Why Covid-19’s economic effects will be worse than in 2008/2009

The crises are different in many ways but the solutions by governments and central banks remain the same

The Covid-19 pandemic has unleashed chaos in financial markets and threatens to inflict long-term damage to the global economy if the crisis response is not managed effectively. Though all efforts at present are aimed at stemming the physical contagion, concurrent efforts are needed to mitigate the financial and economic damage.

For investors there is a sense of déjà vu akin to 2008. Indeed, questions are starting to emerge around how the coronavirus fallout will compare with the global financial crisis. Though there is an eerie similarity to the 2008 recession, the current crisis is very different from the global financial crisis for five main reasons:

The anatomy of the crisis is different. Whereas 2008 was induced by a financial sector crash that spilt over to the real economy, Covid-19 is a health crisis that has turned into an economic crisis with complex political, security and behavioural dimensions.

The global financial crisis contagion was driven by an underlying distrust of the financial system and sparked by a systemic event in the banking system. The current crisis has been primarily driven by a distrust of people. The economic contagion is more pronounced than the financial market contagion and companies rather than banks (now better capitalised and regulated) are likely to feel the pain disproportionately.

Further, whereas there was no restriction placed on physical movement and travel and trade in 2008, this has been a hallmark of the current situation. This is important, because it complicates policymaking. With quarantines set to be the norm and the nature of social engagement changed, economic activity will be muted and demand side measures to stimulate the economy are unlikely to be effective.

To be sure, we now find ourselves in a perfect storm: a global pandemic that has induced a demand-side shock to an already fragile global economy, compounded by the oil war being waged between Russia and Saudi Arabia, affecting developed economies and emerging markets. It is an unprecedented set of circumstances.

The calibre of leadership relative to 2008 is less technocratic.

With leaders like Boris Johnson and Donald Trump at the helm of the leading Group of Seven

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(G7) industrialised economies, the response to the crisis has been a bumbling one. The US and UK took the lead in managing the previous crisis given their status as leading financial centres and were able to respond effectively in a way that provided assurance and comfort to markets. But in our era of strongmen and populists who have placed political expediency over technical competence, these leaders have been exposed by their underwhelming response measures, which have compounded already bad situations.

The result has been twofold: a crisis of credibility and a loss of confidence, which have collectively seen the economic and market contagion intensify. At a time when decisive leadership and strong action are required, global leaders are fumbling and fiddling. With domestic responses clumsy and haphazard, it follows that international co-ordination and response efforts have been equally poor and disjointed.

The global political economic architecture is fundamentally different.

This is arguably one of the reasons for the lack of collective action. Self-isolation may be a response to Covid-19 but it is also an apt metaphor for the current geopolitical landscape, which has seen a surge in nationalistic sentiments. This

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insularity is at odds with the old international liberal order, which placed co-operation at its forefront. With multilateralism in retreat, finding consensus has been a difficult endeavour. Europe’s response has been fragmented and the US’s delayed, while Asia’s has been far more comprehensive.

To effectively create confidence and calm in markets, a synchronised global health-care, fiscal and monetary response involving governments, central banks and key multilateral organisations such as the World Health Organisation, IMF and World Bank will need to be forthcoming.

The global economy is in a very different state than in 2008.

Back then the world had enjoyed a period of strong growth in preceding years, driven by a China-induced commodity supercycle. Emerging and developed markets were in rude health, and globalised free market capitalism was widely accepted as the dominant economic model. The events of the financial contagion shook the system but the policymakers still had a number of levers available to combat the contagion. Aggressive quantitative easing was employed, but the hangover of this is that the financial firepower on the monetary policy side is now reduced and may

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no longer be able to do as much heavy lifting.

Fiscal stimulus measures will be required to support ailing economies, but these will need to be unconventional and creative. Traditional demand-side measures are unlikely to work in the near term because of physical restrictions on the movement of people. Given the internal pressures of major industrialised economies, it is at this stage unclear who will fund the fiscal relief efforts, where the money will come from, and what the long-term consequences of this will be.

The role of social media cannot be overlooked in this crisis.

In the past politicians had the luxury of time to deal with complex issues and did not have their every move or decision scrutinised or live tweeted. The flow of information was largely constrained. Facebook and Twitter were in nascent stages and had not yet achieved the scale or reach that they now enjoy.

The evolution of these platforms as primary providers of news and their networking effects has changed the equation. In times of crisis cool heads are required, yet social media create the opposite effect by increasing anxiety among the public. The uncertainty, misinformation and disinformation on these platforms fuel mass panic and hysteria and create vicious loops that erode confidence and drive irrational behaviour. The result is a herd mentality that is manifested in panic buying. Today’s disinformation pandemic is arguably as dangerous as the health pandemic.

So, what do the contours of this crisis look like? There has not been a sustained public emergency like this since the end of World War 2, and the threats of mass unemployment, business failures and widespread poverty loom large. This crisis is likely to be much deeper and more protracted than the financial crisis of 2008 given that the real economic effects are happening at the same time as the financial effects, and that the shock to the system is broad-based, across all industries and all countries. Indeed, the spread of coronavirus is so different because it is so real — it is causing people to stay at home, thereby causing the wheels of commercial activity to stop turning.

Though the roots of this crisis are different, the cure will ultimately be the same: clear, coordinated and credible policy responses by governments and central banks are the only way to ensure the impending recession does not morph into a depression.

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