Archive for month: April, 2020

The World is at war with an unseen enemy. Mark Twain is attributed in saying that “history does not repeat itself – but it does rhyme”. So, what are the lessons that we can apply to help us to model the future and best prepare to re-build society and the economy – and plan for the new normal?

In any war, the winner the side that makes the fewest mistakes. Every victory comes from imagining a scenario, then testing its assumptions, then responding to how those assumptions play out in real life. This is true of military campaign and dealing with economic circumstance.

The global Covid-19 crisis has the potential to destroy both the social and economic orders as humanity has known them for the last five decades. The relative stability of the World order since the mid-20^th Century has been underpinned by steady growth and a tolerable balance of power between nations and civil forces. Today, hundreds of thousands of businesses – especially in the ‘small and medium’ category – face implosion of their revenue base, and as balance sheets are devalued through lack of activity and markets. As the population begins to be released to socialise in the months ahead, new forms of economic activity and distribution of whatever wealth remains must be constrained by the need to engender fairness across society and power the greater good over self-interest.

The policy response to the global financial crisis of 2008-09 offers important lessons. In the weeks after the failure of Lehman Brothers, it became apparent that the damage to the financial system could push the entire World into a 1930s-type depression. The then UK chancellor, Alistair Darling, has said that Britain came within hours of “a breakdown of law and order” on the day the Royal Bank of Scotland was bailed out. The policy response came quickly – and was substantial. Central banks slashed interest rates, pumped liquidity into the financial system – and bought private sector assets.

The conditions of extreme uncertainty at the moment of the financial crisis had something in common with today – and with wartime scenarios. The ‘normal’ rules of good government just have to be eased. And as the situation unfolds – with both the dramatic scale of the impact and the extent of the timescales before life returns to the new ‘normal’ becoming evident – the need is for speed and scale in the response. Cost is now a problem for the future. Decisions have to be made on the basis of imperfect and fast changing information. This requires improvisation, an acceptance that most decisions will be imperfect, and acceptance that many decisions will be wrong and may even prove counter-productive.

With hindsight the decision not to bailout Lehman Brothers in 2008 might be thought an epic mistake. The subsequent responses to the unfolding situation saved a global economic collapse. However, the cost of the later response was far greater than a single bail-out – and the consequential down-turn has taken over a decade to recover.

Coronavirus has implications that are an order of magnitude greater than the Financial Crisis.

In their response to today’s Covid-19 threat policymakers appear, consciously or not, to have absorbed at least some of these lessons. The immediate fiscal and monetary interventions have been on a huge, and in some areas, unlimited scale. UK Treasury officials are not yet unable to estimate the cost a the raft of new measures to support households as they are dependent on ‘demand’ – and are, therefore, open ended. The US Federal Reserve has said it will buy US treasury bonds in unlimited quantities – and, in radical move, the Fed will for the first time, buy corporate debt.

Policies are rolling out at an unprecedented speed – in much the same way that the allies’ wartime economy often prioritised volume over quality. Right is good enough, it doesn’t need to be perfect – Russian and American tanks were of variable design and quality, but they were produced in far greater numbers than Germany could manufacture. A national emergency robs decision makers of the luxury of time – but not, we trust, of transparency.

Britain’s Chancellor, Rishi Sunak said last week that we cannot allow “the perfect be the enemy of the good”. 800,000 SME’s in the UK need his words to become deeds.

There also seems, at least in some quarters of the USA, to be a recognition that some inefficiencies are the price that must be paid for a fast and comprehensive response. Neel Kashkari, President of the Minneapolis Fed, told The Wall Street Journal: “If a bunch of businesses get help that didn’t need it, that’s fine, that’s much better than taking a decade to rebuild the labor market….We just have to get over it, err on the side of getting more help out there”.

The battle against coronavirus calls for a more unified response than the efforts to arrest the global financial crisis. Bailing out banks and supporting financial markets was hardly popular. The mobilisation of the state today, and the expansion of its role, have so far proved generally uncontroversial. Politicians seem more likely to stand accused of doing too little.

This week’s expansion of those working under the command and control of the state demonstrates needs the consent and the active support of the public. So far, that support is evident – 700,000 people, for instance, signed up for the UK government’s NHS volunteer scheme in less than ten days, almost three times the original target.

Popular support – as in times of war – give government the scope to act on a significant scale. With much private sector activity suppressed, public spending will be needed to sustain household incomes and support business. Government activism, whether in expanding the NHS, taking over capacity in the private health sector, the suspension of rail franchises or a vast scheme of income support, is the order of the day.

Public spending will soar. Last week’s US $2 trillion stimulus package is equivalent to almost 10% of GDP. The Financial Times estimates that the increased public spending announced in the UK in the last two weeks amounts to over £60bn, or 3.0% of UK GDP. Public borrowing in 2020-21, which two months ago looked likely to come in at around £50bn, could now hit £200bn according to the Institute for Fiscal Studies.

