The scars of Covid-19

The coronavirus crisis is likely to have persistent negative effects on world output. Our baseline forecast already assumes the crisis will cut the long-term level of world GDP by around 2%, or US$2.1tn. But our analysis also suggests a plausible downside would see long-term GDP losses of 5%, or US$4.9tn.

Sharply rising public and corporate debt are possible channels through which long-term growth could be hit. Interest rate effects look likely to be muted compared with the past. But high public debt could lead to (unnecessary) austerity, and high company debt could induce increased corporate caution.

A persistent rise in unemployment is another risk. This has been the pattern after past deep recessions, although it’s possible that the extent of “task reallocation” needed this time will be lower, reducing the rise in joblessness.

Weaker world trade growth is likely, with certain areas set to be depressed for some time. This implies a less open world economy. Some studies link reduced trade openness to lower productivity growth, although the link is disputed.

A major danger is lower investment. This could happen via various channels, including “belief scarring” that raises the hurdle rate on capital spending. Policies to preserve the supply side can reduce, but not eliminate, this risk.

The interruption of new business formations, leading to a “lost generation” of young firms, reduced labour turnover, and tighter credit conditions also threaten to have persistent negative effects.

Quantifying the size of these effects suggests long-term GDP losses could exceed 5%. This allows for considerable overlap among these channels. There are good reasons why some channels might not operate strongly this time around, but risks around some of the estimated effects are not all one-way.

Topics: Coronavirus