COVID’s laggards to begin the long process of catch-up next year - Capital Economics
The Chief Economist’s Note

COVID’s laggards to begin the long process of catch-up next year

The webinars we held last week told a tale of two economies. China was hit early and hard by the virus, but its rebound was swift and it is now the only major economy to have recovered all the output it lost during the crisis. In contrast, the UK economy has languished amongst the global stragglers and is now staring down the barrel of another quarterly fall in GDP following the reimposition of an England-wide lockdown. If that wasn’t enough, yet another Brexit deadline is looming. 

I don’t propose to go over the same ground that was covered in these webinars (recordings of which are here). But it is worth reflecting upon some of the issues that came up in the discussions.

An important one relates to the challenges the pandemic has posed to economic statisticians. The concept of GDP has entered our lexicon without much thought having been given to how it is actually measured. But estimating GDP is complicated at the best of times, and particularly difficult when economies undergo severe shocks. 

Concerns about accuracy have long dogged official Chinese data and, perhaps unsurprisingly, some have suggested that its post-virus rebound is a statistical mirage. We have also in the past voiced concerns about the quality of Chinese data but, as it happens, the recovery over the past six months looks genuine; our own measure of growth – the China Activity Proxy, or CAP – paints a similar picture to that of the official data this year.  

If anything, there are bigger questions surrounding the UK data. To be clear, there is no suggestion that the UK data are in any way being manipulated. Rather, this issue has more to do with philosophical differences in the way that output is measured, which has led the UK’s Office for National Statistics to adopt a different approach to other statistics agencies. One consequence of this is that the UK has adjusted for inflation in some components of GDP in a different way to other countries. As a result, while the UK has experienced a similar decline in nominal GDP to other European countries, the fall in real GDP (i.e. adjusting for inflation) has been much larger (the flip side of this has been a much larger rise in the UK’s GDP deflator.)

Given the different approaches, nominal GDP may be a better measure of cross-country performance during the pandemic. Viewed this way, the UK’s underperformance looks much less extreme. (See Chart.) 

Chart: Difference from Pre-Crisis Levels of GDP (%-pts)

Difference from Pre-Crisis Levels of GDP (%-pts)

With that said, the chart also makes clear that there has been a huge variation in economic performance this year. Measuring output in a pandemic is difficult, but the wide range of outcomes is not statistical artefact – it’s genuine. What’s more, even if the UK’s underperformance has been exaggerated on some measures, it still ranks among the economies that have been hardest hit by the virus. 

These differences in performance are the result of three factors. The first, and most important, is the differing success of countries in controlling the virus, and the subsequent need for containment measures. China got on top of the virus quickly. In contrast, Europe is in the midst of a second wave and has entered new lockdowns. 

The second factor is the sectoral make-up of economies. Service sector industries have been hit particularly hard by lockdowns – meaning economies that are heavily reliant on services have suffered most. In contrast, China has benefited from a shift in consumption patterns in developed economies away from services such as leisure, travel and hospitality and towards consumer goods such as TVs, computers and household goods. 

Finally, the degree of policy support has also influenced economic outcomes. Governments across the world have been right to implement huge fiscal support packages – but the size, timing and focus of these have varied. In the US, fiscal measures were rolled out quickly and to a greater degree than other countries, which were focussed on supporting aggregate demand rather than providing financial assistance to struggling companies. This helps to explain why the hit to US output was smaller than to other countries in Q2 – and why the recovery is starting to show signs of fading now the support has expired.

The key question is whether these divergences will persist. In the short-term, which is to say the next 3-6 months, then the answer is almost certainly “yes”. New lockdowns mean that most economies in Europe are likely to contract again in Q4. The US will probably escape that fate, but growth is still likely to slow significantly over the coming months. In contrast, the latest data suggest that China’s recovery is both gathering momentum and broadening out to other sectors. 

Beyond the next few months, the growing likelihood that effective vaccines soon start to be deployed has brightened the outlook for those countries that have struggled to contain the virus. It is therefore likely that some of the worst performing economies this year will register impressive rates of growth in 2021. But we need to be careful how this is interpreted: rapid growth next year needs to be viewed in the context of large falls in output this year. The best way to assess relative performance over the next year or so will be by looking at the level of GDP relative to its pre-virus starting point. On this measure, the underperformance of Europe and the US compared to China is likely to narrow in 2021 and 2022 – but it won’t be eliminated entirely. 

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