False alert: Why Covid-19 will not be the 21st century Great Depression

By Uendi Hajderaj

In general terms, an economic depression is a severe and prolonged contraction of economic activity enduring a minimum of three years and resulting in a collapse of economic indicators. Concretely, this means a dramatic decline in production levels, employment numbers, property sales, average wages, and drastic changes in inflation rates, among other things. Nearly one century ago, the world witnessed its one and only major depression in its lifetime. As the name implies, the Great Depression was great in every feasible aspect. In one year alone (1933), the annual GDP shrank by almost 13% and the employment rate by nearly 25%, the biggest contractions ever; moreover, within a period of four years, inflation rates went down by 27%, world trade levels by 66%, and wages by more than 50%. Ironically enough, the Depression succeeded a sustained period of a rather unusual growth of “expansion without inflation” driven by a boom in industrial production, construction, and overconsumption. Nonetheless, it was a boom mainly financed by increasing debt, which, combined with incompetent monetary and fiscal responses, only contributed to a prolonged economic crisis that we shall never return to.

Today we find ourselves in the midst of a sui generis crisis that, just like the Great Depression, has called into question the efficiency of the authorities, challenged key institutions worldwide, distorted not only the political order but probably also threatened the liberal democratic one. The Covid-19 pandemic has been a bolt on the blue to the medical experts who have found themselves overwhelmed, overworked, and understaffed as rarely seen before. Besides that, it has forced an unprecedented widespread suspension of economic activities, triggering thus not only worldwide recessions but also beliefs of a forthcoming depression.

Indeed, from a short-term economic perspective, the numbers are scary: during its peak in the second quarter of the year, U.S. annual GDP growth contracted by 9%, unemployment reached 15%, wages declined by more than 6%, the lowest figures since the afterwar period. On the other hand, the statistics are largely measured on an annualized or quarter-to-quarter basis, which means they tend to be more volatile than year-on-year growth rates, thus the overwhelming numbers. Also, looking at the bigger picture, the crisis seems to have an enormous advantage, that is, its ability to recover quickly. During the third quarter of the year, economic indicators—real GDP growth, unemployment, and wages— have shown, perhaps, the quickest rebound in the history of modern financial crises.

All things considered, there are fears Covid-19 may turn into the Great Depression of the 21st century given its unusual global uncertainty and high volatility. This article, therefore, contributes to proving the opposite by briefly analysing the distinctive attributes between the Great Depression and the coronavirus shock, and most importantly, why the latter stands far from leading to a comparable depression.

But first, let me briefly explain why this belief is to some extent logical and easily credible. Perhaps the most common characteristic of the Great Depression and the Covid-19 shock is their unprecedented nature: they both lacked theoretical and practical foundations upon emergence, explaining thus the absence of prescribed solutions at hand. At the peak of the Great Depression, government intervention in the economy was rather unpopular and Keynes’ theory of deficit spending only appeared in 1936, long after institutional deficits had been exposed. Similarly, Covid-19 has caught experts by a big surprise and rather unprepared due to a simultaneous shock in both demand and supply, in addition to the enforced interruption of economic activity by the authorities for the first time in history.

A second similarity to the Great Depression is the indiscriminate effect on the size of the economy. In both events, the advanced economies have been hit hard, while the developing nations—many of which dependent upon the former— have been particularly fragile due to institutional weaknesses and lack of solid economic pillars.

And lastly, just like the Great Depression left a long-term mark on people’s economic behaviours and on the future policymaking, there is no doubt the current crisis will demonstrate ensuing long-term effects on the whole global community from the enforcement of physical protective measures, dependence on a country’s own means, accountability toward global economic partners, or planning for future safeguard economic mechanisms.

However, on the other hand, the Great Depression was a crisis that quickly became existential; it exhausted people from money, employment, and even food to the extent that many were forced to steal in order to feed their families. In contrast, Covid-19 has not deprived people of money—we see governments increasing welfare benefits and partly paying employee wages; definitely not deprived them of food—supermarket chains and groceries worldwide have reached record revenues—and despite highest unemployment figures since decades, the numbers have experienced a rather quick and unprecedented recovery.

