Nasty, brutish, but short; shipping must navigate gaping downside risks to avoid a great depression

A rapid market recovery is dependent on the success of policy responses and failure could be disaster, writes James Frew from Maritime Strategies International.

To state the obvious, the likely impact of the COVID-19 epidemic is without precedent within shipping and without recent parallel in terms of its more human impacts. However, from a shipping industry perspective, parallels with the Global Financial Crisis (GFC) post-2008 are instructive in understanding the likely dynamics of the recovery. In short, this time round the recession will be far more acute, but has the potential for faster economic recovery, whilst limited oversupply in both the shipping and shipbuilding markets facilitating a faster rebound should the global economy pull out of its nosedive.

Macro-economically, this represents an unprecedented shock. In contrast to either the Great Recession or Great Depression, the economic downturn did not start endogenously from a financial bubble, but instead represents an exogenous shock. Whilst there is certainly a real risk of the situation evolving into a full-blown financial crisis, there remains the possibility that this can be avoided. The importance of avoiding a financial crisis is based on the well-established body of literature discussing how financial crises lead to longer-term downgrades to economic output (indeed, Ben Bernanke’s doctoral thesis was on the topic).

Unsurprisingly, there is little corresponding literature on the dynamics of economic recoveries from viral pandemics, but we would suggest that a few themes are key to determining the recovery trajectory – the length of time social distancing continues, the spill-over effects into the financial sector, the likelihood that some people who have lost their jobs will remain out of work for a prolonged period and lastly – and most importantly – the policymaker response.

Towards a V-shaped recovery

It is beyond MSI’s remit to meaningfully comment on each of these specific variables, but instead we can draw some general comparisons with historical downturns. We plot the recovery trajectory of European economies following three recent historical recessions. As it shows, the European Exchange Rate Mechanism (ERM) recession – which in some ways as an external shock to an otherwise relatively benign economic environment – saw growth struggle for a year before returning. The 1980s Monetarist recession took longer to unfold, and saw slower growth as economies continued to contend with ongoing tight monetary policy designed to tackle inflation.

The Global Financial Crisis was the most profound recession in terms of its severity and the time required to make up lost ground, with output remaining below the previous trend for years. At present, MSI’s Base Case – shown in the Chart below – is predicated on the assumption that the COVID-19 induced recession will follow a ‘V’ shape, with a staggeringly acute decline induced by social distancing reversed as the economy restarts, aided by full-throated government stimulus.

Chart – EU 27 + UK economic trajectories

There is no question that this relatively benign view of the medium-term is subject to gaping downside risks, which are so numerous that it is hard to know where to begin. Perhaps the most obvious is that efforts to restart economies lead to a resurgence in the virus, and as a result the downturn in economic activity is far longer. This scenario both damages the economy directly and makes a longer-term loss of productivity through unemployment, capital destruction and financial contagion far more likely. In the most extreme scenario, if policies to restart economic activity fail, the unwinding of existing economic relationships will bear a greater resemblance to the 1930s than the 2000s.

China’s changing demand mix

Whilst governments are unrolling policy responses, which in the UK and US have been unprecedented in size and scale, in reality there are no political precedents for such a pandemic, and there is likely to be some delay or inefficiency in the translation of any such stimulus into the real economy, and potentially even further delay in the resulting pick-up in economic activity driving increased shipping demand.

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