Much has changed in the global economic outlook over the last few months and forecast growth rates are being revised downwards by the day. Coronavirus is spreading. It may be under some sort of control in China, it clearly is not in Europe or in the United States.
The economic effects are widespread. Supply chains in China have been disrupted and this is having a significant negative effect on industrial production in the world at large. On the demand side, tourism is collapsing and the numerous and growing restrictions on daily activities and on travel are curtailing retail spending and output in the service sector. In addition, financial markets have reacted in ways similar to those that followed the financial crisis of 2008-09. Stock markets have suffered huge losses and liquidity is running short. Confidence is inevitably affected. All this bodes ill for the future. Monetary policy in the U.S., UK and Eurozone has reacted forcefully, but there are limits to its effectiveness given that interest rates are already close to (or even below) zero in many countries. Fiscal policy in Europe, bar Britain and Italy, is still hesitating in providing significant stimulus, constrained as it is by Germany’s reluctance to use the fiscal lever and relative complacency about the disease.
Forecasting possible outcomes is fraught with uncertainties, the most important of which is knowing how soon the spread of the virus will be contained. To get a rough idea of the potential magnitude of possible losses, it is probably best to look at the two countries that have taken the most drastic measures so far to curb the disease: China from end-January of this year and Italy from mid-March. Oxford Economics estimates that the hit to China’s first quarter 2020 growth could be of the order of 3½ to 4 percentage points of GDP. Since China seems to be going back to work, some recovery is expected in the next two quarters. As a result, 2020 growth has been cut from the 6.0 percent rate forecast before the outbreak of COVID-19, to 4.8 per cent now. The most recent estimates for Italy are more negative. First and second quarter year-on-year growth rates are put at -2.2 and -5.2 per cent respectively as against earlier forecasts of +0.3 growth in both quarters. Output for 2020 as a whole could shrink by 2½ per cent rather than grow marginally as in earlier projections, plunging the country into a fully-fledged recession.
The revisions to other countries’ forecasts are, at present, much smaller (roughly of the order of -½ a per cent for 2020 GDP growth in North America and in Western Europe). This may well be optimistic since the health situation seems to be worsening rapidly and almost everywhere. It may not be far-fetched to think that other countries may have to put in place some of the severe measures adopted in China. Recent evidence suggests that the social distancing imposed in the country may be having some positive effects. And tentative evidence on the incidence of the so-called Spanish flu in U.S. cities in 1918 also suggests that multiple interventions designed to reduce social interactions lowered disease transmission in those cities which adopted them. Imitating China may not be easy in less authoritarian systems such as those of Europe or North America, but Italy is showing the way.
A back of the envelope calculation, extrapolating from the Chinese and Italian forecast revisions mentioned above, would, in a scenario of similarly drastic controls in other countries, result in a fall in North American and European GDP in 2020 of, perhaps, 2 percentage points relative to earlier forecasts. This would yield roughly zero or slightly negative growth in the U.S. this year and a -1 to -1½ per cent recession in Europe. While clearly painful, these recessions would still look mild in comparison to the losses of output suffered at the time of the “Great Recession” of 2009 (respectively -2½ and -4½ per cent). Should a generalized pandemic break out with hundreds of thousands contaminated the outlook would, of course, worsen dramatically, but, at present at least, such an outcome looks less likely.
By Professor Andrea Boltho, Kroll Real Estate Advisory Group (REAG) Advisory Board Member Emeritus Fellow, Magdalen College, University of Oxford