In the last few days Australia, like Japan and Hong Kong, has had a panic run on toilet paper. Riding the calm and good-natured Melbourne trams, I don’t get any sense of a society in meltdown. Nor is this a country in the frontline of the coronavirus epidemic with 100 cases so far identified, and three fatalities. Tragic individually but paling into insignificance in comparison to the annual death toll from flu.
Nonetheless many people are not convinced either that country is relatively safe, or by the knowledge that coronavirus does not produce diarrhoea. Even Australia’s capacity to make its own loo paper does not offer reassurance. People calculate instead that they might be infected and quarantined and will need a stock of essentials. The risks are remote but the response itself is not irrational.
Australia may not be the best place to get a handle on the epidemiology of coronavirus. But it is an excellent vantage point to look at the economics. More than other developed economies, its economic outlook is affected by what happens in China. Indeed its prosperity and solid growth depend to a considerable degree on Asian growth, especially China’s.
Already, some sectors of the economy are being badly hit. Visitors’ bookings from Hong Kong, Singapore and Japan are down over 70 per cent since the outbreak, aborting a recovery from the recent bushfires. Schools and colleges heavily dependent on Chinese student fees are under threat. Exports of food products and raw materials are being hit. The construction industry is believed to have around 40 per cent of its equipment and supplies from China. The Reserve Bank was quick to cut interest rates to reduce the considerable risk of Australia moving into recession.
While the public, in almost every country, is naturally preoccupied with the chances and consequences of catching the bug, governments are having to prepare for what could be a major pandemic-induced recession. We cannot yet tell if the impacts will be on the scale of the oil price shocks or the 2008 financial crisis but there are good reasons to be fearful.
As it happens, Australian economists Fernando and McKibbin have already produced some clever modelling of the likely economic effect of coronavirus in different countries under different assumptions. In the increasingly improbable event that the epidemic is largely confined to China, then China loses 6 per cent of GDP in 2020, Australia 0.7 per cent, the UK 0.3 per cent and the eurozone 0.4 per cent.
If the virus leads to a full-blown global pandemic, losses rise, on a worst case scenario, to 10 per cent of GDP in Japan, 8.4 per cent in the eurozone and the USA, and 6 per cent in China and the UK. These potential losses are on top of other problems, not least the impending end of the Brexit transition period in the UK. The capacity of “global Britain” to conclude preferential trade deals the world over inside nine months is ebbing by the day. Meanwhile, countries with already struggling economies and big outbreaks like Italy are especially at risk.
The economic impacts of a coronavirus shock are to be seen on the supply and the demand side of the economy. Supply is already being disrupted by the loss of key components from China, and a consequent scramble for scarce products. China may resume production quite soon but loss of trust in suppliers, leading to panic restocking, and the knock-on effects will have longer-term consequences.
Just as a severe but relatively short blockage on a motorway can produce miles and hours of tailbacks, even brief disruption in a supply chain can have a considerable domino effect. Adding to the disruption in supply of things will be a contraction in the supply of labour. As the epidemic takes hold, there will be potentially large absences from work while people recover from the symptoms and quarantine themselves to curb the outbreak.
On the demand side, we are already seeing the impact of cutbacks in consumption in some sectors, notably travel. This is not a good time to be an airline; a cruise-ship operator; a conference facility, or a major sports venue. The British government’s decision last week not to continue bailing out Flybe may be an indication of bigger casualties on the way. And there are serious doubts about whether Sunday’s Australian Grand Prix in Melbourne can go ahead.
Though there are opportunities for manufacturers of medicines, hand creams, fumigants and face masks – and, of course, loo rolls – these small sectoral peaks pale into insignificance beside the overall damage to consumer confidence. A climate of general pessimism about the future, which any pandemic engenders, can have major impacts on economic behaviour. The large sell-off of stocks last week was one, early, forward indicator of an economic downturn.
The 2008 financial crisis provides a template for how to use the full toolkit of economic responses to a global emergency: both the demand-side stimulus of fiscal deficits and loose money and supply-side intervention, which was then about keeping banks afloat and credit flowing and the car industry from collapse. Now it is about keeping a wider gamut of economic activity going. Maybe Boris Johnson should show a bit of statesmanship and invite in Gordon Brown, Alistair Darling and Mervyn King to learn from their experience. Their decision to make a deep but temporary cut in VAT to stimulate spending may yet prove a valuable lesson.
Governments do face an immense problem in that demand-side tools are blunted from overuse and may not work again. Interest rates are already close to zero and there is little scope for further cuts beyond those reached last week (negative rates are theoretically possible – penalising savings – but can have potentially crippling effects on banks and their stability).
Quantitative easing large scale bond purchases by central banks can and will be tried again but the main mechanism by which they work (driving down long-term interest rates) has already been achieved since bond yields are already rock bottom.
The use of fiscal policy is inhibited by the fact that governments almost everywhere have much higher levels of debt than before the 2008 crisis, in particular China – hero of the last crisis – now has huge deficits from its massive programme of infrastructure investment.
Supply-side measures could include government wage subsidies to firms to cover the costs of workers (including contractors) being quarantined. In particular, it is reported that China is already channelling financial support to struggling companies, and it may not be long before the west has to take a similar approach.
Likewise, state supervised rationing becomes a real possibility. Such measures are more easily introduced in communist China than the west but rationing has been used selectively before (fuel) and will be imperative if, for example, medicines run short.
This crisis will also bring to the surface deeper, longer-term issues and obscure others. It will highlight the vulnerability inherent in economic interdependence, and the folly of reducing cross-border cooperation. The fact that paracetamol relies on an ingredient produced for much of the world in one factory in China is striking. Yet long-term existential issues risk being pushed to the bottom of the pile.
A few weeks ago, Australia was immersed in a climate debate stemming from unprecedented fires and the government’s complacency. Now, all that is forgotten as a more immediate threat appears.
Sir Vince Cable is a former leader of the Liberal Democrats and a former secretary of state for business
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