The Pandemic Depression
The Global Economy Will Never Be the Same
After wasting nearly three months watching the pandemic crisis from afar, Americans awoke to a new reality in the last two weeks: no one is spared. The world is engaged in a momentous battle against an invisible enemy.
Unchecked, the disease caused by the novel coronavirus, known as COVID-19, will overwhelm any health-care system, leaving vast numbers of people with no proper treatment and a grim prognosis. The numbers are almost beyond comprehension. According to a recent and widely circulated report from the Imperial College COVID-19 Response Team, the demand for critical-care beds could exceed maximum capacity 30 times over in both the United Kingdom and the United States. That same study estimates the loss of life at 2.2 million for the United States alone.
Most countries were caught largely unprepared. Some, including the United States, were even outright complacent. The time will come to draw the proper lessons.
Right now, the priority is the pandemic. Health experts are unanimous: we need drastic social-distancing policies. The benefit of these suppression policies is illustrated by the now familiar arcs in Figure 1. The red curve illustrates the number of cases without public health measures. The red-shaded area, above the capacity of the health-care system, shows the cases that face sharply higher mortality risk. By imposing strict social-isolation measures, the aim is to spread the pandemic out over time, to “flatten the curve,” enabling more people to receive proper treatment. The blue curve represents this approach.
Authorities are rapidly moving to flatten the curve. California imposed a lockdown on its 40 million residents on March 19. Illinois and New York quickly followed. As of this writing, a total of 16 U.S. states, with more than 156 million residents, have imposed stay-at-home orders. China, France, Italy, Spain, and the United Kingdom have also imposed tight confinement policies. When strictly followed, these policies deliver strong results.
Suppression policies buy time. That time must be used well. Ultimately, the battle can be won only by drastically raising the capacity of the health-care sector: more beds, more ventilators, more facemasks, more tests, more health-care professionals, more vaccine funding, more testing, more tracking. Such an expansion requires an important reorientation of part of our productive sector. That shift is (slowly) happening in many countries.
Sadly, the current U.S. administration seems to be reversing course. Not only has it refrained from using the formidable powers of the executive office to commandeer resources, but it is now contemplating reopening the economy well before the arc of the epidemic has been bent. The human consequences could be disastrous. On this, too, history will pass judgment.
The reason for the equivocation is all too clear. Flattening the infection curve inevitably steepens the macroeconomic recession curve. Social distancing requires closing schools, universities, and all nonessential businesses—basically confining the working-age population at home. Although some people may be able to work from home, they are a small fraction of the overall labor force, concentrated in a few white-collar occupations. Strict suppression policies put a sudden stop to the economy. China started such restrictions earlier than everyone else, and the numbers now coming out validate that scenario: industrial production and international trade declined by 19 percent and 17 percent in January and February, relative to 2019.
Shutting down the economy, even for a short period of time, inflicts considerable damage. Imagine that, relative to a baseline, suppression policies reduced economic activity by 40 percent for two months, after which time the economy returned to the baseline. Such a sharp but short-lived decline would deliver a powerful blow to economic activity, leading to a decline in annual output growth of about 6.5 percent, relative to the previous year. Imagine that it took another month to return to the baseline, and the decline in annual output growth reaches 10 percent.
As a point of comparison, the decline in annual output growth in the United States during the 2008–9 Great Recession was only 4.5 percent. By now, most analysts agree that we are about to witness a downturn that will dwarf the Great Recession. A comparison to the 1929 Great Depression may be more appropriate.
Why are the numbers for the current crisis projected to be so much larger? The answer is that even at the peak of the 2008–9 financial crisis, the vast majority of people were still employed and working. The proportion of the working-age population that was employed declined from 71.8 percent in 2007 to 66.6 percent in 2011. By contrast, under strict suppression policies, less than 50.0 percent of the working-age population may be able to work. The impact on economic activity is comparatively that much larger.
And this scenario is the optimistic one. It assumes that, once the health authorities give the all clear, the economic engines restart immediately: workers go back to work, factories turn back on, restaurants reopen, ships load their cargo, and planes take off.
Unless the impact of the health crisis is properly managed, there will be no instant restart. A modern economy is a complex web of interconnected parties: workers, businesses, suppliers, consumers, banks. Everyone is someone else’s employee, customer, supplier, lender, or the like. A downturn of this magnitude will send shock waves throughout the economy that could do tremendous and lasting damage.
A large number of business failures will dramatically affect the health of the financial sector.
Such a sudden stop can easily trigger a chain of cascading events, fueled by individually rational but collectively catastrophic decisions. Faced with the prospect of few to no sales, many businesses may have little choice but to lay off workers. Unemployed workers, with no immediate prospects of reemployment while they are confined may have no choice but to ignore confinement orders, putting their lives and those of others at risk—and undermining the health policy itself. Many businesses, unable to pay their suppliers or their loans without support, will be forced to close their doors, perhaps permanently. A large number of business failures will dramatically affect the health of the financial sector. Panic or loss of confidence can then take over and make things even worse. This is already happening. As I write, new unemployment claims are surging in the United States: the Department of Labor reported that 3.3 million new unemployed workers filed for benefits for the week ending on March 21, 2020. By comparison, in a typical week, that number is closer to 220,000—the increase is fifteen fold.
