The economics of a sudden, screeching stop

lockdown

In a ‘normal’ recession the economy slows down gradually as confidence wanes. Not this time. The current lockdown, intended to stop the spread of the coronavirus and prevent our healthcare system from being overwhelmed, has deliberately slammed the brakes on economic interactions.

The UK economy has thus come screeching to a sudden stop. Whilst GDP figures are not yet available, the latest figures from the Purchasing Managers’ Index (PMI) show that manufacturing and services industries are experiencing the biggest slump ever recorded.

The speed and depth of the economic downturn are staggering. The Office for Budget Responsibility (OBR) suggests a 35% contraction in GDP followed by a rapid bounce back, in a ‘V’ shaped recession and recovery.

This has been echoed – albeit cautiously – by Gertjan Vlieghe, who sits on the Bank of England’s Monetary Policy Committee. I hope this is right, but fear that it isn’t guaranteed unless policy works.

On the scale and speed of the downturn, data firm IHS Markit has just released its April PMI measures, tracking activity across the services and manufacturing sectors.

A PMI figure above 50 indicates an expansion of business activity and below 50 a contraction. During the financial crisis in 2008 the composite PMI measure fell to 38.1. This week the composite PMI collapsed, hitting 12.9, the lowest reading in two decades of records.

The services PMI slumped to 12.3 (from 34.5 in March – already a very low figure) and the manufacturing PMI fell to 16.6 (from 43.9 in March).

The latest CBI quarterly survey of manufacturers charted a similar collapse, and said that nearly a half of manufacturers surveyed expected output to be limited by shortages of materials or components, a figure on a par with the mid-1970s.

IHS Markit suggest that the PMI data is consistent with the UK economy contracting by seven percent this quarter.

But these PMI measures may underestimate the actual decline in business activity taking place as they exclude many self-employed people who have been badly impacted by the lockdown, as well as retail activity, much of which has shut down.

The real economic decline could be greater.

Meanwhile some 1.4 million people have signed on for Universal Credit, and the cost of the government’s interventions to keep capacity and jobs in place was indicated by the government’s borrowing requirement rising to £180 billion over the next three months.

The Office for Budget Responsibility sees borrowing rising to some £273 billion this year, or 14% of GDP. That would be the biggest budget deficit in peacetime.

Vlieghe stated that the virus, and the induced lockdown, has created both a supply-side shock (people can’t work so production is disrupted) and a demand-side shock (as consumption is disrupted by the lockdown and confidence takes a hit).

This economic shock is also ‘highly asymmetric’, he noted, with some sectors faring much worse than others. The latest PMI figures showed financial services much less badly impacted than car manufacturing, for example.

That in turn will likely have a marked spatial impact. KPMG have forecasted that the West Midlands will be badly affected, with car plants and the auto supply chain shutting down – and London would be least affected.

The issue this raises is that a swift economic bounce back and V-shaped recovery isn’t guaranteed.

It depends on the government’s interventions – like the job retention scheme and business interruption loan fund – working effectively to make sure that most capacity and jobs are kept in place.

And here there is a real danger of businesses running out of cash and failing, leaving a more deeply entrenched downturn that is difficult to exit, with a ‘U’ or even ‘L’ shaped recession.

If there is serious damage in terms of firms going bust and jobs being lost then a V- shaped recession and recovery will be much more difficult to achieve.

All of which raises some big questions about whether the government interventions are doing the job, or whether a scarring effect is already happening.

A big issue is over how quickly business support, such as the Coronavirus Business Interruption Loan scheme (CBILS) is getting through to businesses, and whether the banking system – bailed out in the financial crisis – is working in the way we want it to. The figures don’t look good so far.

Some £2.8 billion has been lent under CBILS so far, to 16,624 firms. That’s small beer compared to Switzerland where banks issued some $15 billion of SME loans within the first week of a new loan scheme.

Here in the UK around half of the £2.8 billion was lent in the last week, so there has been some progress after the government was forced to revise the scheme to try to get more money out of the door.

Yet there have been 36,000 applications, so many firms still seem unable to access support. The speed and volume of lending, and the number of firms helped, is deeply worrying.

On this the Federation of Small Businesses (FSB) Chairman Mike Cherry makes a number of telling points:

“The average value of a CBILS loan stands at more than £170,000… The small shops, restaurants, gyms, manufacturers and mechanics at the heart of our communities are not seeking loans of anywhere near this size. The government should up its guarantee on emergency loans with values under £30,000 from 80% to 100%. That, combined with the streamlined application process that should be in place for facilities of this size, should help to get more cash to the small firms that really need it. We continue to hear from small firms that made enquiries when this scheme launched but have still been unable to make an application because of unresponsive customer service teams. For those that have made an application, the process is very slow.”

Given all this, one wonders how many very small borrowers have actually been helped? For smaller borrowers the government might offer 100% loan guarantees as the FSB calls for (in line with policy in Germany).

That’s something that the Chancellor is now thought to be considering – he needs to act on this quickly.

That’s not enough, though. For very small borrowers seeking £5,000 or £10,000 then as Nils Pratley notes, the Treasury might be better advised to by-pass the banks and offer grants so as to get the cash out more quickly.

The key point here is that the lockdown is for a very good reason: saving lives.

Ending the lockdown too early brings all sorts of economic risks in terms of a second wave of illness affecting workers and output, and in denting confidence as Jonathan Portes has rightly pointed out.

Meanwhile, getting through the lockdown with minimal economic damage means making sure that business support schemes work effectively so as to avoid lasting economic damage or scarring.

And on that further work is needed by the government to especially help smaller businesses through the crisis.

By David Bailey, Senior Fellow at The UK in a Changing Europe and Professor of Business Economics at Birmingham Business School.

Disclaimer:
The views expressed in this analysis post are those of the authors and not necessarily those of the UK in a Changing Europe initiative.

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