07 Apr 2020

Thinking about economic shocks

Harold Hutchinson

Head of research

Are we stretching the UK economy beyond return? 

On the surface, the Scottish port of Dundee might seem an unlikely place for one of the most important discoveries in electromagnetism. Yet it was a Dundee-born scholar, Sir James Alfred Ewing, who first coined the word ‘hysteresis’. Ewing used the term to refer to electromagnetic effects that remain after the removal of a former magnetising force.

 

A key implication of hysteresis is that the application of a large shock may not mean an eventual return to the previous state. In everyday terms, think about an elastic band, for example. On normal stretching, it returns to its previous state; stretch it far enough and it snaps, and there is no way back.

 

Many years ago, a small group of us at St. Andrews University argued that the shocks associated with the peaks of actual unemployment are themselves part of the process that determines steady-state unemployment, in contrast to the then-prevailing paradigm of a timeless ‘natural’ rate. In crude terms, put a cohort of workers out of work for long enough and it becomes impossible to re-employ them.

 

That raises long-term unemployment. The idea was particularly relevant in the era of Margaret Thatcher when a policy-induced high real value of sterling was making whole swathes of the UK’s manufacturing industry uncompetitive. Industries disappeared forever and long-term unemployment grew. 

What hysteresis suggests is that corporates and families should both be doing everything possible to keep our workforces and children mentally engaged.

Clearly, we are at a moment when the UK economy has been buffeted by several large shocks, in this case negatively, both to demand and supply from COVID-19 and then positively from the UK’s fiscal and monetary responses. The net effect is uncertain, but even the most optimistic policymakers admit the initial outcome will be negative, at least for a period. The current stock market volatility foretells a similar outlook.

 

Can an understanding of hysteresis help us prevail through the hard weeks ahead? Well, it just might. In basic terms, it lends support to the UK’s policy of throwing the full weight of its fiscal and monetary might at the problem – that at least should minimize the net disturbance and unwanted risks in the first place. So well done to the Treasury and Bank of England, especially their new heads, Chancellor Rishi Sunak and Andrew Bailey, arriving at a moment of crisis. 

In case we do get into a longer and deeper slump than we hope, what hysteresis suggests is that corporates and families should both be doing everything possible to keep our workforces and children mentally engaged over the period; we may be constrained by social distancing, but we should encourage an intellectual gathering.

 

We can all use these extraordinary times to develop new skill sets and master the vast range of technologies that are at our fingertips today but which are often under-used as we remain tied to old work and learning practices. We are seeing examples of this already in heart-warming stories from around the globe. 

 

However, if we do not, negative long-term economic implications may ensue from a recession. But, if we do, we might just come out of this whole thing with a helpful productivity shock driven by working in closer harmony with technology…a positive hysteresis effect that could foster growth over the medium term.

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