The Big Break – Post-pandemic ‘New-Normal’ | Part 1
This is the second edition of ‘The big break’, the first being published on the 8th April. This edition now covers the likely ‘new normal’ of 40 sectors and contains views on the impact on community, work and religion and a more in-depth economic outlook. Whilst ‘new normal’ is now a slightly overused phrase it represents well the business environment and changed circumstances that are likely to emerge after the lock-down and virtual closure of most sectors during the pandemic are lifted.
Following a season of environmental turbulence, we now face the challenge of surviving the COVID19 Coronavirus pandemic and of equal importance to business, its aftermath. In addition, in the UK, and for the rest of the EU, the impending change brought about by BREXIT and our desire to counter the impact of man-made climate change will add to the general discontinuity. Add to this, the inexorable rise of technology which presents us with the challenge to change, not just the technology we use but also our processes, culture and even our propositions. Automation and new practices will impact almost every area of our lives in the future. It will present itself in many guises, including through artificial intelligence (AI), the internet of things (IoT), 5G, edge and quantum computing and every sort of virtual and extended reality and also generate data on a scale and speed that we have never experienced and rarely imagined possible.
What the lockdown has shown us is that the imperative of co-location, which stemmed from the industrial era, is no longer a pre-requisite in the knowledge economy and we can now imagine new ways of working, seeking health advice, learning and entertaining ourselves, to name but a few ways. This report illustrates how forty sectors are likely to have changed after the strictures of the pandemic are fully lifted.
This report is written for two audiences:
- For organisations to be informed and motivated to think that their position before the pandemic might never be regained in the same way. Some will see great opportunities to build on changes that emerged during the lockdown of the world. Others may believe that most things will return to normal. Only time will tell us who is right. However, one thing is certain, slipping into irrelevance is not just possible but has been experienced by many past sector leaders who refused to think that the world and its needs, could ever change.
2. For Agencies and advisers to help their clients to not just grasp that times may be changing but that they need to lead the sectors they serve into that change, its consequences and potential responses. This is a time for confident firms/brands to prepare their markets to not just meet these new challenges but renew themselves in the process. A time to share their thought leadership with their target markets.
Every one of the following short illustrations on how sectors may change post pandemic can be expanded to produce comprehensive illustrations of the changes and challenges faced by their participants in the years ahead.
David A. Smith Graeme M. Leach
Chief Executive Director of Economics
We are not going back to the ‘normal’ we had before, however much certain industries or businesses may want to. Beyond the immediate and perhaps long-term health implications of the virus, lie the certainty of a deep recession or depression, shifting industry structures and hugely impacted human behaviours and expectationsi. It is plausible that five yearsworth of ‘change’ has occurred in just five weeks, and it is natural that such a shock has led many CEOs and leaders into fire-fighting mode. Were this crisis either a strict public health issue or a one-off economic problem, such a stance may be understandable. However, the intertwined nature of this crisis, not to mention its depth and breadth, necessitate a different approach, especially as lockdowns begin to ease around the world.
The assumptions we were operating on in a pre-COVID-19 world were already straining at the seams, with sustainability, changing consumer wants, uncertain global norms all demanding change, not to mention the friction from advanced technologies with legacy business, political and economic systems. Some of the changes underway will be turbocharged by the pandemic, some possibly reversed and whole new dimensions of risk, change and uncertainty introduced. We need to re-think our plans, strategies and purpose, using tools and methodologies able to interrogate a wider range of drivers than is typically available in corporate strategy processes.
Uncertainty is at present our only reliable indicator; for many this is profoundly uncomfortable, but it does allow us – or even compel us – to reexamine how we do things and even what it is that we do. Foresight will be central to many efforts. In the post-COVID world, notions of resiliency will change and likely become more systemic. If history teaches us one thing, it is that crises – both economic and social – are inflection points from which new ideas, new companies and new industries emerge. This crisis will be no different in this regard yet the tools, mindset and opportunities to build new services and industries are now more widely spread than perhaps any time in history.
