The economic consequences of the second lockdown will be different from the first - Capital Economics
The Chief Economist’s Note

The economic consequences of the second lockdown will be different from the first

The obvious place to start this week’s note is the US election, but at this stage there’s not much to say that’s not already been said. Our US Update published over the weekend provides an excellent summary of the key points and the implications for the economy and policy, and our markets team have sketched out the consequences for asset prices.

Meanwhile, after the welcome distraction provided by the US election, the focus in Europe has shifted back to the virus. New lockdowns have come into force in the UK, France, Germany, Italy and the Czech Republic, with more countries likely to follow suit over the coming weeks. And renewed lockdowns mean renewed downturns in the region’s economies.  

As it happens, there are three reasons to think that the falls in GDP during second lockdowns will be smaller than those experienced during the initial lockdowns earlier this year. First, economic output is still depressed. As I noted a few weeks ago, GDP in most countries in Europe is still between 5-10% below pre-virus levels. The fact many sectors have yet to fully recover output that was lost during the first lockdown means they are unlikely to see as large a drop in output during the second. 

Second, many companies that are not directly affected by the new measures will by now have found ways of operating in an environment in which activity is restricted by lockdown policies. Work has moved online. Zoom meetings have replaced physical meetings. 

Finally, the new lockdowns have so far been less stringent than the original ones. For now, at least, factories and construction sites are likely to remain open. Importantly, so too are schools. The direct effect of school closures on GDP depends on how education output is measured, which varies across countries. But school closures also have an indirect effect on GDP as the output of working parents is damaged by having to double as teachers. We previously estimated that this could knock 2.5ppts off GDP per quarter. It remains to be seen whether schools will stay open throughout the latest lockdowns but, if they do, it will cushion the blow to output. 

One lesson from the first set of lockdowns is that compliance – and the extent to which people self-impose additional restrictions on activity – will play a significant role in determining the hit to economic output. “Virus fatigue” may mean that compliance is now weaker, which, all other things being equal, might diminish the hit to output. But the flip side of weaker compliance is that infection rates are likely to fall at a slower rate. Most governments have suggested that the new measures will stay in place for around one month, but it wouldn’t be a surprise if they persist in some form for longer.

If all of that is too depressing, cast an eye towards Asia. While Europe has been locking down, it has been opening up – so much so that the annual Pride Parade was held in Tapei at the end of October. This reflects the fact that the virus is now under control in large parts of Asia, which among other things is due to the much better job that governments there have done of testing, tracing and containment. Economic performance has been correspondingly stronger than elsewhere in the world. In the absence of similarly effective contact tracing programmes, countries in Europe (and indeed the US) will struggle to suppress the virus for any length of time. Instead, it’s increasingly likely that they will have to wait for the development of an effective vaccine to finally bring the virus to heel. In the meantime, the smart money should be on Asian economies to outperform. 

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