The economics of Covid-19

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July 6, 2020 6:01 AM

An unanticipated shock compelling physical distancing is a rare phenomenon, especially at a global scale. When it all ends, the global economy would have recovered to get back to its status quo ante.

While all lives are precious, it is becoming clear that the mortality from Covid is less than 1% of the population.

We have now had Covid-19 for more than six months. It has been a unique global sampling exercise, with more data from the developed countries than the developing/emerging countries to begin with. The latter—Brazil, India, South Africa—are catching up. The scientific side is still uncertain. We have no vaccine and no clue as to the timing of a second epidemic. There are not enough cases of second infection as yet to generalise.

What is universally true is that economic effects everywhere have been severe. Death rates may have differed, whether a country adopted mitigation as Sweden did, or suppression with social distancing as India or the UK did, but the economic costs have not been that different. No one has found the silver bullet of taking on the infection without suffering economic costs.

While all lives are precious, it is becoming clear that the mortality from Covid is less than 1% of the population; indeed even less than 0.1%. Some countries have defined ‘excess deaths’, i.e. the number of deaths above the long-run average whether attributed to the virus or not. This measures the collateral deaths from other morbidities, which may have caused deaths due to overcrowded medical facilities, etc. Even excess deaths do not get up to more than 0.2% of the population. Thus, the Covid-19 is not the Spanish flu-type catastrophe, but because it can be transmitted at a distance, and there is as yet no vaccine, there is no certainty as to its final incidence.

The loss of economic output is large across all economies. Generalising across, we have a 20-25% loss of GDP and a matching amount of unemployment. The larger the informal, less mechanised sector, the bigger the proportion of job loss to the loss of revenue. There is much less uncertainty about the loss that has already happened than about the mortality rates. This raises a fundamental question. In what ways does Covid differ from other crises so as to have such a sharp and sudden effect?

A simple clue says that only the shape of the recovery will tell us the nature of the downward effect. If the recovery is V-shaped, then we will know that the economy is a contact business, in which, individuals can only carry out economic activity in close physical alignment. Distancing costs money.

The point of saying this is that traditionally economists have theorised in terms of individual behaviour, consuming, supplying labour, migration, etc. What Covid has taught us is that consumption is a joint activity as is buying and selling. We have tried online selling and buying, and online working. But, these activities have proven poor substitutes. Consumer expenditure has been down in all economies, not just for those who have lost income because their work involved social proximity, but even the salaried who worked from home have consumed less and saved more.

Normally, recovery from recessions relies on the return of confidence, reduction in interest rates or tax rates or Keynesian spending. This time, Keynesian spending has at best cushioned the income shock as the economy has gone down. It has had no employment multiplier effects. Governments have incurred debts to offer income transfers (furlough payments as in the UK) to reduce the negative impact.

The recovery can only come when physical contact among groups of people resumes. There is no uncertainty about this nor any need for changing expectations. As soon as people can meet and gather together, the economy will resume since no physical capital has been destroyed. This is a totally new idea for economists. We debate about market failure or government failure. That is not the issue here. The market has not failed. It has ceased to exist because there are no people gathered together to constitute a market.

The Hayekian idea of the market as a signalling system requires someone to give a signal and someone else to receive. Markets are more efficient the denser they are. The economy is a network of millions of groups engaging in physical activity in a coordinated way.

This is one reason why stock markets have stayed active and even more cheerful because remote signalling is all that is necessary for stock markets, and no objects need to be physically exchanged in the transaction. But, production is down because factories require physically getting together, physical delivery systems in real-time and space.
This has been so obvious that no economist has thought it worth mentioning. But, its importance lies in the pattern of recovery from the recession. Relaxing the lockdown, abolishing social distancing is all that is necessary to restore the economy. The loss of demand will be made up by excess demand which has been pent up during the lockdown. They will finance the extra consumption for the sharp upward side of V.

Should economists seek a new theory? Perhaps not. An unanticipated shock compelling physical distancing is a rare phenomenon, especially at a global scale. When it all ends, the global economy would have recovered to get back to its status quo ante. No change, let alone revolution. Back to the old normal.

The author is a prominent economist & Labour peer. Views are personal

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