The impact of the 2020 coronavirus recession on GDP will continue to be felt for years to come, with GDP levels in the largest advanced economies expected to remain around 3% to 4% below their pre-virus trend path by the middle of this decade, according to a recently published Fitch Ratings report.
"There will be lasting damage to supply-side productive potential from the coronavirus shock as long-term unemployment rises, working hours fall, and investment and capital accumulation slow," says Maxime Darmet, director of Fitch's economics team.
Huge uncertainties surround the economic outlook in the aftermath of the massive shock in the first half of 2020, the report points out. It also states that the path that the coronavirus outbreak will take is unknown. Repeated waves of new infections and renewed nationwide lockdowns could see a very sluggish recovery, while medical breakthroughs could result in a rapid normalisation of economic activity.
A reasonable base-case working assumption for the purpose of economic analysis is that the health crisis gradually eases over time, with renewed nationwide lockdowns avoided and virus containment sought through more targeted responses. On this basis, Fitch extended its GDP projections for the largest advanced economies to the middle of the decade, beyond the two-year horizon of its global economic outlook forecasts.
Longer-term economic forecast horizons are useful for credit analysis and require a greater focus on supply-side productive potential. Fitch updated its projections for potential GDP using its existing framework based on the medium-term outlook for trend labour inputs, the stock of fixed capital, and trend productivity.
For the 10 advanced countries covered in Fitch’s global economic outlook, its updated annual potential GDP growth projections for 2020 to 2025 are, on average (unweighted), around 0.6 percentage points (pp) below its previous five-year ahead projections. US productive potential growth has been revised to 1.4% from 1.9%, the UK to 0.9% from 1.6%, and the eurozone (weighted average of Germany, France, Italy and Spain) to 0.7% from 1.2%.
"The level of supply-side productive capacity by 2025 will be around 3pp to 4pp below that implied by our pre-virus projections of potential GDP," adds Brian Coulton, Fitch’s chief economist.
These revisions, Fitch notes, partly reflect its expectation of a rise in long-term unemployment in the aftermath of the shock. The jobs shock is likely to see many workers - particularly in the most adversely affected and labour-intensive travel, tourism and leisure sectors - struggle to find re-employment quickly, resulting in detachment from the labour market.
Large increases in unemployment after the global financial crisis resulted in a marked rise in the share of long-term unemployment. Labour market dislocation will also see a sustained reduction in average working hours and possibly lower labour force participation rates.
The anticipated sharp falls in business investment, Fitch predicts, will also lead to lower growth in the capital stock, which could be exacerbated by early scrapping of existing fixed assets as a result of the shock. A weaker outlook for capital accumulation accounts for about half of the revision to potential growth, with the rest explained by the anticipated reduction in labour input as unemployment rises and average hours worked fall on a sustained basis.
These revisions to potential GDP have important implications for the forecast recovery path beyond the next two years, the report states. By 2025, the rating agency expects aggregate demand and aggregate supply to be aligned and assumes that the output gap (i.e., actual GDP relative to potential GDP) will be zero. This framework would suggest that actual growth should proceed at a faster pace than estimated supply-side potential growth over the next few years as the large negative output gap that has opened up in 2020 is closed.
Demand-side considerations would suggest that this is reasonable given the unprecedented amount of macro policy easing since March. Moreover, the lack of financial imbalances and a more resilient banking sector in the largest advanced economies, pre-virus, suggest that demand should be able to recover more rapidly than after the global financial crisis.
However, the report also notes that the cuts to estimated potential GDP imply that this 'catch-up' growth over the next five years will be far more subdued than would otherwise be the case, with the level of GDP ratcheting downwards relative to the pre-virus trend. To illustrate, US growth is projected to average just over 2% from 2023 to 2025 compared with over 3% if no adjustments were made to estimated supply-side potential growth.
Risks surrounding these projections, according to Fitch, are very large and include not only those associated with the path of the health crisis itself but also with whether there will be a renewed period of fiscal consolidation in the medium term as governments seek to repair public finances.
On the other hand, job subsidy schemes could prove more effective than anticipated in limiting the rise in unemployment in Europe over the next six to 12 months.