Counting the economic cost: How vulnerable could you be?
The economic impact
To highlight the importance of preparing for a potential future economic stagnation, we have calculated the impact this scenario could have on businesses and the wider economy.
The ultimate cost of a systemic stagnation can be difficult to derive because although there are historical precedents, the modern world bears less resemblance to the industrial landscape of even 50 years ago. Our analysis has therefore used a mix of in-depth scenario modelling and historical studies to calculate the severity and probability of a systemic stagnation, as well as the potential economic loss it would generate.
If this scenario were to take place, the global economic impact could reach $5.2 trillion over a five-year period (this represents the probability weighted average across the three severities we have modelled), with an expected loss of $62 billion (the economic loss multiplied by the probability of the event occurring).
The global losses across the three severity levels modelled range from $4.6 trillion in the least severe scenario to $17 trillion in the most extreme, equivalent to a reduction in global GDP of between 0.7% and 2.6% over the period.
Recovery
The speed and scale of recovery from the initial GDP shock is dependent on the socioeconomic resilience of the countries affected. Determining the macroeconomic impacts of a stagnation involves estimating the direct impacts, including business closure and job losses, as well as disruption to the financial industry, affecting investment and growth. Other impacts include damage to productivity and consumer confidence.
Regional risk
How exposed could your region or country be?
A country’s reliance on private capital (i.e. the need to raise funding in external financial markets rather than through fiscal means) is a good proxy for the government’s fiscal preparedness for a stagnation scenario. Economies which are more reliant on private capital may be more vulnerable to market fluctuations and thus struggle to fund necessary fiscal policies.
From a regional level, North America would see the greatest losses from this global economic stagnation scenario, with a potential loss of $1.6 trillion over a five year period, equivalent to a 1.2% reduction in GDP[1]. Europe could stand to lose $1.3 trillion, closely followed by Greater China with an economic loss of $972 billion.
Use the tool below to explore the potential impact of this global scenario on your country or region, at the three levels of severity explored in the research.
[1] Baseline GDP figures provided by Oxford Economics Global City Service
An aggregating model: In this model, a systemic event has a significant ‘ripple effect’ of impacts across the globe. The cost of the event is aggregated up from country and regional levels to provide a global economic loss number.
– For example, the COVID-19 pandemic quickly spread around the world, affecting many countries' economies in a significant way, but did so from one location with a cascade of impacts globally
A non-aggregating model: Our non-aggregating model is used for events that have a smaller ripple effect and for scenarios where multiple separate events could occur.
– For example, a major volcanic eruption is likely to have a much greater impact in the country in which the volcano erupts. In our non-aggregating model, we do not assume that all events occur simultaneously across the globe (i.e. multiple major volcanoes erupting at once)
– Country and regional data in a non-aggregating scenario is based on the event occurring in that region and/or country. Therefore in a non-aggregating scenario, the sum of countries’ economic losses will not equate to total regional or global economic losses
In our economic stagnation scenario, losses are calculated using an aggregating model.
National economies around the world are more inter-connected than ever, and increasingly behave as an international financial system of aligned national markets. We model the potential for stagnation within each country having its own national economy, but also categorize each national economy by its degree of connectedness into the global financial system. The threat assessment was done at the country level.
The International Monetary Fund (IMF) categorizes the various free market national economies and their central banks into ‘core’ markets, that are highly interconnected with each other at the centre of the global financial system, and ‘periphery’ markets that are linked to the core, sometimes through historical links to some of the national markets in the core, but that behave more independently of the core system.
Centrally planned economies are less reliant on private capital, and less connected to or affected by the international financial system. These are assumed to have their own periodic crises, but independent of the crises that may occur in the global financial system.
Sector risk
Which sectors might be most at risk?
Financial services
Most at risk from the impacts of stagnation, there are many examples of the challenges financial institutions face when confronted by a significant drop in market activity and investor growth. In February 2008, Northern Rock experienced a ‘run on the Rock’. The UK building society needed support from the Bank of England after the subprime crisis in America stopped any lending[2] .
Real estate
Property markets and the construction sector can suffer in a stagnant economy as consumer and business confidence falls. Following a period of healthy growth and high productivity through the 1980s, Japan’s equity and real estate markets collapsed, leading to the so called “Lost Decades” of Japan which saw an economic growth rate of only 1.14% between 1991 and 2003.
Industrials and utilities
As growth slows, capacity in manufacturing and energy sectors can exceed customer demand, forcing companies to reduce their outputs and make savings (including potential lay-offs). Any major new investments are likely to be put on hold while firms wait for economic recovery. Margins are also likely to be squeezed as customers look for a keen price and competitors are forced to outbid each other for business.
[3] https://www.bbc.co.uk/news/business-41229513#:~:text=Northern%20Rock%20was%20an%20obvious,was%20nationalised%20in%20February%202008.
How can risk owners respond
The threat from stagnation is not an overnight occurrence and it will only set in after a long period of low or slow economic growth. This slowdown means that companies stop hiring and consumer confidence – and therefore spending – drops. Many of the outcomes of stagnation are inevitable if businesses are not prepared. A key challenge in facing up to a period of prolonged stagnation is how to stretch business reserves and emergency policies to ride out the storm.
Stress testing: In recent years our time-tested economic models have been thrown into doubt – as stable inflation and near-constant growth have made way for soaring prices and now, recession in many economies. This highlights the importance of looking beyond model outputs to really challenge the resilience of a business to these events – stress testing and scenario modelling for increases in interest rates, market volatility and other events. It is also valuable to consider the knock-on impacts of other enterprise risks such as cyber attacks or supply chain disruptions, which could have compounding effects during times of economic stress.
Cashflow: Companies with high debt and low cashflow may struggle to access credit to see them over the worst of the lull. Addressing these prior to a crisis emerging is a challenge for a great number of businesses, but pursuing reservation of equity and or establishing an equity swap system is a robust business strategy for any organisation facing a crisis which will impact the economy. Increasing the levels of cash reserves could also help organisations mitigate the risks of an economic stagnation.
Operating model: Keeping an eye on costly business practices and building in efficiencies could reduce reliance on government or banking support during a long-term crisis. In parallel, building in diversification or contingencies, for example of supply chains, can help organisations manage any localised disruption that could arise from the economic situation.
Download the key insights
We have consolidated the insight and key financial data from this scenario in a summary takeaway document.
Explore the impact of economic stagnation
The role of insurance
Additional insight from the scenario
Disclaimer
This report has been produced by Lloyd's Futureset and Cambridge Centre for Risk Studies for general information purposes only.
While care has been taken in gathering the data and preparing the report Lloyd's and Cambridge Centre for Risk Studies do not, severally or jointly, make any representations or warranties on behalf of themselves or others as to its accuracy or completeness and expressly exclude to the maximum extent permitted by law all those that might otherwise be implied.
Lloyd's and Cambridge Centre for Risk Studies accept no responsibility or liability for any loss or damage of any nature occasioned to any person as a result of acting or refraining from acting as a result of, or in reliance on, any statement, fact, figure or expression of opinion or belief contained in this report. This report does not constitute advice of any kind.
Note that this report does not seek to replace or inform any of the mandatory scenarios which Lloyd’s publishes to support the Realistic Disaster Scenario exercises managing agents are required to undertake in respect of the syndicates managed by them.