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Why the Economic Recovery Looks More Like an L Than a V

The global coronavirus pandemic is lasting longer than many economists had predicted, and with multiple-wave clusters in Asia and continued first wave increases in the U.S., the chances of economic gains stalling is increasing.

And the trend will have the global economic recovery resembling an “L” shape—meaning it will be slow with persistent unemployment and stagnant growth—instead of what had been a much hoped for “V” shaped recovery, where the decline is sharp but brief, and recovery is strong.

“Globally, GDP dropped 4 percent this year and rising 6 percent next year,” Ethan Harris, head of global economics at Bank of America, said during a webinar on the global economic outlook last week. “In Europe, GDP will fall 8 percent, and in the U.S., will fall 5.7 percent. Most of the emerging markets have a similar negative number.”

The big exceptions are countries that have been able to contain the coronavirus with effective quarantine systems, Harris said, citing China, which he expects will see small positive growth in 2020.

By watching data flow, Harris said it has become increasingly clear that the initial “V” shape some countries saw was “just a bounce off the bottom.”

“The real outlook is a much more slower recovery,” he said. “The virus slowed, but has not stopped. The current peak is not as bad as what we had in April [and] the virus has rotated. We see it now in the South and West of the U.S., and in the hotspots in Latin America and India.”

Cases in Europe have stabilized, with a few hotspots seeing targeted shutdowns, which were able to help contain the virus and not overwhelm the hospital systems. But it will be hard in the U.S. and other western countries to “mimic the drill in Asia,” Harris said, as the populations there are more “compliant” because they have been used to taking precautionary measures like wearing facial masks. In contrast, in the Western democracies, it’s hard to get limited movement, he said.

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While Europe seems to be on what he calls the “recovery track,” Harris doesn’t believe it will get back to normal in the next few months because of possible second waves. In North America, the recovery will take longer and the timing of it all can’t be assessed until there’s more control over COVID-19. “The U.S. picked up very fast, and it looks like it will pay a price [for] that,” the economist said, noting that the U.S. will likely have a slower pick-up in July and August.

“The data already suggests the economy leveled off in July in most impacted states,” Harris said. With the virus “now out of control in a big chunk of the economy,” or surging in 40 percent of the U.S., the rest of the country is likely to reopen more slowly, he added.

Mobility data is supporting the view for an “L” shape recovery in the U.S. Looking at data for people’s cell phone usage, the economist said activity appears “heavily constrained.” People are reluctant to go back to work or head to transit stations. They are flooding their local parks instead and staying in their local residences more. The data is also showing a consistent pattern in where people are located and where they are not going.

While the U.S. saw some uptick in the second quarter at plus 20 percent, making the economic curve appear as though it yield a “V”-shaped recovery, Harris said that was owed to the initial activity surrounding people re-engaging post lockdown, boosted by pent-up demand in spending. The problem is, he said, it “doesn’t tell where we will be at year-end.”

And that uncertainty has had a chilling effect on business.

“Businesses are postponing capital investment until they feel more comfortable with the outlook,” Hrris said. “Every recession starts with some big shock. Even when the shock goes away, the recession deepens.”

Another possibility is a second round of shocks, such as persistently high jobless claims. The U.S. is still seeing upward of one million new claims for unemployment benefits each week, and that’s not the full number, just those claims covered by regular state programs. “One to two million layoffs [each week], even [as] the U.S. economy is reopening, is a very negative sign,” Harris said. He isn’t sure whether any of those jobs will ever come back, and if the layoffs are part of a structural shift that’s happening, then there’s a chance that shift is going to be accelerated. “The crisis forced companies to rethink their tech investments and how they deploy their workforce,” he said.

Aditya Bhave, senior global economist, who also spoke during the BofA webinar, focused more on future concerns down the road. While inflation has been a topic concern, he said the cost of the various global fiscal stimulus programs likely won’t cause the specter of inflation to loom on the horizon. The overall weakness is not in the economy itself, Bhave explained, but more a weakness in the labor market, which can, in turn, impact businesses’ capital expenditures.

One area of concern in developed markets that could be a problem down the road, is what Bhave calls “Japanification,” which is caused by zero or negative policy risks for extended periods to time. With flat yields from a move to negative interest rates and fewer options left for fiscal policy ammunition, there’s now a raised risk of extended deflation similar to what Japan had for the last two decades.

“We don’t really see a return to full employment in the near future, [and it could mean we] will get something like what Japan has,” Bhave said. “That’s a bigger concern than a spike in inflation.”