A little over ten years ago I was approached by some health experts who wanted to look at the economic effects of a influenza pandemic. They needed someone with a macroeconomic model to look at the general equilibrium impacts. In the 1990s I had led a small team that constructed a model called COMPACT, and these health experts and I completed a paper that was subsequently published in Health Economics. We reference to other studies that had been done earlier in that paper.
The current coronavirus outbreak will have different characteristics to the pandemic we studied, and hopefully it will not become a pandemic at all. (In terms of mortality it seems to be somewhere in between the ‘base case’ and ‘severe case’ we looked at in our work.) But I think there were some general lessons from the exercise we did that will be relevant if this particular coronavirus does become a global pandemic. One proviso is that a key assumption we made about the pandemic is that it was mainly a 3 month affair, and obviously what I have to say is dependent on it being short-lived.
It is worth saying at the start that the bottom line of all this for me is that the economics are secondary to the health consequences for any pandemic that has a significant fatality rate (as coronavirus so far appears to have). The economics are important in their own right and as a warning to avoid drastic measures that do not influence the number of deaths, but beyond that there is no meaningful trade-off between preventing deaths and losing some percent of GDP for less than half the year.
Let me start with the least important impact from an economic point of view, and that is the fall in production due to workers taking more time off sick. It is least important in part because firms have ways of compensating for this, particularly if illness is spread over the quarter. For example those who have been sick and come back to work can work overtime. This will raise costs and might lead to some temporary inflation, but the central bank should ignore this.
This ‘direct’ impact of the pandemic will reduce GDP in that quarter by a few percentage points. The precise number will depend on what proportion of the population that get sick, on what the fatality rate in the UK turns out to be, and how many people miss work in an attempt not to get the disease. The impact on GDP for the whole year following the pandemic is much less at around 1% or 2%, partly because output after the pandemic quarter is higher as firms replenish diminished stocks and meet postponed demand.
All this assumes schools do not close once the pandemic takes hold. School closures can amplify the reduction in labour supply if some workers are forced to take time off to look after children. On the basis of the assumptions we made, if schools close for around 4 weeks that can multiply the GDP impacts above by as much as a factor of 3, and if they close for a whole quarter by twice that. If that seems large, remember nationwide school closures impact everyone with children and not just those with the disease.
But even with all schools closed for 3 months and many people avoiding work when they were not sick, the largest impact we got for GDP loss over a year was less than 5%. That is a one quarter very severe recession, but there is no reason why the economy cannot bounce back to full strength once the pandemic is over. Unlike a normal recession, information on the cause of the output loss, and therefore when it should end, is clear.
All this assumes that consumers who have not yet got the disease do not alter their behaviour. For a pandemic that spreads gradually this seems unlikely. The most important lesson I learnt from doing this study is that the pandemic need not just be a supply shock. It can also be a demand shock that can hit specific sectors very hard, depending on how consumers behave. This is because a lot of our consumption nowadays can be called social, by which I mean doing things that bring you into contact with other people. Things like going to the pub, to restaurants, to football matches or travel. Other sectors that provide consumption services that involve personal contact (e.g haircuts) and can easily be postponed may also be hit.
If people start worrying about getting the disease sufficiently to cut back on this social consumption, the economic impact will be more severe than any numbers discussed so far. One reason it is severe is that it is partly a permanent loss. Maybe you will have a few more meals out once the pandemic is over to make up for what you missed when you stayed home, but there is likely to be a net fall in your consumption of meals out over the year. What I realised when I did the analysis was just how much of our consumption was social.
This is why the biggest impacts on GDP occur when we have people reducing their social consumption in an effort not to get the disease. However falls in social consumption do not scale up all scenarios by the same amount, for the simple reason that supply and demand are complimentary. If school closures and people taking more time off work increase the size of the supply shock, the demand shock has less scope to do damage. The largest fall in annual GDP in all the variants we looked at was 6%.
Could conventional monetary or fiscal policy offset the fall in social consumption? Only partially, because the drop in consumption is focused on specific sectors. What is more important, and what we didn’t explore in the exercise, is what would happen if the banks failed to provide bridging finance for the firms having to deal with a sudden fall in demand. The banks may judge that some businesses that are already indebted may not be able to cope with any additional short term loans, leading to business closures during the pandemic.
It is in this light that we should view the collapse of stock markets around the world. In macroeconomic terms this is a one-off shock, so Martin Sandbu is right that the recent stock market reaction looks overblown. But if many businesses are at financial risk from the temporary drop in social consumption, that implies a rise in the equity risk premia, which helps account for the size of the stock market collapse we have seen. (I say 'helps' deliberately, as much of the impact will be on smaller businesses that do not find their way into the main stock market indices.)
If I was running the central bank or government, I would have already started having conversations with banks about not forcing firms into bankruptcy during any pandemic.
But economics can also influence health outcomes, and not just in terms of NHS resources. For a minority of self employed workers there will be no sick-pay and those without a financial cushion will be put under stress. One of the concerns as far as the spread of the pandemic is concerned is that workers will not be able to afford to self-isolate if they have the disease. So if I was in government I would be thinking of setting up something like a sick-leave fund that such workers could apply to if they get coronavirus symptoms.
The government also needs to think about keeping public services and utilities running when workers in those services start falling ill. In fact there are a whole host of things the government should now be doing to prepare for a pandemic. It is at times like these that we really need governments to act fast and think ahead. Do we in the UK, and US citizens, have confidence that the government will do what is required? One lesson of coronavirus may be never put into power politicians that have a habit of ignoring experts.