Some economic dimensions

No one quite knows –  and may never do so –  quite how bad the slump in GDP is during the current four-week partial lockdown.  We don’t have a monthly GDP series (unlike Canada and the UK), our quarterly series comes out with a very long lag (June quarter data should be around in late September) and we can expect greater than usual revisions to that data in the years to come, and (so far at least) there is no sign of Statistics New Zealand doing the sort of flash estimate the French statistical agency published a few weeks ago.     One thing to remember is that to whatever extent consumption is holding up, there is almost certainly large-scale destocking going on.

But whatever the scale of the slump in value-added (GDP) where would it take us back to, in real per capita terms?  Using the Conference Board database (which goes back to 1950) here is GDP per capita for each year as a percentage of last year’s.

old GDP

If GDP for the current month were 64 per cent less than last year’s, we’d be back to real per capita GDP levels in 1950.  60 per cent takes one back to 1957, and a 50 per cent fall to 1970.

If, perchance, you are an optimist, a 40 per cent fall takes us back to 1984 and a 30 per cent fall to 1997 levels.

Now, of course, there are important differences.  First, the fall in GDP during the partial lockdown is for four weeks only, not a full year.  But second, plenty of people (think public servants, farmers etc) aren’t losing any income at all – even if, as in the case of many public servants value-added is likely to be down – while others are facing catastrophic losses.   By contrast, in 1950, 1957, and 1970, there was pretty much full employment in New Zealand.  The third important difference is, of course, the scope for a rebound – the underlying technologies and knowledge that made our society relatively prosperous haven’t suddenly disappeared.

Time and fragmentary data will eventually tell, but I struggle to see how the economy right now can be running at more than 50 per cent of normal.  There are baseline things that haven’t changed:  the imputed rent on owner-occupied housing is the starkest example, but you could think of Police, supermarkets (and their suppliers), farmers, the main news media outlets, and so on.  Others probably aren’t very adversely affected: banks as an example (in terms of GDP contribution), and some online services. But even in the public sector, there will be plenty of areas where real value-added will have dried up –  not much activity for immigration or biosecurity staff at airports, hospitals are much emptier than usual and so on.  Getting paid isn’t the same as producing: in many cases, the real value-added just won’t be there, just income transfers from employers (including government ones) to employees.

Of course, whatever the extent of the loss of output/value-added at present, perhaps that loss will be shortlived and we will soon emerge to some slightly less-restricted scenario.  There was one optimistic columnist last week looking forward to a scenario in which New Zealand had, in effect, “eliminated” the virus and so life could, in time, return to “normal” behind our ocean moat: this was described as an “idyllic scenario”.  In overall economic terms it would be anything but.    Recall the statistic I heard quoted by a government minister at the Epidemic Committee a week or two back: just over 9 per cent of New Zealand jobs stem from overseas tourism.  So there is a tenth of the workforce added to the unemployment numbers, alone enough to still leave us with the highest unemployment rate we’ve had since before World War Two.  And if the virus continues to rage in the rest of the world, even if only lurking in some places, the fear and uncertainty will remain very real. Business and consumer confidence will remain extremely low. Willingness to commit to long-term contracts will be at a very low-ebb, so private investment (20 per cent of GDP) will be very low.  And banks, quite rationally, will be very cautious indeed, watching out for the adverse selection problem –  people keen to borrow in such a climate will, in many cases, not be those banks would sensibly wish to lend to.

Now, sure, there is some scope for substitution. But for those (many) accustomed to sunny winter holidays, Ohope or Whangamata in the July holidays just isn’t going to be a serious substitute.    And there are going to be compounding supply chain problems –  not just for local producers, but for local consumers, as not only foreign production of many items is disrupted, but air and sea freight services, and local distribution, just don’t work as they once did.  Even if people are keen to spend –  and many won’t be –  their options are likely to be fewer, even behind the moat.

Of course, direct government demand for goods and services (as distinct from just income transfers) may boost economic activity to some extent.  But (a) realistically, it will take some considerable time for even ambitious schemes to hit the ground in meaningful ways, and (b) as the scale of the gaping fiscal deficits begins to hit home, people (firms and households) are likely to begin adjusting their behaviour, at least to some extent, to allow for the near-inevitable fiscal austerity (higher taxes, cut to some other spending) to come.

At this point, specific numbers are really not much more than a marker of broad orders of magnitude, but even if that Hooton “idyllic scenario” were to be in place by, say, the start of the third quarter, I struggle to see how real GDP is not still perhaps 15 per cent (range perhaps 10-20 per cent) lower than otherwise for the second half of the year.   That would still be by far the deepest recession we’d had since before World War Two.  (And simply on the revenue losses alone –  automatic stabilisers to be sure, but it could take some years to fully recover –  that could add 6-7 percentage points to the fiscal deficit as a share of GDP.)

Finally, I wanted to draw attention to a piece published on Thursday by Bryce Wilkinson of the New Zealand Initiative, under the heading “Quantifying the wellbeing costs of COVID-19”.   I haven’t seen any media coverage of it, which is a shame.  It is a nicely framed and phrased note.  This is from the summary.

In deciding whether to extend the current lockdown, the government must balance the likely benefits of reduced sickness and deaths against the cost of lost national income and jobs. To do so systematically requires an analytical framework that organises the available information.

A preliminary model illustrating how this can be done was published in 2017 by five of New Zealand’s leading epidemiologists and colleagues. This research note does not critique that model. Instead, it uses it to quantify the possible costs of morbidity and mortality due to Covid-19 as a starting point for further analysis and debate.

