Beyond short term economic impacts: a look at the long-term challenges

As we move into the next phase of the crisis, the government have responded by effectively putting the country on partial ‘lockdown’ with all but essential activity prohibited.

As we pointed out last week, the stronger the public health response, the greater the shutdown required to our day-to-day economic activity.

Of course, there is no trade-off between protecting people’s lives and the economy. But the challenges now facing our economy are huge. This is why the Chancellor’s response last week was so significant. Not only will the measures help protect livelihoods in the short-term, but they will also help support the recovery.

However, even with these measures we are already seeing firms shutting up shop for the last time. And it seems inconceivable that current events will not have a long-term impact upon our economy.

The short-term hit to the economy

When the economic fallout from the coronavirus pandemic first started to emerge, much of the discussion revolved around how best to mitigate any temporary hit to growth and employment.

The key word in all this is temporary. People off-work will return. Activities postponed will take place once again. And gummed-up supply chains will gradually return to normal.

Economists have a good understanding of the channels through which the economy will be impacted by the coronavirus pandemic in the short-term.

Firstly, there is the direct impact of people who are sick and taking time off work. But provided that the effects of the virus on the working age population are – as predicted – time limited, the impact will be relatively small, and short-lived.

Secondly, and more significantly, are the implications from the public health response. Quite rightly, governments across the world are reacting to contain the spread of the virus. But the medicine, is for ‘non-essential’ parts our economy to effectively shut-down.

On the demand side, many sectors of our economy – from tourism through to pubs, restaurants and other forms of ‘social spending’ – face an unimaginably tough few months. With yesterday’s lock-down, this will extend to many more sectors of our economy. Unlike previous recessions where we might expect single digit % falls; here, we are talking about a total cut-off in demand.

On the supply side, encouraging people to work from home will – for some – impact on their hours worked and/or productivity. For others, it is simply impossible to work from home. The closing of schools etc. and banning of all but essential travel takes this to a new level.

Add on to this, a period of uncertainty, plus a synchronised global downturn, and it’s easy to see how you can arrive at some big numbers for the economic impact – see

Inconceivably just a week or so ago, a double digit fall in GDP over the quarter would now not come as a shock.

 The longer-term risks

So how quickly might our economy bounce back?

Obviously, much depends upon how the crisis pans out in the weeks ahead. And how quickly our economy can get back to some form of normality. But hopes that we will enter a ‘v’ recession, look increasingly shaky in the light of the scale of the crisis.

In what ways might, what is hopefully a temporary public health issues, leave behind scarring effects on our economy?

  1. Most obviously, the more that individual businesses fail, and unemployment rises, the longer it will take for things to return to normal. It’s easier to shut-down a business than to start one.
  2. Some sectors, such as manufacturing, can make up for lost ground following a break in demand. Customers who put off buying things will make-up for that in the future. But for others, particularly in the badly hit ‘social spending’ sectors, even with a rebound when restrictions ease, a sizeable part of the lost demand will be permanent. Even very simple things like people buying coffee each morning on their way to work, THEY won’t buy 20 coffees on their first morning back.
  3. Economists have long been concerned about so-called ‘hysteresis effects’, particularly in the labour market. Evidence suggests whilst unemployment might rise sharply during a recession, it takes time to fall back. Breakdowns in skills-job matching, delays in search activity etc. all can make any recovery that bit more challenging.
  4. Similar ‘hysteresis’ concerns exist around entrepreneurship, business formation and innovation. Any strain on financial returns may also cause banks to scale back lending in the long-run. The area of self-employment is one that the government are being urged to do more for. Of course, there are a number of challenges here in designing a support package for the self-employed given the incredibly varied nature of what self-employment comprises – see here from the IFS.
  5. The impact on individuals and families from financial insecurity or unemployment can have negative impacts upon wellbeing and health. Even for those affected less, longer term behavioural changes aimed at rebuilding a degree of financial security may mitigate against past spending patterns being restored. The effects from such scarring can last for years.
  6. At such times, uncertainty is an enemy. Uncertainty – both in terms of the pandemic itself and economic outlook – could potentially put off investment and limit exports for a long time to come.
  7. A keen eye will be kept by policymakers on businesses that have externalities on the wider economy (e.g. transport through to firms controlling major national energy infrastructures). The ripple effects of any distress here would be significant. Just yesterday, the UK Government have stepped in to suspend rail franchises and (effectively) nationalise any losses for 6 months to protect the future of the UK railways.
  8. The combination of economic shock, combined with changing behaviours, might have their own long-lasting effects on individual sectors. Scotland’s oil and gas industry faces its 2nd crisis in 5 years. Traditional retail – already squeezed by the growth of online shopping – faces an uncertain future.
  9. The effects of this crisis will vary by sector and by locality. Rural communities for example, where tourism is a major employer are particularly exposed. Any sharp loss of jobs in these communities may force people to move away to seek new opportunities elsewhere, making it harder for them to get back on their feet. Ordinarily in a downturn we would be looking to add demand to the economy to support struggling sectors – but not in this case. Nowhere is this clearer than the case of tourism and the rural economy where the very clear message of Government is NOT to try to encourage demand. The simple reason is to prevent rural healthcare provision from being overwhelmed by tourists who may become unwell.
  10. Finally, the government have said that they will do (and spend) what it takes to support the economy through the economy. Questions around the public finance are clearly for another day, but what is clear is that the debt position that the government will be left with will be high.

Faced with these risks, the Chancellor’s response makes sound economic sense. Of course, there is a moral argument about protecting families and businesses in response to the public health emergency. This is what government is there for.

However, it’s also the right economic response. Last week’s announcements were an investment in the public health of the country. But they were also an investment in the long-term health of our economy.

Whether this will be enough we wait to see. Soon, as the immediate crisis passes, we’re going to have to start talking about rebuilding an economy that might look quite different to the one that we knew just a few weeks ago.



The Fraser of Allander Institute (FAI) is a leading economy research institute based in the Department of Economics at the University of Strathclyde, Glasgow.