Economy could have relatively rapid recovery from Covid-19

As a result of the last decade’s financial crisis, the Irish government borrowed €120 billion between 2007 and 2014, €75 billion for day-to-day services and another €45 billion to bail out the banks. While the Covid-19 economic crisis will be much sharper, hopefully it won’t last as long, and government borrowing could end up being a quarter of what it was in the last crisis.

Over the last 10 days, a series of studies have been published on the possible economic effects of coronavirus on world economies. While some assume a short, sharp shock, other studies have looked at a range of options on duration, up to peak economic disruption lasting for six months.

Most of the studies, including one by OECD, suggest that the fall in output for the months in which economies are in lockdown could be 25 per cent. However, depending on the length of the peak, the effect on output on an annual basis would be substantially lower – the OECD suggests that annual output will be reduced by two percentage points for every month of lockdown. The ESRI’s work two weeks ago, based on a three-month lockdown, is consistent with that formula.

Restrictions

It is now clear that we are not facing just three months of massive effort to stem the epidemic. Until an effective vaccine becomes widely available, hopefully by summer 2021, economies may not fully return to a normal footing. Restrictions on normal activity will still be needed to prevent a second wave of infections. China is leading the return towards normality and, while they are seeing a sharp pick-up in economic activity from the crisis nadir, the virus is still out there.

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So the major economic disruption in Europe could last through the summer, meaning that the fall in annual output in the Republic for 2020 could be more than 10 per cent. It now looks like unemployment here will peak at about 25 per cent of the labour force. Even with a good recovery in the autumn, the decline in unemployment is likely to lag the recovery in output. For certain sectors, especially tourism, it could well be 2022 before they see a return to normal trading conditions.

In addition, because the crisis has not been synchronised across the developed world, China is now in recovery, Europe is in lockdown and the United States some distance behind. This means that, instead of world trade taking a nose-dive and then recovering rapidly, it is likely to be the end of the year before demand in Europe and the US matches production of components from China , returning the world supply chain to normality. Delayed return to normal consumer demand will be a drag on the recovery in the sectors of economies that export.

The OECD analysis suggested that the initial economic impact of the crisis on Ireland would be the least severe of all OECD countries. While partly reflecting use of GDP, a poor measure of the State's national income, this finding also reflects the favourable structure of the tradeable sector of the Irish economy.

Restrictions

Irish production of pharmaceuticals, medical devices, and IT services will be little disrupted by the crisis, and they face steady external markets that are not dependent on consumers in lockdown. People will continue to eat. Leaving aside Brexit, demand for Irish food products should also stabilise in the recovery. This means that after the storm, return to normal working in the Irish economy may be more rapid than in economies that depend on making goods such as cars and aircraft.

If output in Ireland this year is down by at least 10 per cent, without further government action this would translate into a government deficit of at least 5 per cent of national income, to which will be added the cost of supporting households and companies amounting to at least another 5 per cent. This would take borrowing this year to at least €20 billion, and possibly another €10 billion in 2021. However, this would just constitute a quarter of the borrowing occasioned by the 2008 crash.

After this crisis is over, there will be an economic price to be paid. For this reason, the Government has been wise to target support to those who need it. The US approach of “helicopter money”, paying small handouts to everyone, is foolish. For the many households whose incomes have been maintained, but whose capacity to spend has been hit by lockdowns, a handout will just be saved. The European approach of targeted wage subsidies, enhanced unemployment payments and debt forbearance is likely to better shield those worst affected.