Competitors will increasingly emerge from previously unrelated fields, as will potential partners and talent. Industries from banking to manufacturing and construction to law are likely to see lasting shifts in how business is conducted, what it means to be a professional in such an industry and what it is these industries even do.
“It is not necessary to change. Survival is not mandatory.”
W. Edwards Deming
2020-21 Coronanomics scenarios
The scale of economic uncertainty at present is perhaps greater than at any time in our economic history. As these scenarios show, in the second half of the year the economy could bounce back and regain all the lost output in the first half. Alternatively, if there is a second wave to the pandemic – over the Autumn-Winter period – the economy could implode and not regain pre-pandemic output levels until 2025-30. The range of possibilities is that stark.
Social distancing and the lockdown are a double-edged sword. They achieve the vital task of slowing the spread of the disease, but this leaves the majority of the population with little chance of gaining herd immunity. The knock-on economic threat is that permanent damage to the economy is likely to be a non-linear function of the length of the lockdown. It is non-linear because the longer the lockdown and social distancing continue the more economic difficulties intensify, with rising indebtedness, insolvencies, unemployment and precautionary behaviour. Of course, if the containment measures are released too early, a second pandemic wave might ensue, with the possibility of even more dire economic consequences. Governments need the wisdom of Solomon at times such as this.
The reason why a recession became a public health necessity remains the same. In the words of one American epidemiologist: “This virus is a combination of The Alien, The Day the Earth Stood Still, The Andromeda Strain and Apocalypse Now”.
Whilst there is increasing concern at the economic carnage wrought by social distancing and the lockdown, this does not mean that the tail is now wagging the dog. Epidemiological factors continue to outweigh economic considerations in the minds of policymakers. Newspaper reports on the Prime Minister’s first Cabinet meeting following his dice with death and Covid-19, stated that he quoted the Roman orator Cicero: “The Health of the people should be the supreme law”.
This is not to suggest that economic factors are being ignored, anything but. The Government clearly wants to get as many people as possible back to work “safely”. Flattening the curve has flattened the economy but lifting decisions will still be epidemiologically driven. Not least because a second wave to the pandemic would be even more devastating from an economic perspective, because the reintroduced lockdown could then extend for many more months.
The Government’s strategy is to move towards more targeted and less disruptive measures, subject to the reality that, “this ain’t over until it’s over” – when herd immunity and a vaccine are finally obtained, and that is likely to be 2021 at the earliest. Life is going to remain very different until that point in time. It is going to be very difficult to maintain control of the virus without some form of social distancing, unless a highly effective contact, tracing and isolation system can be put into operation.
So in lifting the lockdown and social distancing the Government is likely to proceed very cautiously with what has been described as a “whack-a-mole policy” hitting down hard on any flare ups with the potential re-imposition of stringent lockdown and social distancing where required. This has also been described as “adaptive tightening” with containment measures responding to hot spots around the country.
The economic need for lifting is obvious, but there is an epidemiological reason as well. Epidemiological models may not fully account for what is known as an endogenous behavioural response. This is the behavioural change which occurs during the lockdown and social distancing, which if not accounted for, risks leaving the containment measures in place too long. This points towards another sociological reason for lifting the lockdown as quickly and safely as possible. Former Governor of the Bank of England, Lord Mervyn King, has spoken of the potential for “rebellion risk” from people fed up with the controls and likely to start breaking all the rules.
Assuming there is no immediate complete lifting, or the authorities do not leave all the containment measures in place until there is an effective vaccine, there are 4 unlocking and lifting options:
- Unlocking based on age.
- Unlocking based on geography.
- Unlocking based on immunisation.
- Unlocking based on economic activity.
