As I prefaced my very first post on coronavirus-inspired issues – less than four weeks ago – “who knows quite what will happen with the current coronavirus”. No one does, and I certainly don’t claim any insight on that medical/epidemiological point. But there are serious experts in those fields now beginning to talk about the possibility – some put it much stronger than that – of it turning into something that infects perhaps 40 to 70 per cent of the world’s population (I gather that sort of incidence isn’t uncommon in past serious pandemics), with perhaps 1 to 2 per cent of those people dying. In that scenario – it is purely a scenario – something from 0.4 to 1.4 per cent of the world’s population dies. The middle of that range would be similar to New Zealand’s experience in 1918.
My interest here is in the the economic impact of such a scenario (and can I repeat, this is simply based on one scenario – with no probability attached, and one every sane person presumably hopes does not eventuate, but probably still the sort of thought experiment people in the economic agencies of governments should be thinking through, even just as a tail risk).
Perhaps a first stake in the ground is that even if something this bad happens, in a couple of years time the crisis would be over and something akin to normality would have returned. Societies would no doubt still be scarred by the disruption – economic, social, and perhaps political – and by the utterly unexpected scale of the human losses (the normal annual number of deaths in New Zealand is around 0.8 per cent of the population), perhaps in a way they don’t seem to have been in 1918 (coming off far greater death, destruction, and dislocation in the war). But borders would open, commercial premises operating, people free to come and go within countries as they like with no unusual fear etc etc. Health systems – potentially grossly overloaded during the crisis scenario – would be back to more or less normal either. In other words, most of the effects are temporary.
Readers will know that there are debates, with real world consequences, about the nature of the costs and losses associated with financial crises, and debates about whether most of the effects are temporary or more permanent. I can’t see how the overwhelming bulk of the economic effects of a even a very severe pandemic would be other than temporary. The pandemic won’t have been endogenous to our economic system (so it won’t tell us much about initial gross misallocation of resources), isn’t likely to affect innovation or incentives to innovate or invest, and isn’t even likely to have much impact on productive human capital (especially if, as at present, deaths are concentrated among the elderly). Perhaps there would be some persistent effect in dampening globalisation (reassessment of risk of cross-border supply chains etc), but the aggregateeconomic effects would take time to cumulate and spot, and be second-order relative to the near-term disruption.
But if we could be pretty confident that a couple of years hence things would be functioning more or less normally again – even if, as globally in 1918, there were several distinct waves of the infection – at the other end of the calendar, things would be characterised by extreme uncertainty. First, even if a scenario of the sort I’m dealing with here comes to pass, none of us it will know it for some considerable time. There would be duelling optimists and pessimists, each with plausible arguments and straws in the wind. And presumably none of us would know where the infection rate would surge next.
That alone is a recipe for economic paralysis: the rational response to extreme uncertainty (often quite well-warranted uncertainty) is to postpone (travel, investment, discretionary spending), delay, stick close to home etc etc (and that without the seemingly irrational responses we see reports of in New Zealand at present, of people avoiding Chinese restaurants). Even if air travel was still possible – it would quickly get much harder, as commercial imperatives (let alone regulatory ones) led to cancellations, and the rational prospect of future cancellations – the number of people willing to travel far or for long will drop away. Travel insurance also becomes a real issue. Who wants even a modest risk of being stuck for weeks, with a potentially life-threatening conditions, in some foreign hospital with doubts about your ability to pay. Nations will be reluctant to host lots of visitors who could fall sick while in your country, who – even with ability to pay, which not all would have – could further overburden a potentially severely stretched health system. As flights get cancelled, air freight is also disrupted.
We are already seeing the extent of social-distancing, cancellation of events etc – mostly not forced by governments – in places that currently have a relatively modest number of cases (Singapore, Hong Kong, and to some extent Japan). Imagine the demonstration effects when – this is a scenario remember – the next country, and one more transparent than China, gets a severe outbreak. And the next, and so on. (Scenario, remember.)
When such an outbreak happen, lets assume that no free country is going to be able or willing to impose such extreme lockdowns as the PRC has done. But you don’t need that level of lockdown for the level of economic activity to be savaged. Lots of people are sick in this scenario, in many cases really quite seriously ill, and typically (it appears) not just for a few days. Those people will need people to care for them (not necessarily medically, but just the comfort we’d all want to offer to a seriously ill family member). And between voluntary and semi-compulsory pressures, not that many people with a sick family member are going to be welcome in the office/workplace for a while. More than a few employees will find hours drying up, or jobs disappearing altogether. Sure, people still need to eat – though who knows how effectively distribution systems hold up – but there is a great deal of expenditure, business and private, that is discretionary (over a horizon of several months). At one extreme – long-term asset sales – for example, the Chinese data show the property market having dried up for now.
