One thing is clear about the UK’s recovery from the Covid-19 crisis - no-one really knows what it will look like.
The word ‘unprecedented’ has been overused in recent weeks, but it’s a fair description of the economic shock we’re experiencing today. Never before have we voluntarily shut down whole sectors of the economy. We’re flying blind.
A survey of economists, conducted by the Treasury and reported this morning in the FT, suggests that the scars might be longer-lasting than hoped, even permanent. By the next election at the end of 2024 we might be looking at GDP 4% lower than forecast just three months ago.
That will be costly because it will sharply reduce the amount of money that the government is able to raise in taxes from both individuals and businesses. The gap between tax revenues and spending commitments, the budget deficit, might be more than £100bn a year.
Remember, that compares with the government’s pre-crisis ambition of balancing the books. Living within our means was the whole point of the austerity that characterised the decade after the 2010 Conservative election victory.
With the government turning its back on spending cuts in the wake of its election successes in the Midlands and North last December, and with the Conservative philosophy remaining a tax-cutting rather than a tax-raising one, a big question hangs over new Chancellor Rishi Sunak.
How will he repay the high cost of supporting the economy through Covid-19? Will he even bother to try - there is a case to be made for simply letting public sector borrowings rise in an environment of low interest rates where the deficit can be funded very cheaply.
Just how much of a gap the Chancellor has to fill will be determined by the shape of the recovery once the economy starts to re-open this summer. There is a wide range of possibilities, tagged by economists with a whole alphabet-soup of descriptions.
Top of most investors’ wish-lists is the so-called V-shaped recovery. This is the deep plunge and rapid recovery in activity that is being used to justify the stock-market’s rapid return to form since late March. Although still possible, support for this type of bounce is now harder to find as the scale of the likely job losses and changed patterns of consumption are appreciated.
A variant of the V-shaped recovery is the Z-shape. This sees a rapid initial recovery, probably above trend, before growth settles back to a more normal level. Again, most of us would settle for this outcome but it may be asking too much of a battered and bruised economy.
Most economists’ central case is the U-shaped recovery, which gets us back to trend growth eventually but only after an extended period of pain. A variant of the U is the W-shaped recovery, which has a strong recovery to start with that hits the buffers after a premature opening up of the economy and a rise in infections. A relapse in activity is followed by eventual recovery back to trend growth in due course.
The last shape, and the one that most closely matches the findings from the Treasury’s survey of economists is the L-shaped rally. This sees a return to the previous rate of growth but at a lower absolute level of activity. In other words, there is some permanent scarring in the economy. Some of the country’s wealth is lost for ever.
This actually seems quite plausible. It is similar to a concept introduced recently by the Economist magazine when it talked about a ‘90% economy’, one which looks like the old world but never quite regains its vibrancy. Shops are open again, but we’ve just lost our enthusiasm for visiting them. Restaurants re-open but eating in a socially-distanced way just doesn’t seem such fun anymore.
In such a scenario, we could return to earlier rates of growth, but the starting and end points will be lower. The economy will just be a bit smaller than we might have expected in those blissful days before we’d ever used the words corona, furlough or zoom.
In such a world there will be parts of the economy that do very well. And perhaps these are the parts of the economy over-represented by companies listed on stock markets, which explains some of the apparent mismatch between the economic headlines and the level of the stock market.
But it will be a permanently changed world in which investors will need to re-calibrate their investments towards those businesses that can survive and thrive in a new environment. Picking the winners and avoiding the losers will never be more important
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