There are difficulties with all of the approaches. Unlocking by age might require that it becomes an offence to meet with people outside of the cohort age group. That’s surely not workable. A lack of herd immunity would also risk spreading the disease even with unlocking by age. Lifting by geography would yield the greatest economic benefit if it started in London, but that is where the threat of new cases could potentially be greatest given the melting pot of peoples. Without effective testing and tracking the infection rate might quickly climb back up. Lifting by
Economic scenarios summary
• The economic uncertainty is now greater than at any time in our peacetime economic
history. It is possible that any of the 5 scenarios, Super V, V, U, W or L could occur.
• On balance we think the U scenario is the most likely, given the lack of herd immunity to date, and the need for sustained social distancing rules for a sustained period, which will be a constant reminder of the threat to lives and livelihoods.
• Economic history suggests that Super V or V shaped bouncebacks are possible, but these tend to be after economic downturns far less than at present.
• A second wave to the pandemic would have catastrophic consequences for the economy.
Previous pandemics and the economy
Studies of the Spanish Flu suggest it resulted in a 6-8% reduction in GDP and a 20% loss of manufacturing output. But we’re hampered by poor data and a dearth of studies on this earlier period. One literature reviewii of the impact of the Spanish Flu on the US economy found little effect.
A cursory glance at the historic quarterly UK GDP series for the period of the Asian and Hong Kong Flu pandemics shows mere blips with a complete bounce back in the next quarter.
The most recent studies modelling the economic impact of pandemics have been of an order of magnitude greater than previous ones. A 2020 studyiii from the OECD estimated that a large economic shutdown as a result of a pandemic would result in a 20-25% GDP loss for each month, implying a three-month shutdown would induce a 5-6% drop in annual GDP – other things unchanged. In the UK, the Office for Budget Responsibility (OBR), in compiling its baseline reference scenarioiv for HM Treasury, estimated that each month of full lockdown reduces the level of monthly GDP by 35%.
Moreover, the longer the crisis lasts the bigger the economic problem becomes as wider negative effects take hold. The difference between the economic impact of this pandemic with those previously, has been highlighted by the Bank for has stated that: “the context of high globalisation and high leverage in parts of the corporate and household sectors makes these short-term amplification mechanisms more potent than in past epidemics”.
What we do know is that: (1) The economic consequences of a pandemic will differ in each case. (2) The economic impact is a combination of supply and demand shock effects. (3) Pandemics can have long lasting economic effects well beyond the point when herd immunity is attained.
The 5 scenarios
The 5 economic scenarios are intended to be illustrative of the key factors which will lead to alternative outcomes.
From an economic perspective the critical epidemiological influences are:
The speed and scale of the lifting (or re-imposition) of containment measures.
Whether or not there is a second or third wave to the pandemic.
The economic scenarios described are:
- Super V economic cycle (The miraculous recovery scenario) – Based on a superfast lifting of the lockdown and social distancing. This results in a miraculous economic recovery with pre-pandemic output regained by the end of the third quarter 2020.
- V economic cycle (The full recovery scenario) – This scenario assumes a fast lifting of the lockdown and social distancing, with half the economic losses removed in 2020Q3 and the remainder in 2020Q4. This results in a full economic recovery by the end of the year.
- U economic cycle (The hospitalised scenario) – Based on a slow lifting of the lockdown and social distancing, with the economy continuing to be hospitalised and pre-pandemic output levels not regained until 2023.
- W economic cycle (The intensive care scenario) – This scenario sees the emergence of a second wave of infections, with a tightening in lockdown and social distancing. This is enough to keep the economy in intensive care over the 2020-21 period. The double-dip in output means that pre-pandemic output levels aren’t regained until 2025.
- L economic cycle (The near-death scenario) – This scenario sees the emergence of a massive second and possibly third wave of infections over the 2020-21 period. Mutation of the virus and very low levels of herd immunity result in draconian lockdown and social distancing rules, the economic consequences of which are catastrophic. The economy nearly dies and takes until 2030 to recover pre-pandemic output levels. It’s that bad. This is an outlier scenario to illustrate the worst possible case.