Countries have always run up huge debts fighting wars and countering recessions. In the UK the financial crisis lifted debt from 40% to more than 80% of GDP. In coming months government spending will be the prop holding up economies across the West. Tax revenues will plummet. Levels of public debt seem likely to rise above the peaks seen during the financial crisis.

Crises or wars can shape economies in other ways. The financial crisis revealed deep fragilities in the financial system. Policymakers today are less tolerant of financial risk and banks face far greater regulatory scrutiny – yet are now being asked to lend as never before to keep business and employment open to resume. In the UK, the mass mobilisation of the second world war helped create a consensus in favour of big government, with the creation of the welfare state, widespread nationalisation and activist economic policies. The war helped popularise the idea of the state as a guarantor of welfare and economic security – and we may need to return to greater nationalisation and a welfare state to avoid deep and destructive inequalities as we come out of the immediate crisis.

The current crisis has revealed unforeseen – or rather foreseen but chosen to be ignored – weaknesses in food supply chains, medical supplies, healthcare provision and many other areas. What is highly efficient in normal times – such as ‘just in time’ food supply – has become a vulnerability in a crisis. Governments and voters may be unable – or unwilling – to return to the status quo once the first wave of the crisis is over. The step change in health spending now underway may never be unwound; and Switzerland, which for decades has seemed slightly idiosyncratic in its commitment to maintain strategic stockpiles of food, now looks like the example to all nations.

Pandemics have long been on the list of potential ‘black swan’ events – unexpected negative shocks with major consequences. However, for the public and private sectors around the globe, they have been ranked low down a long list of threats. This will change for nations everywhere – just as Hong Kong and Singapore’s experience of SARS has shaped their health policy – and their ability to responds to the coronavirus. What is unfolding today will establish pandemics as a core risk for businesses, investors and insurers – along with cyber-attacks, terrorism and climate change.

The long-term effects of an external shock often exceed the immediate effects – sometimes in quite unexpected ways. Thanks, in part, to the vigorous response of the Fed, the 9/11 terror attacks did not knock the US economy off balance. But the attacks transformed America’s defence and foreign policy, and triggered two long and expensive wars – in both social and financial terms – that have totally changed the balance of power in the Middle East. The Fukushima nuclear disaster in Japan in 2011 led to the closure of the country’s entire civil nuclear programme – and a surge in fossil fuel imports and in electricity prices…and higher energy prices squeezed spending on heating that have caused a surge in deaths far larger than that been seen in the original nuclear disaster.

Pandemics face humanity with a trade-off between human health and economic activity. The 1918 flu epidemic killed over 50m people globally – and almost three quarters of a million Americans. Many Americans carried on working because, in the absence of social security, they had no other source of income. Concern about the economic impact of restrictions on movement meant some US cities were slow to act and suffered far higher casualties than those which moved quickly. Remarkably, the US federal government had little formal role in combating the 1918 flu epidemic – and President Woodrow Wilson never publicly mentioned the disease.

Richer societies, with more extensive systems of welfare and government, have far greater capacity to control diseases and the social and economic consequences – and the greater and instant global press coverage is highlighting the inequalities between first- and third-world nations and their ability to protect life and welfare of their populations.

The restrictions on movement introduced across the developed World testify to a collective willingness to trade economic activity for human health. The loss of activity in the near term will be significant but deemed acceptable as a trade-off. Second quarter GDP in the US, EU and UK is likely to contract sharply. Professor Simon Wren-Lewis of Oxford University, this week updated his earlier analysis of the effects of a flu pandemic – now estimating that in the first financial quarter during the pandemic GDP is likely to contract by 30%. This is at least three times as much as any other forecast to date – but testifies to the potential economic impact of social distancing on activity.

In one important respect, what we are observing today is different from anything that has preceded it in modern times. In past crises, governments have sought to boost economic activity, whether to fight wars or counter the effects of a natural disaster or a downturn. This time, governments are suppressing economic activity through restrictions on movement in order to slow the progress of the coronavirus. The massive interventions by central banks and governments are designed not to stimulate activity, but to preserve jobs and businesses for an upturn in the second half of 2020.

In that endeavour policymakers seem to have been guided by the experience of earlier crises. They have acted swiftly – and on a large scale. ‘Conventional’ wisdom has been set aside and the established rules of government have been suspended or altered. This is to the greater good. The immediate effects of this crisis are immense. History suggests that the long term consequences will be profound.

I would like to acknowledge the work of the Deloitte economics team for their analyses some of which are included in this piece – and their generosity in allowing it to be quoted in these unparalleled times.