Second, the Great Depression was an all-pervasive, all-inclusive crisis that largely affected all industries and production sectors, from agriculture, food and durable goods, construction among others. On the other hand, Covid-19 has indeed caused historic blows to certain sectors including the travel industry, the hospitality business, oil markets, and entertainment services and facilities; nonetheless it has induced a boom on other, more technology-driven services like online shopping, online entertainment services, virtual communication systems and similar.

Third, the Great Depression exposed great institutional deficiencies in crisis management. To start with, the monetary policy turned out to be inept. The Fed halted its quantitative easing program during the worst time of the depression, causing a widespread fragility in the financial system as banks suffered from resources, and consumers and investors from credit. Today we have the exact opposite scenario. Banks have neither been affected by, nor are they affecting a contracting economy. In fact, central banks in major economies have long been loyal to an ultra-low interest rate environment in the effort of triggering inflation. To continue, the fiscal toolbox during the Great Depression was ill-advised and ill-equipped. Enforcement of protectionist tariffs in 1930, delayed economic response, and the obsession of balanced budgets did only harm to an already alarming crisis. In addition, the welfare state in the U.S. was unfamiliar until 1932 with the introduction of the New Deal, after which, only then—during the peak of the crisis—did people realize the meaning and importance of welfare benefits. Today, the world is far more prepared in terms of policymaking. Monetary and fiscal responses are relatively fast and effective, countries seem to learn from each other’s mistakes, and above all, every democratic nation has a solid welfare system defined in their own terms. The last one is of particular importance and leads to two key points, both of which moderate the intensity of a crisis: 1) the authorities are equipped with the essential tools and instruments to prevent a probable escalation, and 2) people are fully conscious and familiar of the social welfare benefits, making them less liable to cause a panic in consumption or investment.

Lastly, in terms of healing, the Great Depression was long, gradual, and severe all at the same time, which is why it took years to recover. (Some even claim it was the war that eventually got the U.S. out of the Depression.) On the other hand, relevant data on the current economic state show that the disruption is rather temporary: despite the largest GDP fall in U.S. history, we are now seeing a rapid upward movement in GDP figures, wages are quickly rebounding—from a minus 6.64% in April to a positive 2.11% in October—and unemployment numbers are swiftly recovering—from its peak of almost 15% around April-May to less than 7% in November. Economists De Grauwe and Ji believe an economic recovery is, relatively more favourable and highly probable. They argue that during the Great Depression “banks had to be fixed before a recovery could be sustainable… [which inevitably] took some time. Today banks do not have to be fixed…[therefore] provided governments and central banks continue their operations aimed at supporting economic activity, the recovery can be relatively quick.”

All things considered, whether we are in the precipice of an assumed long-term economic collapse, that is a rather bold and aggressive statement to make at such an early point in time. We should remember, the Great Depression was once a recession prolonged due to institutional deficiencies, lack of coordination between monetary and fiscal policymaking, and deferred action from both parties, all of which could be prevented. Covid-19, on the other hand, is primarily a health crisis, therefore, its duration and severity are partly out of the control of policymakers. In spite of that, we see monetary stimulus going beyond conservative means and fiscal response being unsparing as rarely seen, with the U.S. national budget deficit recording the highest percentage of GDP since wartime (17.9% compared to the wartime peak of 26.9%). Thus, if there is one thing we should learn from the Great Depression, is that we should not, by any means, succumb to an aura of over pessimism and crisis of confidence which have a direct negative effect on investment and consumption that could potentially deepen the crisis. It is in our hands to decide what the legacy of the Covid-19 will be: a historical episode of a chronic economic disease, or a global successful effort of swift and effective coordination.

Uendi Hajderaj is a graduate of LMU Munich with a degree in Business Mathematics. She has been writing articles for little more than a year, mainly on economic, political, and even social issues.

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Foreign Policy News

Foreign Policy News is a self-financed initiative providing a venue and forum for political analysts and experts to disseminate analysis of major political and business-related events in the world, shed light on particulars of U.S. foreign policy from the perspective of foreign media and present alternative overview on current events affecting the international relations.

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