In both Canada and the United States, business activity is coming back from its horrific plunge in April. People are returning to work, retail sales are climbing, stock prices are surging.
This is reassuring. Unfortunately, the short-term numbers don’t have a lot to say about what shape the recovery will take over the long haul.
If corporate profits can snap back close to normal over the next couple of years, today’s stock prices make perfect sense. But if growth remains substandard for much of the coming decade, all bets are off.
There are some reasons for concern on that score.
Consider the rather dour outlook from the Congressional Budget Office in Washington. The non-partisan body sees U.S. unemployment remaining above 5 per cent until 2029. (Recall that joblessness was below 4 per cent before the pandemic hit.)
The CBO also expects the federal funds rate, a key determinant of interest rates, to stay close to zero until 2027. This suggests the economy will require an unusual degree of policy support for a long, long while.
To be sure, long-term forecasts are always a guessing game. What makes the current situation so treacherous is that there is no clear-cut precedent.
Most investors favour optimism and for good reason: In nearly all the recessions over the past half-century, the economy quickly bounced back to long-term trend lines.
But the financial crisis of 2007-08 shows a fast rebound doesn’t necessarily occur.
In Canada, unemployment jumped after 2008 and did not fall back to its precrisis level until 2017.
During that same patch, economic growth across most of the developed world faded. Output expanded, but it did so at a plodding pace compared with its precrisis trajectory. As a result, many economies were significantly smaller 10 years after the financial crisis than precrisis forecasters had expected.
“Will we ever recover?” the Federal Reserve Bank of San Francisco asked plaintively in a 2018 report.
Its short answer: Probably not.
It calculated that the U.S. economy in 2017 was 12 per cent smaller than it would have been if the pre-2007 growth trend had continued. The slowdown had cost an average American US$70,000 in forgone wealth, according to the Fed’s calculations. It did not expect the lost ground to be made up any time soon.
A survey of 180 countries by the International Monetary Fund last year found many similar cases. There were significant shortfalls between where most economies were operating a decade after the financial crisis and where a forecaster in 2007 would have expected them to be.
The question now is whether the pandemic will deliver yet another disappointing decade for the global economy.
The most obvious threat would come from a failure to contain the coronavirus. The World Health Organization warned this week that the worst of the pandemic may still lie ahead. Case numbers are soaring across much of the U.S. and Latin America, as well as in India.
A successful vaccine could brighten the picture practically overnight. But it’s unclear when – or if – such a vaccine will be available. Until it is, the pandemic is likely to hobble growth in many ways.
Physical-distancing requirements could hobble restaurants, hotels and other hospitality industries. Stricter public-health measures could chop airline traffic, force companies to reconfigure supply lines and empty office space.
The pandemic might reduce staffing levels and make it difficult for young workers to join the work force. It could force older households to ratchet up debt to make ends meet. And it could compel many two-income households to put one career on hold if schools can’t return to full classrooms and home-schooling children becomes a permanent part of many parents’ job description.
Mind you, economies are more flexible than most of us realize. “History suggests we should not be too pessimistic,” Vicky Redwood, senior economic adviser at Capital Economics in London, argued in a report last week.
The U.S. rebound from the Great Depression demonstrates an economy can bounce back even after a huge fall in output, she says. Furthermore, some pandemic-inspired shifts – such as the move to more work-at-home arrangements and less commuting – could actually help boost productivity.
“It will be a slow process, though,” Ms. Redwood cautions. By the end of 2022, global output is still likely to be about 3 per cent below where it would have been without the crisis, she figures. “Even if the gap is eventually closed completely, as we think is possible, that could easily take until the middle of this decade or longer.”
Much will depend on how governments behave. If they prematurely turn to austerity or decide to wage trade battles, the results could be ugly.
“But the risks are not all to the downside,” Ms. Redwood says. “If the coronavirus provides firms with incentives to invest; turns government policy in a helpful direction; and prompts firms to undertake productivity-boosting measures quicker than they otherwise would have done, then some economies might end up stronger as a result of all this.”
Let us hope that is the case. Investors, though, may want to exercise a bit of caution before assuming a strong recovery is a done deal.
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