What does economic history tell us about pandemics?

Sunday Times Economics Editor David Smith writes an exclusive column for ICAEW’s Financial Services faculty every month. This month he tackles the effect of pandemics on economies and what we could expect from the coronavirus.

There are two things to be said at the outset about the coronavirus COVID-19 pandemic. The first is that it developed with astonishing speed from the something that we eyed with curiosity when it emerged in significant scale in China just a few weeks ago, to the public health emergency faced by most countries in the world now.

The second is that it has brought a response from governments and central banks that dwarf what was done during the global financial crisis and which, if they are not temporary, will change permanently the way economies work.

A situation is anything but normal in which the government, via the chancellor Rishi Sunak steps in to pay 80% of the wages of workers who are “furloughed” – still employed but forced into inactivity – guarantees up to £330bn of business loans, postpones regular VAT and self-assessment payments and makes many firms exempt from business rates for 12 months, alongside three separate fiscal packages in the space of a month. 

When it is accompanied by a reduction in Bank Rate to just 0.1%, another £200bn of quantitative easing, a term funding scheme for small firms and a commercial paper facility for larger ones, all done by the Bank of England during and after the handover from Mark Carney to Andrew Bailey as governor, you know that something truly exceptional is happening.

By the time you read this, more will have happened. Under a Tory government, large parts of the economy have been shut down or taken under government control in a way that Labour’s Jeremy Corbyn and John McDonnell would have hardly thought possible.

What does economics tell us about how severe this is likely to last and how bad the hit is likely to be. A 2013 World Bank study, Pandemic Risk by Olga Jonas, appeared to provide answers, and some reassurance. A severe flu-like pandemic could cost nearly 5% in global gross domestic product, it said, tipping the world economy into recession. More reassuring, however, was the study’s assessment that the more recent swine flu pandemic of 2009 only reduced global GDP by 0.5%.

The 5% hit, the effect of the 1918-19 Spanish flu pandemic, was a long time ago, and medical science has progressed a lot since then. Not only that but World War One had left much of the world on its knees. The swine flu impact informed assessments like those of the International Monetary Fund in February, which suggested that COVID-19 would trim global growth by a mere 0.1%. Just a month later, on March 23, the IMF was predicting “a recession at least as bad as during the global financial crisis or worse”.

The lesson is not that nothing has changed in a hundred years but that there are certain things, like new virus strains, that even modern medical science struggles to catch up with, though is clearly racing to do so now. The other difference is that, while WW1 killed off globalisation, it was very alive – if damaged by trade wars – when this virus first emerged in China. In that sense, the world was safer before the opening up of China in the final decades of the 20th century.

As for the UK, a 2009 study by Simon Wren-Lewis and Marcus Keogh-Brown, “The possible macroeconomic impact on the UK of an influenza pandemic”, looked at mild and severe effects. Its severe effect scenario, an initial 21% quarterly fall in gross domestic product and a 4.5% fall for the year, looks like the kind of ballpark we should be thinking of, if not worse.

The reassuring lesson from past pandemics is that they are not long-lasting, either because vaccines are developed or because health systems learn to manage them.

This new coronavirus will not disappear but we will learn, if not how to live with it, to keep it under control. Previous pandemics have followed a “V” shaped pattern, with the initial negative impact lasting for 3-4 months, a quarter or so. Sometimes there is a “W”, if there is a second wave of infections. People worry that this pandemic will push us into a depression, but that looks too pessimistic. There was, after all, a long lag between the 1918-19 Spanish flu pandemic and the Great Depression.

What about the banks? Before he stepped down as Bank of England governor, Mark Carney admitted that the bank stress tests had not been conducted with a pandemic in mind but that the economic impacts they incorporated amounted to much the same thing. As it is, he and his successor Andrew Bailey, see the banks as an essential conduit for supporting the economy during this crisis.

On March 25, Bailey, along with Rishi Sunak, the chancellor, and Chris Woolard of the Financial Conduct Authority, wrote to banks and building societies urging their continued efforts in keeping the economy going during the crisis. The assumption behind this that the banks are strong enough to be crisis-proof. The banks, however, will fear that as the bans and shutdowns are extended, many of their business customers will not emerge from the other side of this. It is a nervous time for everybody.

You can read more of David Smith's previous editorials on the Financial Services hub page.