Super V scenario
The Super V economic scenario is based on a rapid lifting of the economic lockdown and social distancing beginning in the middle/end of May, as the authorities draw confidence from other economies such as China and Italy, who are further along the epidemiological curve. Declining cases and deaths leads the authorities into a phased lifting of restrictions with most lifted by mid-August 2020. This is the superfast lift scenario with strong knockon economic effects. What goes down goes back up – this is the idea of Say’s Law, paraphrased as supply creates its own demand, and that if a negative supply shock started the crisis, a positive one can end it, if the intervening period has been relatively short without permanent damage to the economy.
Consumer and business confidence builds as mass testing produces evidence that herd immunity could be reached before the Autumn/Winter. Consumers return to the High Street in droves, eager to spend their repressed consumption. The stock market surges as a result as well. Significantly also, the projected 2020Q2 fall in output is reduced as a result of the containment measures beginning to be lifted in 2020Q2. Unemployment falls quickly under this scenario with most furloughed workers returning to work by the end of 2020.
The strong economic pick-up is encouraged by pro-cyclical fiscal and monetary policy with the economic benefits of the relief measures timed to coincide with shops and businesses reopening. The lag in payments from HMRC to individuals and businesses means that restrictions begin to ease just as the money comes through the letterbox. In other words, fiscal policy begins to take effect in an upturn not a downturn, encouraging the economy to overshoot upwards. The strong policy stimulus – both fiscal and monetary – with an acceleration in money supply growth, leads to higher inflation and higher interest rates in 2021 to slow the economy.
Wider and more enduring economic effects may emerge at this time as well, with the emergence of new business models based around alternative ways of working, retailing and learning which emerged during the crisis. There may also be a greater agility and openness to new business model ideas built around AI, 5G and IoT. We could see a positive sense of post-pandemic new normal emerge, along the lines of what was seen in the US in the ‘Roaring Twenties’ (1920s).
The Super V recovery scenario would be a repeat of the quick rebounds in the UK economy seen after the Asian Flu (195859) and Hong Kong Flu (1969-70). It would also be akin to those seen in China and Hong Kong post SARS in 2003-04.
The V scenario
The V economic scenario has the quarterly rate of output growth slightly slower in 2020 than under the Super V scenario. In the Super V scenario the economy contracts by 20% (quarter-onquarter) in 2020Q2 but then grows by 25% (quarter-on-quarter) in 2020Q3 and a further 3% (quarter-on-quarter) in 2020Q4, thus regaining pre-pandemic level of output by the end of 2020Q3. In the V scenario the economy contracts 30% (quarter-on-quarter) in 2020Q2 but then grows by 21% (quarter-on-quarter) in 2020Q3 and a further 18% (quarter-onquarter) in 2020Q4, thus regaining prepandemic level of output by year-end.
Comparing the V with the Super V scenario there are very similar effects: consumer bounce, improved consumer and business confidence, stock market recovery, investment pick-up, pro-cyclical policy effects, falling unemployment and very little loss of permanent output. These effects are slightly more muted, that’s all. This also means that the upward overshoot seen in the Super V scenario is less marked and the increase in inflation in 2021 (as a result of faster money supply growth in 2020) is as well. This still requires a policy response in 2021 but the tightening is less as a result also.
As with the Super V scenario, the V scenario is supported by historical experience seen in the previous Asian and Hong Kong Flu and SARS episodes. Both the Super V and V economic scenarios may also be supported by the economic effects of the Spanish Flu in 1918-19. The conventional wisdom is that the US economy contracted sharply over that period. However, revised estimates of historical GDP over this period in the US suggest the downturn was far less, and therefore compatible with a V shaped recovery.