The danger, in other words, is that the virus mutates and infects our economic system even as we manage to root it out of our bodies. Its economic form is certainly not as deadly, but it can nonetheless do real damage. Without appropriate support, the shutdown will turn into a major economic and financial crisis that will long outlast the health crisis. Unchecked, the recession threatens to destroy the complex network of economic linkages that allows the economy to operate—a network that would take tremendous time and effort to repair.
The upshot is that the global economy, too, faces a flatten-the-curve problem. Without proper macroeconomic support, the downturn could follow the red curve in Figure 2. That line plots output lost during a sharp and intense downturn, amplified by the economic decisions of millions of agents trying to protect themselves by cutting spending, shelving investment, reducing credit, and generally hunkering down. Notice the irony: for the economy, it is isolation that has negative externalities.
In Figure 2, the blue-shaded area represents the economic downturn if policymakers prevented any additional “economic infection,” which is to say, if the drop in economic activity were limited to the lost production during the public health containment period. That negative number is already likely to be a large one. The red line and red-shaded area represent the additional loss of economic activity if the economy itself were to become “infected” and various negative feedback loops and amplification mechanisms kicked in.
Not by coincidence, the measures that can help solve the health crisis can make the economic crisis worse—at least in the short run—and vice versa: stricter health policies force a larger economic shutdown, a larger blue-shaded area. Yet, although this dynamic may look like a tradeoff, it is not really one: in the short run, there is no other choice but to buy time so that the United States can ramp up its public health response to the virus. As it does this, it will gradually be able to relax the confinement policies to control both the disease and the economy.
Moreover, even if there were no containment policies, a severe recession would eventually occur, fueled by the growing disorganization that an uncontrolled pandemic would provoke and the resulting precautionary and panic behavior of households and firms. This likelihood makes it all the more dismaying to see the current administration tempted to reverse course. Ultimately, ending the containment policies may not help the economy, but it will definitely increase the body count.
Instead, the right economic policy is to act to prevent this economic contagion. The basic objective here is also to flatten the curve and limit the economic damage to only what is inevitable given the confinement policies, as illustrated in Figure 2.
The first economic priority should be to ensure that workers can remain employed even if they are forced to stay home.
It is important to keep in mind what economic policy can and cannot do. The objective is not and cannot be to eliminate the recession altogether. The necessary measures are not “stimulus policies.” The recession will be there, and it will be enormous but hopefully short-lived. The priority is rather to short-circuit all the negative feedback loops and channels of contagion that otherwise amplify this negative shock and allow the economy to restart as quickly as possible.
The first economic priority should be to ensure that workers can remain employed—and collect paychecks—even if they are quarantined or forced to stay home. Short-time work policies, which lay off workers for a certain number of days per week or hours per day but still guarantee some payment and continuity of employment, can be an important component. Germany has adopted such policies. So have France and the United Kingdom. Direct cash assistance should be considered for the self-employed and for workers with weak attachments to the labor market. The U.S. federal government has the further imperative to channel financial support to the state and local governments that manage many safety nets. Without such policies, it is even unclear whether public health advisories can be followed. With them, households can make basic payments while confined at home and resume work quickly when allowed.
At the same time, economic policy has to ensure that small and medium enterprises can weather the storm without going into bankruptcy. Authorities can do this by offering easier borrowing terms, temporarily waiving corporate and payroll taxes, suspending loan payments, or providing direct financial assistance where needed. Finally, policies will be needed to support the financial system as nonperforming loans mount, so as to ensure that the crisis does not morph into a full-blown financial crisis.
The need for taxpayer money to support large nonfinancial corporations is much less obvious. The bankruptcy code is here to protect corporations from creditors, allowing them to continue to operate during and after a crisis. Lobbyists should not be permitted to use this national emergency to line the pockets of their masters.
The timing of these economic measures is important. They are most acutely needed while the economy is in shutdown mode. Stimulus packages after the health crisis is over will be necessary only if we do not manage to act decisively right now, and they could potentially be much costlier.
The cost of the measures outlined above will be momentous. Governments may need to provide income support on a scale roughly comparable to the output lost. If total output loss is on the order of ten percent of annual GDP, a government may need to spend a comparable amount to buttress the economy. Authorities now understand this, and the fiscal packages announced in the last few days in many countries are substantial. They will be financed by debt.
Should we worry about that debt? The short answer is no. To start with, borrowing rates for sovereigns are at historic lows—even more so since the crisis began. The yield on ten-year U.S. Treasury bonds is close to one percent. Rates in the eurozone are similarly low. At these rates, a ten percent increase in the ratio of debt to GDP would increase annual interest payments by only 0.1 percent of GDP. If now is not the time to borrow to support an economy on the verge of collapse, when is?
Bold policy initiatives can help contain the looming recession. They all start with public health policy in the driver’s seat, limiting “human contagion.” Fiscal and financial policies should be designed to address the resulting shock to our economic system and prevent “economic contagion.” Bold actions are called for, but boldness must not provide a cover for corporate handouts. Fiscal support must be at scale, but it also must go where it is needed most.
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