Aug 25 2020
Measures implemented by the UK government intended to help navigate the COVID-19 (coronavirus) pandemic, including social distancing policies, travel restrictions, temporary supply chain shutdowns and a hiatus in non-essential business activity, have resulted in severe economic consequences. On 12 August 2020, upon release of Office for National Statistics (ONS) data on UK GDP, the UK economy was officially declared to be in a technical recession after recording two consecutive quarters of negative economic growth. UK GDP fell by 20.4% in Q2 2020 (April to June), following a 2.2% decline in Q1 (January to March) 2020. UK GDP was down 22.1% in Q2 2020 compared with Q4 (October to December) 2019, prior to the coronavirus outbreak, making this the UK’s deepest recession on record.
Official figures also confirm the pandemic has hit the United Kingdom harder than most other developed economies in the first half of 2020. Second only to Spain (22.7%) among European peers, the UK GDP decline since the end of 2019 was more than double that of the US economy (10.6%) and compares particularly badly with that of Germany (11.9%). The length of the UK’s lockdown coupled with its reliance on the services sector, which is most exposed to government restrictions and has a significant weight in UK GDP, can explain the UK’s underperformance relative to other developed nations. Despite the UK economy being pushed into its first technical recession since 2009, a recovery from the depths of the lockdown gained momentum in June 2020 as restrictions have been eased.
While this is positive news, the United Kingdom is by no means out of the woods and the duration of a pandemic-induced recession will only be obvious in hindsight. However, past recessions and recoveries have followed four common shapes – V, U, W and L – where the letters depict the trajectory of GDP, employment and other key metrics tracking economic conditions. The Bank of England (BoE) has said the shape of the UK’s recovery is so far V-shaped, but how was this determined and what does a V-shaped recovery actually mean? This article examines the four recovery scenarios and speculates on the possibility of each coming to fruition.
The consensus agrees a V-shaped recovery is the best-case scenario. A V-shaped recovery is characterised by a quick rebound in measures of economic performance subsequent to a sharp downturn, and assumes minimal long-lasting financial damage. In essence, a V-shaped recovery would mean UK GDP hits a pre-pandemic level just as quickly as it nosedived away from it. While true that the UK economy has shown early signs of a V-shaped recovery, with output growing by 8.7% month-on-month in June 2020, meaning UK GDP has grown 11.3% since its April nadir, the probability it returns to a pre-pandemic level anytime soon is unlikely. According to ONS data, UK GDP remains 17.2% lower than in February 2020, before the pandemic gained momentum in the United Kingdom, and the BoE has now tempered forecasts for UK economic rebound. In its August 2020 Monetary Policy Report, the BoE stated ‘GDP is not projected to exceed its level in 2019 Q4 until the end of 2021, in part reflecting persistently weaker supply capacity’. For a V-shaped recovery to come to fruition, rapid government intervention that goes beyond measures currently in place to protect jobs, support business activity and reignite consumer spending would likely be needed to help recoup that 17.2% gap in pre-pandemic and current GDP levels during Q3 (July to September) 2020.
As the V-shaped model assumes that all sectors in the economy are reopened simultaneously and consumer behaviour does not change, depending on whether lockdown restrictions are reintroduced if a second wave occurs, the U-shaped recovery is perhaps the most plausible of the four models discussed. This hypothesises a scenario where recovery is prolonged beyond the near term. Although monthly data in June 2020 showed UK GDP has begun to bounce back as shops gradually reopen, factories begin to ramp up production, and construction site activity accelerates, as GDP remains far off its pre-pandemic level, the economy has by no means rebounded instantaneously and UK GDP may not return to a more ‘normal’ level for an extended period. While the economy is reopening at a measured pace and as people gradually return to their normal behaviour patterns, recovery in UK GDP may prove slow or otherwise stagnate amid uncertainty regarding factors determining the outlook. For instance, if an increasing number of businesses with depleted cash reserves are unable to remain commercially viable as the economy reopens and if coronavirus support from the public sector dries up, there may be fewer jobs in the economy going forward, creating further economic dislocation. In turn, the implications of public health restrictions may last beyond the lifting of the first-wave lockdown, resulting in a prolonged period of lacklustre economic prospects; this is a more likely scenario than the V-shaped model.
Arguably, what happens next will determine whether the UK’s economic recovery depicts the W-shaped model or not. Effectively a double-dip recession, the W-shaped scenario foresees an economic cycle of recession, recovery, recession, recovery. The UK economy is now at a critical point in the pandemic. If social-distancing measures are ended prematurely, the potential for a second wave of a coronavirus outbreak could force another lockdown, likely leading to an economic downturn just as deep as, if not deeper than, the recession currently in motion. Similarly, a double-dip could be borne out from the delayed implications of the first lockdown; as public health restrictions are eased and the economy reopens, the longer-term effects of unemployment and corporate bankruptcies could begin to filter through. Considering the W-shaped model is contingent on the occurrence of a second wave and the post-lockdown implications for unemployment and insolvencies, it is said with caution that this scenario is likely. What can be said with a high degree of certainty, however, is that we will find out imminently.
Assumed to be the least likely of our four recovery models and considered the worst-case scenario, the L-shaped model is based on the notion that there is a sharp drop in economic output and GDP will stagnate or recover at a slow pace, if at all. L-shaped recoveries are characterised by persistently high unemployment, a subdued return of business investment and capital acquisition activity, sluggish production output, weak consumer spending and consistently low sentiment. While the official recession may end within a few quarters, the L-shaped model foresees years, rather than months, of recovery before GDP returns to its pre-pandemic level. For the L-shaped scenario to become a reality, almost everything has to go wrong in dealing with the coronavirus crisis. If, for example, the number of coronavirus cases rises significantly and continues to do so beyond the near term, forcing protracted lockdowns, the economy would likely continue to operate below normal capacity for an extended period, potentially resulting in years of financial hardship and a drawn-out adjustment process. Optimists are hopeful current measures to prevent further outbreaks and supportive policies to simulate both business activity and consumer spending go far enough to thwart the possibility of this scenario. However, poor handling of the coronavirus crisis from this point onwards could push the economy into an L-shaped recovery.
These four recovery models are by no means the only shapes the UK’s macroeconomic recovery could take. We could discuss scenarios where economic recovery sees the gulf between the ‘haves’ and ‘have nots’ move in disparate directions and widen, in a K-shaped recovery, or where the economy goes around in circles for a while before the UK market breaks free from pandemic-imposed restraints on growth, known as a Q-shaped recovery. Frankly, it is difficult to determine what shape the economic recovery will be, as the duration of a pandemic-induced recession will only be confirmed in hindsight. What is certain, however, is that the UK economy is currently at a tipping point. The critical decisions regarding the ongoing reopening of society will dictate whether the country will re-enter lockdown and if economic output can accelerate with assistance from government policy, or whether the threat of a second wave is heightened and the UK market needs to prepare for a protracted quarantine and lacklustre economic prospects. For UK GDP to rally in a V- or U-shaped formation, sectors like construction, services, and industrial production must be able to operate at regular capacity and have access to finance, working capital, labour and supply chains. However, fears of a W- or L-shaped recovery will gain momentum, pending a second wave or the delayed economic implications of the first lockdown period.