(There were estimates last week that regions accounting for more than 50 per cent of Chinese GDP were in lockdown. If those areas are operating at no more than half capacity for a month – stabs in the dark, but they don’t look implausible numbers based on (for example) charts like these – “true” Chinese GDP for this quarter could be 8 per cent lower than otherwise, when reported quarterly GDP growth is about 1.5 per cent.)
Now assume – as the scenario requires – that this isn’t just about one country, but about a steadily increasing number of countries. And start factoring in the serious disruption to supply chains – which we are already seeing in and from China (and recall that a supply chain isn’t much stronger, in effect, than its weakest link) – and there is lot more economic activity at risk, even if all the workers were available and ready to work.
In each and every country, lots of businesses – and more than a few workers – are going to be facing big drops in income. Initially each will like to think it is a matter of a week or two, but already that doesn’t really look like the China experience, and on this scenario, the problem has become worldwide. Plenty of businesses have debt or very very limited cash reserves and so lots of firms will soon be in the hands of their bankers. Responsible banks will want to stick by and support good longstanding clients, but there are limits (collateral values are likely to be falling, markets illiquid, even if temporarily), and banks themselves are likely to be affected by fresh waves of caution and risk aversion. Bank funding might start to become a bit on issue playing on the minds of boards and management.
Financial markets have proved remarkably sanguine about the coronavirus so far. Perhaps that makes sense if you believe the public-facing PRC story, that everything is coming under control before too many more weeks things will be getting back to normal. But that isn’t the scenario I’m working with in this post. In such a scenario, global uncertainty would be huge and uncertainty is the enemy of asset market valuations. Quite probably there would be some real high profile company failures (or big state bailouts) going on – airlines anyone? – short-term earnings estimates would be being savaged, and risk spreads would be widening I doubt any supervisory agency has stress-tested its financial system for a shock of the sort I’m using in this scenario, and even if the event wasn’t severe enough to pose a systemic threat (a) there would be a great deal of uncertainty, including about who had what exposures, and (b) this scenario would come on the back of a global economy with a lot of vulnerabilities, including in financial systems, anyway – the euro area economic performance anyone?
Perhaps the mitigating factor in all this is macro policy? Which is a nice thought, except that so many advanced countries already have official interest rates at zero, or below (few/none have more than a 200 basis point buffer, and in major past downturns – even shortlived ones – 500 basis points has been a not uncommon reaction). No doubt, fiscal policy would swing into action – in fact, you rather hope practical contingency thought is already going on. Even in highly-indebted countries, for a genuinely short-term shock (1-2 years) there is room for some additional spending. Some of it might even be effective – in eg retaining attachment to the labour market (some of the specific subsidies after Christchurch and Kaikoura), but it is hard to be that optimistic about the overall degree of effectiveness. Governments can cut taxes in short order and put more money in individuals’ pocket, but in this scenario risk-aversion, social-distancing etc, suggests that cash constraints won’t be the ones binding individuals. Governments can, of course, purchase real goods and services…..a common last-resort stimulus suggestion, but not one likely to work as well when it is a struggle to keep factories/shops open with staff turning up.
For New Zealand, one mitigant we could probably count on to help would be a lower exchange rate. Historically, global risk events tend to be really rather bad for the NZD (and the AUD). Export volumes and world prices might take a hit – savage in some cases – but what foreign exchange was being earned would generate quite a bit more income.
What about inflation? One sees various stories already about disrupted supply chains putting upward pressure on prices/inflation for manufactured goods. That seems plausible enough in some cases – if, as reports suggest now, there are disruptions to the flow of winter fashions to our stores, there is less likely to be excess stock for sales late in the season, and so on – but my sense is still that a scenario of the scale I’m writing about here is, on balance, a seriously disinflationary one. That is both because commodity prices would be falling – in some cases plummeting – but also because the hit to demand for the fear, uncertainty, delay, distancing, physical disruption, would exceed the disruption to supply (but that needs teasing out with further analysis) and the risks of inflation expectations taking a further downward hit is also real. This is the risk I, and others, have been highlighting for some years – that in the next serious downturn, people will quickly realise that policy capacity is much less than usual and adjust expectations accordingly. If that happened, it would risk severely impeding a return to full employment, even after the virus itself had passed into history.
This is all very speculative – and around a scenario we must all hope never happens. But we need policy agencies – and others, be it academics or other commentators – to be thinking hard about these contingencies, including thinking about what options (and when) make sense to deploy early to minimise, to the extent possible, the human and economic dislocations, which could be very large.
I’m wedded to very few of the arguments here, and would welcome comment/challenge (not about the probability – on which I have no particular view – but on the implications of a deliberately extreme scenario, even if one that more medical experts of warning us we could yet face). It would also be good to have a sense that the New Zealand governments was taking the issue and risk seriously and pro-actively planning. On what we see at present – which perhaps isn’t all there is – it looks like lethargic political leadership, as keen as anything on keeping Beijing not too unhappy, with not much sign that the bureaucracy is much more than reactive either (officials will, no doubt, respond to political incentives).