Federal Reserves lowered interest rates by one percentage point, to 0-0.25%. But let us presume that Fed’s communication was exemplary. Can the American central bank stop the virus from spreading? Will such a panic-struck move repair the global supply chain and revive production? Another rhetorical question. The monetary policy is helpless with the supply shock. The level of interest rates does not matter if an entrepreneur cannot get the necessary semi-finished goods from Asia to his plant or if his employees do not turn up to work.
Let us presume that the problem lays in the demand, as politicians and bankers will surely argue. In what way will lowering interest rates help if, at the same time, people are encouraged to stay home and, consequently, business activity is limited? Which companies start to invest during a period of low demand, disruptions in the supply chain or dropping prices?
If ultra-low interest rates did not help to rekindle unusually weak economic growth after the Great Recession when the coronavirus was present only in bats and pangolins, they will definitely not help now. The coronavirus affects the economy mostly through people’s behaviour – central banks’ efforts will not change anything (and maybe they should not, since the social distancing is our best weapon to combat the virus). Reducing interest rates by Fed or other central banks, including the National Bank of Poland, was unnecessary and it will not help the economy that is crippled by a pandemic. It might, however, intensify negative consequences of the unconventional monetary policy such as over-indebtedness or zombie-companies.
Coronavirus and Poland
Polish economy will not be affected by the pandemic as much as other European countries. Firstly, the Polish economy, on contrary to German, is less dependent on export or on China. Secondly, the tourist and entertainment sector represent smaller GDP percentage in comparison with South-European countries. Also, Polish economy is strongly diversified. Thirdly, greater growth rate in Poland, compared with Germany or other western countries, creates a broader space before a possible recession.
Nonetheless, it is being forecasted that the economic growth will be weakened. In the Inflation Report in March, the National Bank of Poland reduced Polish GDP growth from 3.6% to 3.2%. Central bank itself sees a risk of slower growth rate in case of extended period of the pandemic. The National Bank of Poland’s base scenario, in which there was assumed that the epidemic would be contained quickly and its negative effects would concern only China and its related economies, has become rather a wish. Despite the National Bank of Poland’s report, the economic growth in Poland will fall below 3%. However, I will not try to go into more details due to too much uncertainty. It is also worth mentioning that suspending education will lead to increased absenteeism at work, as many parents will stay home to take care of their children, which in turn will affect the economic activity.
Pandemics may have social consequences, too. The first potential negative effect is growth of government that will broaden its rights and expenditures in order to eradicate the present and future pandemic. Public debt will increase. There is a risk that the government will not withhold the rights that it conferred on itself during the pandemic. Second risk is intensification of xenophobic or protective tendencies, such as limiting flow of goods and people across countries.
Nevertheless, it is worth looking at the pandemic from somewhat more optimistic perspective. In a way, the gigantic costs that governments incur to fight with the coronavirus reveal how rich the world has got and how precious human life has become in recent decades. Thanks to the economic growth, societies have enough resources to implement preventive measures such as quarantine of whole regions. Several dozen years ago, no one would think of undertaking such radical steps in response to a pandemic with a moderate death rate, and citizens would have to go to work despite the risk.
Also, there is a hope that the pandemic will bring some positive long-term effects and that it will increase people’s awareness. Firstly, it will show how important the hygiene is for public health. Secondly, the pandemic explicitly shows how unwieldy health service is in many countries. Thirdly, suspension of school classes gives food for thought on the obligatory education in today’s world. The biggest problem associated with the closure of schools is not lack of classes but rather the fact that parents will have to be taking care of children. It clearly illustrates that, in many cases, school’s role is more of a care rather than learning institution, thanks to which parents can work and pay taxes. Fourthly, when the quarantine in which government and schools encourage online learning is over, politicians may finally open their eyes and understand that, in modern economy, clocking in and out is not always necessary. It is possible to work and learn remotely. Let us hope that this observation will lead to more flexibility in the market and to development of distance learning forms. Fifthly, the pandemic proves how important savings for a rainy day are, both these private and public ones. Sixthly, it will make it evident for people and companies that there is a need for diversification. I mean by this both, sources of income and sources of supply. In many cases, firms rely on just one Asian subcontractor.
The coronavirus pandemic increases the chances of global recession this year. The recession will be in the first and, most probably, in the second quarter. The fight is mainly about the second half-year. Of course, after the pandemic the economy will bounce back but, as opposed to the situation from the previous month, the chances that it will take the V-shape diminishes. The monetary policy will not help. There are necessary initiatives influencing supply, such as withdrawing taxes that were imposed by USA and China, or further trade liberalisation in order to neutralize any disruptions in international trade. Writing off levy or, at least, adjourning deadlines for tax payment would positively affect the financial situation of businesses during the pandemic.
The probability of a deep recession in Poland is rather low. It all depends on the development of the pandemic and on the shape of the epidemic curve. In the South-Korean model, new incidence peak occurs lower and sooner, and the country is able to function. On the other hand, in the Italian scenario, proliferation of the disease is bigger and lasts longer, the mortality rate is higher, which leads to imposing state of emergency and significantly reducing business activity. In case of Poland, it is too early to speculate what the economic consequences will be. There is considerable uncertainty. For the time being, daily number of new cases is smaller than in other countries but the coming days will be crucial. Since we still have not reached the peak, the worst is yet to come. But after that, it will be better.
Dr Arkadiusz Sieroń
An extended version of the article was first published on mises.pl