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Permanent damage has been inflicted on the global economy

This report provides an outlook for the global economy in the midst of COVID-19 and is produced with ICAEW's partner Oxford Economics, one of the world’s foremost advisory firms. Their analytical tools provide an unparalleled ability to forecast economic trends.

  • Coronavirus has caused mild permanent damage to the global economy
  • Governments are unleashing unprecedented stimulus to prevent further long-term damage
  • Deglobalisation would constrain future productivity

Beyond the shorter term, there is also a possibility that there will be medium-term costs to the global economy in the form of lost activity from the pandemic. Oxford Economics assumes that the level of global GDP does not fully converge back on the path that they were forecasting before COVID-19, implying that there are some longstanding losses arising from the pandemic. In the medium term, the cost of the virus outbreak could be in the region of 1.6% of global GDP, although this estimate is subject to a high degree of uncertainty.

Global GDP: medium-term damage

The degree to which GDP reverts to pre-crisis trends after sharp downturns and historical epidemics and pandemics varies. Historical evidence points to large upfront output losses from pandemics and natural disasters, but the medium-term outcomes are mixed. Large policy responses to such health crises, unsurprisingly, typically result in smaller adverse medium-term effects for the economy.

Unprecedented policy response is aimed at minimising long-term damage

On the face of it, then, the early and aggressive action by policymakers bodes well for medium-term prospects. Nonetheless, much will depend on how quickly policy is tightened once the recovery begins.

In the short term, government deficits could soar to as much as 20% of GDP due to increased lending and plunging revenues as a result of the lockdown. As a result, Oxford Economics expects government debt levels will rise by 10%-20% of GDP by 2021 in most advanced economies. Record low interest rates means these economies should be able to finance these deficits cheaply, helped by massive quantitative easing policies where central banks such as the FED, ECB and Bank of England attempt to keep financial conditions exceptionally supportive. But economies without monetary independence or more precarious fiscal positions, such as some southern eurozone economies and emerging markets, may find it hard to finance large deficits cheaply for an indefinite period of time.

Given the abruptness of the COVID-19 shock, speedy support is crucial to support the recovery. Economic expansions are typically vulnerable to adverse shocks when they are in their infancy – in the early stages of a recovery, confidence is typically weak, and it may only take relatively small shocks to push the economy into recession. If policymakers begin to reverse the policy measures before the recovery has built significant momentum, due to pressures from financial markets or domestic political factors, then the risk of a ‘double dip’, as occurred in Europe after the global financial crisis, would increase.

Similarly, while the size of the policy support is crucial, the design of the policy is just as important. If emergency loans and transfers take too long to arrive then this will increase the likelihood of firms folding and/or being forced to make redundancies.

Budget deficits

More generally, deep and longer-lasting recessions, especially those involving financial crises, tend to be associated with weaker economic growth subsequently, resulting in larger medium-term losses. Deep and lengthy recessions in the 1970s and 1980s saw ‘hysteresis’ effects, whereby sharp rises in unemployment and business failures cast long shadows over several years. The 2008 global financial crisis is a prime example of a financial crisis, where the pace of GDP growth in the recovery years persistently underwhelmed relative to pre-crisis trends.

In this respect, there are also some encouraging signs that the shock will not inevitably take a huge toll on the economy in the medium term. While the recession will be large, Oxford Economics’ baseline assumption is that it will be short. Nonetheless, if the threat from COVID-19 lingers forcing stringent lockdowns to remain in place, or alternatively a relaxation of restrictions triggers a second wave of COVID-19 cases that left governments with little choice but to substantially re-tighten lockdowns, then the recession period could lengthen, increasing the likelihood of more substantial hysteresis effects.

Oxford Economics’ baseline forecast assumes that central bank actions will be enough to prevent some form of financial crisis. Recent financial market developments are encouraging in this respect. Nonetheless, it would be unwise to rule out the possibility of the pandemic triggering some form of financial crisis. In such a scenario, the likely medium-term effect on the economy from the COVID-19 outbreak would be more substantial than assumed in their baseline.

Another way in which the crisis may be harmful for GDP in the medium term is if it triggers more structural changes in the private sector. One risk is that households and firms respond to the crisis by trying to reduce debt and increase precautionary savings. While this might be a rational choice it would also lead to a weaker economic recovery and accelerate the shift toward ‘Japanification’ of major advanced economies – a prolonged period of ultra-sluggish demand despite extensive monetary easing.

Rising protectionism before the outbreak could come back even stronger

The crisis might also exacerbate trends that predated the COVID-19 outbreak. Before the pandemic, global trade was already slowing as a result of the prolonged trade war between the US and China. The imposition of trade tariffs between the two nations, and by the US on Mexico and Europe, caused global goods trade to slow from 6.5% growth in 2017 to just 0.3% in 2019.

This trend towards deglobalisation could likely accelerate after the 2020 coronavirus pandemic, as firms look to insure themselves against further significant supply chain disruption in the event of national lockdown in economies where parts of their supply-chain are located. While this may mitigate future risks, it may result in less efficient production at a global level. In 2019, a decoupling of ideas, a break in consensus views with regards to free markets and trade, and diverging international standards began between the US, Europe and China. This could likely accelerate as firms have to reshape their business model to focus on more localised demand and supply, further reducing economies of scale and adding to inefficiencies.