Suddenly then gradually is how the economic downturn will be

On Friday (1 May) I was astounded to hear that the US stock market index S&P 500 had its best month since 1987, after its dramatic fall in the earlier months of the year. I was aghast when I further thought I heard that it had recovered practically all its lost ground in 2020. That reinforced an impression that many people are in denial about just how bad things are, especially in America.

Some notes of caution before readers rush to sell their American shares, or short the index. The S&P 500 was in fact still 13% below its starting point at the end of April, and fell nearly another 3% on that Friday. I probably misheard a comment about the tech-heavy NASDAQ, which was just 2% down. The movements of share prices arise from dark forces, whose nature only becomes apparent long after the event, if ever. Newspaper headlines attributing movements to some coincidental event (on Friday it was trade relations with China) are just speculation. There may well be a much more rational explanation for the stock index level other than delusion. Though it still looks like a long-term “sell”.

The impression of delusion was heightened by statements, from the President among others, that the USA is past the peak of the virus outbreak, and many states are relaxing their lockdowns. In Britain the Prime Minister, Boris Johnson, has been saying the same thing about being over the worst, though still very reticent about relaxing the lockdown. Economically at least, however, the world’s troubles have only just begun. The troubles are in several layers.

The first issue is that the virus has proved itself to be both very infectious and deadly, and it is still very far from beaten. The relaxation of restrictions in the USA is most likely to result in a surge of infections that will overwhelm the hospitals in the states where it happens. This is a complex business, and some US states may not in fact be very vulnerable, because their populations are very dispersed and populations relatively static. But that does not apply to many of the states relaxing restrictions, such as Georgia. In Europe each country is wrestling with how to relax the lockdown, without reigniting the crisis. Only a small number of states (and not in Europe) seem to be able to relax lockdown significantly, and that only by drastically limiting travel in and out. It will be impossible to get back to normal until a freely available vaccine or cure is found and distributed en masse. That’s a long way off.

The second issue is that this crisis is a global one; no country will be able to bounce back and lead the recovery. In the Great Financial Crisis, a relatively small number of countries took the initial brunt (the USA and Britain mostly); others (in particular other European countries) suffered in the aftershock, but while the initial impacts had stabilised. Across the globe countries were able to launch a massive stimulus to use up the spare capacity created by the crisis, with particular credit to both the USA and China. This will not happen this time; both of these countries have had suffered severe shocks to the supply sides of their economies, which limits their ability to carry out effective stimulus. States across the world are intervening massively to limit the economic damage of the pandemic, but this is strictly damage-limitation. Reversing much of the damage already done is another matter.

And this leads to a third problem, which is the biggest of all. The world is coming to the end of one of its 40-year growth cycles, and the crisis is about to cause a deep unravelling of the growth model that drove it. They old tricks don’t work any more, just like Keynesian stimulus did not work in the 1970s.

The current growth cycle began to take off in the 1980s. It was driven by three main things. The first was continued productivity growth by developed world businesses, partly through the application of new technology, and partly by a ruthless cutting away of “slack” regardless of whether this represented waste or sensible resilience. One feature was the extensive use of outsourcing, and the stretching of supply chains. The main problem with this steady transformation of business was that the rewards were skewed towards the owners of capital and the top managers and their advisers, and not most of their workers. The second growth driver was steadily increased consumer spending, driven by steadily increasing private sector borrowing, in turn linked to increasing property valuations. This allowed the mass of consumers not benefiting so much from the productivity gains to nevertheless keep growing their consumption. The problem with this is that it is not sustainable in the long term – but as the saying goes, tomorrow never comes. The third factor was the entry of the less developed Asian economies as a source of cheap labour. Japan was the first, followed by Korea and Taiwan, and then China and India. It is important to note that this development was not exploitative for the most part. Those Asian economies benefited hugely, which allows those taking a world view to say this 40 year cycle has been by far the most beneficial to humanity (if you gloss over environmental impact). What was happening is explainable using the ancient economic principle of comparative advantage, and benefited both sides. What people did not appreciate at the time, and for the most part still don’t, is that these gains are time-limited. As the developing nations catch up, their labour increases in price, and so the developed world ceases to benefit. And so it has been as China in particular closes the gap.

The whole system is now unravelling at speed. Just how much developed world industry has been relying on reduced resilience to get next year’s increase in profits is only now becoming clear. As an illustration this Economist article on the US meat industry shows how scary it can get. And, of course, reliance on cheap foreign labour to keep prices down looks like a bad bet too, as hospitals scramble to find masks and gowns to protect their workers. But the most worrying development in terms of its potential impact is that the shock will puncture the ever growing cycle of consumption, debt and property values.

What this amounts to is a prolonged and almighty economic slump. Demand management through government stimulus will only help so far because the crisis is killing productivity and supply. What will emerge from this is hard to say. Many hope that it will be a kinder, more sustainable and more equal economic system. But there are other possibilities of course. I have written before that there will be a huge impetus to get back to familiar world of before, and this will undo many of the short-term hopes raised by the crisis. But over the longer term something better is possible.

“Gradually and then suddenly,” is the famous Ernest Hemingway quote about bankruptcy. With this crisis it will be the opposite.