(Among the co-authors are the newly- prominent Otago academics Michael Baker and Nick Wilson.)

(And before anyone gets upset at the idea of economists wanting to “sacrifice the old”, I hope Bryce won’t mind me pointing out that since his PhD was awarded in 1976, and he got his first degree in 1968, I’m pretty sure he must be over 70 himself now.)

What is the nature of the exercise?

The five New Zealand authors developed the model using parameters drawn from the experience of the 1918 flu epidemic. Some have since made a major contribution to the papers addressing the Covid-19 crisis published by the Ministry of Health in the last fortnight.

Unfortunately, an updated version of the 2017 model does not appear to have been published. Nor do the recently released papers appear to express the potential morbidity and mortality implications of Covid-19 in terms comparable to costs.

This research note takes the 2017 spreadsheet model as given and modifies it only to measure the morbidity and mortality rates indicated for Covid-19 in the papers.

Bryce adds the caveat

It cannot be stressed enough that these results are highly conditional. This report is a contribution to public debate, nothing more. Hopefully, the public sector is building much better models to advise ministers.

I wish I had any confidence that they were.

These are the adjustments/updates done

b) Modifying the model to Covid-19 parameters.
The first necessary adjustment replaced the age distribution of deaths for the 1918 flu epidemic with one that considers that Covid-19 disproportionately kills the elderly.

Values for the age distribution for hospitalisation and deaths were taken from Table A3-2 in a February draft paper for the Ministry of Health.8 With some interpolation, it showed those aged at least 65 years accounted for 35% of estimated 336,000 hospitalisations and 82% of deaths. In its “plan for” scenario, the number of hospitalisations was kept at 336,000 whether deaths were 33,600 or 12,600.

The next step was to align various other parameters with advice from New Zealand’s leading epidemiologists to the Ministry of Health.

Specifically, a draft paper for the Ministry of Health dated 27 February 2020 provided the following guidance about relevant parameters:9
• 65% of the population (3.23 million) stood to be infected if the virus was “substantially uncontrolled;”
• 34% of the population (1.68 million) would be symptomatic.

The total 2014 population in the 2017 model was scaled up until 65% of the 3.23 million were infected which increased the value of a lost QALY was to $52,500 (national disposable income per capita for the latest available year).

With a bottom line as follows

The adapted model indicates spending 6.1% of GDP to save 33,600 deaths, or 3.7% of GDP to save 12,600 lives, is economically justifiable. To spend more begs the question of whether more lives could be saved over time if [as illustrative examples of the sort of prioristisation that routinely goes on in public and private choices] the money went instead to make safer roads and buildings, or perhaps spent on other health services.

There are a number of caveats and uncertainties listed on page 6 of the note.  The first of them is

This presumes spending 6% of GDP would achieve the hoped-for savings. It would not justify spending as much where there is only a modest chance of success.

As I said, I thought it was a nice, short, note highlighting some of the issues and choices; a way of thinking about things which should be influential with policymakers and advisers even if (with all the resources available to them) the specific estimates and assumptions Bryce uses might be usefully refined.

Of course, even if in some sense Bryce’s numbers are “right”, it isn’t entirely clear how much further ahead it leaves us, whether individually as voters/citizens or for the government supposedly making collective decisions on our behalf.   As I’ve noted in various posts here it is really important to think in marginal terms –  eg how many lives are likely to be saved from this particular intervention –  not in the broadbrush.

Almost certainly, (New Zealand) GDP this year will be more than 6 per cent lower than otherwise. But interesting as that number is for some purposes, much of it simply isn’t a matter under the control (or heavy influence) of New Zealand governments.  The world economy –  yes, even China –  is in a very severe slump, and there isn’t anything much we can do about that (although, hobbyhorse issue, sorting out domestic monetary policy would help a little).  There is no global coordinating mechanism.   Travel bookings to New Zealand were slumping well before the government closed the border and imposed quarantine requirements (and if the government re-opened the border tomorrow there still would not be much travel).  Domestically, many people had made choices to, for example, avoid air travel, or avoid large events etc before any restrictions were in place.  The relevant metric for New Zealand policymakers is surely the marginal economic costs of their specific interventions, relative to the marginal number of lives saved as a result only of that same set of interventions.

Recall too that Bryce’s numbers are expressed as a share of annual GDP.  But suppose a series of domestic lockdowns (to a greater or lesser extent) affected economic activity for only a quarter, then even if everything else in the note was accurate, it could be worth sacrificing almost 25 per cent of one quarter’s GDP purely as a result of those lockdowns if by doing so the authorities were highly confident of saving the 33600 lives purely as a result of those lockdowns.  For the economic costs, that order of magnitude might yet be in the right ballpark for the marginal impact of these lockdown measures.  Whether, with a high degree of confidence, that many lives are likely to be saved purely as a result of those specific interventions isn’t something I’m going to opine on.

There aren’t many, perhaps any, clearcut answers to many of these issues (apart from anything else, no one knows the end-game), but that doesn’t make a disciplined framework for trying to help structure thinking and policy advice any less valuable.   One would like to think that The Treasury, the Ministry of Health, and other key agencies are doing exactly this sort of thinking, and scrutinising and robustly debating each wave of results, and each apparent fresh set of insights on the broadly-defined costs and beneftis of each set of interventions being explored.

(And, although this is an economics-focused blog, I hope that when Cabinet is deliberating on choices in the next few weeks it isn’t just the measureable economic dimensions of the costs of interventions they focused, but also some of frankly inhuman restrictions that have been imposed to date, that treat families and civil societies as, in effect, some luxury considerations, able to be set aside at the whim of politicians.)