Will the Corona Crisis lead to an Economic Crisis?
As the Corona (or Covid-19) virus is spreading, more people and more businesses are affected. Governments are placing whole regions in quarantine. Will the Corona Crisis eventually lead to an economic crisis? Is the downfall in the stock markets the first sign of longer lasting effect on the international economy? And can the crisis also have a positive effect on trade; do countries or companies profit from this extraordinary situation?
Julia Swart and Marc Schramm from the Utrecht University School of Economics (U.S.E.) shed their light on the economic consequences of the Corona Crisis. ‘This shock is temporary,’ says Schramm, ‘it will last a few months. And if it turns out to be a pandemic, it will last some months more. But it is not a permanent shock.’
When we meet to reflect on the economic consequences of the Corona Crisis, news just comes in that there’s a major downfall in the international stock markets, strongly linked to the decline of the oil price.
‘Two shocks coinciding leads to much more insecurity about profit prospects in the future,’ says Marc Schramm. ‘Oil prices also declined a lot during the corona crisis,’ says Julia Swart, Assistant Professor of Economic Sustainanility: ‘because people are traveling less, as well as by car as by airplane and that has had a strong effect on the demand for oil. That is only natural, this is how the market works. The question is: how long will it take?’
I wouldn’t say this a prelude to a deep crisis, like the ’29 crisis in the 20th century or the 2008 crisis.
Different types of crisis
‘The uncertainty makes it difficult for us to make a prediction,’ Swart adds, ’because it is not solely an economic prediction, it is also about how the virus will evolve, spread and how politicians will deal with that.’
‘I wouldn’t say this a prelude to a deep crisis, like the ’29 crisis in the 20th century or the 2008 crisis’, Schramm says. ‘Stock prices rise and fall in times when there is insecurity about the future. That is the case now, with the outbreak of the virus and because of the policy responses to this, for instance by containing entire areas like the major industrial region of Wuhan in China and Milan, the ‘engine’ of the Italian economy. That kind of response will have negative effects on firms and their profit’, he says, ‘but we do not know if this kind of putting regions in quarantine will be extended to other regions.’
‘Shocks in the past, like the mortgage shock for example, were a crisis in the financial sector itself. Investors didn’t know which banks were safe and which were not and we saw a collapse in trust in the financial sector. We didn’t know when the shock would be over. That meant that more insecurity drove the investment decisions, consumer decisions in spending, and led to a much bigger and prolonged recession than, I would say, a virus will.’
Can this crisis be compared to the effect of the SARS crisis?
‘It can,’ says Swart, ‘we saw the same events then. It is a shock in the economy. That creates uncertainty and the markets respond in a very rational way. People want to invest less, taking their money from companies that are hit the most. You can see that not all companies stocks have declined; there are also companies who benefit from this crisis. That is similar to what we have seen during the SARS outbreak. There is, however, an important difference between the two crises. SARS is now seventeen years ago and China was already a big player in the market, but nowadays China’s GDP is over 15% of global GDP. When production in China stops or decreases nowadays, it has a much larger impact in the global economy.
The type of shock that occurs in the economy now is of a different nature. When the virus broke out, it was not that we wanted to consume less, we could simply not get access to some products. You see the prices of some goods increasing: it affects other countries through a supply chain shock. It is much stronger this time because China has become much bigger in terms of how much they consume and also because of how they link to other economies through the supply chain.’
Supply shock and demand shock
Could the current crisis also be considered as a necessary correction, like a forest fire, and have a cooling down effect on the Chinese economy?
‘I do not think so,’ Swart responds. ‘There are others tools to cool down an economy: monetary policy, fiscal policies. In the case of the Corona crisis you have winners and losers. The shock is never good, because it hits some firms more than others. It is disproportional and creates imbalances in the economy and that’s never good.’
Schramm: ‘The Corona outbreak contains two types of shocks: a supply shock and a demand shock. We see a standstill or limited production in the regions put in quarantine – a negative supply shock. People get sick, and can’t go to work; negative supply shock.
But it also a demand shock. People are not going to bars and restaurants any more, are not travelling as much. The drawback with this virus is, that it also hits service industries; retail, café’s, hotels etcetera. And these are typically services and goods a government does not purchase. Normally a government can stimulate the economy by spending more, but I don’t see the Chinese government spending more in cafés and restaurants, and the same goes for lowering the interest rates.’
The big firms start selling less, sometimes had to close their doors and experience a shock but will eventually come back to normal. But the small and medium size firms in particular services can get a shock that is permanent.
When the situation returns to normal, you will have the same competition again.
Do you see winners, who profit from this crisis?
‘It happens,’ Swart confirms. ‘American companies for instance started producing the masks people are wearing during this Corona virus outbreak. But at the same time most companies already have a few alternatives of firms from which they can buy. Apple may be a specific case (and there are more) but usually companies look for competition, lower prices. And in this situation the Chinese prices will be higher and they might turn to another supplier. So there is some room for change, and some companies might benefit from the crisis, but companies hardly have become bigger than others because of the crisis. When the situation returns to normal, you will have the same competition again.’
‘This shock is temporary,’ says Schramm, ‘it will last a few months. And if it turns out to be a pandemic, it will last some months more. You only get a relocation in the supply chain, when it’s a more enduring process. For instance when China would become more expensive, companies like Apple are inclined to move to Bangladesh, Vietnam or other low cost economies. But it will not lead to a major recession.’
Small and medium size businesses are hit the most
Have we become dependent on the Chinese economy?
‘We are dependent on China,’ Swart says. ‘Many companies were hit when China stopped producing, but not on such a large scale.’
‘And it is confined to a certain region,’ Schramm adds, ‘the Hubei region is about heavy industry, chemicals etcetera. It is not the whole range of manufacturing industries that was affected. ‘
‘The issue is that it really hurts some small firms,’ says Swart. ‘The big firms start selling less, sometimes had to close their doors and experience a shock but will eventually come back to normal. But the small and medium size firms in particular services can get a shock that is permanent. People are not going to the gym any more, not going to restaurants anymore. They may have invested a lot, and acquired a lot of debt, and the bank might say: sorry, we have to file for bankruptcy.’
‘This will definitely hurt,’ Schramm adds. ‘But is temporary. If the gym survives, next year customers will be back for sure. A more permanent shock could be the trade war between China and the US, which results in trade barriers and makes firms think about relocation,’ says Schramm. ‘The initial response in the US to the Corona virus was: “that is good, because now we can produce more,” which is a pretty lame statement. But it is not trivial to look at how the US respond to such a crisis. An inadequate policy response to such a temporary crisis could have an effect on the profit prospects of major American companies in the world and on the stock markets in general.’
Contact & Expertise
Would you like to know more about international economic developments linked to the Corona crisis? Please contact Julia Swart and Marc Schramm.