V, W, U or L: What could the economic recovery from coronavirus look like?

The Corona crisis continues to affect the global economy. It is now clear that economic output will slump sharply. But when will a recovery start? Economists think of four basic scenarios.

The alphabet of economic development

In the wake of a crisis, the development of a country’s gross domestic product (GDP) over time can be described using the letters V, W, U, and L (see Figure 1).

The V-Scenario (best case scenario)

In this scenario, a sharp drop in GDP is first prevalent. But this drop is quickly offset by an economic upturn. The real economic problems are only temporary:

• Companies will reopen after a brief period of closure. The company has contained the coronavirus or created the necessary capacities in the health system to care for the sick.
• The social security systems can compensate for the temporary loss of income.
• The decline in employment is only short-term. The subsequent increase in production has a positive effect on employment levels and real wages.
• The credit-financed economic stimulus packages cause the national debt to rise. However, the following years with stable growth allow a reduction in national debt.
• Companies can compensate for their temporary losses, and there is no wave of insolvencies.

In this scenario, the global economy emerges from the crisis with a black eye.

The L-Scenario (worst case scenario)

The extensive production stop caused by the corona crisis lasts for many months. There is no economic recovery, and GDP remains at a low level. This results in serious economic problems:

• Companies that produce nothing can’t pay wages. The disposable incomes of private households fall. As a result, consumer demand is declining.
• Even a decline in consumer demand will eventually exceed the supply of goods, if the supply of goods becomes ever smaller without replenishment. The result is rising prices with simultaneous supply bottlenecks. Without a sufficient supply of goods, the inflation rate continues to rise.
• In the event of a production standstill, companies do not generate any revenues. Many running costs must still be paid. Sooner or later, companies cannot meet their payment obligations and have to file for bankruptcy.
• Company closures lead to an increase in unemployment. In addition to the associated social upheavals, this also has consequences for the national budget: growing expenditure on transfer payments and extensive – but unsuccessful – economic stimulus packages come up against lower government revenues. Public debt is rising rapidly. Sooner or later there is a threat of national bankruptcy.

The result of a prolonged production stop is a combination of a supply crisis which includes rising prices, a solvency crisis with numerous company closures and mass unemployment, and a national debt crisis. Sooner or later this will likely lead to social tensions with a political polarization.

The W-Scenario

Phases of economic recovery and setbacks alternate. The slumps may be the result of a renewed increase in the number of people affected, or they may be due to falls in stock market prices or other reasons. An economic downturn such as in the L-Scenario is prevented, but the uncertainty of the citizens is great.

Economy and society are in crisis mode for a long time. The economic problems – declining production and employment, unemployment, supply bottlenecks, increasing indebtedness of states and companies etc. – flare up again and again.

At some point in time, however, an economic recovery occurs in this scenario and the economic crisis is overcome.

The U-Scenario

In this scenario, it takes longer for the economy to recover from the massive slump in growth. Depending on the severity and duration of the recession, the socio-economic problems will vary in size:

• The economic slump is severe and recovery does not begin until after 2021: In this development, the ultimate consequences of the L-Scenario are to be feared. Even if there is an economic upturn at some point, the losses in real income and unemployment are high. Public debt has exploded. Many companies are insolvent after a long recession.
• The economic slump is huge and the economic recovery will start in beginning/mid 2021: The state uses enormous financial resources to revive the economy. Insolvencies have been prevented by generous liquidity assistance, and state guarantees have taken over bursting corporate loans. The transition to an L-Scenario with all its social upheavals is prevented.
• The economic slump is minor and the economic recovery starts in beginning/mid 2021: This scenario moves towards a V-Scenario. The economic damage is slightly higher than in this best-case scenario, and the same applies to public debt. The economic dent is thus greater than in the V-Scenario, but the damage is manageable.
• The economic dip is small, but the economic recovery does not set in until after 2021: The economic damage increases with the duration of the recession.

What can we expect?

It is still not possible to predict which of these four scenarios is most likely for the global economy.

After the Lehman bankruptcy in September 2008, most countries experienced a rapid economic recovery. If real GDP in 2007, the last crisis-free year, is set at 100 percent, Figure 2 shows that except Italy, all G7 countries were able to achieve a – more or less – V-Shaped economic trend. Even in 2019, Italy had not yet reached the pre-crisis level.

However, it is uncertain whether this rapid recovery will continue after the corona crisis. At the moment, everything points to the global economy sliding into a deeper recession. This will also make an economic recovery more difficult than after the Lehman bankruptcy.

This massive effort by governments, e.g. in the form of extensive economic stimulus packages in the US is therefore urgently needed. Perhaps they can cause most countries to achieve an economic development shaped as a V or a short U.