In the UK the economy boomed over the 1918-20 period. Comparisons are however confounded by the difficulty in separating out the effects of Spanish Flu from demobilisation at the end of World War 1, poor quality data and a dearth of economic studies on the impact of the pandemic on the economy. The sheer scale of the Spanish Flu pandemic makes it relevant to understanding Covid-19 now, but it’s a frustrating comparison. Unlike the US, the UK had an immediate postwar boom, but then experienced a GDP downturn in the early 1920s which was worse than in the depression of the 1930s.
The U scenario
The U economic scenario is based on a slow lifting of the lockdown with around half the bounce back seen in the Super V and V scenarios in 2020Q3 and 2020Q4. Subsequently, whilst there is no second wave of infections in the U scenario, there are sporadic upticks in cases and deaths which result in the authorities keeping some aspects of social distancing (e.g. for the over 70s and those with vulnerable conditions, or on a geographical basis tied to hot spots) until after the Autumn/Winter of 2020-21.
The retention of these controls provides a constant reminder to households and firms that an invisible threat to their lives and their livelihoods remains. The natural consequence of this is a significant increase in precautionary savings by individuals and companies, a caution reinforced by the higher levels of unemployment this scenario entails. Firms are also likely to be wary of making investment decisions given the greater uncertainty which will arise every time an uptick in cases or deaths occurs. As a result, the U economic scenario foresees the economy not regaining pre-pandemic levels of output until 2023, partly due to the permanent losses of output which occur due to the depth and duration of the downturn.
Another important factor in this U-shaped cycle is the emergence of stagflation i.e. high simultaneous levels of both unemployment and inflation. The weaker economic recovery following the sharp downturn naturally lead to higher levels of unemployment. However, the economic policy response (government guarantees for bank lending and monetisation of the budget deficit) leads to more inflation as well due to an acceleration in the money supply. This requires a little explanation, for the opposite might thought to be the case.
The initial economic effect of the pandemic was a supply-side shock as the Government sought to prevent workers from working, and consumers from consuming, in order to keep infected and uninfected people as far apart as possible. This resulted in a collapse in output way below its potential rate of growth – in economic speak, a very wide output gap opened up. In this situation of rising precautionary saving and reduced investment (saving exceeding investment in the economy), deflationary pressures might be expected to increase, and they could if nothing else changed.
But these developments are not in isolation. There has been a massive fiscal and monetary policy response. Moreover, this response – certainly in the US at the time of writing, less so in the UK, but changing – has resulted in a sharp acceleration in the money supply. The money supply is being boosted by further quantitative easing, the monetisation of budget deficits and commercial banks encouraged to lend – as opposed to being told re-build capital after the financial crisis. The velocity of money (crudely, the number of times it changes hands) will have fallen as well with the lockdown and social distancing, and this will take some of the edge off the inflation increase.
The W scenario
The W economic scenario is the second worst economic scenario in the set of 5. It’s worse because it incorporates the possibility of a moderate second wave of infections in the Autumn-Winter of 202021. This leads the authorities to tighten social distancing rules and certain aspects of the lockdown. It is not a full-retreat to the containment policies enforced over the March-May period, but it is sufficient to have a very negative effect on consumer and business confidence.
The W shaped cycle incorporates a 23%(quarter-on-quarter) recovery in output in 2020Q3. Things appear to be fine, but then the second wave hits in the Autumn and the economy contracts by -6% (quarter-on-quarter) in 2020Q4 and by 7% (quarter-on-quarter) in 2021Q1. This second wave is brought under control, but it is sufficient to trigger a further wave of insolvencies and unemployment.
This scenario is dangerous because it results in GDP in 2021Q1 still being at only 75% of its pre-pandemic level in 2020Q1. This suggests enormous permanent losses in output across the economy. Precautionary saving is much higher and investment much lower, as the nascent recovery is completely snuffed out.
The scale of the explosion in public debt is enormous because in this scenario: (1) Automatic stabilisers – such as unemployment and other benefits – are much higher. (2) Tax revenues are much lower. (3) Discretionary expenditures – such as reliefs for business – are much higher. (4) Government guarantees to the banks begin to be called in on a large scale.
In contrast to the Stagflation seen in the U economic scenario, the W scenario foresees the arrival of Super Stagflation with sustained double-digit inflation and unemployment. The super stagflation is encouraged by even greater monetisation of the budget deficit and consequent money supply growth.
In this scenario more inflation becomes an actual policy target as a means of eroding the real value of debt in the public and private sector. The rise in inflation triggers a response in the bond markets with spikes in yields well beyond current extraordinarily low levels. This further weakens the economy and the prospects for recovery, with the result that the economy doesn’t regain its pre-pandemic level of output until 2025.
One of the dangers in the W scenario is that if the weakness intensifies in a supply-demand doom loop, the shape of the cycle could end-up being less W and more VL shape. In such circumstances the even more frightening prospect of the L scenario comes into play.
The L scenario
The L economic scenario is without doubt the most shocking economic outlook I’ve ever considered in 30 years of economic forecasting. Everything but the kitchen sink is in there (listed below), not because it would all happen (though it could), but simply because everything in there is a possibility, if there were to be a major second and possibly third wave of infection. If herd immunity levels are very low going into the Autumn/Winter and/or the virus mutates, this lower probability ultra-high impact scenario could come to pass. It is a scenario where the R0 number moves well above 2 and a massive lockdown is then enforced, even more stringent than before. Draconian containment measures are then kept in place throughout the Autumn/Winter of 2020-21.
The economic consequences of a second (and third wave) are simply horrific.
Having grown 15% (quarter-on-quarter) in 2020Q3, the economy declines -7% (quarter-on-quarter) in 2020Q4 and a further -14% (quarter-on-quarter) in 2021Q1. There is also the possibility of a further contraction in GDP in 2021Q3, due to a third wave, but this is less important (in terms of whether it happens or not) because the damage will already have been done.
Under the L scenario, by the end of 2021Q1 the UK economy would be at 60% of its pre-pandemic level of output. In other words the economy will be down 40% (year-on-year). Feed these assumptions through and it means that the UK economy would contract 22% (year-on-year) in 2020 and 23% (year-onyear) in 2021. Such an economic scenario would unleash economic, social and political dislocation on a par with a devastating war – it is the Armageddon scenario. This is ‘one L of a recovery’ for all the wrong reasons. Here are just a few of the potential outcomes from it:
- Depression levels of unemployment at 20%+.
- Transition from deflation to inflation.
- Massive public deficits above 20% of GDP, with an explosion in public debt.
- Monetisation of budget deficits.
- A surge in inflation because of monetisation.
- Financial contagion.
- Supply-demand doom loops.
- Sovereign-bank doom loops.
- Protectionism and beggar thy neighbour policies.
- Return of the euro crisis.
- North-South tensions in the EU and pressures towards disintegration.
- An epidemic of zombie companies.
- A glacial return to normal with prepandemic output not regained until 2030.
- The epidemiological uncertainty is such that all the scenarios need to be considered. The most probable at present would appear to be the U-shaped cycle because of the likely maintenance of social distancing and certain aspects of the lockdown for many months to come. Prepare your business for this scenario but also be alert to signs that alternative scenarios might be coming to pass. If evidence of stronger herd immunity appears then the V and possibly even the Super V scenario would come into play. The lack of evidence of herd immunity and any sign of a second wave brings the W scenario into consideration.
- Most commentators think that the crisis is likely to lead to deflation. Whilst this might be true in the short-term, later in the year and into 2021 inflationary pressures might begin to emerge because of the acceleration in the money supply underway. Be aware of this possibility in your business planning.
- Be alert to the potential introduction of new business models around AI, 5G and IoT by your competitors. Lessons learned in the lockdown could have an enduring impact and make companies more agile than previously.
The Big Break – Post-pandemic ‘New-Normal’ | Part 2 – … To be continued/…